by Professor Edoardo Traversa and Pierre Sabbadini
On May 5, the European Commission made available to the public its January 11 decision that Belgian excess profit rulings tax scheme is illegal under EU State aid rules.
In essence, the excess profit exemption scheme allows Belgian-resident multinational companies and Belgian permanent establishments of foreign-resident multinationals to deduct a so-called “excess profit” from their actually recorded Belgian profits.
The excess profit is determined in two steps. First, the hypothetical average profit that a standalone company carrying out comparable activities is estimated on the basis of a transfer pricing methodology. Second, that amount is subtracted from the profit actually recorded by the Belgian group entity. The difference is considered as an “excess profit” that is not considered the result of the activity of Belgian entity but of synergies with other entities of the group, and therefore not taxable in Belgium.
The excess profit mechanism is based on a specific provision of the Income Tax Code (Article 185, §2), whose wording reflects Article 9 of the OECD Model Tax Convention, which constitutes the basis upon which tax authorities carry on transfer pricing adjustments to transactions carried out between entities of multinational groups. According to the Belgian provision, the exclusion of excess profits can only be granted through an advance ruling issued by a special ruling commission.
European Commission’s position
The Commission began to question the excess profits ruling scheme in December 2013, exchanging views with the Belgian tax authorities at that time. A formal investigation was launched in February 2015, which lead to the negative decision of January 11.
In its decision, the Commission concludes that the scheme amounts to an aid illegally granted to Belgium to certain multinational companies, in violation of Article 107 of the Treaty of the functioning of the European Union. According to the Commission, the excess profit exemption constitutes an advantage if compared to the normal system of computation of profits for corporate income tax purposes. This advantage is deemed to be selective and not general in nature, because it is not available to standalone companies or to entities that belong to national groups. Moreover, it is subject to an administrative authorization.
The Commission also points out inconsistencies in the choice of transfer pricing methodologies by Belgian tax authorities in the excess profits rulings and contests the Belgian tax authority’s assertion that the scheme is as an application of the arm’s length principle.
Finally, the Commission said the derogation cannot be justified by the nature or the scheme of the reference framework, in this case by the objective of avoiding double taxation.
“The Excess Profit exemption provides a unilateral exemption granted in advance that does not require the exempted profit to have been or to be included in the tax base of an associated foreign group entity in another tax jurisdiction, nor that that profit is effectively taxed by that jurisdiction,” the Commission said.
The Commission concluded that the contested scheme “clearly goes beyond what is necessary and proportionate to achieve the objective of preventing double taxation and therefore cannot be justified.”
Next steps
Belgium has already appealed the Commission’s decision before the General Court of the European Union. The General Court, and possibly, the European Court of Justice, will have to review the Commission’s arguments and verify whether the decision is legal.
It is likely that the main points of discussion will be the extent of the room for maneuver left to Member States to autonomously apply transfer pricing rules and, from a procedural perspective, whether the Commission approach is novel, justifying the non-retroactive application of the decision.
It is worth noting that the US Treasury Secretary has formally expressed concerns about the issue of retroactivity, in letter addressed to President Juncker and Commissioner Vestager last February, urging the EU Commission to reconsider its approach.
— Edoardo Traversa is a Professor of European and International Tax Law at the University of Louvain, Belgium, and coordinates the EU Tax Taskforce at Liedekerke, Brussels. He can be reached at [email protected].
— Pierre Sabbadini is a lawyer at Liedekerke, Brussels. He can be reached at [email protected].
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