Weekend Edition Nº180

POSTLUDE FOR THE SECOND FISCAL AID WAVE

THE COMMISSION’S DEFEAT BEFORE THE ECJ IN THE ENGIE STATE AID CASE

Postlude for the second fiscal aid wave: The Commission’s defeat before the ECJ in the Engie state aid case

Dimitrios Kyriazis 1

On 5 December 2023, the Grand Chamber of the Court of Justice of the European Union (‘the Court of Justice’ or ‘the Court’) handed down a seminal State aid ruling.2 This is one of the most important judgments ever on the ‘selectivity’ condition of Article 107 TFEU in relation to fiscal State aid cases.

More specifically, in Engie (Joined Cases C‑451/21 P and C‑454/21 P), the Court accepted the appeals of the Luxembourg and Engie, quashed the General Court’s ruling3 and annulled the underlying Commission decision,4 thus putting an end to the Engie State aid case.

Unlike the Fiat State aid judgment,5 on which I have commented previously,6 this case was not about transfer pricing. It is thus of relatively broader application and should be studied closely by state aid and tax specialists alike.

The structure is as follows. First, the factual background of the case will be addressed. Second, the relevant case law and the key issues, as summarised by the Court of Justice, will be briefly set out. Then, the answers provided by the Court will be presented. Finally, the conclusions of the Court will be critically analysed, while pondering on the broader ramifications of this judgment.

1. Dimitrios Kyriazis (DPhil, Oxon) is an Assistant Professor in EU Law at the Law School of the Aristotle University of Thessaloniki.

2. Judgment of the Court of Justice of 5 December 2023, Engie and Others (Joined Cases C‑451/21 P and C‑454/21 P, EU:C:2023:948).

3. Judgment of the General Court of 12 May 2021, Engie (Joined Cases T‑516/18 and T‑525/18, EU:T:2021:251).

4. Commission Decision of 20.6.2018 on State Aid SA.44888 (2016/C) (ex 2016/NN) implemented by Luxembourg in favour of Engie.

5. Judgment of the Court of Justice of 8 November 2022, Fiat Chrysler Finance Europe (Joined Cases C‑885/19 P and C‑898/19 P, EU:C:2022:859).

6. See here

Factual Background

The facts, according to a summary7 of the Commission’s original State aid decision, were as follows. The case concerned Luxembourg’s tax treatment of the profits made by two companies in the Engie group, namely Engie LNG Supply (which mainly buys, sells and trades liquefied natural gas) and Engie Treasury Management (which manages internal financing within the Engie group). Both are Luxembourg incorporated companies that are fully owned by the Engie group and ultimately controlled by Engie S.A. in France.

The alleged aid measures were essentially two tax rulings (with amendments) issued by Luxembourg which endorsed two sets of transactions with a similar economic and legal structure within the Engie group. The rulings were issued in 2008 and 2010. The transaction represent a hybrid convertible loan structure between three Engie group companies. This triangular structure was summarised by the Court in its rulings (paras. 7 9) in the following manner.

First, a company in the Engie group transfers the assets constituting its business activity to a subsidiary company (‘the subsidiary’). In order to finance that purchase, the subsidiary issues to an intermediary company (‘the intermediary’) a bond for a term of 15 years that is mandatorily convertible into shares at maturity. That bond does not give rise to the payment of interest to the intermediary, but is converted, at its maturity, into shares. That conversion takes into account the performance, either positive or negative, of the issuer of the bond, namely the subsidiary, during the term of that bond. This type of contract is known as a zero interest bond repayable in shares (ZORA).

The remuneration of the intermediary, which has acquired the bond, is therefore indexed to the subsidiary’s performance. Thus, when the bond matures, the subsidiary must repay, by issuing shares, the nominal amount of the bond plus a ‘premium’ consisting of all the profit made by the subsidiary during the term of the bond, referred to as ‘ZORA accretions’. The amount of that premium is reduced by the amount resulting from the application of the percentage corresponding to the taxation agreed with the Luxembourg tax authorities. If the subsidiary makes a loss in one or more financial years, that loss is taken into account in the same way, reducing the profit for the purpose of calculating the final amount of the premium. These are referred to as ‘ZORA reductions, as the Court noted.

In order to finance the bond that it has acquired, the intermediary uses a prepaid forward sale contract (‘prepaid forward contract’) entered into with a holding company (‘the holding company’), which is the sole shareholder of both the subsidiary and the intermediary. The holding company pays to the intermediary, on entering into that contract, an amount corresponding to the nominal amount of the ZORA, in consideration for which the intermediary transfers to the holding company the rights to the shares that will be issued at the end of the ZORA, including those corresponding, where applicable, to the cumulative value of the ZORA accretions.

7. See here

From a tax perspective, this structure enabled the treatment of the same financing both as debt (from the perspective of the subsidiary) and as an investment in return for shares (from the perspective of the holding company). As a result, the subsidiary only paid taxes on about 1% of its profits. The remaining 99% were not taxed neither at the level of the subsidiary nor at the level of holding company, which received these profits in the form of shares. Income from shares is exempted from taxation under standard Luxembourg tax law (as it is in many other countries). Thus, the effective tax rate of Engie in Luxembourg was quite low.

The procedure before the Commission (as presented by the Court)

On 19 September 2016, the Commission initiated the formal investigation procedure provided for in Article 108(2) TFEU. On 20 June 2018, the Commission adopted the final decision (the one which was contested before the General Court and the Court of Justice), by which it found, in essence, that the Luxembourg had granted, through its tax authorities, in breach of Articles 107(1) and 108(3) TFEU, a selective advantage to the Engie group, regarded as a single economic unit.

Without calling into question the lawfulness under Luxembourg tax law of the entire financing structure established by the Engie group, the Commission disputed the effects of that structure on that group’s total tax liability, on the ground, in essence, that almost all of the profit made by the Engie subsidiaries in Luxembourg had not actually been taxed. I will laconically describe why the Commission thought that the conditions of Article 107 TFEU were fulfilled, and solely elaborate on the selectivity condition, which was actually the focal point of the Court of Justice too. First, as regards imputability of the tax rulings, this is always relatively straightforward: they are issued by a Member State, here Luxembourg, and their imputability stems from the fact that those rulings were adopted by the Luxembourg tax authorities. Second, they use state resources since they allegedly result in a loss of (otherwise due) tax revenue. Third, as regards the grant of an economic advantage, the Commission found that that advantage lay in the fact that the income from participations held by the holding company, on the one hand, and the Engie subsidiary, on the other, was not taxed. That income corresponds, from an economic perspective, to the ZORA accretions that they deducted from their taxable income as expenses.

Without calling into question the lawfulness under Luxembourg tax law of the entire financing structure established by the Engie group, the Commission disputed the effects of that structure on that group’s total tax liability

Now the plot thickens. In order to prove the selectivity of those tax rulings, the Commission, as the Court itself asserts in paras 31onwards of its judgment, principally relied, on three primary lines of reasoning. The first two concern the existence of a selective advantage at the level of the holding companies, in the light, first of all, of a reference framework encompassing the Luxembourg corporate income tax system and, next, of a reference framework limited to the provisions of Luxembourg law on the taxation of profit distributions and the exemption of income from participations. The third line of reasoning related to the existence of an advantage at the level of the Engie group, in the light of a reference framework encompassing the Luxembourg corporate income tax system. Finally, by a fourth line of reasoning, set out in the alternative, the Commission considered that a selective advantage resulted from the non application by the Luxembourg tax authorities of a national tax law on abuse of law. Overall, the Commission considered that there was no justification for the selective advantage. Therefore, all three steps of the traditional selectivity test were found to be fulfilled. Having found all the State aid conditions to be fulfilled, the Commission also decided that the aid granted was incompatible with the internal market and unlawful, thus ordering its recovery.

Let us delve deeper on each of the Commission’s arguments regarding selectivity. As regards the first line of reasoning, the Commission stated that the tax rulings at issue conferred on the Engie group, at the level of the holding companies, a selective advantage inasmuch as those rulings derogated from the Luxembourg corporate income tax system. According to it, companies resident in Luxembourg which are liable to corporation tax in that State are taxed on their profit, as recorded in their accounts. The Commission found that the identification, for the purpose of defining a reference framework, of an objective that could be inferred from those provisions was consistent with the case law of the Court of Justice. It also found that that objective, namely the taxation of the profit of all companies subject to tax in Luxembourg, was clearly apparent from the national provisions.

Kindly pause and consider the above. First step: it’s OK to identify the national tax laws’ objective, i.e. it’s fine for the Commission to infer the national legislator’s ‘intent’. Second, what was the actual objective found to exist? It was ‘the taxation of the profit of all companies subject to tax in Luxembourg’. We will come back to these points later, since the Court took issue with these assertions by the Commission.

As regards the second line of selectivity reasoning, the Commission considered that the tax rulings at issue conferred on the Engie group, at the level of the holding companies, a selective advantage inasmuch as they derogated from the reference framework limited to the provisions on the exemption of income from participations and the taxation of profit distributions. The exemption of income from participations was available to a parent company only if the distributed profit had been taxed beforehand at the level of its subsidiary. Income from participations that was exempted from tax at the level of the holding companies corresponded, from an economic perspective, to the ZORA accretions deducted by the subsidiaries from their taxable income as expenses. This was the Commission’s argument here. Building on this, the Commission found that, from an economic perspective, having regard to the direct and clear link between the income exempted at the level of the holding companies and the ZORA accretions deducted at the level of the subsidiaries, those accretions were equivalent to profit distributions.

Coming now to the third line of selectivity reasoning, the Commission maintained that the selectivity of the tax rulings at issue was also apparent from an analysis at the level of the group comprising the holding companies, the intermediaries and the subsidiaries concerned. The reason was that from 2015 onwards, those companies formed a single tax unit by paying their taxes on a consolidated basis (para. 37). In any event, according to the Commission, since the economic effects of State measures must be analysed by reference to undertakings, the holding companies, the intermediaries and the subsidiaries must be regarded as forming part of the same undertaking for the purposes of State aid law. This is an important point to make.

To substantiate it, the Commission also added that the tax ruling requests related to the tax treatment of all the entities of the Engie group involved in the transactions at issue and that the economic advantage which, in its view, that group enjoyed lay in the combination of an exemption of income from participations at the level of the holding companies and a deduction of the ZORA accretions as expenses at the level of the subsidiaries. The selective advantage granted to the Engie group stemmed from the fact that the tax rulings derogated from the reference framework corresponding to the Luxembourg corporate income tax system, the aim of which is to tax companies subject to tax in Luxembourg on their profit, as recorded in their accounts. With this, we have a full picture of the three primary lines of selectivity reasoning of the Commission.

The burden of proof is on the Member State to demonstrate that the measure is justified by the nature or general scheme of its tax system. In other words, the Commission does not need to prove that it is not justified; the Member State has to shows that it, in fact, is

As regards the Commission’s alternative analysis (para. 39), it was based on the fact that, by the tax rulings at issue, the Luxembourg tax authorities had ruled out the application of Article 6 of the Law on tax adjustment, whereas the four criteria identified by the case law of the Luxembourg courts for establishing that there has been an abuse of law, namely the use of forms or institutions governed by private law, the reduction in the tax burden, the use of inappropriate legal means and the absence of non tax reasons, were met. Therefore, an abuse of law could be substantiated, even if no actual violation of Luxembourg law had taken place. Concerning the last two criteria in particular, the Commission considered that the almost total absence of taxation of the profit made by the subsidiaries in Luxembourg would not have been possible if the business sectors had been transferred using an equity instrument or a loan between the subsidiaries and the holding companies concerned. Moreover, apart from the achievement of significant tax savings, there were allegedly no genuine economic reasons for the Engie group to opt for the complex financing structures established and endorsed by the tax rulings at issue (para. 40).

Having, in its view, identified the correct reference framework and established that a derogation therefrom existed, the last step was to decide whether Luxembourg could justify its prima facie selective behaviour. Here, the reader needs to remember that the burden of

proof is on the Member State to demonstrate that the measure is justified by the nature or general scheme of its tax system. In other words, the Commission does not need to prove that it is not justified; the Member State has to shows that it, in fact, is. In this respect, the Commission took the view that Luxembourg had not put forward any justification for the favourable treatment enjoyed by the holding companies. It concluded that that treatment could not be justified by the nature or general scheme of the Luxembourg tax system. In any event, it stated that a hypothetical justification based on the avoidance of economic double taxation could not, in essence, be accepted. Its rather laconic reasoning here represents the fact that it is actually very difficult for a Member State to prevail once prima facie selectivity is established, since the categories/justifications allowed in this context are very few and very restrictively interpreted by the Court.

Having, in its view, established the selective nature of the alleged aid measure, the Commission went on to show how it also distorted competition (a low threshold to meet) and why it was incompatible with the internal market. From that point on, recovery was inevitable. The Commission ordered Luxembourg to take immediate action to recover the aid resulting from the first set of tax rulings, and to refrain from applying the second set of tax rulings.

The procedure before the General Court (as presented by the Court)

The Commission’s decision was challenged before the GC by both Luxembourg and Engie. The cases were joined and assigned to the extended composition of the Second Chamber. In support of its action, Luxembourg put forward six pleas in law, alleging, inter alia, incorrect assessment by the Commission of the selectivity of the tax rulings at issue. Engie put forward eight pleas in law in support of its action, six of which overlapped with those put forward by the Grand Duchy of Luxembourg. Engie maintained, in addition, that the tax rulings at issue could not be imputed to the State and that, in any event, the Commission had incorrectly classified them as individual aid.

The GC was not particularly sympathetic to all above pleas. In fact, it rejected all of the pleas raised in the aforementioned actions and dismissed the actions in their entirety. We will here only focus on the GC’s assessment of the selectivity argumentation of the Commission, which it entirely upheld.

First, the GC held that the Commission had not imposed its own interpretation of Luxembourg tax law when establishing the selectivity of those tax rulings, but had confined itself to setting out the provisions of that law, relying not on its own interpretation of that law but on that of the Luxembourg tax authorities. Also, the GC held that the Commission did not engage in any ‘tax harmonisation’, but merely exercised the power conferred on it by Article 107(1) TFEU. As we will see infra when we discuss the ECJ’s judgment, this is a contentious point.

The GC also upheld the way in which the Commission interlinked the conferral of a tax advantage with the existence of a derogation, thus killing two birds (advantage and selectivity) with one stone. The thorny issue, however, as we now certainly know, was the identification of the reference framework, i.e. the first step of the selectivity exercise. Engie and Luxembourg had argued that the Commission had incorrectly restricted the reference framework to the provisions applicable to purely internal situations. The GC, countering them, pointed out that the situation at issue was a purely internal one, since the holding companies, the subsidiaries and intermediaries concerned were established in Luxembourg. Consequently, the tax situations of those companies fell within the purview of the same tax authority, which excluded the risks of double taxation inherent in the application of different tax systems and the involvement of different tax authorities, which might exist in the case of cross border distributions.

Coming to the the reference framework itself, the GC rejected the applicants’ line of argument, according to which the definition of a reference framework limited to Articles 164 and 166 of the LIR alone was based on an incorrect combined reading of those two provisions. More specifically, they asserted that a ZORA did not entail a profit distribution for the purposes of Article 164, and, second, that Article 166 could not be interpreted as making entitlement to the exemption at the level of a parent company dependent on there being no tax deduction at the level of the subsidiary of the income generated during the ZORA.

The General Court, while recognising that Article 166 of the LIR did not make the grant of the exemption of income from participations at the level of a parent company formally dependent on the prior taxation of distributed profit at the level of its subsidiary, nonetheless held that the grant of such an exemption could be contemplated only if the income distributed by a subsidiary had been taxed beforehand, short of there being double non taxation of profit in a purely internal situation. In the second place, while also accepting that the ZORA accretions were not, formally

speaking, profit distributions, it held that the income from participations exempted at the level of LNG Holding corresponded, in essence, to the amount of those accretions, so that those accretions corresponded in practical terms, ‘in the very specific circumstances of the present case and against the background of a corporate structure involving a holding company, an intermediary company and a subsidiary, to profit distributions’.

For the sake of completeness, the GC also made yet another assessment. More specifically, it considered that it was appropriate to examine the selectivity of the tax rulings in the light of the reference framework comprising Article 6 of the Law on tax adjustment, on abuse of law, in view of the unprecedented nature of the reasoning adopted in that regard by the Commission. The GC found, in the first place, that the Commission had, as early as the decision to initiate the formal investigation procedure, drawn attention to the non application of that provision by the Luxembourg authorities and, subsequently, made a request to the Grand Duchy of Luxembourg and the Engie group to submit additional comments on that issue. The GC also noted, in the second place, that even though Article 6 of the Law on tax adjustment raised no difficulties of interpretation in the present case, the Commission had referred to both the administrative practice and the judicial practice in Luxembourg. It found, in the third place, that the criteria to be met under Luxembourg law in order to establish an abuse of law were met in the present case. It inferred therefrom that the Commission had demonstrated to the requisite legal standard that the Luxembourg tax authorities had derogated from the reference framework comprising Article 6 of the Law on tax adjustment (para. 67).

This is a key issue, and a brief critical comment is necessary here. The GC essentially found that the ‘intertia’ of Luxembourg in activating an existing tax provision to ‘catch’ the abuse of law committed by Engie was a factor which amounted to selectivity. If one thinks about it, it is quite a bold assertion, both by the Commission, which initially made it, and by the GC, which applauded the Commission by upholding it. This is paradigmatic case, in my view, of the Commission delving too deeply into national tax matters and infringing Member States’ tax sovereignty. Why is the Commission the appropriate party to judge whether the provisions of national tax law are fulfilled? Why is Luxembourg obliged to accept the Commission’s interpretation of a provision which acts, par excellence and in all jurisdictions adopting it, as a safety net? Why claim that there is a state aid advantage when an abuse of law procedure is not initiated against a taxpayer? If this is not something that needs to be reserved for the national tax authorities, one does not know what is (see para. 120 of the Court’s ruling infra).

In any case, whether one agrees or disagrees with the Commission and the GC on these points, the level of detail to which parties need to resort to identify the reference framework in fiscal aid cases is remarkable. National law reigns supreme, as shown in the Fiat case of November 2022,8 and its correct interpretation is frequently rendered tricky.

8. Judgment of the Court of Justice, Fiat

Whether one agrees or disagrees with the Commission and the GC on these points, the level of detail to which parties need to resort to identify the reference framework in fiscal aid cases is remarkable

The Relevant Case Law and Issues (as presented by the Court)

The Court started assessing the case before it in a very orthodox manner, i.e. by reminding the parties of certain self evident EU law ‘truths’. In para. 104, it stressed that action by Member States in areas that are not subject to harmonisation by EU law is not excluded from the scope of the state aid provisions of the TFEU. The Member States must thus refrain from adopting any tax measure liable to constitute State aid that is incompatible with the internal market. It then went on to repeat the state aid conditions and elaborate on what is needed in order to fulfill the selectivity test. In fiscal aid cases, the the determination of the reference framework is of particular importance, since the existence of an economic advantage for the purposes of Article 107(1) TFEU may be established only when compared with ‘normal’ taxation (para 108).

The Court went on to build on this reasoning, arguing (correctly) that the determination of the set of undertakings which are in a comparable factual and legal situation depends on the prior definition of the legal regime in the light of whose objective it is necessary, where applicable, to examine whether the factual and legal situation of the undertakings favoured by the measure in question is comparable with that of those which are not. Therefore, it is necessary that the common tax regime or the reference system applicable in the Member State concerned be correctly identified in the Commission decision and examined by the court hearing a dispute concerning that identification. Since the determination of the reference system constitutes the starting point for the comparative examination to be carried out in the context of the assessment of selectivity, an error made in that determination necessarily vitiates the whole of the analysis of the condition relating to selectivity.

In other words, the Court warns the Commission that a mistake in the identification of the reference framework will be sufficient, on its own, to make its entire State aid analysis collapse. How? Well, an improper identification would mean that selectivity is not present, and since all State aid conditions are cumulative, no State aid exists. The entire case is thrown out.

The Court then went on (para. 111) to firstly note that the determination of the reference framework, which must be carried out following an exchange of arguments with the Member State concerned, must follow from an objective examination of the content, the structure and the specific effects of the applicable rules under the national law of that State. So, national tax law is key! Only a very detailed analysis and understanding of the choices of national legislator will elucidate the reference framework.

Secondly, it stressed that, outside the spheres in which EU tax law has been harmonised, it is the Member State concerned which determines, by exercising its own competence in the matter of direct taxation and with due regard for its fiscal autonomy, the characteristics constituting the tax, which define, in principle, the reference system or the ‘normal’ tax regime, from which it is necessary to analyse the condition relating to selectivity. This includes, in particular, the determination of the basis of assessment, the taxable event and any exemptions to which the tax is subject. This is also key. Kindly note the emphasis placed by the Court on tax sovereignty. This is fully in the right direction, in my view, and the reflects the right balance between an exclusive EU competence (State aid) and Member States’ fiscal autonomy.

The Court warns the Commission that a mistake in the identification of the reference framework will be sufficient, on its own, to make its entire State aid analysis collapse

The Court’s in abstracto conclusion was, thus, inevitable (para. 113): only the national law applicable in the Member State concerned must be taken into account in order to identify the reference system for direct taxation, that identification being itself an essential prerequisite for assessing not only the existence of an advantage, but also whether it is selective in nature. Still, the Court made clarification, which will be familiar to state aid cognoscenti: there might be cases, like the infamous Gibraltar case,9 where the reference framework itself, as it results from national law, is incompatible with EU law on State aid, since the tax system at issue has been configured according to manifestly discriminatory parameters intended to circumvent that law.

Having set the scene, the Court went on to assess whether the Commission committed errors of law and/or distorted the facts in the determination of the reference framework in the Engie case. The Court referred (para. 119) to the principle of legality. This principle forms part of the legal order of the European Union as a general principle of law and requires that any obligation to pay a tax and all the essential elements defining the substantive features thereof must be provided for by law. Moreover, the taxable person must be in a position to foresee and calculate the amount of tax due and determine the point at which it becomes payable. This could be said to be an application of the broader rule of law principle to the area of taxation, via its subbranch of the principle of legality.

This finding led to one of the most significant dicta of the Court. More specifically, in para. 120 of its judgment, the Court held that ‘when determining the reference framework for the purpose of applying Article 107(1) TFEU to tax measures, the Commission is in principle required to accept the interpretation of the relevant provisions of national law given by the Member State concerned […], provided that that interpretation is compatible with the wording of those provisions’

This is absolutely crucial. Before moving on to para. 121 and the exception to this rule, let us try to explain the rule itself. The Court stressed that the Commission is in principle (i.e. as a default rule) obliged to accept the interpretation of national law which the Member State gives it, as long as the latter is compatible with the wording of those provisions. This clarification is self evident, i.e. the Member State should not engage in contra legem interpretation.

9. Judgment of the Court of Justice of 15 November 2011, Gibraltar (Joined Cases C‑106/09 P and C‑107/09 P, EU:C:2011:732).

As a rule, the Commission cannot second guess Member States’ interpretation of its own laws. This should go without saying, but evidently it needed to be said, and it was thankfully said loud and clear by the Court

What does this mean in practice? It means that, as a rule, the Commission cannot second guess Member States’ interpretation of its own laws. This should go without saying, but evidently it needed to be said, and it was thankfully said loud and clear by the Court. The rule is simple: Member States interpret their own laws, the EU interprets its own laws. This is straightforward, and reflects the rule of law principles and the principle of legality.

What is the exception? This is set out in para. 121. The Commision ‘ may depart from that interpretation only if it is able to establish, on the basis of reliable and consistent evidence that has been the subject of that exchange of arguments, that another interpretation prevails in the case-law or the administrative practice of that Member State’. So, the exception is not really an exception from the rule that only national law matters. It is an exception to the rule that the Commission needs to take the Member States’ submissions at face value. If it can establish that a Member State is essentially misreporting the legal position which actually applies in its national legal order, the Commission is allowed to go straight to the source and look at what happens on the ground, so to speak. This means that the Commission is allowed to disregard the Member State’s arguments in a specific case as regards the interpretation of the relevant provisions of national law, but, then, its only option is to examine national case law (national judicature) or administrative practice (national executive). This is a valuable safety valve, but it does not challenge the rule set out above.

What is the justification for this ‘exception’? the Court explained this eloquently in paragraph 122 of its judgment. In ‘accordance with Article 4(3) TEU, that Member State is bound by a duty of sincere cooperation throughout the procedure for the examination of a measure by reference to the provisions of EU law on State aid’. What this duty implies is that ‘that Member State must in good faith provide the Commission with all relevant information requested by it concerning the interpretation of the provisions of national law that are relevant for the purpose of determining the reference framework, as derived from national case-law or administrative practice’. Again, this is absolutely reasonable and in the right direction. EU law does dictate that Member States act in good faith and do not mislead the Commission.

Having set out the rule, the ‘exception’ and the justification for both, the Court went on to apply them to the facts of the Engie case. In para. 124, it found that the GC had departed from a literal interpretation of Luxembourg’s tax provisions. How, exactly, did it do so? Confirming the Commission’s approach, the GC first considered that the exemption of a holding company’s income from participations could be contemplated under Luxembourg law only if the income distributed by its subsidiary had been taxed beforehand. To reach this conclusion, it relied on two elements identified by the Commission in the decision at issue. The first of those is the letter of 31

January 2018, which was deemed ‘unambiguous’, since the Grand Duchy of Luxembourg acknowledged therein that ‘all [income from participations] eligible for the exemption scheme under Article 166 [of the] LIR [was] also covered by the provisions of Article 164 [of the] LIR’. Second, the General Court referred to the 1965 opinion of Luxembourg’s Council of State on the bill incorporating Article 166 into the LIR, in which it stated that that provision made it possible, ‘for reasons of fiscal equity and economic order’, to avoid double or triple taxation of distributed income, but not, in essence, to avoid the complete non taxation of that income.

The GC then took a bold step, finding it necessary to abandon the formalistic approach consisting of taking in isolation each of the transactions comprising the financial arrangement drawn up by the companies concerned and to go beyond the legal form in order to understand the economic and fiscal reality of that arrangement. This ‘exercise’ led it to hold that the ZORA accretions corresponded, in practical terms, ‘in the very specific circumstances of the present case, to profit distributions’. Therefore, after recalling the existence of a link, in Luxembourg law, between the exemption of income from participations at the level of a parent company and the deductibility of distributed income at the level of its subsidiary, the GC concluded that, ‘on account of that link and the consideration of the combined effect of those two transactions at the level of the holding companies concerned, the tax rulings at issue [derogated] from the … reference framework’ comprising Articles 164 and 166 of the LIR. It followed, first, that the Commission was fully entitled to infer from that combined effect that there was a derogation from that reference framework and, second, that the Commission had not erred in law by looking at the combined effect, at the level of the holding companies, of the deductibility of income at the level of a subsidiary and the subsequent exemption of that income at the level of its parent company.

The Court took issue with this train of thought, and rightly so. In para. 128 of its ruling, the Court underlined that the elements on which the General Court relied did not permit it validly to find that the Commission had been able to establish to the requisite legal standard that an interpretation prevailed in Luxembourg law other than that put forward by the Grand Duchy of Luxembourg, with regard to whether the exemption provided for in Article 166 of the LIR is made dependent on the taxation, at the level of the subsidiary companies, of the income exempted at the level of the holding companies. Moreover, it held that the wording of that provision (Article 166) did not formally establish such dependence. The Court then went on to debunk the GC’s reliance on the 2018 aforementioned letter and the 1965 opinion of the Council of State in order to make such bold inferences regarding the appropriate interpretation of Luxembourg’s tax law.

The conclusion was inevitable (para. 131). The GC’s analysis was vitiated by an error of law and a distortion of facts; thus, the first ground of the appeals had to be upheld.

Coming now to the second ground of the appeals, the appellants submitted four arguments. These were as follows. First, that the GC had adopted a manifestly incorrect premiss and that it distorted national law. Second, that the GC had erred in law in identifying the reference framework which it used in respect of abuse of law and that the GC judgment was vitiated by an inadequate and contradictory statement of reasons. Third, that there were errors in the demonstration of a derogation from that reference framework. Fourth, in the alternative, that the rights of defence of the Grand Duchy of Luxembourg had been infringed.

After describing the arguments of the appellants and presenting the Commission’s responses, the Court focused on the accusation that the GC had erred in finding that the Commission could establish the selective nature of the tax rulings at issue in the light of the reference framework comprising Article 6 of the Law tax adjustment without taking into account the national administrative practice relating to that provision. The Commission had done so on the grounds that that provision did not give rise to any difficulties of interpretation.

The Court recalled that classifying a tax measure as ‘selective’ presupposes not only familiarity with the content of the provisions of relevant law but also requires examination of their scope on the basis, inter alia, of the administrative and judicial practice of the Member State concerned (para 152). Secondly, echoing the Opinion of AG Kokott,10 the Court stressed that a provision intended to prevent abuse in tax matters horizontally, such as Article 6 of the Law on tax adjustment, is inherently particularly general in nature, and may be applied in a very wide range of contexts and situations.

Building on its aforementioned dicta relating to the importance of national tax law and tax sovereignty, the Court underscored the fact that the choice to lay down such a provision in national law and to define the manner in which the tax authorities are to implement it falls within the Member States’ own competence in the matter of direct taxation in areas that have not been harmonised under EU law and, therefore, within their fiscal autonomy (para. 154). Therefore, and in view of the nature of an anti abuse provision, the Commission could not conclude that the non application of that provision by the tax authorities led to the grant of a selective advantage. The only way in which such a conclusion can be reached is if that non application departs from the national case law or administrative practice relating to that provision (para. 155). Thus, what we observe, once again, is that the national legal order reigns supreme. Whether this is the national tax legislation (legislator), the national case law (judicature) or the national administrative practice (executive), the fact remains: in principle, the focus has to be the national tax choices of the fiscally autonomous Member States.

The Court underscored the fact that the choice to lay down such a provision in national law and to define the manner in which the tax authorities are to implement it falls within the Member States

10. Advocate General Kokott’s Opinion of 4 May 2023 in Engie (Joined Cases Case C‑454/21 P and Case C‑451/21 P, EU:C:2023:383).

The Court compellingly asserted that, if this were not the case, the Commission would itself be able to define what does or does not constitute a correct application of such a provision, which would exceed the limits of the powers conferred on it by the Treaties in the field of State aid review and would be incompatible with the fiscal autonomy of the Member States (para. 155). At this point, I think national tax lawyers, especially governments’ legal advisors, are tempted to frame this dictum and place it in their office so that they can gaze upon it every single day…

In light of the above, the Court concluded that the GC had erred in law when it held that the Commission was not required to take into account the administrative practice of the Luxembourg tax authorities relating to Article 6 of the Law on tax adjustment, on the ground that that provision did not give rise to any difficulties of interpretation (para. 156).

Having found that the first and second grounds of the appeals were well founded, the GC judgment under appeal had to thus be set aside, without it being necessary to rule on the other grounds of the appeals (para. 160). It is well established, according to Article 61 of the Statute of the Court of Justice of the European Union, that if the decision of the GC is set aside, the Court of Justice may itself give final judgment in the matter, where the state of the proceedings so permits (para. 161). This was judged to be so in the case at hand, since the pleas in law of the actions seeking annulment of the Commission decision were the subject of an exchange of arguments before the GC and examining them did not require the adoption of any additional measure of organisation of procedure or inquiry.

The Court went on to pinpoint the Commission’s errors and address them accordingly. For instance, it noted that the Commission had expressly acknowledged that, from an economic perspective, the income received from the conversion of the ZORAs was equivalent to such a profit distribution. Since that distribution was not taxed at the ‘appropriate’ level, the Commission found that there was a derogation from a reference framework comprising the rules of Luxembourg law on the exemption of income from participations and the taxation of profit distributions. That analysis was, however, vitiated by an error which vitiated the whole of the second line of reasoning on selectivity of the Commission.

The Court then went on to assess the pleas that the Commission erred in concluding that the tax rulings at issue had conferred selective advantages on LNG Holding and on CEF or on the Engie group in the light of a reference framework encompassing the Luxembourg corporate income tax system (para. 174). In this respect, the Commission had not considered that the exemptions provided for by the Luxembourg corporate income tax system and, in particular, the exemption provided for in Article 166 of the LIR, constituted in themselves an aid scheme, but that their application by means of the tax rulings at issue had conferred a selective advantage on the Engie group. Thus, the Commission had neither alleged nor established that Article 107 TFEU was infringed on account of the very existence of the relevant provisions of Luxembourg tax law (para. 175). Consequently, the reference framework itself, as it results from national law, is surely not per se incompatible with EU law on State aid (para 176).

Based on this understanding of the selectivity test, the Court went on to find that the misidentification of the reference framework by the Commission had vitiated the whole of the selectivity analysis

The next paragraph is arguably the most significant of all. In paragraph 177 of its judgment, the Court articulated a rule which should find itself in state aid textbooks, since it truly helps clarify and solidify, in my view correctly, the proper ‘exercise’ for identifying the reference framework in fiscal State aid cases. More specifically, the Court stressed that ‘the reference system or the ‘normal’ tax regime, on the basis of which the condition relating to selectivity must be analysed, must include the provisions laying down the exemptions which the national tax authorities considered to be applicable to the present case, where those provisions do not, in themselves, confer a selective advantage for the purposes of Article 107(1) TFEU’. It went on to add that in ‘such a situation, in the light of the Member States’ own competence in the matter of direct taxation and the regard to be had for their fiscal autonomy [...] the Commission cannot establish a derogation from a reference framework merely by finding that a measure departs from a general objective of taxing all companies resident in the Member State concerned, without taking account of provisions of national law specifying the manner in which that objective is to be implemented’.

Even if this judgment had gifted us no other dicta, this dictum alone is worth the candle. Based on this understanding of the selectivity test, the Court went on to find that the misidentification of the reference framework by the Commission had vitiated the whole of the selectivity analysis, which had been carried out on the basis of a reference framework encompassing the Luxembourg corporate income tax system.

The Court, having set aside the GC’s judgment, annulled the Commission’s decision and ended the Engie saga.

Key Takeaways and Broader Ramifications

The Grand Chamber ruling in  Engie is important for a variety of reasons. Firstly, it underscored the crucial role played by Member States’ fiscal autonomy, rendering this concept the silver thread binding this ruling together. To paraphrase Felix Frankfurter,11 US Supreme Court Justice, instead of ‘read the statute, read the statute, read the statute’, the rule in EU state aid law should henceforth be ‘read the national law, read the national law, read the national law (and case law and administrative practice)’.

11. https://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=12566&context=journal_articles

Secondly, the Court stressed that the reference system, namely the first crucial step in the selectivity test, must include the provisions laying down the exemptions which the national tax authorities considered to be applicable, where those provisions do not, in themselves, confer a selective advantage for the purposes of Article 107(1) TFEU. The significance of this dictum cannot be overstated.

Thirdly and finally, the Engie judgment represents yet another high profile defeat for the Commission, following a string of setbacks in fiscal aid cases in the past few years. The Court has, so far, compellingly defended Member States’ fiscal autonomy, thus guarding against creative interpretations of EU state aid law tackling issues which should only be addressed legislatively and not judicially.

The Engie judgment represents yet another high profile defeat for the Commission, following a string of setbacks in fiscal aid cases in the past few years