Over the last 18 months, the European Commission (the Commission) has been investigating tax rulings granted to several multinational companies to determine whether they constitute impermissible state aid (see box "State aid"). Tax rulings are comfort letters issued by the tax authorities to an individual company on a specific tax matter.

On 21 October 2015, Margrethe Vestager, the EU Commissioner in charge of competition policy, announced that tax rulings given to Fiat by the Luxembourg tax authority and to Starbucks by the Netherlands tax authority were illegal state aid. These EU member states must now recover the unlawful benefit from the companies, which is estimated at around €20 million to €30 million each.

Fiat had a financing company in Luxembourg, Fiat Financing and Trade, which acted as a centralised group treasury company, carrying out activities similar to a bank, for example, dealing with cash pooling, external bank relationships, foreign exchange and risk management. Fiat Financing was granted a tax ruling in 2012 on the transfer pricing methodology to be used to determine its taxable profits, which gave Fiat Financing certainty about its tax position in Luxembourg, as was common practice there at the time.

The Commission found that Fiat Financing's tax ruling was unduly lenient. Although Fiat Financing used comparable market prices for interest rates and loan fees available for credit transactions between unrelated parties as a starting point when benchmarking its intra-group transactions, the Commission determined that the ruling was based on an artificial and extremely complex methodology. It included economically unjustifiable assumptions and downward adjustments that understated both Fiat Financing's capital deployed and its returns on that capital compared to industry norms.

As a result, Fiat Financing's profit did not depend on its actual returns, but was based on a low fixed amount of capital, with inappropriate risk weightings, and returns based on inappropriate comparables. The Commission estimated that the ruling produced a taxable profit that was only a 20th of what might be expected on an arm's length basis.

Starbucks had a coffee roasting company in the Netherlands, Starbucks Manufacturing EN BV, which was granted a tax ruling in 2008 on the Dutch tax treatment of two intra-group transactions. In the first transaction, it bought unroasted green coffee beans from a sister company in Switzerland. In the second transaction, it paid royalties to a sister entity in the UK for the licensing of know-how relating to the roasting of the beans. The UK entity was a limited partnership, and neither it nor its members were taxed in the UK or the Netherlands on its income.

The Commission found that Starbucks Manufacturing paid the Swiss company a significantly higher price for the coffee beans than an arm's length price, which could not be justified by the alleged quality of the beans. It also determined that the royalty paid to the UK limited partnership was much larger than could be justified.

The Commission determined that both Fiat and Starbucks had been granted a selective tax advantage by the relevant member state, arising from the member state agreeing to an artificial transfer pricing method that did not properly reflect the economic reality, which enabled the companies to pay less tax. In other words, the rulings agreed an arbitrary amount of tax payable with little proper transfer pricing analysis.

Fiat and Starbucks are likely to appeal against the Commission's determinations. The Commission also has ongoing in-depth investigations where it has raised concerns that tax rulings may give rise to state aid issues concerning Apple in Ireland and Amazon in Luxembourg. These companies may also appeal if the Commission's decisions go against them.

There are reasons to believe that at least some of these appeals, if brought, might be successful. For example, it might be found that the treatment is not selective because it was based on the general law and administrative practice of the tax authority in the relevant member state and that, in principle, a similar ruling was available to any taxpayer on request.

Even if Fiat and Starbucks were to lose their appeals, the Commission is unlikely to investigate the tax rulings granted to hundreds or thousands of other businesses to determine if there has been state aid. It is more probable that the Commission might investigate a few particularly egregious cases to encourage compliance by others. Member states could be asked to review historic rulings, although there seems to be little political appetite for that.

Tax authorities in several member states have already changed their tax ruling practice markedly, becoming much more reluctant to give tax rulings, which generally cover less ground and take longer to approve than when Fiat and Starbucks obtained their tax rulings.

In parallel, the EU has introduced a Directive that will require more transparency in relation to cross-border tax rulings, including the automatic exchange of rulings between tax authorities (the proposed Tax Ruling Directive amending Council Directive 2011/16/EU and repealing Directive 77/799/EEC). These changes should mean that there is much less chance of a tax ruling granted today being found to be illegal state aid at a later date.

Taxpayers that are currently relying on historic tax rulings similar to those in Fiat and Starbucks should review their position to determine if they might face claims of unlawful state aid. Advanced pricing rulings for transfer pricing purposes could be in danger if they depart from the Organisation for Economic Co-operation and Development's arm's length principles (www.oecd.org/tax/transfer-pricing/transfer-pricing-guidelines.htm). Advanced tax rulings that are just confirming the generally applicable law, for example, the debt treatment of instruments, the ability to claim a deduction for return on these instruments or whether withholding applies to those returns, do not seem open to challenge on state aid grounds.