On 19 September 2018 the European Commission determined that the non-taxation of certain profits arising to McDonald’s Europe Franchising in Luxembourg did not amount to illegal State aid.

The Commission had investigated under EU State aid rules whether the double non-taxation of certain McDonald’s profits resulted from misapplication by Luxembourg of its tax laws and of the Luxembourg-US Double Taxation Treaty to reduce tax payable by McDonald’s. The EU State aid rules do not allow Member States to offer unfair advantages to selected companies and this also applies to illegal tax benefits.

McDonald’s Europe Franchising is a subsidiary of the US-based McDonald’s Corporation. The company is tax resident in Luxembourg and has two branches, one in the United States 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 It allocated these rights to the US branch of the company. McDonald’s Europe Franchising therefore receives royalties from franchisees operating fast food outlets in Europe, Ukraine and Russia and using 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 Luxembourg granted McDonald’s Europe Franchising a tax ruling confirming that the company was not taxable in Luxembourg as the profits would be subject to taxation in the United States. This was justified by reference to the Luxembourg – US Double Taxation Treaty, which exempts the income from corporate tax in Luxembourg if it may be taxed in the US. Under this ruling McDonald’s Europe Franchising was required to submit proof annually to Luxembourg that the royalties transferred to the US via Switzerland were subject to tax in the US and in Switzerland.

Luxembourg and McDonald’s then began discussions on the permanent establishment (PE) of McDonald’s Europe Franchising in the US. McDonald’s argued that although the US branch was not a PE under US tax law it was a PE under Luxembourg tax law. The royalty income should therefore be exempt from taxation in Luxembourg. In September 2009 Luxembourg issued a second tax ruling to confirm that McDonald’s Europe Franchising was no longer required to prove that the royalty income was subject to taxation in the US.

This second tax ruling resulted in the double non-taxation of the royalties attributed to the US branch, and the European Commission therefore investigated the background to the ruling. These investigations confirmed that the US branch of McDonald’s Europe Franchising did not fulfil the relevant provisions under the US tax code to be considered a PE.

The Commission found that Luxembourg could exempt the US branch of McDonald’s Europe Franchising from corporate taxation without violating the Double Taxation Treaty because the US branch could be considered a PE under Luxembourg tax law. The Commission therefore concluded that Luxembourg did not misapply the Luxembourg-US tax treaty when exempting the income of the US branch from Luxembourg taxation.

On 19 June 2018 draft legislation was introduced in Luxembourg to bring the relevant provision into line with the OECD’s BEPS recommendations. This would avoid similar cases of double non-taxation in the future as the conditions to determine the existence of a PE in Luxembourg would be strengthened. Luxembourg could also under certain conditions require companies that claim to have a taxable presence abroad to submit confirmation that they are subject to taxation in the other country.