The Foreign Subsidies Regulation: The Extraterritorial Tax Dimension

In the fourth post in the Renforce Blog Series on the Foreign Subsidies Regulation, Dionysios Pelekis looks at the notion of a “subsidy” in relation to the notion of State aid, and discusses the extraterritorial fiscal implications of the Regulation. Taxation, and the ability to carry out economic, social, and industrial policy via the tax system, is a central aspect of sovereignty. However, due to the width of the notion of a subsidy, and to the scope of the Regulation, this new instrument seems capable of affecting the tax affairs of third countries. 

The Foreign Subsidies Regulation (FSR), as has been covered by previous posts in this series, addresses a gap in the EU’s regulatory framework, and interrelates with EU competition law, and State aid law. In effect, it represents an extraterritorial dimension of EU State aid law. Thus, this blog post will focus on the notion of a “subsidy” for the purposes of State aid law, and thus, grosso modo, the FSR. Following from this, it will discuss what a fiscal subsidy is, and the effect that this notion can have on fiscal matters for non-EU governments, and undertakings established outside the EU.

What is a “subsidy”?

Article 3(1) of the FSR defines a (foreign) “subsidy” as a selective financial contribution, direct or indirect, provided by a third country, which confers a benefit to an undertaking active in the internal market, and which distorts that market. This definition is very similar to that of an “aid” under Article 107(1) TFEU, where a State aid is defined as selective advantage (or benefit) granted to an undertaking by the State via its resources, which distorts competition and affects trade between EU Member States. Article 3(2) FSR adds more meat to the “financial contribution” and the “provided by a third country” elements of a subsidy’s definition, and brings it closer to the notion of an aid under EU law. We can conclude therefore that the two notions are indeed very closely related conceptually, despite some differences between the two regimes.

Beyond the definition of an aid or subsidy however, another important element is the width of those notions. Both the Notice on the Notion of Aid, and Article 3 FSR clearly point towards a wide conception of aids/subsidies. For instance, it has long been accepted that “State aid” includes tax measures and fiscal advantages, while the same is true of “subsidies” under the FSR, per Article 3(2)(a) and (b). Thus, both Article 107 TFEU and the FSR have the potential to affect States’ exercise of their fiscal powers.

Subsidy control and fiscal sovereignty

In an EU context, the limitation of Member States’ fiscal sovereignty is part and parcel of their membership – while direct taxation remains within their purview, they must exercise those powers in accordance with Union law. State aid law is far from being the only part of EU law which places limits on those powers – there are several Treaty articles which explicitly or implicitly do so too. However, the limits that State aid law places on fiscal sovereignty can be argued to be amongst the most stringent.

The key component in fiscal aid cases is “selectivity”, or specificity. This effectively examines whether and how the advantage is limited, or its award is “selective”. In tax matters, this is assessed by looking for unjustified deviations from the “general tax system”, which is conceived of as an abstracted view of “normal taxation”, provided that those deviations produce an advantage for their beneficiaries.  The notion of fiscal selectivity has been stretched to the point where a general measure of objectively conditional application falls within the scope of Article 107(1) TFEU. A simplified example of that would be that a tax deduction dependant on a specified act, e.g., the purchase of shares in non-domestic companies, would satisfy the selectivity criterion, even if the condition is open to all comparable taxpayers. In brief, the notion of selectivity is rather wide. To further complicate matters, the construction of “normal taxation” can be based on principles that extend beyond the national tax law of the Member States, such as the Commission’s conception of transfer pricing rules.

The other elements of a subsidy do not fit well within the mould of direct taxation – a fiscal subsidy will always come from the State; and if it does indeed confer a financial benefit, it will be liable to distort the market. This makes selectivity the core element of the definition, meaning that the scope of the notion of fiscal subsidies is rather wide. To add to this, the chance of a positive compatibility assessment for fiscal aid is also limited. Compatibility is in effect the process by which a subsidy can be deemed to be acceptable in the internal market. The reliance on this process as a result of the prohibition’s wide scope can be rather restrictive in the case of the FSR. This is because in the FSR there are no (as of yet at least) block exemptions (which are a core element of the compatibility regime), and the balancing test encompassed in Article 6 FSR is rather ad hoc. In other words, the notion of a fiscal subsidy is wide, and once a fiscal measure is deemed a subsidy it is difficult for it to be deemed acceptable. Thus, the prohibition of tax subsidies can affect fiscal sovereignty – as a large number of fiscal measures can be deemed “subsidies”, and few of those may be allowed to stand.

Extraterritorial tax limitations – or how far can the FSR go?

The FSR explicitly includes fiscal incentives and tax deductions in its scope, and the expression of the selectivity criterion in the FSR seems based on the ECJ’s language in the application of the same criterion in State aid cases. If we follow the logic and language of the notion of a “subsidy” in the FSR by acknowledging its conceptual similarities with the notion of an “aid”, it becomes clear that the scope of a tax subsidy in the FSR is also quite wide.

Thus, the FSR, within the thresholds it sets, would seem to have the same far-reaching effects on fiscal sovereignty that State aid law has. The key difference however is one of competence – EU Member States have willingly surrendered part of their powers to be part of the EU, and that has been the case since the inception and creation of the Union. Given the centrality of tax policy and design in relation to economic and industrial policy (consider for instance the large tax incentives of the Inflation Reduction Act in the USA), this restriction on an integral part of the sovereignty of third countries seems rather severe.

The situation can get even more complex if we take into account transfer pricing and the arm’s length principle, on which some of the Commission’s most controversial State aid Decisions were based. There, based on its decisional practice in the context of State aid, the Commission could in effect impose its own conception of an arm’s length principle – or in plainer terms, impose its own extraterritorial reading and application of domestic, third-country, tax laws.

On a more practical note, depending of course on how the Commission enforces the FSR, this could leave undertakings, the actual addressees of the FSR, with a tough choice between three options: refuse or opt-out of generally applicable tax deductions and other incentives, fall within the scope of the FSR, with all that that entails, or forego the EU internal market. After all, undertakings have at best very limited control over the tax system and its constituent laws of the jurisdictions in which they operate, so their most reasonable option would be to change their corporate behaviour.

So, what’s the picture?

It is of course too early to tell exactly what the effects of the FSR will be; let alone its potential extraterritorial fiscal effects. The system is still in its infancy, and will need time, effort, and discretion (from both the Commission and the Court) to crystallise. However, if we take into account the state of fiscal State aid, the text of the FSR, and the apparent close conceptual kinship between State aid law and the FSR, the tax, and tax policy, implications for third-countries and undertakings look far-reaching, and complex. The Commission’s discretion and central role in the regime, its limited accountability, as well as a turn to unilaterality, can make the legal, political, and economic situation rather complex too. Let’s hope that the old adage about those who sow winds proves to be inaccurate.