This is the fifth Op-Ed of a Symposium on the Apple State Aid case (C‑465/20 P). Previous Op-Eds have been authored by Romero J. S. Tavares , Scott Wilkie, Svitlana Buriak and Juan Jorge Piernas López.
Introduction
That’s all folks! The UK Controlled Foreign Company (‘CFC’) judgment (C‑555/22 P, C‑556/22 P and C‑564/22 P), handed down by the Court of Justice on 19 September 2024, was the final it would hand down concerning the UK. This Op-ed examines the case and highlights the contrast between the reasoning in this judgment and that of the Court of Justice, the previous week, in Apple ( C-465/20 P).
General Background
When triggered, the CFC rules attribute (all or some portion of) the overseas profits of a Subsidiary (the ‘CFC’) to a controlling Parent in the Parent’s home jurisdiction, for our purposes the UK. CFC rules, in principle, run counter to the territoriality principle, which broadly constrains a country’s taxing power to the activities that take place within its borders. As a result, they tend to be narrowly targeted at activities where the risk of profits being artificially shifted is high. In the absence of CFC rules, there are two very easy ways in which a Parent could shift profits to a low tax jurisdiction. The Parent could provide funds to a low taxed Subsidiary which it would then lend back to the Parent (known as an ‘upstream loan’). The interest payable to the CFC would be deducted from the Parent’s taxable profits. Or, rather than the Parent depositing those funds in a bank itself and paying tax on any interest accrued, the Parent could provide them to the Subsidiary which in turn would deposit them in a bank and generate interest (known as a ‘moneybox loan’).
The UK has had CFC rules since 1984 following an apparent increase in the use of tax haven companies after the removal of exchange controls in 1979. There have been multiple changes to the rules since. Most notably, the rules were amended in response to the Cadbury Schweppes (C-196/04) case, where it was found that the UK regime was not compatible with EU law insofar as it targeted more than just ‘wholly artificial arrangements’.
The relevant UK CFC rules
The rules were changed in 2012, with effect from January 2013 and amended again from January 2019. It was the 2012 iteration of the rules that the Commission took issue with, in particular the rules around non-trading finance profits (‘NTFP’). Putting it at its simplest, NTFP are profits which arise from the provision of loans, hence ‘finance profits’, but the entity which provides the loans is not functionally equivalent to a bank and instead might act more like an investor, hence ‘non-trading’. Specifically, the Commission argued that the rules imposing a CFC charge on the NTFP of a CFC (found in Chapter 5 of 2010–Taxation [International and Other Provisions] Act, ‘TIOPA’) breached Article 107(1) in so far as there was an exemption (partial or full, and to be found in Chapter 9 of TIOPA 2010) to the charge in cases where these profits arise from a qualifying loan (‘QL’) relationship, namely where loans are made to other non-UK subsidiaries.
The Chapter 5 charge applied in 2 scenarios: where the profits were attributable to (1) significant people functions (‘SPFs’) carried out in the UK or (2) UK funds. As for scenario (1), analysing whether SPFs are present, and if so where, is a form of transfer pricing analysis, which is complicated and time-consuming. As for scenario (2) meanwhile, tracing whether fungible capital within a multinational group comes from the UK is also a cumbersome exercise. As such, Chapter 5 triggers serious administrative inconvenience both for the tax authority and the taxpayer concerned. That administrative inconvenience is spared by the Chapter 9 exemption.
According to the UK (and other interested parties in the litigation), Chapter 9 provided the exemption because there was a low risk of profits being artificially diverted where the CFC provides QLs. The exemption did not apply, conversely, to instances where the risk of abuse was high, such as in the case of upstream or moneybox loans. Limiting the scope of the CFC rules to those high-risk circumstances also accorded with the Cadbury Schweppes judgment insofar as they only targeted wholly artificial arrangements.
The Commission decision
In matters of tax, it is the ‘selective advantage’ criterion which is essentially determinative as to whether Article 107(1) TFEU is breached (AG Kokott opinion in Case C-66/14, para 114). The Commission’s selective advantage assessment, with which the General Court agreed (Cases T-363/19 and T-456/19), was as follows:
- the reference framework was the UK CFC rules;
- there was an advantage insofar as NTFP were exempted for CFCs with QL relationships;
- this advantage was a priori selective as it applied to UK parented groups with a CFC making QLs, but not in comparable circumstances as with upstream or moneybox loans;
- as for justification, the Commission agreed that in instances where the NTFP of the CFC arise from UK funded loans but where the CFC has no UK SPF, it would be excessively cumbersome to require a tracing exercise (scenario (2) above). But this would not be the case where the NTFP of the CFC arise from UK SPFs (scenario (1). Such SPF analysis would also have ensured that only wholly artificial arrangements (à la Cadbury Schweppes) were combatted.
The UK was ordered accordingly, in April 2019, to collect unpaid back taxes, which may have been over £1billion (though the author understands that a far lower figure was in fact due).
The Court of Justice
The UK (and interested parties) appealed to the Court of Justice, with the determination of the reference framework being key to the appeal. In line with the Advocate General’s opinion, the Court of Justice agreed with the UK’s analysis that the reference framework ought to have been the General Corporation Tax System (‘GCTS’) and the failure to apply the correct reference framework vitiated the entire analysis. The GCTS is largely territorial and the CFC rules provided an exception to the principle of territoriality only where there was a high risk of profits being artificially diverted from the UK; profits which would, but for the artificial diversion, ordinarily be taxable in the UK. As such, the logic of the CFC and GCTS rules was the same and they were inseparable (paras. 107-108). The risk-based approach to the legislation mandated that Chapter 9 should not be seen as an exemption to Chapter 5. Instead, the two should be read together as defining the scope of the charge (para. 112). In other words, the risk of artificial diversion of profits was high not where Chapter 5 applies per se, but instead only where Chapter 9 does not apply and Chapter 5 conditions are present.
In arriving at this conclusion, the Court of Justice faithfully applied the approach handed down by the Court last year in Engie (C‑451/21 P and C‑454/21 P). In determining the reference framework, the Commission should defer to the Member State’s interpretation of its rules, provided that it is compatible with the wording of the legislation and the Commission cannot point to consistent and reliable evidence to the contrary from case law or administrative practice. Given that the Commission could not point to such contrary evidence, the Court’s analysis hinged on the compatibility of the UK interpretation with the legislative wording, which the Court found not to be incompatible (see paras. 113-127).
Reconciling Apple?
The judgment, handed down just over a week after the Court’s controversial findings in the €13billion Apple case (C-465/20 P), jars in its use of the deferential Engie approach. Whereas in UK CFC , the Court of Justice applied Engie to the tee, in Apple, the Court of Justice very much did not. In Apple. there was a dispute about how to interpret Irish law, specifically Taxes Consolidation Act (TCA) 1997, s. 25, which taxes non-resident companies on their Irish trading profits. Was the Irish interpretation compatible with the wording of the legislation? Well, given that the legislation at the time was quite vague, it is very difficult to say the interpretation was incompatible. In that case, the Commission should have accepted the Irish interpretation unless it had evidence to the contrary. But the case law is best read as aligning with the Irish interpretation (see my discussion of Murphy v Dataproducts [1988] IR 10 in Intertax) and the Commission itself had accepted that Ireland did not have a consistent administrative practice as regards how to approach TCA 1997, s. 25 (recital 403). That the Court of Justice could so radically change its approach to the State aid rules from one week to the next is, frankly, scandalous.
The only way of reconciling the judgments is by hiding behind the principle of res judicata (paras. 144 and 303), by way of which unchallenged findings from the General Court cannot be reopened at the Court of Justice. But that is entirely unsatisfactory for myriad reasons, only two of which I raise here. First, the Engie case postdates the appeal in the Apple case, so the effect of res judicata is to bar Ireland from pursuing an argument that it never had the opportunity to make.
Secondly, in Koen Lenaerts’ own words (at p. 29), the principle of res judicata is not ‘absolute’. The Court is not barred per se from re-examining issues even where there is no cross appeal. If the Court wants to find a way of re-examining an issue, it can certainly find a way (as suggested also by Juan Jorge Piernas López). Indeed, it did just that in the context of an issue in the case which was not subject to appeal: the Court (see paras. 273-275 in particular) happily reopened the issue of the conflation of the advantage and selectivity criteria by the General Court, despite this not being subject to cross appeal. Indeed, the possibility that the Court can reopen points is reinforced by its strong pronouncements in the Engie (para. 78), FIAT (para. 85), and UK CFC (para. 60) cases that an error in defining the correct reference framework is an error of EU law that the Court of Justice cannot be barred from revisiting. But in Apple, the Court of Justice should bar itself from revisiting such an issue knowing that, in the process, it is making an error of EU Law?
There is a further tension between the Apple and UK CFC judgments in respect of the treatment of territoriality. Ireland had argued its interpretation of TCA 1997, s. 25 reflected the territoriality principle (recital 195), but the Court did not accept the relevance of the principle to understanding Irish law (para. 309). In the UK CFC judgment on the other hand, the Court was clearly very receptive to using the territoriality principle to understand UK law.
Conclusion
Ultimately, the UK CFC judgment is another in a growing list of State aid judgments (Amazon, Engie, FIAT and the turnover tax cases ( C 562/19 P and C 596/19 P)) where the Court of Justice has strongly upheld Member State sovereignty and pushed back against the Commission’s attempts to expand the scope of the State aid rules. When it comes to fundamental tax rules or the interpretation of domestic tax rules, the Court will respect Member State choices. Just not all the time, as the Apple decision tells us.
