On September 19, 2018, the European Commission issued a decision that nontaxation of certain McDonald's profits in Luxembourg was not illegal State Aid.
The decision ends a lengthy saga that began in 2015, when the European Commission alleged that two rulings by the Luxembourg authorities provided McDonald's with a selective advantage. These rulings enabled McDonald's European subsidiary to pay no corporate tax in Luxembourg despite recording large profits from royal- ties paid by franchisees operating in Europe and Russia. According to the first 2009 ruling, McDonald's Europe Franchising did not pay corporate taxes in Luxembourg on the grounds that the profits were subject to tax in the U.S.; McDonald's was required to submit proof every year that the royalties were declared in the U.S. and subject to tax there. In a second ruling, issued six months later, the Luxembourg authorities removed the requirement to produce proof of tax payment; according to Luxemburg law, McDonald's Europe Franchising had a taxable presence in the U.S.
Article 107(1) of the Treaty on the Functioning of the European Union ("T.E.F.E.U.") identifies illegal State Aid as "any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market."
In the September 19 decision, the European Commission ruled that Luxembourg did not break the E.U. State Aid rule but relied on a double taxation treaty between Luxemburg and the U.S. (the "Treaty"). The benefit was the result of a mismatch under the Treaty, rather than a selective advantage.
The benefit to McDonald's occurred because the definition of permanent establishment is different under Luxembourg and U.S. tax laws. The Treaty states that Luxembourg cannot tax the profits of a company if it may be taxed in the U.S. because it operates a permanent establishment there. Under U.S. tax law, the U.S. branch of McDonald's Europe Franchising was not treated as a permanent establishment, and therefore, it was not taxed in the U.S. However, the same U.S. branch was treated as a U.S. permanent establishment under Luxembourg tax law, thereby exempting its income under the Treaty and resulting in double non-taxation.
While McDonald's appears to have succeeded where other major multinationals (such as Fiat, Amazon, Starbucks, and Apple) failed, the victory is not without con- sequences. To prevent future abuse, the Luxembourg government is taking steps to prevent such situations by strengthening the definition of permanent establish- ment under its tax code. Once the change is adopted, taxpayers will be required to provide a certificate of residency in the other country to obtain a tax exemption in Luxembourg, thus proving that the other country recognizes the existence of a taxable permanent establishment of the company.
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