On September 19th 2018, the European Commission (“Commission”) announced that it had concluded that the treatment of McDonald’s profits in Luxembourg did not constitute illegal state aid within the meaning of Article 107 of the Treaty of the Functioning of the European Union. In December 2015, the Commission had launched an investigation into two rulings granted by the Luxembourg tax authorities regarding the tax treatment of McDonald’s in Luxembourg.
According to the publicly available documents, McDonald’s Corporation (the “Parent”), which is a US resident, operated a subsidiary resident in Luxembourg (McDonald’s Europe Franchising, the “Subsidiary”). The Subsidiary operated a US branch. After obtaining the franchise rights from its Parent, the Subsidiary allocated these rights to the US branch. The Subsidiary received royalties from franchisees operating McDonald’s restaurants in Europe, Ukraine and Russia which were allocated to the US branch that held the franchise rights.
The rulings at issue confirmed that, under Luxembourg law, the Subsidiary’s US branch constituted a permanent establishment (“PE”) and was therefore exempt from Luxembourg corporation tax pursuant to the Luxembourg – US double tax treaty. On the other hand, the US branch did not constitute a PE pursuant to domestic US law and therefore was not liable to corporation tax in the US. In the second ruling, the Luxembourg tax authorities agreed with McDonald’s that it did not have to provide proof the US branch was effectively subject to tax. According to the Commission, this resulted in double non-taxation of the royalty income attributed to the US branch.
In its press release, the Commission concludes that the so-called double non-taxation of McDonald’s royalty income is the result of a mismatch between Luxembourg and US domestic tax laws rather than of a selective advantage granted by the Luxembourg tax authorities. The Commission takes the view that this mismatch nevertheless results from a correct interpretation of the double tax treaty by the Luxembourg tax authorities. Finally, the Commission notes that Luxembourg has taken steps to address these types of outcomes by submitting a draft law to parliament on June 18th 2018 (please refer to our newsletter of July 2018 for more details on the BEPS related amendments to the Luxembourg tax law). In a statement issued on the same day, the Luxembourg Minister of Finance acknowledged the Commission’s decision and welcomed the Commission’s recognition of the steps taken by Luxembourg to avoid similar cases in the future.