Introduction
(Harmful) tax competition is well-regarded as a topic which warrants particular attention in the international tax landscape, and particularly within the European Union (“EU”). The state aid control of Articles 107 and 108 of the Treaty of Functioning of the European Union (“TFEU”) has been key in this respect, to ensure a level playing field in accessing and operating within the internal market, though revealing insufficient to curb distortive foreign subsidies given its intra-EU scope of application. The same holds true for current EU trade defence mechanisms, which, being generally limited to the importation of goods within the EU, do not capture subsidised investments, nor foreign subsidies taking the form of financial flows or services.
Against this backdrop, the Foreign Subsidies Regulation[1] (“FSR”) has been put forward as a tool with the potential to neutralise distortions in the internal market caused by foreign subsidies, that fall outside the reach of the previously mentioned instruments[2]. It also finds its grounds on the need to preserve EU’s open strategic autonomy, namely by safeguarding key economic sectors from “undesirable” concentration operations, which may potentially lead to changes of control or takeover of strategic assets/undertakings which are considered to be crucial[3]. Nonetheless, the FSR gives rise to several challenges, particularly in the tax domain, that may at first sight pass unnoticed.
The FSR in short
Under Article 3(1) and Recital 11 FSR, a foreign subsidy shall be deemed to exist if a given non-EU country provides, either directly or indirectly, a financial contribution which confers a benefit to a given undertaking, which is engaged in an economic activity within the EU, the benefit being, in law or in fact, limited to one or more industries or undertakings. Before (qualifying) foreign subsidies, the EU Commission is now vested with a two-prone investigation power, the so-called ex officio investigation procedure (Article 9 FSR):
- Firstly, it may conduct a preliminary review, pursuant to which it will request and collect information to assess whether there is a foreign financial contribution meeting the criteria proscribed in Article 3(1) FSR, and which has a potentially distortive effect in the internal market[4], as defined in Article 4 FSR (Article 10 FSR); and
- In case sufficient grounds have been found on the existence of a distortive foreign subsidy, the EU Commission may conduct an in-depth investigation to conclude on whether the financial contribution under scrutiny requires neutralisation (Article 11 FSR).
Once the presence of a foreign subsidy which distorts the internal market has been established, the EU Commission is empowered to apply redressive measures aimed at correcting their disruptive effect (which should abide with proportionality standards – Article 7(3) FSR). The set of measures part of the EU Commission’s arsenal is quite vast in this respect, ranging from temporary restrictions on the carrying out of the undertaking’s commercial activity, to the repayment of the foreign subsidy (Article 7(4) FSR). Interim redressive measures are also possible, pending an ex officio investigation, should there be a risk of irreparable damage to competition on the internal market (Article 12 FSR).
A fundamental difference with the state aid procedure may in this respect already be drawn, in the sense that the addressee of the redressive measure is the undertaking under investigation, and not a State.
The ex officio review, functioning as a broad market investigation procedure for examining activities with an economic link to the EU which are subsidised by foreign countries, is further complemented with an ex ante clearance tool for large-scale mergers and bids in public procurement procedures[5] – the concentration and public procurement control procedures.
Broadly, concentration operations targeted by the FSR concern changes of control on a long-standing basis stemming from the mergers, direct or indirect acquisitions, as well as the creation of a joint venture functioning as an autonomous economic entity on a lasting basis (Article 20(1) and (2) FSR). Conversely to foreign subsidies generally covered by the ex officio review, foreign subsidies granted in qualifying concentration operations may trigger a notification obligation (which needs to be respected before the merger, acquisition or join venture is implemented, with some exceptions – Article 24 FSR), without the need to first assess whether such operation is selective in nature. This should be the case when one of the undertakings involved has an aggregate turnover in the EU of at least EUR 500 million, and the involved entities were awarded a financial contribution (from a foreign State) of more than EUR 50 million in the three years preceding the conclusion of the agreement, announcement of the public bid or the acquisition of the qualifying controlling interest (Articles 20(3), 22 and 23 FSR). If the undertaking decides to nonetheless implement the concentration operation, without complying with the notification obligation, fines up to 10% of its aggregate turnover in the preceding financial year may be levied (Article 26(1) and (3) FSR).
Similarly, notification obligations may be imposed in qualifying public procurement procedures, i.e., those whose value of the underlying contract/framework agreement amounts at least to EUR 250 million (excluding VAT), and in which the economic operator received foreign financial contributions of at last EUR 4 million per non-EU country in the three preceding years, once again without the need to first establish the existence of a selective benefit (Articles 28 and 29 FSR). As for the qualifying concentration operations, fines may also be levied in case of non-abidance with the notification obligation (Article 33 FSR).
The FSR in the tax domain – the definition of financing contribution
The FSR’s scope is quite far-reaching, and can potentially cover several tax related foreign subsidies. The definition of financial contribution might encompass inter alia fiscal incentives, the granting of tax credits, as well as the relief from tax debts (cfr. Article 3(2)(b) FSR), awarded through, for example, tax exemptions and/or tax debt forgiveness[6]. The financial contribution should be considered to be granted as from the moment that the undertaking is entitled to receive it, not being necessary to have an actual disbursement for the FSR to apply (Recital 15 FSR). Ought to be stressed though that financial contributions which are granted to finance a non-economic activity of the undertaking should not qualify as a foreign subsidy, as long as they are (also) not used to cross-subsidise the undertaking’s economic activities (Recital 16 FSR).
The financial contribution should also confer a benefit to the undertaking under potential investigation. Indeed, Recital 13, as well as Article 3(1) of the FSR, seem to suggest, upon first reading, that the existence of a benefit and of a financial contribution constitute two separate requirements. It does seem though that, in tax matters, these conditions come hand-in-hand. Arguably, all tax related foreign subsidies directly impact the beneficiary’s financial position, by reducing its tax burden, thus automatically fulfilling the benefit requirement.
It is also important to note that the financial contribution can be granted directly or indirectly (Article 3(1) FSR). In this respect, whilst there may be instances where the tracing of the foreign tax subsidy by the EU Commission is rather straightforward, this might not always be the case. Indeed, what to think of special equity financing tax measures applied to a foreign parent company injecting equity in an EU subsidiary? In these cases, the direct recipient of the subsidy is actually the foreign parent entity, and not the undertaking conducting an economic activity in the EU. Nevertheless, the tax advantage provided by an equity deduction allowance in the foreign jurisdiction is indirectly repercussed into the EU undertaking, as capital/equity injections become more easily accessible. In these situations, it may be rather difficult for the EU Commission to prove the existence of a (beneficial) financial contribution, particularly if there is no formal obligation in the multinational group to pass on the tax advantage[7].
Interaction with Double Tax Treaties (“DTTs”)
The FSR’s broad scope might also cast a problem of compatibility with DTTs. Indeed, and as mentioned beforehand, before a distortive foreign subsidy, the EU Commission is entitled to apply redressive measures, such as the repayment of the foreign subsidy (Article 7(4)(h) FSR). To the extent that the subsidy has been awarded by a third country which is not bound by the TFEU, the repayment obligation will be addressed to the undertaking carrying out an economic activity in the EU. However, it may be the case that, under an applicable DTT concluded between the foreign jurisdiction awarding the (tax) benefit and the residence jurisdiction of the EU undertaking, the exclusive right to tax is allocated to the former jurisdiction. Upon enforcement of the redressive measure though, the recovery of the tax benefit will not flow to the foreign jurisdiction which had the sole prerogative to tax. Foreign countries may thus end up requesting the EU Commission to hand over the tax advantage which ended up being repaid arguably in direct violation of an existing DTT[8].
It may nonetheless be argued that this compatibility issue is misplaced. Indeed, whilst there should be no doubt that DTTs would generally apply in these situations, the amount repaid to the EU Commission as a result of a redressive measure under Article 7(4)(h) FSR should not be automatically equated to a “covered tax” for the purposes of the DTT concerned. Upon closer inspection, the recovered sum might rather have the nature of a compensatory payment/penalty of the same value of the tax benefit awarded by the foreign country.
Broadly, a “covered tax” should correspond to a tax on income and capital, as defined in Article 2(2) of the OECD Model Tax Convention on Income and Capital(“OECD-MC”)[9], levied on behalf of a Contracting State or its political subdivisions/local authorities (Article 2(1) OECD-MC). Albeit not being settled in tax literature if the definition of “tax”, for these purposes, should be an autonomous one, or constructed through reference to domestic law, it is generally accepted that taxes are compulsory, unrequited monetary payments to government units. The Article 7(4)(h) FSR charge does seem to qualify as a mandatory unrequired monetary payment, despite failing the governmental units recipient criterion. This could obviously point out to its qualification as a penalty, but, even if so, the problematic would still not be settled, given that penalties may be potentially equated to taxes when they are directly connected to the existence of a tax liability[10]. Indeed, the definition of “tax” (that is, the third country’s tax on income, whose charge had been, to some extent, forfeited by virtue of the application of the tax subsidy) could be potentially extended to the redressive charge, whose existence, levy and amount directly hinge on the foreign tax subsidy. However, considering that DTTs usually do not provide explicit clarification as to when and whether a penalty should be directly connected to a tax liability, the solution could end up having to be found in applicable domestic laws, which could be undesirable given the divergent countries’ practices in this regard.
Notwithstanding the above, it could be argued that, in a FSR context, the redressive measure is not levied on behalf of one of the Contracting States, but rather on behalf of the EU Commission/EU generally speaking. Consequently, even if the nature of the charge could be assimilated to a tax on income/capital, the requirements of Article 2(1) OECD-MC would not be fulfilled, as taxes imposed on behalf of supranational organizations should not qualify for DTT protection[11]. Further, qualifying the redressive measure as a tax could also come at odds with the fact that the power to levy taxes should be reserved to EU Member States.
The same logic could be applied to the interest component compounded on the repaid sum of Article 7(4)(h) FSR, in accordance with the method set out in the Commission Regulation (EC) No 794/2004. Not only do most States not consider interest on taxes as falling within the scope of Article 2 OECD-MC[12], but it also seems adequate that the interest qualification would follow that of the redressive measure.
Essentially, the non-qualification of the Article 7(4)(h) FSR charge as a covered tax could potentially solve (at least some of the) questions raised on the compatibility of DTTs and the FSR, albeit closing the door for third countries to resort to some of the mechanisms governed in DTTs to resolve potential disputes/claim back the repaid redressive charge (such as, for example, the mutual agreement procedure of Article 25 OECD-MC). Key takeaway is that this discussion warrants more attention.
Assessing the existence of a benefit – comparative benchmarks and selectivity
On top of the potential (in)compatibility with DTTs, the FSR also creates some friction with other important legal instruments, such as the state aid mechanism. Though sometimes presented together with state aid as the two sides of the same coin, the parameters used, in a FSR context, to assess whether a selective benefit was granted may to some extent collide with those currently used in state aid procedures.
It stems from Article 3(1) that the awarded financial contribution, for the purposes of the FSR, should necessarily confer a benefit. Recital 13 of the FSR adds some colour to what exactly should be understood as a “benefit”, in clarifying that a “financial contribution should be considered to confer a benefit on an undertaking if it could not have been obtained under normal market conditions”. It further prescribes that pinpointing a benefit should be made through the resort to “comparative benchmarks”, such as the investment practice of private investors, a comparable tax treatment, financing rates obtainable on the market or the adequate remuneration for a specific service or good. Absent of available directly comparative benchmarks, adjustments to the existing benchmarks could be undertaken or alternative benchmarks found, based on “generally accepted assessment methods”.
As already pointed out by some tax literature[13] though, whilst the use of alternative benchmarks may be suitable for financing rates and investment practices, it is rather unlikely that “generally accepted assessment methods” can be similarly applied in the tax domain, within the context of the FSR. Taking investment practices as an example, in principle the market economy operator principle (“MEOP”)[14], upheld by the Court of Justice of the European Union (“CJEU”) in state aid procedures, can be of aid. Indeed, to ascertain whether a given (public) investment confers an undue benefit, it may be examined, under the MEOP, if the Member State investing in a given undertaking acts in an economically rational way and if, in similar circumstances, a private investor of comparable size would have done the same investment. Now, and even though the CJEU in EDF (case C-124/10) has recognised that the MEOP may apply when the Member State acts in its capacity of shareholder of the undertaking regardless of the fact that the benefit was awarded through powers that only belonged to States (such as tax exemptions), in a FSR context the advantage is granted by a foreign country, thus being questionable whether the MEOP/generally accepted standards methods could serve as an “alternative” to non-existent tax avoidance measures that could have cancelled out the unintended (tax) advantage resulting from such foreign (tax) subsidy[15].
Putting it differently, the CJEU clarified in FIAT (joined cases C-885/19P and C-898/19P)that only the national law of the concerned Member State should be used as the reference system for direct tax purposes, being the basis for ascertaining if there is or nor an advantage, which is selective in nature[16]. In the FSR though, the advantage stems from a foreign country, the question thus boiling down as to (i) how should the benchmarking reference system be delineated and (ii) whether the Commission will end up with greater leeway than the one allowed by the CJEU in FIAT to determine whether a benefit exists, within the meaning of Art. 3(1) and Recital 13 FSR. This can be illustrated by situations falling within the scope of transfer pricing adjustments. Indeed, in case of a non-arm’s length remuneration for a given good/service (e.g., price below market conditions), aside from the non-tax benefit of reduced lower costs for the EU undertaking purchasing such good/service, a tax benefit may also crystallise in the foreign jurisdiction – a lower tax charge, if an arm’s length principle is part of that foreign jurisdiction’s domestic law which ends up not being (duly) applied[17]. Further guidance would be desirable in this respect on whether and how such tax benefit would have to be factored by the EU Commission, and in light of which reference (comparability) system (the foreign arm’s length rules or the rules arm’s length rules of the Member State where the EU undertaking operates?).
The contrast between the FSR and state aid becomes even more evident in qualifying concentration and public procurement procedure. Whilst selectivity is key in assessing whether there is unlawful state aid, this criterion is completely set aside when it comes to the notification obligation imposed in Articles 20(3) and 28(1) FSR. Even if one was to take the view that the concept of “financial contribution” should intrinsically include a benefit element, it could be questioned whether, from a proportionality standpoint, it is logical to impose a notification obligation for tax advantages which are attributed to all economic operators as a result of general provisions.
Notification obligation – disproportionate burden?
Not only may the notification obligation be trigger in (arguably) unintended situations, but its content may also be disproportionally burdensome for the taxpayer.
Indeed, the Draft Implementing Regulation on FSR, on Section 5 of Annex I and Section 3 to Annex II, requires the undertaking operating within the EU to describe each tax subsidy that can qualify as a foreign financial contribution, its rationale and objectives, conditions of application and why it could have a distortive effect. It further obliges the taxpayer to hand in all supporting documentation related to the financial contribution under scrutiny in the three years preceding the notification, and related analyses, reports, studies, surveys and alike from the entity awarding the foreign tax subsidy and the recipient (Section 6 of Annex II to the Draft Implementing Regulation on FSR).
The list of (mandatory) documentation and information to be provided seems too vast, and is likely to materialise in a near impossibility to provide a complete notification in a timely manner. This can prove to be particularly challenging in qualifying M&A operations (whose implementation would be barred until the notification obligation is duly fulfilled). The excessive burden also seems to be particularly difficult to be compatibilized with the fact that there may be notifiable operations for which the existence of a benefit is not a prerequisite.
Conclusion
The FSR gives rise to several challenges in the tax domain, which warrant particular attention. The definition of financial contribution can potentially capture several foreign tax incentives, whose identification and proof may, in some instances, be particularly challenging for the EU Commission. Questions about the interplay and its compatibility with DTTs may also come to surface once specific redressive measures are applied by the EU Commission. The FSR may also come at odds with existing comparative benchmarking standards used to assess whether a selective benefit has been conferred, whilst completely ruling out the necessity of introducing a selectiveness criterion when it comes to notification obligations within the context of qualifying contraction operations and public procurement procedures. Lastly, questions about the proportionality of the notification obligation (and related content) may also be put forward, as arguably the need to safeguard the internal market from foreign tax subsidies may not yet be adequately calibrated with the excessive burden imposed on taxpayers.
Vasco Chuaqui
November 2023
[1] Regulation (EU) 2022/2560 of the European Parliament and of the Council of 14 December 2022 on foreign subsidies distorting the internal market.
[2] Cfr. Recitals 5 and 6 of the FSR, as well as Art. 1(1) of the FSR.
[3] Cfr. Recitals 2, 4 and 7 of the FSR.
[4] Article 5 FSR provides, in this respect, a list of categories of foreign subsidies which are most likely to distort the internal market.
[5] A Critical Analysis of the EU’s Eclectic Foreign Subsidies Regulation: Can the Level Playing Field Be Achieved?, Xueji Su.
[6] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure, Raymond Luja.
[7] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure.
[8] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure, Raymond Luja.
[9] Under Article 2(2) OECD-MC, taxes on income and on capital should be “all taxes imposed on total income, on total capital, or on elements of income or of capital, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation”. Please note that reference has been made to the OECD-MC, though of course the concept of “covered tax” varies across DTTs. The nuances across DTTs should also be considered in this respect.
[10] Cfr. para. 27 Commentary to Article 2 OECD-MC, Roland Ismer / Alexander Blank, in Klaus Vogel on Double Taxation Conventions, 5th Edition, Volume I.
[11] Cfr. para. 16 Commentary to Article 2 OECD-MC, Roland Ismer / Alexander Blank, in Klaus Vogel on Double Taxation Conventions, 5th Edition, Volume I.
[12] Cfr. para. 4 OECD Commentaries to Article 2 OECD-MC.
[13] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure, Raymond Luja.
[14] Albeit nonetheless with some limits – please refer, for e.g., to the ING Group (C-224/12P), Land Burgenland (joined cases C-214, P, C-215/12 P and C-223/12 P), etc.
[15] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure, Raymond Luja.
[16] Para. 75 joined cases C-885/19P and C-898/19P.
[17] The Foreign Subsidies Regulation: The Challenge of Notifying Non-Selective Tax Expenditure, Raymond Luja.