There are known cases in which companies transfer profits abroad via transfer prices in order to reduce the tax burden. The Member States of the European Union then regularly impose the arm's length principle in order to retain a tax base in their country. Since 2012/2013, however, the EU Commission has been systematically investigating so-called “Tax Rulings” with regard to their state aid compliance. Tax rulings are tax rulings on transfer pricing issued by Member States’ tax authorities. In this context, the Commission examines whether these do not comply with the arm's length principle and therefore constitute unlawful aid. In their judgments, the EU courts lay down very specific requirements for the assessment of the conformity of transfer prices with Union law. In this article, we explain the requirements.

1st problem: transfer prices as unlawful aid

1.1. Tax Rulings as a starting point

Since 2012/2013, the problem arises as to whether the State approval of transfer pricing constitutes unlawful aid. Since then, the EU Commission has systematically checked so-called “Tax Rulings” for their compliance with the aid. Tax rulings are tax rulings on transfer pricing.

Tax rulings are intended to provide companies with legal certainty and planning security and are completely legal. In particular, they are important with regard to transfer pricing behaviour. This is because transfer pricing is the basis for a company’s tax burden in a particular tax jurisdiction. However, the problem is that tax rulings also have the potential to distort competition. On the one hand, Member States can use such information tools in international location competition to attract investment. On the other hand, such information can also be used to grant certain companies tax advantages over other companies. In particular, in the light of the last consideration, tax rulings may indisputably involve State aid.

1.2. Relevance especially for large companies

Member States regularly grant the possibility to transfer profits to low-taxed countries via such tax rulings. This reduces the overall tax burden of the company. These practices have gained importance because large companies are affected. For example, Member States – such as Ireland in the case of Apple – want to incentivise large companies to stay in the country in order to preserve jobs, for example. As a result, Ireland also opposed the Commission’s decision to classify the rulings as unlawful aid. According to the Commission, Apple owes Ireland approximately EUR 13 billion in tax back payments.

In assessing whether these rulings constitute unlawful aid, the main question is whether the Member States concerned have accepted transfer prices that are not in line with the arm's length principle in the context of rulings. They then grant the undertaking concerned advantages which other undertakings are not entitled to.

1.3. the arm's length principle as an object of State aid control

The arm's length principle has taken on a new significance in transfer pricing law. So far it has played a different role. In this respect, the Commission considers that the arm's-length principle does not apply to the tax base of a Member State.

Now, however, the Commission is pursuing the arm's length principle. In doing so, it seeks to counter the practices of the Member States in which they allow an unjustified reduction in the tax base of the respective companies.

1.4. Unauthorised aid possible despite tax sovereignty

It does not exceed the competence of the EU Commission if it also subjects tax rulings to state aid control. This is not prevented by the fiscal sovereignty of the Member States. Member States are also bound by Union law in the non-harmonised area of tax law. The Commission does not pursue disguised harmonisation in this respect either. It shall carry out the State aid control incumbent on it. In doing so, it aims to clarify the tension between the protection of undistorted competition and tax sovereignty or the economic governance objectives of the Member States.

1.5. No exclusion of withdrawal due to planning security

Against the background that tax rulings should provide legal certainty and planning security, it is particularly unfortunate if these are objected to and revoked afterwards. Then there can be immense tax back payments. According to the General Court, however, the principle of legal certainty does not preclude recovery. Member States must also respect Union law in the non-harmonised area of tax law. Therefore, it is likely that the Commission will examine individual tax rulings.

2. Unauthorised aid Legal disputes

2.1 Scope of examination of European courts

The determination of transfer prices has a strong economic character and the transfer pricing practice is quite complex. Therefore, it would have been conceivable that the Commission would have a significant margin of appreciation for the assessment of transfer prices. However, the CFI judgments showed that the General Court carried out a detailed examination. The Commission is therefore under full judicial control.

2.2. Other assessment of the unlawful aid

The EU Commission did not complain about a large part of the tax rulings. In some cases, however, it accepted unlawful aid. The review of the legality of this assessment is now carried out by the Union courts. The Court of First Instance only confirmed the Commission’s view in one case in the context of an action for annulment. This case concerned Luxembourg and the Fiat/Chrysler Group. However, this judgment was overturned by the ECJ in the meantime by decision of 08.11.2022.

In the other cases, the CFI did not accept any unlawful aid. The reason for this is that the Commission failed to demonstrate the existence of an advantage within the meaning of Article 107(1) TFEU. We explain the strict requirements imposed by the European courts on whether the approval of transfer pricing may constitute unlawful aid.

3. Conditions of unlawful aid

3.1. Unauthorised aid: Relevance in tax law

Article 107(1) TFEU prohibits State aid affecting trade between EU Member States. Tax laws or individual tax measures can also constitute unlawful aid if this means that a homogeneous group of undertakings (or an individual undertaking) has to pay less tax than should actually be the reference system under the generally applicable tax rules of the respective Member State.

3.2. Three-stage construction

In tax law, the focus of the assessment of the aid is on whether a selective advantage has been granted. There is an advantage here if a company is made better financially than other companies. The selectivity criterion then serves to determine whether a tax measure in the context of the tax system is likely to favour certain undertakings or the production of certain goods over other undertakings.

The European courts generally carry out the examination in three stages.