Out-Law News 3 min. read

EU to formally investigate 'double non-taxation' of McDonalds in Luxembourg

Special tax arrangements granted by Luxembourg to McDonald's European franchising operation may have resulted in the restaurant chain paying no tax on certain royalty payments at all, the European Commission has said.

Competition commissioner Margrethe Vestager has confirmed that the Commission is formally investigating two 'tax rulings' granted by authorities in Luxembourg to McDonald's Europe Franchising. Vestager said that the company had paid no corporate tax in Luxembourg since 2009, despite recording large profits from royalties paid by franchisees operating McDonald's restaurants throughout Europe and Russia for use of the chain's brand and services.

"A tax ruling that agrees to McDonald's paying no tax on their European royalties either in Luxembourg or in the US has to be looked at very carefully under EU state aid rules," she said. "The purpose of 'double taxation' treaties between countries is to avoid double taxation – not to justify double non-taxation."

According to its announcement, the Commission will particularly focus on whether two tax rulings, granted by Luxembourg to the company in March and September 2009 respectively, went against national tax law and the Luxembourg-US double taxation treaty. The Commission's case is that by doing so, Luxembourg gave McDonald's an advantage not available to other companies in comparable factual and legal situations in breach of EU state aid rules.

McDonald's Europe Franchising is headquartered in Luxembourg but also has two branches, in Switzerland and the US. The head office is designated as responsible for corporate "strategic decision-making"; while the Swiss branch has limited activity relating to franchising rights and the US branch has no 'real' activities, according to the Commission. All royalties received by McDonald's Europe Franchising are transferred internally to the US branch.

According to the Commission, the March 2009 tax ruling confirmed that the company was not due to pay corporate tax in Luxembourg on the grounds that the profits were subject to US tax under the Luxembourg-US double taxation treaty. However, as the company had no taxable presence in the US under US law, the profits were not in fact subject to US tax. McDonald's requested a second tax ruling to confirm that it did not have to prove that the income was subject to US tax in order to benefit from the Luxembourg exemption, which was granted by Luxembourg in September 2009.

The European Commission does not have direct authority over national direct tax systems. However, it can investigate whether certain advantageous fiscal regimes would be prohibited under its state aid rules, which are intended to prevent the distortion of competition that occurs when national governments grant advantages or incentives to particular companies. If the Commission rules that member states have given unlawful state aid, the member state may be required to make the company pay back any illegal reliefs granted over a period usually covering up to 10 years.

The Commission began investigating the tax ruling practices of certain member states in June 2013, and extended its requests for information to all member states in December 2014. In October 2015, it decided that tax rulings granted to Fiat Finance and Trade in Luxembourg and Starbucks in the Netherlands breached state aid rules. Luxembourg and the Netherlands are now required to recover the unpaid tax, although both have confirmed that they intend to appeal the Commission's findings.

The outcomes of the Commission's investigations into rulings granted to Apple by Ireland and Amazon by Luxembourg are expected soon. Tax expert Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said that news of further investigations was "likely" in the coming weeks, as the EU continued to look closely at the tax affairs of US multinationals.

"Unlike the Starbucks and Fiat decisions, which are primarily about transfer pricing methods, the McDonald's ruling relates to income which is not taxed in either Luxembourg or the US," she said.

"The OECD's 'base erosion and profit shifting' project is already targeting such 'double non-taxation', so such structures are now under fire from all sides. Rulings which rely on non-taxable branches have been relatively common in Luxembourg. Companies should consider whether the risks of such structures have started to outweigh the potential benefits," she said.

Self said that the US Treasury had "begun to complain about the potential consequences" of the EU's investigations into US multinationals.

"Although fundamental US tax reform is unlikely in the short term, it is possible that they will bring in anti-avoidance rules which would charge US tax on 'exempt branch' structures. The balance of power may then shift back from the EU to the US," she said.

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