CJEU ruling clarifies application of state aid rules on national tax measures

Following the decision, on certain UK rules on the taxation of controlled foreign companies (CFCs), all UK companies that had been required to pay additional tax based on the previous General Court analysis will now have it repaid. 

Jake Landman, tax law expert at Pinsent Masons, said: “There was previously a lot of surprise about the General Court’s analysis of the UK CFC rules and a feeling that the rules had been misunderstood. The CJEU overturning the General Court is perhaps not a surprise in that sense.”

The UK’s CFC rules are designed to prevent UK-based companies from shifting profits to subsidiaries in low-tax jurisdictions and to tackle related tax issues. The European Commission had previously found that the UK had granted a selective tax advantage to certain multinational groups by means of an exemption from the CFC charge and this was incompatible with state aid rules.

The Commission’s decision was challenged by the UK and several affected companies. The General Court initially rejected these challenges in 2022, upholding the Commission’s findings. In line with the Commission’s decision, the General Court determined that the UK CFC rules were severable from the wider UK general corporation tax system (GCTS) when embarking on the identification of the reference framework for the purpose of determining “selectivity” in the state aid analysis.

However, the CJEU’s recent judgment overturns the previous ruling, finding that the General Court had erred in law in concluding that the CFC rules constituted the relevant reference framework for determining whether a selective advantage had been conferred. In its decision, the CJEU emphasised that in identifying the correct reference framework, the Commission had to accept the member state’s interpretation of its national law unless it could demonstrate that another interpretation prevailed in either the case law or administrative practice of that member state. In the absence of any such case law or administrative practice, the Commission’s interpretation could only prevail where it was able to demonstrate that the member state’s interpretation was incompatible with the wording of the relevant provisions.

In this case, the court concluded that the Commission analysis, which the General Court had upheld, had failed to establish that the UK’s interpretation of its CFC rules was incompatible with the wording of the relevant provisions.

The CJEU held that the General Court had erred in law in concluding that the reference framework for the purposes of examining the selectivity of the CFC exemptions at issue consisted solely of the CFC rules.  That error vitiated the Commission’s state aid analysis and subsequent conclusions and was sufficient for the purposes of the CJEU setting aside the General Court’s decision in its entirety and annulling the Commission’s original decision. 

“The CFC exemptions that were the subject of the Commission’s complaint had in fact been removed from the UK CFC rules in 2019 in any event,” said Landman.

Dr Totis Kotsonis, state aid law expert at Pinsent Masons, added: “The court’s decision will be welcomed. It confirms previous case law and provides further clarity on the question of how the Commission should go about determining the appropriate reference framework on the basis of which it then seeks to determine whether certain businesses in the internal market might have been granted an exemption from the relevant rules which amounts to an unjustified selective advantage under state aid law”.

“At the same time, it is important not to overestimate the impact of this decision on state aid policy. Although the Commission got it wrong in terms of its state aid analysis, the CJEU’s decision does not affect the all-important underlying principle that the Commission has the right to look into the tax arrangements of member states to determine whether these might breach state aid rules. This right has often been challenged by member states as encroaching on their competences, but the CJEU has confirmed the Commission’s right to conduct such investigations time and again, not least in its recent Apple judgment.”