McDonald's Luxembourg deal did not break tax rules

A lengthy investigation by the European Commission has concluded that Luxembourg did not offer illegal state aid to McDonald’s with favourable tax treatments, and the reason for the double non-taxation was down to a mismatch between Luxemburg and US tax rules

The Commission’s investigation began in December 2015 and looked at whether Luxembourg had offered the US giant selective tax treatment and might have misapplied its double taxation treaty with the US. It has concluded that Luxembourg's tax treatment of McDonald's Europe Franchising does not violate this treaty and on that basis, the tax rulings granted to McDonald's do not infringe EU state aid rules.

McDonald's Europe Franchising is a subsidiary of McDonald's Corporation, based in the US. The company is tax resident in Luxembourg and has two branches, one in the US and the other in Switzerland. In 2009, McDonald's Europe Franchising acquired a number of McDonald's franchise rights from McDonald's Corporation in the US, which it subsequently allocated internally to the US branch of the company.

As a result, McDonald's Europe Franchising receives royalties from franchisees operating McDonald's fast food outlets in Europe, Ukraine and Russia for the right to use the McDonald's brand.

McDonald's Europe Franchising also set up a Swiss branch responsible for the licensing of the franchise rights to franchisors and through which royalty payments flowed from Luxembourg to the US branch of the company.

In March 2009, the Luxembourg authorities granted McDonald's Europe Franchising a first tax ruling confirming that the company did not need to pay corporate tax in Luxembourg since the profits would be subject to taxation in the US.

The Luxembourg authorities and McDonald's then engaged in discussions concerning the taxable presence of McDonald's Europe Franchising in the US (a so-called ‘permanent establishment’). McDonald's claimed that although the US branch was not a ‘permanent establishment’ according to US tax law, it was a ‘permanent establishment’ according to Luxembourg tax law. As a result, the royalty income should be exempt from taxation under Luxembourg corporate tax law.

The Luxembourg authorities ultimately agreed with this interpretation and, in September 2009, issued a second tax ruling according to which McDonald's Europe Franchising was no longer required to prove that the royalty income was subject to taxation in the US.

Commissioner Margrethe Vestager, in charge of competition policy, said: ‘Our in-depth investigation has shown that the reason for double non-taxation in this case is a mismatch between Luxembourg and US tax laws, and not a special treatment by Luxembourg. Therefore, Luxembourg did not break EU state aid rules.

‘Of course, the fact remains that McDonald's did not pay any taxes on these profits – and this is not how it should be from a tax fairness point of view. 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.’

In June, the Luxembourg government introduced draft legislation to amend the tax code to bring the relevant provision into line with the OECD’s base erosion and profit shifting (BEPS) project and to avoid similar cases of double non-taxation in the future. This is currently being discussed by the Luxembourg Parliament.

Under the proposed new provision, the conditions to determine the existence of a permanent establishment under Luxembourg law would be strengthened. In addition, Luxembourg would be able to, under certain conditions, require companies that claim to have a taxable presence abroad to submit confirmation that they are indeed subject to taxation in the other country.

Report by Pat Sweet

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