The Commission opened a state aid investigation in December 2015 into two tax rulings granted by Luxembourg to McDonald's Europe Franchising, a Luxembourg-based subsidiary of the fast food chain, in 2009. The rulings exempted from taxation in Luxembourg all franchise profits that McDonald's received from third parties operating McDonald's outlets in Europe, Russia and Ukraine.
The rulings had the effect that McDonald's paid no tax on certain royalty payments at all. However, the Commission has now concluded that this was due to a mismatch between the tax laws in Luxembourg and the US, and not because Luxembourg granted special treatment to McDonald's in breach of EU state aid rules.
The first state aid ruling granted to McDonald's by Luxembourg had been based on the false assumption that the payments were taxable in the US. The second ruling removed any obligation on McDonald's to prove that the payments were taxable in the US.
The European Commission has opened several in-depth investigations into whether tax rulings granted to multinational companies by member states including Ireland, Luxembourg and the Netherlands breached state aid rules. This is the first time that one of these investigations has failed to find unlawful state aid.
"The McDonald's case shows that state aid challenges won't always work where multinationals end up paying tax nowhere - no matter how distasteful the Commission may find this," said tax expert Catherine Robins of Pinsent Masons, the law firm behind Out-Law.com. "The Commission has had to accept that if the Luxembourg tax authorities always interpret the double tax treaty in a particular way there can be no selective advantage and therefore no state aid."
"This is the first tax state aid investigation involving a US multinational where the Commission has failed to find unlawful state aid. It may be more cautious in the future in opening investigations into more borderline cases, even if large sums have apparently escaped being taxed anywhere. Many would argue that problems with Luxembourg's tax rules should be addressed by legislative changes in Luxembourg - as seems to now be happening - not by EU state aid challenges," she said.
McDonald's Europe Franchising is headquartered in Luxembourg but also has two branches, in Switzerland and the US. All royalties received by McDonald's Europe Franchising are transferred internally to the US branch.
Under the Luxembourg-US double taxation treaty, Luxembourg cannot tax the profits of companies that may be taxed in the US because they have a 'permanent establishment', from which they carry out business and have a taxable presence, in the US. The US branch was classed as a permanent establishment by Luxembourg using the Luxembourg definition of the law, meaning that it could not be taxed by Luxembourg. However, the US branch was not classed as a permanent establishment under US tax law.
EU competition commissioner Margrethe Vestager said that although there had been "double non-taxation" in this case, "this was not due to any special treatment awarded by Luxembourg to McDonald's".
"Of course, the fact remains that McDonald's did not pay any taxes in Luxembourg on these profits - and this is not how it should be from a tax fairness point of view," she said. "That's why I very much welcome that the Luxembourg government is taking legislative steps to address the issue that arose in this case and avoid such situations in the future."
The Luxembourg parliament is currently considering changes to the tax code which would strengthen Luxembourg's criteria for defining a permanent establishment as part of its implementation of the EU's Anti Tax Avoidance Directive. These changes would require a taxpayer, in certain circumstances, to provide proof that another country recognises the existence of a taxable permanent establishment of the company if it wants to benefit from a tax exemption in Luxembourg.