EU court addresses legality of progressive turnover taxes

By Dr. Patricia Lampreave, Professor at the Instituto de Estudios Busatiles, Madrid

On 27 June the EU General Court annulled an EU Commission decision finding that the Hungarian advertisement tax was incompatible with the EU State aid rules.

This is the third Hungarian tax levied on turnover that the European Commission has found incompatible State aid (previously, taxes on tobacco products and inspection of the food chain). It is also the second recent General Court decision addressing the legality of taxes on turnover that have progressive rates.

The General Court stated in this case that neither that tax’s progressivity, nor the possibility for undertakings not making a profit in 2013 to deduct from the 2014 basis of assessment for that tax losses carried forward from the earlier financial years constitute a selective advantage in favour of certain undertakings.

The General Court concluded that the tax’s progressivity does not constitute a selective advantage within the meaning of EU restrictions on State aid. Nonetheless, it appears that we cannot conclude from this case that countries are free to tax a company based on size and thus target large companies.

 The Hungarian advertisement tax

The Hungarian advertisement tax, introduced in 2014, is a special tax applied on turnover derived from the broadcasting or publication of advertisements in Hungary.

Under these rules, taxable persons are economic operators that broadcast or publish advertisements are subject to that tax, that is to say, in particular, newspapers, audiovisual media, and billposters.

It is a progressive tax base in turnover. The taxable amount is the net turnover for the financial year generated by the broadcasting or publication of advertisements, to which progressive rates ranging from 0% to 50% per bracket of turnover are applied, the first taxable bracket commencing at 500 million Hungarian forints (HUF) (approximately €1 562 000).

On 4 June 2015, Hungary replaced the six progressive rates with two rates: a 0% rate for the portion of the taxable amount below HUF 100 million (approximately €312 000) and a 5.3% rate for the excess.

A special deduction is provided for taxable persons subject to the advertisement tax whose pre-tax profits for the financial year 2013 were zero or negative. Under these rules, such taxpayers could deduct from their 2014 taxable amount 50% of the losses carried forward from the earlier financial years.

Hungary defended the progressive nature of the advertising tax, arguing it was linked to the ability of each company to pay for public policies.

EU Commission Decision

On 4 November 2016, the Commission found, in Case SA.39235, that the Hungarian progressive tax rates and the provisions prescribing a reduction in that tax in the form of deduction of losses carried constituted a State aid measure incompatible with art 107 TFEU.

This is another state aid case with a strong prima facie selectivity element: taxes are selective as regards size with no justification for progressivity (different from profit taxes which disregard costs and ability to pay).

The Commission considered that the progressive tax rates differentiate between undertakings with high advertisement revenues (and thus larger undertakings) and undertakings with low advertisement revenues (and thus smaller undertakings), granting a selective advantage to the latter based on their size.

The Commission considered that the reference system for the taxation of advertisement turnover was therefore selective by design in a way that is not justified in light of the objective of the advertisement tax, which is to promote the principle of public burden sharing and collect funds for the State budget.

The changes to the law did not eliminate the selectivity elements, the Commission said.

In the Commission’s view, the reference system for the taxation of advertisement turnover should be a tax on advertisement turnover which would comply with State aid rules i.e. where advertisement turnovers are subject to the same (single) tax rate and no other element is maintained or introduced that would provide a selective advantage to certain undertakings.

On 16 May 2017, Hungary repealed the advertisement tax with retroactive effect and brought before the General Court in an action for annulment of the Commission’s decision.

Polish retail tax

The Commission’s decision has similarities with the EC decision on Polish tax on the retail sector, SA.44351.  

In the retail tax decision, the Commission’s in-depth investigation determined that progressivity of the tax rates would unduly favor certain companies over others, depending on their turnover and size.

With the progressive tax rate structure (tax rates varied from 0% to 1.4% depending on the turnover and an exemption applies to the part of the company’s turnover below €4.02 million), smaller companies would either pay no retail tax at all or face a lower average tax rate than larger competitors. This would give companies with a lower turnover an unfair economic advantage.

The Commission, in the Polish retail tax decision, considered that smaller companies should, of course, pay less tax than their larger competitors in absolute terms, but still in the same proportion to their turnover.

Is the derogation justified by the logic of the tax system?

The EU Courts have developed a three-step framework to assess whether a fiscal measure is selective, which the Commission uses in analysing its files: First, it is necessary to determine the tax reference framework. The next step is to determine whether the tax system provides any derogation leading to a different treat­ment for economic operators who, in light of the objective of the system, are in a comparable legal and factual situation.  Finally, even if there is a deviation from the reference tax framework, it should be determined if this can be justified by principles inherent to the respective tax system. It is for the Member State to provide such justification.

The Commission, in its 1998 Notice on administrative practice under State aid, stated that the progressiveness of income/corporate tax could be justified by the redistributive purpose of the tax or the ability to pay.

As mentioned above, the Commission rejected the argument of Hungary that the turnover and the size of undertakings reflected their ability to pay and therefore to contribute to the cost of public policies.

General Court decision

The General Court annulled the 27 June the Commission decision for the same reasons as those set out in its recent judgment (on 16 May 2019) concerning the Polish tax on the retail sector (Joint Cases: T-836/16 and T-624/17 Poland v Commission).

In the earlier decision, the General Court stated that a tax that is progressive in relation to turnover, and therefore, size, may not be selective in the meaning of Article 107(1) TFEU.

In the Hungarian advertisement tax case, the General Court argued that the Commission identified a ‘normal’ system which was either incomplete, without any tax rate, hypothetical, or with a single tax rate.

Whether or not a tax advantage is selective must be analyzed in the light of the actual characteristics of the ‘normal’ system of taxation of which it forms part (including its single scale of progressive rates and successive bands), not in the light of assumptions that have not been accepted by the competent authority.

Objective of the tax in question

 The Court further stated that the Commission is not entitled to select for the tax at issue an objective other than that identified by the Hungarian authorities — namely the objective of establishing sectoral taxation on turnover in accordance with a redistributive purpose — on the ground that the scheme of the tax at issue, characterised by a progressive tax structure, would not have been consistent with that objective.

The Commission seemed to want to prove that the different tax rates were inherently discriminatory in the same way that the Gibraltar system was designed on purpose to exclude offshore companies (case C-106/09 P, Commission v Gibraltar, para. 91-93). 

The Court said further that the Commission’s characterisation of the advertisement tax as a measure entailing a selective advantage solely because of its progressive structure is unfounded.

In addition, the Commission failed to demonstrate that the progressive taxation structure actually chosen had been adopted in a manner which largely deprived the objective of the tax in question of its substance.

Loss carry forwards

The General Court also concluded in that the fact that entities cannot carry forward tax losses under the Hungarian law did not constitute a selective advantage within the meaning of EU restrictions on State aid.

 The 50% deductibility of the losses carried forward does not entail a discriminatory element contrary to the advertisement tax’s objective, the Court said.

Conclusions

Member States are free to design their corporate tax systems as long as they do not grant State aid or infringe fundamental internal market freedoms (as stated in C-487/06 P, British Aggregates v Commission ).

The Commission must respect the objective of the tax as defined by the national legislature and also must accept the tax system as defined by Member States, including all its components such as base, rates, and bands. It is not possible to exclude tax rates from the substance of a system of taxation as the Commission did.

Despite the fact that a company’s ability to pay is better reflected by profits rather than turnover, the progressive structure of tax rates cannot in itself and automatically be considered as an indicator of the existence of selective advantages in progressive tax structures, including those with significant non-taxable limits, bands, or amounts, which are not exceptions to tax systems.

However, this argument is not a silver bullet: Member states should consider that a progressive tax measure could still be selective if it were shown that the progressive tax structure in practice was adopted in a manner which largely contradicted the purpose of that tax measure. Every case should be judged on its own merits.

We should also bear in mind the Polish and Hungarian cases will likely be appealed by the Commission and that the European Union Court of Justice frequently annuls General Court resolutions.