IAG's Flybe complaint sets stage for Brexit bust-up over state aid and climate

The UK government bailout of Flybe, which has drawn a state aid complaint to the European Commission from rival IAG, comes just as the EU digs in its heels on keeping the UK tied to the bloc's "level playing field" rules in future.

There's now a legal and environmental debate to be had over Air Passenger Duties: While Ryanair claimed yesterday that allowing Flybe to defer payment of the tax breaches EU state aid rules, the UK government will argue that such measures are available for any airline that's in trouble, making them compatible with the law.

More broadly, the case is a worthy prelude to an argument over state aid that's going to heat up during the EU-UK trade negotiations, which will determine the extent of the EU's future powers to vet UK subsidies. It could also draw in environmental considerations, as climate-conscious consumers increasingly shun short-haul flights operated by the likes of Flybe.

The announcement that the UK government had agreed a bailout deal for Flybe — details of which remain unclear — came just hours after the European Commission released a slide deck detailing its intention to keep the UK tied to its state aid rulebook.

The tug of war between market access on the one hand, and regulatory alignment on the other, will be one of the defining issues of the next phase of Brexit talks. The EU is making clear that if the UK wants zero tariffs and zero quotas on goods, then it will need to keep in step with EU rules in the areas of competition, the environment and labor markets.

That's designed to stop the UK from being able to undercut EU businesses by, for example, bailing out failing companies. So it suits Flybe's competitors to point to this week's bailout as exactly the sort of behavior the UK government risks indulging in, absent EU oversight.

Air Passenger Duties

Air Passenger Duties are a tax on passengers collected on behalf of the government. At least part of the bailout package would involve granting Flybe a forbearance on paying the tax for a limited period.

Off the back of this, the UK government has also promised a broader overhaul of duties on domestic flights. But yesterday Ryanair's CEO Michael O'Leary said that, unless the same tax "holiday" is granted to Flybe's rivals immediately, the UK government will be in breach of EU state aid rules.

He has given the government seven days to extend the same exemption to Flybe's UK competitors and reveal the full details of the bailout, or Ryanair will start legal action. Yet in this case, the UK government will argue that allowing the company to put off paying its taxes is different from exempting it from them altogether.

In 2008, the European Commission cracked down on airlines that were allowed a "forbearance" on taxes. At the time, it concluded that Greece's Olympic Air shouldn't have been allowed to defer its debts, including tax liabilities, because it was "loss making and chronically indebted."

"There is no realistic prospect Olympic Airways services ever being in a position to repay these amounts to the State at any stage in the future," the commission said in justifying its decision.

Any assessment of Flybe would likely include a consideration, then, of whether the airline is in a similarly irretrievable situation to Olympic, or whether the bailout can genuinely restore it to health.

And if the government has also extended a direct loan to the troubled airline, it could face a further legal issue. But until the details of the bailout become clear, it's hard for competitors to articulate any specific legal challenge.

Green issues?

The "level playing field" goes beyond state aid, however. It also encompasses environmental policy, so the planned overhaul of the duties might also cause friction with the EU in this area — adding complication to the state aid arguments over Flybe.

As many consumers turn their backs on short-haul flights for environmental reasons, competition officials might take the view that the failure of low-cost, regional airlines is simply the market at work. Other low-cost airlines focused on shorter routes have gone bust in recent years, such as Air Berlin and Flybmi.

Moreover, the airline sector is facing increasing pressure in the EU for its impact on rising global temperatures. According to a commission report leaked earlier this year by environmental group Transport & Environment, the UK's Air Passenger Duty is actually one of the highest among the few EU countries that have such taxes in place, including France and Germany.

But the UK would still be going against the grain by lowering or abolishing the tax, and some may question how it's compatible with a commitment to achieving climate neutrality by 2050.

Among others, Germany will soon increase its air traffic tax on commercial flights while France is set to introduce eco levies on both domestic and intra-EU flights. At the same time, the commission is being pressured to introduce a bloc-wide tax on jet fuel.

And the EU's antitrust regulator is increasingly thinking about whether the environment should play more of a role in its state aid decisions — which might not prompt much political support in Brussels for Ryanair's demands to extend the UK's Flybe concessions to other airlines.

Frustration with the general political direction of travel in the EU is palpable from Ryanair's boss. O'Leary told the Irish Times on his way into a meeting with EU officials last month that more taxes are the "last thing" the airline needs.

Next steps

The commission still has time to decide whether to open a state aid probe into Flybe. Under the Brexit agreement, it will still be able to open it until the end of the transition period, set for December this year.

But even after that period, the Irish Border Protocol — the permanent solution for regulating trade between Northern Ireland and the Republic of Ireland — still gives it options.

That says that the EU's state aid oversight, and the EU court by extension, will still apply to the UK "in respect of measures which affect that trade between Northern Ireland and the Union which is subject to this protocol."

A bailout for Flybe could therefore fall within the very broad scope of this provision, since the airline operates flights out of Northern Ireland to EU destinations. Any EU carrier competing on the same routes might argue that the UK aid has placed them at a disadvantage under the protocol.

Consciously or unconsciously, as the UK prepares to leave the bloc at the end of this month, it has baited EU competition officials to confront it over Flybe.

It's down to Brussels to make the next move in a game that encompasses two of the hottest political potatoes — UK sovereignty and the future of the environment.