Case Overview (European Commission; decision adopted 2018, published 2019)
In SA.38945 (McDonald’s Europe), the European Commission examined whether Luxembourg tax rulings issued to McD Europe Franchising S.à r.l. improperly exempted profits attributed to a US “Franchise Branch” under the Luxembourg–US tax treaty, even though those profits were not taxed in the United States.
The Commission closed the investigation with a no-State-aid finding, concluding it could not establish a selective advantage because the exemption followed a legally defensible interpretation of the treaty as applied under Luxembourg law.
Key Facts
- Beneficiary: McD Europe Franchising S.à r.l., tax resident in Luxembourg, with:
- a US Franchise Branch (Oak Brook, Illinois); and
- a Swiss Service Branch (Geneva).
(Decision recitals 22, 29–33)
- IP/royalty structure (as described in the ruling requests):
- franchise rights were allocated to the US Franchise Branch; and
- the Swiss branch sub-licensed the rights and performed services, remunerated on a cost-plus basis (mark-up range redacted).
(Recitals 22, 31–33)
- Contested rulings (recitals 25–46):
- 30 March 2009 (initial ruling): accepted both branches as PEs and exempted their attributable profits in Luxembourg, subject to annual proof that profits were declared and subject to tax abroad.
- 17 September 2009 (revised ruling): accepted the adviser’s analysis that, for the US treaty exemption, Luxembourg did not require effective US taxation (thereby removing the practical “proof of US tax” condition for the US branch).
- Procedure:
- Commission opened the formal investigation on 3 December 2015 (recital 9).
- Final decision adopted 19 September 2018 (published later as Decision (EU) 2019/1252).
The Dispute
Luxembourg generally taxes resident companies on worldwide profits, but grants treaty relief where a double tax treaty applies. Under the Luxembourg–US treaty, Luxembourg must exempt income that, “in accordance with the provisions of [the] Convention, may be taxed in the United States” (Article 25(2)(a)), which connects to Article 7 (business profits attributable to a US PE). (Recitals 59–60)
In its Opening Decision, the Commission doubted the revised ruling’s treaty application: if (as argued in the ruling file) the US branch was not a sufficiently substantial US trade or business/PE under US concepts, the US might not be able to tax the income—so Luxembourg arguably should not have exempted it. The Commission’s preliminary concern was that this could amount to a misapplication of the treaty and thus a selective advantage. (Recitals 62–68)
Luxembourg and McDonald’s countered that:
- treaty terms not defined in the treaty are interpreted by each contracting state under its own law (Article 3(2));
- treaties allocate taxing rights to avoid double taxation but do not guarantee actual taxation; and
- absent a switch-over mechanism, Luxembourg could not “reclaim” taxing rights just because the US did not tax. (Recitals 70–76, 84–86)
Holding (No State Aid)
The Commission concluded that the contested rulings did not constitute State aid because it was not established that they derogated from the applicable reference framework (Luxembourg corporate tax system including the Luxembourg–US treaty) by misapplying the treaty. (Recitals 102, 109–115)
Key points in the Commission’s reasoning:
-
Treaty application turned on Luxembourg’s interpretation of undefined terms
While “permanent establishment” is defined in the treaty, the term “business” (and “business profits”) is not. Under Article 3(2) of the Luxembourg–US treaty, Luxembourg could apply its domestic meaning when applying the treaty. (Recitals 112–113)
-
Luxembourg could treat the US branch as a PE under Luxembourg law
The Commission saw no reason to disagree with the adviser’s conclusion that the US Franchise Branch constituted a PE under Article 16 StAnpG (Luxembourg’s PE concept). Therefore, Luxembourg did not misapply the treaty by concluding the income “may be taxed” in the US for treaty-exemption purposes, even if US tax outcomes differed. (Recitals 114–115)
-
Actual US taxation (and Luxembourg’s knowledge of it) was not decisive
Contrary to the preliminary approach in the Opening Decision, the Commission accepted that—where the issue is a difference of interpretation—Luxembourg’s exemption is not invalidated merely because the US does not tax and even if Luxembourg was aware of that outcome. (Recitals 113, 115–117)
-
Double non-taxation was treated as a mismatch outcome, not selective treatment
The Commission viewed the non-taxation as mainly resulting from the US not exercising (or not having, under its domestic interpretation) the taxing right Luxembourg assumed it had allocated under the treaty. The Commission also considered (and ultimately rejected) characterising the case as a conflict of qualification; it found instead a difference of interpretation of the same treaty provision (Article 5), and noted the treaty lacked a switch-over-type mechanism addressing that scenario. (Recitals 117–121)
Takeaways for Practitioners
- State aid risk hinges on proving a “derogation”: even politically contentious “double non-taxation” does not automatically equal State aid; the Commission must prove a selective advantage grounded in a misapplication of the applicable rules.
- Treaty interpretation clauses matter: Article 3(2)-type “undefined terms” rules can be outcome-determinative where countries interpret PE/business concepts differently.
- Mismatch governance is often legislative/treaty-based: the decision highlights that remedies may lie in treaty renegotiation/MAP or domestic law changes—rather than retroactive State-aid recovery.
Related Content
For practical compliance steps, see our Transfer Pricing Documentation Guide. For core concepts used when assessing profit allocations (including for branches/PEs), revisit the Arm’s Length Principle.
Frequently Asked Questions
Q1. What did Luxembourg’s rulings do?
They confirmed that profits attributable to McD Europe’s US Franchise Branch (and Swiss branch) were exempt from Luxembourg corporate income tax under Luxembourg’s application of its tax treaties. The initial ruling required annual proof of taxation abroad; the revised ruling accepted that effective US taxation was not a condition for the US-branch treaty exemption.
Q2. Why was there double non-taxation?
Because Luxembourg exempted the income under its treaty analysis, while—based on the facts described in the file—the US did not tax the branch profits under US domestic concepts (trade-or-business/effectively connected income and PE substance thresholds). The result was a mismatch.