The European Commission in Chapter 8 of its Screening Report for Serbia, emphasized that specific aid instruments related to the corporate profit tax were not fully in line with the acquis. Simultaneously, the Commission has made the same recommendations in regards to the Montenegrin direct taxation system.
This is highly relevant, given that harmonization of the subject tax schemes with the EU state aid rules, in case they prove unlawful, might be set as a “condition precedent” (legal benchmark), for opening and/or closing of Chapter 8 and, eventually, for the accession of both Serbia and Montenegro to the EU.
In case of Serbia, relevant provisions of the Corporate Profit Tax Act (“CPT Act”) provide legal grounds for an exemption from corporate profit tax duty for a period of 10 years if the following conditions are cumulatively met:
Bearing in mind that this specific provision formulates an exception to general principles of the tax regime in the Republic of Serbia, its implementation is perceived as contrary to state aid rules.
In Montenegro on the other hand, Article 31 of the Corporate Profit Tax Act provides the legal basis for a total exemption of profit tax for eight years, for newly established legal entities in underdeveloped municipalities. The total amount of said exemption cannot exceed EUR 200,000.00 for the period of eight years. The Commission emphasized in its Screening Report for Montenegro that this exemption, insofar as it constituted operating aid, was not clearly linked to a policy objective and was not proportionate, and therefore would not be regarded as compatible with the acquis.
Generally, benefits assigned to undertakings are to be treated as state aid if the following criteria are met:
Among the four listed criteria, “selectivity of the advantage” proves to be the main criterion in any state aid assessment. In order to determine whether certain benefit constitutes state aid, the Commission is to estimate whether, under a particular tax regime, a national measure to introduce the subject benefit, is of such nature as to favor “certain undertakings or the production of certain goods” in comparison with other undertakings that are, in light of the objective pursued by that specific tax regime, in a comparable legal and factual situation.
However, even a selective tax measure can be justified by the nature or general scheme of the tax system at hand. In this context, the Commission will presumably assess the following:
The fact that tax benefits represent an exception from an existing regime (as explained by the General Court of the EU) is not sufficient to consider the subject measure selective, particularly when such measure is potentially accessible to all undertakings (see for example, Case T-515/13 Spain v. Commission and T-719/13 Lico Leasing and PYMAR v. Commission).
However, where a measure poses a requirement of high minimum levels of investment or a requirement to offer a high minimum number of jobs, it might effectively exclude from its scope small and medium sized enterprises, and consequently be regarded as selective in size. What is more, as per words of the former European Commissioner for Competition Policy Mario Monti, the Commission tends to consider that the criterion of selectivity is fulfilled in the event that the examined tax provision benefits only large companies or groups of companies.
In Serbia, the controversial provision of the CPT Act (particularly due to strict criteria it introduces) opens a dilemma: is the preferential treatment introduced via this provision designed only for large companies? In other words, albeit de lege directed to every company operating in Serbia, it remains questionable whether the provision at hand de facto retains its non-discriminatory nature. This dilemma stems from the fact that, in order to receive the prescribed treatment, a taxpayer must employ at minimum 100 employees for an indefinite period of time and invest at minimum RSD 1 billion (about. EUR 8.4 million) in its fixed assets.
Therefore, it can be argued that the disputed provision de facto limits its own scope of applicability by the criteria it prescribes. Firstly, when it comes to the amount of investment required, it must be noted that said requirement cannot be equally satisfied by all undertakings. Not all the companies are equally profitable and/or have equal capital reserves. This, in turn, has implications on their capability to acquire additional resources, most notably, in the context of their borrowing capacity. Thus, from the perspective of the tax incentive at hand, profitable companies which are more creditworthy than others might be privileged in comparison to the companies which face hardships in obtaining additional sources of funding. Secondly, when it comes to the employment criterion, it must be noted that not all industries depend on manpower. In other words, undertakings conducting business in capital-oriented industries might find it irrational to employ one hundred employees (even when such decision would grant them access to the preferential tax treatment). It follows that the subject provision of the CPT Act can be seen as incentivizing companies operating in labour-oriented industries. These assessment criteria are only indicative of whether the tax measure at hand is selective or not. In order to make the final call on the matter, an in-depth analysis of the measure’s nature and its effects, as well as overall analysis of features of the national system would need to be carried out.
In Montenegro, the exemption of the corporate tax duty for businesses operating in underdeveloped municipalities might be at risk from the perspective of state aid rules. As a measure of general character, which does not relate to carrying out a specific project, it could be argued that this measure constitutes “operating aid”. According to the Commission’s established practice, operating aid is, in principle prohibited. The Commission authorizes operating aid only in exceptional cases and when it is subject to specific conditions (for example, in shipbuilding, certain types of environmental protection aid and in specific underdeveloped regions, including ultra-peripheral regions), provided that they are duly justified and their level is proportional to the handicaps they are intended to offset. What is more, any operating aid must, in principle, be digressive and clearly limited in duration.
Irrespective of whether the Commission, on the basis of the abovementioned and other criteria, eventually characterizes the subject tax exemptions as selective or not, the crucial question for determining whether they amount to illegal state aid is – can those exemptions be justified under the general scheme of the national tax systems or not? In this regard, it is the Commission’s position that only objectives inherent to the tax system, such as prevention of tax avoidance and double taxation, or the progressive nature of income tax, can be used to justify a selective tax measure. Extrinsic objectives, such as maintenance of employment, generally cannot be relied upon (Case C-6/12 – P Oy).
Finally, from the EU accession standpoint, if criteria similar to those in the Croatia’s Accession Agreement would apply, state aid granted via corporate profit tax exemption would not have the status of existing aid. Hence, there is a risk that the Commission would ask for reimbursement of the granted aid (if such aid is declared illegal), post-accession. The amount to be covered would be calculated on the basis of a comparison between tax actually paid and the amount which should have been paid if the generally applicable rule had been applied.
In this sense, a potential change of the CPT Act or Montenegrin Corporate Profit Tax Act (which would redesign the rules on corporate profit tax to make them fully compliant with state aid rule) appears as a viable option. However, said amendment could potentially raise other concerns from the perspective of the same state aid rules. Namely, in case of change of the relevant provisions of the mentioned acts, a potential problem could arise from the perspective of stabilization clauses in international investment agreements, which protect investors from adverse changes of laws in the host state. More precisely, if, due to subsequent change of tax acts contrary to a stabilization clause which would place an undertaking benefiting from said clause into a disadvantaged position, Serbia and/or Montenegro would be compelled to indemnify said undertaking for the damage suffered, this indemnification might also be regarded as state aid.
For instance, in the famous Micula case, as a condition of its accession to the EU, Romania repealed the tax incentives granted to the Micula brothers in 2004 because the EU considered such incentives incompatible with State aid rules. The repeal of those incentives triggered the dispute that the Micula brothers brought before an arbitration tribunal under the Romanian-Swedish bilateral investment treaty. Romania then found itself in a “catch 22” position. While Romanian funds were being burdened with the obligation to compensate the Micula brothers for the damages, in accordance with the arbitral award, the Commission simultaneously initiated a formal investigation against Romania, suspecting that payment of the damages awarded by the arbitral tribunal appeared to constitute state aid.
In its final decision, the Commission found that its state aid analysis cannot be prejudged by the fact that the aid was granted through the payment of compensation awarded by an arbitral tribunal. Namely, the Commission concluded that, if the effect of the arbitral decisions is contrary to EU norms and decisions, such decisions will also constitute sufficient ground for granting of illegal state aid, as the award itself would undoubtedly be aimed at reinstating a state aid measure that would be declared unlawful under the EU law.
As initially suggested, given all the, it follows that the amendments of the Serbian CPT Act and the Montenegrin Corporate Profit Tax Act are surely options worth considering, for the three main reasons:
Any such amendment would need to be done in such a manner as to take into account the interests of all stakeholders (especially interests of investors benefiting from the existing incentive schemes).
This article was previously published by Thomson Reuters/Practical Law and available on our website with the permission of the publisher
Authors: Marija Papić i Tatjana Sofijanić, Gecić Law
Sources: The primary source of the information contained in this article can be found on the webpage of legal database “Paragraf Lex”, in Serbian language. The link to the webpage is the following: http://www.paragraf.rs; “State aid: Commission orders Romania to recover incompatible state aid granted in compensation for abolished investment aid scheme”, European Commission Press Release Database, available at: http://europa.eu/rapid/press-release_IP-15-4725_en.htm
