McDonald’s probe tests EU competition department's power over tax treaties

15 January 2018 10:35am
EU Flags In Wind

11 January 2018. By Matthew Newman.

More than two years after starting an in-depth probe into Luxembourg’s sweetheart tax break for McDonald’s, the European Commission has so far only succeeded in digging up controversy.

In November, antitrust chief Margrethe Vestager admitted at a European Parliament hearing that what initially looked like an “easy” case had turned out to be “much more complicated,” and her department had to “figure out what our legal basis is.” The investigation has raised important questions about the legal oversight of double-taxation treaties.

For critics of the long-running probe, Vestager’s acknowledgment that there’s a problem with its legal basis doesn’t come as a surprise. An EU state-aid investigation that interrogates a bilateral tax treaty between Luxembourg and the US is overreaching, they argue. A commission spokesperson declined to elaborate on Vestager’s comments.

These critics acknowledge that pursuing countries such as Luxembourg, the Netherlands, Belgium and Ireland for allowing multinationals to avoid tax is a valid EU policy objective. But tackling tax avoidance should be done through legislative changes or international negotiations, not through state-aid enforcement, they say.

The probe looks into allegations that McDonald’s has ended up avoiding tax in both the US and Luxembourg since 2009. This was down to two comfort letters from Luxembourg to the restaurant chain that allowed McDonald’s profits to be exempt from tax there, even though those profits were also exempt in the US.

The probe focuses on the 1996 Luxembourg-US Double Taxation Treaty. Commission officials have been trying to determine if the conditions that made McDonald’s exempt in Luxembourg were a “selective advantage” over other economic operators in the country.

Probe procedure

In state-aid cases involving tax, the commission goes through a three-step process to determine if there’s been illegal aid.

First, the commission identifies a “‘reference system” that will be used to compare the tax rulings for McDonald’s. In this case, it’s Luxembourg’s general corporate income-tax system.

Secondly, the watchdog determines whether the tax measures deviate from this reference system in light of the objectives pursued by that system.

Finally, the commission analyses whether the measures can be justified by the nature and the general scheme of the reference system.

Following this three-step test, the commission must determine if Luxembourg has granted McDonald’s more favorable treatment than other companies in the same “factual and legal” situation.

If it finds that Luxembourg gave the US multinational a “selective advantage” over its rivals, it would force the government to claw back millions of euros in unpaid tax.

Legal analysis

But this is where the commission may be running into problems. The analysis involves digging into Luxembourgish tax law and determining whether tax authorities have correctly interpreted the treaty with the US.

Critics have said that determining if there’s been a “derogation” from Luxembourg’s normal tax policy means that the commission is taking a stance on a grey area in the treaty regarding when Luxembourg may exempt a company from tax.

The treaty says that Luxembourg may exempt a resident company from tax when it “derives income … which … may be taxed in the US.” McDonald’s argues that its US Franchise Branch indeed “may be taxed in the US,” and is therefore eligible for the Luxembourgish exemption — even though, in actuality, it isn’t taxed in the US.

The commission, by contrast, says the “may be taxed” clause implies that income should be effectively taxed in the US to be eligible for exemption in Luxembourg. The beginning of the same clause specifies that its purpose is that “double taxation shall be eliminated.” Since that branch of McDonalds doesn’t pay tax in the US, the double taxation issue isn’t relevant.

Therefore, Luxembourg’s decision to grant a tax exemption conferred a “selective advantage” to McDonald’s, because the authorities were aware that branch of the company wasn’t paying tax in the US either, the commission said in its decision to open an in-depth probe.

But critics argue that the commission’s analysis on selectivity — a key component in state-aid cases — falls flat. That’s because, if Luxembourg always interprets the bilateral treaty the same way, McDonald’s is treated the same as any other company and there’s no selective advantage and thus no state aid.

In other words, Luxembourg may well be giving McDonald’s a sweetheart tax deal. But it’s only a matter for the EU competition authorities if they can prove it wouldn’t do the same for other US companies. If not, it’s a domestic political question for Luxembourg.

EU competence

Under EU rules, the commission has no powers to legislate on tax, but it does have the authority to investigate whether national tax administrations issue rulings that infringe the bloc’s state-aid rules. The commission has argued that EU rules take precedence over national legislation, including international treaties that have been integrated into national laws.

In the McDonald’s case, the watchdog says that Luxembourg’s reading of the bilateral treaty isn’t faithful to the treaty “objective” — making sure income streams are taxed once and only once.

Strictly speaking, though, the treaty doesn’t say it’s trying to prevent double non-taxation. It deals only with double taxation.

So, critics would argue, the commission is encroaching on a member state’s sovereign right to determine its tax rules. If there’s a problem with double non-taxation in Luxembourg’s rules, that should be addressed through a legislative change by the country’s lawmakers, not EU state-aid rules.

It’s an open question whether these misgivings about the EU’s competence over bilateral treaties will be enough to convince Vestager to keep the McDonald’s probe permanently on the back burner.