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Amazon and Luxembourg beat European Commission in state aid appeal

TAX ALERT  | 

On May 12, 2021, the European Court of Justice (ECJ) announced its decision to annul findings by the European Commission (Commission) that would have required Amazon to remit €250 million (approximately $300 million) to Luxembourg. The Commission previously ruled that Amazon's subsidiary in Luxembourg gained an undue tax reduction when the subsidiary paid royalties to Amazon in violation of the arm's length principle, and that such reduction constituted illegal state aid. 

Fact pattern of the Amazon case:

In 2004, Amazon US structured its European operations through Amazon EU Sàrl (Amazon Lux), a Luxembourg-based operating subsidiary, to shift profits to Amazon Europe Holding Technologies (Amazon EU). The holding company was a limited partnership with no employees, offices or business activities. 

Amazon Lux held the intellectual property (IP) rights under a November 2003 cost-sharing agreement with Amazon US and was required to make annual cost-sharing payments for the future development of Amazon's intangibles for the European market. In doing so, the arrangement allowed the holding company to grant an exclusive license to Amazon EU and receive royalty payments in return. 

Even though Amazon Lux had adequate substance in managing the cost-share arrangement, it did not manage nor control the research and development activities performed by Amazon US. In fact, Amazon Lux only paid to cover the costs of developing the IP.  

Amazon defended its position by arguing that the IP transfer was conducted at arm's length. In contrast, the Commission argued that the royalties were inflated to reduce Amazon's taxable profits. While the Luxembourg authorities and Amazon favored the comparable uncontrolled price (CUP) method, the Commission argued that the residual profit method was more reliable.

In October 2017, the Commission issued its decision that a tax ruling in effect between 2006 and 2014 reduced the tax rate on royalties granted to relevant Amazon group members, which effectively awarded the group €250 million (approximately $300 million) in state aid that must be remitted to Luxembourg. 

The European Court of Justice Ruling:

In its judgment, the ECJ upheld, in essence, the arguments of Luxembourg and Amazon, challenging both the primary and subsidiary findings of an advantage, and subsequently annulled the contested decision in its entirety. According to the ECJ, the Commission failed to demonstrate that a Luxembourg tax ruling supporting Amazon's transfer pricing methodology created an unfair advantage to Amazon under EU state aid law.

Applying criteria used to determine whether a government provides 'State aid' in the context of tax rulings, the ECJ concluded that the Commission's analysis of the transfer pricing was flawed in several areas for the following reasons: 

  • The Commission misunderstood the functions of the holding company in exploiting its intangible assets—a critical factor in determining how much profit should be attributed to an entity.
  • The Commission did not prove that the Luxembourg tax authorities should not have chosen the operating company as the tested party for assessing the royalty payments.
  • The Commission did not prove that there was an advantage in using the transfer pricing method because it did not consider the increase in the value of the intangible assets.
  • The Commission's assertions about the mark-up due to the holding company were incorrect.
  • The Commission also failed to show that methodological errors meant that less profit was attributed to the operating company than there would be under normal market conditions, which would prove an advantage.

Implications for tax payers:

This case is significant for several reasons. First, it demonstrates taxpayers engaged in international transactions often must consider not only tax but also other regulatory regimes because tax and non-tax rules are often intertwined. In addition, taxpayers should consider whether this ECJ decision will apply to other similar agreements and whether it may apply to years that predate the years at issue in the case.   

We believe the ECJ decision in the Amazon case increases legal certainty for taxpayers, especially for transactions that lie at the boundary of the arm's length principle (e.g., intangible sales and buy-in payments in cost-sharing agreements). In essence, tax planning and compliance measures that follow transfer-pricing principles can be defended in court.

The ECJ's decision on Luxembourg's tax treatment of the Amazon group is one of many setbacks to the Commission's efforts to tackle corporate tax avoidance. While the decision is a massive win for Amazon, which faced a multimillion-dollar tax bill, we expect to see increased global scrutiny on corporate tax planning as we have seen with the Base Erosion Profit Sharing (BEPS) initiative and Global Intangible Low-Taxed Income (GILTI) rules enacted by the United States in 2017. 

For example, the Commission plans to create a new framework by 2023 for business taxation in the EU. The purposed of this new framework will be to provide a single corporate tax rulebook for the EU, providing for fair allocation of taxing rights between member states. In a more specific press release, the Commission announced the proposal of its Business in Europe: Framework for Income Taxation (BEFIT) on May 18, 2021, defining a two-year tax agenda with compressive measures that reduce compliance costs and minimize tax avoidance opportunities.  

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