UK tax exemption ruled to be illegal State aid: reports emerge that HMRC may have to recover “tens to hundreds of millions of pounds” from beneficiary businesses.

We are grateful to Jonathan Branton and Alexander Rose of DWF for contributing this article. 

On 2nd April 2019 the European Commission concluded that a tax break introduced in the Finance Act 2012 constitutes unlawful State aid to certain multi-national businesses. The European Commission has directed the UK Government to identify the tax liability of beneficiary businesses ahead of recovery which is “expected to be in the range of tens to hundreds of millions of pounds” according to sources quoted in the Financial Times. This finding will reignite the fierce debate about whether the European Commission should be using State aid law as a weapon to tackle international tax avoidance and whether the EU Treaty principle of freedom of establishment is being eroded.

The Controlled Foreign Company Rules and the Group Financing Exemption

The UK’s Controlled Foreign Company rules (“CFC Rules”) are designed to prevent companies in the UK avoiding or deferring taxes by shifting profits to subsidiaries in low tax jurisdictions. The CFC Rules operate by subjecting certain profits of overseas subsidiaries to UK tax. The UK’s CFC Rules were amended with effect from 1 January 2019 following the adoption of the Anti-Tax Avoidance Directive (ATAD) and the European Commission has confirmed that it has no concerns about the compliance of the amended CFC Rules.

However between 1st January 2013 and 31st December 2018, the UK’s CFC Rules included a tax exemption called the Group Financing Exemption (“GFE”) that provided a full or partial (75%) exemption for finance income (interest payments received from loans) between non-UK members of a corporate group. The exemption applied even where the income was generated from UK activities and was therefore considered by the European Commission to operate as a proxy for the actual level of tax due (as the exemption of 100% or 75% was not based upon accurate verification of the amounts due).

In October 2017 the European Commission launched a formal investigation into the CFC Rules, alleging the GFE regime provided a selective and unjustified advantage to UK parent companies with subsidiaries based in non-UK jurisdictions. In line with European Commission procedures, a prima facie case was published and interested parties were invited to provide responses.

European Commission Decision dated 2nd April 2019

In April 2019 the European Commission published its findings (the full decision will be published in due course), reaching different conclusions on the application of the GFE depending upon whether or not the finance income is derived from UK activities.

Where the GFE relates to finance income that is not generated from UK activities the European Commission concluded that the exemption is justifiable and proportionate. Having considered representations from the UK Government, the European Commission accepted that the alternative (for the Member State to pursue complex intra-group tracing exercises to verify the percentage of profits funded through UK funds or assets) would be disproportionately burdensome and therefore the use of a proxy rate can be justified. As a justified measure, this part of the GFE is considered ‘no aid’ under State aid law.

However, when the finance income derives from UK activities (even though the financing is through offshore companies) then the GFE is considered not to be justified. This is because, the calculation to assess the proportion of finance income sourced from UK activities is not considered to be particularly complex or burdensome.  As a result, the use of a proxy rate cannot be justified and actuals should be sought instead.  The Commission found this to have resulted in undue advantage arising to a number of companies accordingly.

The European Commission regards the measure to be illegal State aid because the multi-national companies that were able to use the GFE for finance income generated from UK activities were placed in a better position than their competitors who were required to pay the UK standard rate of tax.

Recovery

The UK has been directed to reassess the tax liability of companies who received unlawful State aid by utilising the GFE in respect of finance income from UK activities.

Under Article 16 of Council Regulation (EU) 2015/1589 (the “Procedural Regulation”) following a finding of unlawful State aid, the Member State is obliged to take action to recover the funding from the beneficiary with interest backdated to the point the State aid was awarded.  The funding should be returned to the funder, which in this case will be the UK Government.  As interest is applied, the value of the aid to be repaid will always be greater than the initial benefit.  All those companies who have benefited from the scheme in respect of financing UK activities should therefore expect to hear from HMRC on this issue and make provision accordingly, if they have not already done so.

State aid as a means to address international tax avoidance

This finding represents the latest chapter of the European Commission using State aid law to address international tax avoidance. This has included findings against Luxembourg and the Netherlands in respect of Fiat and Starbucks (for €23.1 million and €25.7 million respectively), against Ireland in respect of a ‘sweetheart tax deal with Apple (which led to recovery of €14.3 billion), against Luxembourg in respect of Amazon (resulting in the recovery of €282.7 million) and against Gibraltar (involving multiple beneficiaries with a value of c. €100 million). There are currently two other live European Commission investigations into tax arrangements relating to Dutch tax arrangements (with Inter IKEA and Nike) and tax rulings in Luxembourg (Huhtamäki), although there may be others which are still in their initial stages.

Although there has been criticism of the initiative, the European Commission appears committed to its policy. Commenting on the GFE case, the Commissioner for Competition, Margrethe Vestager stated that “Anti–tax avoidance rules are important to ensure that all companies pay their fair share of tax. But they must apply equally to all taxpayers. The UK gave certain multinationals a selective advantage by granting them an unjustified exemption from UK anti–tax avoidance rules. This is illegal under EU State aid rules. The UK must now recover the undue tax benefits.”

Next Steps

For the time being the UK has not issued a public statement on the European Commission decision. The UK may choose to accept the decision, in which case HMRC will check and seek recovery from beneficiaries. Alternatively, the UK could seek to overturn the decision by making representations in the General Court (or thereafter the CJEU). To do so, litigation would normally need to be initiated within 2 months of the decision being published in the Official Journal of the European Union.

Brexit

Brexit has the potential to affect the implementation of the State aid decision. In the event of a no deal exit as of 13 April 2019 (which remains possible as at the time of writing), then there would appear to be no legislative obligation for the UK to be required to recover the aid (NB. there would be no basis on which to do this through World Trade Organisation rules). However, given the Government’s draft State Aid (EU Exit) Regulations 2019 create a new UK State aid law regime enforced by the Competition and Markets Authority that is dynamically aligned with the existing EU rules on State aid there would, at the very least, appear to be a political willingness to sustain EU rules in substance, which would include seeking to give effect to rulings of the European Court of Justice handed down prior to the UK’s formal exit.

In the event of a revocation of Article 50 then the European Commission would continue oversight over State aid law. If the existing draft UK-EU Withdrawal Agreement is adopted then under Article 93 the Competition and Markets Authority will be set up to take on State aid responsibilities only after the transition period had ended, ie. 1 January 2021, with EU rules and jurisdiction in State aid continuing until then.  During the transition period the European Commission will maintain oversight of State aid law (and may take action to address any instances of unlawful State aid awarded during this time, and for a period of 4 years thereafter).

Conclusion

This case is a reminder that it is incumbent upon the beneficiary of public support, (whether this is in the form of a grant, guarantee, tax exemption or otherwise) to make its own assessment of compliance with the State aid rules.  Failure to do so can result in the repayment of a sum greater than the initial value of the aid received and an expectation that the aid was legitimate does not override this.  This case also highlights how emerging themes, in this case the European Commission’s recent focus upon using State aid to tax avoidance and Brexit negotiations, can change the risk profile of companies considering whether to accept State aid.

Jonathan Branton                                                   Alexander Rose

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Application of the private investor test in State aid cases: lessons from the EDF saga.

We are grateful to Sophie Bertin, Rolf Ali, and Geoffrey Kalantari of Covington & Burling for the following note.  We welcome similar contributions (which could be in the form of a case note or article) on any State-aid related topic (including policy and economics as well as law): email gperetz@monckton.com. 

 

On 13 December 2018, the European Court of Justice (“ECJ”) rejected an appeal by Electricité de France (“EDF”) against a General Court (“GC”) judgment confirming a Commission decision ordering France to recover EUR 1.37 billion in State aid from EDF (Case C-221/18 P EDF v Commission). The ECJ judgment confirms that the aid, which had been granted back in 1997, had to be recovered. The EDF saga provides several lessons on how the private investor test should be applied by the Commission and on the burden of proof imposed on the Member State under this test.

 

The facts

 

In 1997, the French State restructured EDF’s balance sheet and increased its capital. As part of that restructuring, EDF, which was wholly-owned by the French State, was granted a tax break of EUR 888.89 million on its corporate tax. This formed part of a wider effort to clarify the legal and financial regime under which EDF operated, in order to prepare for the opening up of the Internal Market for electricity in 1998.

 

Previous EC Decisions and Judgments

 

In 2003, the European Commission (“EC”) adopted its first decision (SA.13869 EDF) which concluded that the EUR 888.89 million waiver of the corporation tax liability, granted as part of EDF’s restructuring effort, constituted State aid that strengthened EDF’s position in the Internal Market. The EC estimated that the total amount to be repaid, including interest, amounted to EUR 1.37 billion.

 

The GC annulled the EC’s decision in 2009, stating that it had failed to apply the “private investor test” (Case T-156/04 EDF v Commission). According to the Court, the EC could not conclude that the measure was State aid merely by reason of its fiscal nature. Instead, it should have assessed whether a private investor would have acted to preserve its investment in the same way as the French State in such circumstances. If not, it must have acted as a public authority.

 

The ECJ agreed in 2012 (Case C-124/10 P Commission v EDF). In its judgment, the ECJ also clarified that, while the EC could not ignore the private investor test merely because the measure was a fiscal one, the State bore the burden of proving that it had acted as a private investor.

 

In 2013, its initial decision having been annulled, the EC  re-opened its  investigation. It concluded in 2015 that the tax break granted by the French State did not satisfy the private investor test and the decision to grant a tax break had been made in its capacity as a public authority rather than as a shareholder.

 

EDF again appealed the EC’s decision to the GC (Case T-747/15 EDF v Commission). The GC dismissed EDF’s appeal on the basis that the French State had failed to show during the administrative procedure that it had acted as a private investor by evaluating the profitability of its investment in EDF before granting the tax break. The EC was therefore right to consider that the measure was State aid because the French State had acted as public authority rather than as a private investor. EDF subsequently appealed to the ECJ.

 

The 2018 ECJ Appeal

 

On appeal to the ECJ, EDF brought five claims, all of which were rejected.

 

First, EDF argued that the GC did not fulfil its obligation to state reasons for its decision and distorted evidence. The ECJ rejected those claims, stating that the GC had adequately set out why the measure at hand was the tax consideration, and not the recapitalization of EDF.

Second, the ECJ confirmed that the GC had correctly applied the principles stemming from the Frucona Košice judgment (Case C-300/16 P Commission v Frucona Košice), which obliges the EC to review evidence that could show that the measure in question fulfils the private investor test, despite the fact that the GC’s judgment made no reference to that case.

 

In its 2015 Decision, the EC took heed of the initial judgment of the ECJ as to the need to review all the available economic evidence in concluding that the tax break did not meet the private investor test. The EC’s conclusion having been confirmed by the GC, on appeal, the ECJ confirmed that the EC had taken into account all elements available to it to decide that the measure did not meet the private investor test. It also noted that EDF had not brought any new evidence that the EC had not already considered.

 

Lastly, EDF also argued that the GC infringed the principle of res judicata by ruling on the same matter twice, once in 2009 and again in early 2018. However, the ECJ confirmed that the cases were indeed different, given the second investigation and newly adopted EC decision.

 

Sophie Bertin, Rolf Ali, and Geoffrey Kalantari

Covington & Burling

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The State Aid (EU Exit) Regulations 2019: some initial comments

The State Aid (EU Exit) Regulations 2019, published in draft on 21 January, set out a replacement State aid regime for the United Kingdom on exit day in the absence of any withdrawal agreement. At this point in time, it very difficult to forecast whether or not there will be a withdrawal agreement, or whether Brexit will be postponed or even revoked. But even readers who are confident that a “no deal” Brexit will not happen should have a quick look at the Regulations, as they give an indication of the sort of domestic State aid regime that the Government has in mind as part of the final arrangement with the EU.

The starting point here is to remember that the effect of section 4 of the EU (Withdrawal) Act is that Article 108(3) of the TFEU – the right to a remedy by those affected by unlawful State aid – remains, along with the definition of State aid in Article 107(1) on which it depends, part of domestic law after exit day. The only way of stopping that outcome would (probably) have been to pass domestic legislation repealing that Article. But the Government has not done that: instead, it has decided to preserve a State aid regime.

Two immediate challenges arise.

Effect on trade

The first challenge is one of substance. The State aid rules apply, only, to aids that affect trade between Member States. That threshold may not be set very high: but it is an important one and has resulted in “no aid” decisions (see, for example, SA.38441 Isles of Scilly Airport (no effect on trade as runway too short for more than very small planes, unable to fly further than 30 minutes to the Cornish mainland as too small for a loo).  If the Secretary of State had decided to replace “trade between Member States” with “trade within the United Kingdom” (cf the “translation” of Article 101(1) TFEU in section 2 of the Competition Act 1998), then a number of grants that would not now count as State aid would undoubtedly have fallen into the domestic State aid regime – a point made at §6.19 of the Explanatory Notes.  On the other hand, replacing “trade between Member States” with “trade between the United Kingdom and any other country” would potentially have widened the rules.  Faced with those alternatives, one can see why the Secretary of State opted to retain the current position, so that the UK test now covers a State aid “so far as it affects trade between the United Kingdom and the European Union”: regulation 2(4).  But that option does have the odd consequence that, even on a “no deal” Brexit” in which the EU becomes in every other respect a third country, it is only aids that affect trade with the EU that will be subject to the regime: a result which is even odder when one remembers that on a “no deal”, in the EU, aids that affect only trade between the EU and the UK will not be subject to Articles 107 and 108.

The role of the CMA

The second challenge arises because Article 108(3) presupposes an apparatus for the notification and approval of State aid by the European Commission – set out in Article 107, as well as other provisions such as Article 93 – which vanishes on exit day. That apparatus has to be reconstructed domestically – and it is that reconstruction that occupies the bulk of the Regulations.

As earlier announced, the CMA plays the central role in the system occupied by the Commission. But that central role is subject to three caveats.

First, and understandably in the UK constitutional order, the CMA is not granted the power that the Commission has to set aside an Act of the UK Parliament on the basis that it is a State aid measure (although, as I wrote earlier on this blog, the CMA would have that power under the “backstop protocol”). Instead, regulation 4(5) and Schedule 3 set out a mechanism for the CMA to report on whether an Act of the UK Parliament – say, a tax measure – involves a State aid and if so whether it is compatible. But the UK Parliament can ignore such a report if it wishes to. Note, here, though, that it is only the UK Parliament that enjoys this carve out: although there is no express provision to this effect, there is no doubt that an Act of the Scottish, Welsh, or Northern Ireland Parliaments that granted an aid would be fully subject to the notification requirement and the CMA’s powers to declare an unnotified or unapproved aid to be contrary to Article 108(3) and hence unlawful and to order termination of it. The grant to what is, at the end of the day, an organ of the UK Government of such a power to set aside Acts of the devolved Parliaments may well be controversial.

The second caveat is that the Secretary of State is given power to issue guidance to which the CMA must have regard when assessing compatibility (regulations 5(2) and 56). The Secretary of State has to consult the devolved governments (as well as the CMA) (regulation 56(2)) but, at the end of the day, it is his decision. Further, in assessing compatibility, the CMA has to have regard to its own statements of policy (though until it does so, the Commission’s current statements of policy continue to apply) – but those statements of policy have to be approved by the Secretary of State (this time, without any formal role for the devolved governments): regulation 54. The effect of all this is to place a lot of the power to set policy in the hands of the Secretary of State: a position that those with concerns about the attitude to State aid policy of a future government led by Mr Corbyn might well wish to reflect on.

The third caveat is a carve-out for “urgent cases”: see regulation 57. This provision might be thought to have been inspired by the power of the Council to approve aid in “exceptional circumstances” under Article 108(2): but §§6.20-6.24 of the Explanatory Notes do not refer to that provision but instead state that the caveat is needed to prevent a “deficiency in retained EU law related to the UK not having the same concept of compatibility with the EU internal market after EU exit” (a passage I find a bit hard to follow) – and indeed §7.4 of the Explanatory Notes state that it was not thought appropriate to carry over that power of the Council. In any event, “urgent cases” are defined as aids: to remedy a serious disturbance in the UK economy; to preserve financial stability (presumably inspired the dramatic events of 2008); and to prevent serious social hardship. The effect of the carve-out is, however, limited: the aid can be put into effect immediately and without notification/clearance, but it then has to be notified and cleared, and, if it is not, the aid can be recovered (see regulation 57(5)). The impact of the provision is therefore simply to limit the possibility of seeking an injunction in the courts to restrain such a measure if it is implemented before being cleared.

Notification – improvements vis-à-vis the EU regime

There are two obvious improvements compared to the EU regime.

First, notification may be made by the aid grantor directly: an aid grantor that fears that the grant may amount to aid does not have to go through the process of persuading BEIS to make a notification.

Secondly, the CMA is given a 40 working day deadline to approve an aid or to open a phase 2 investigation (regulation 8): if it fails to meet that deadline the aid can be lawfully implemented provided that notice of implementation is given to the CMA. As to phase 2 investigations, the CMA is given 18 months to take a decision (regulation 13): that period is not, however, significantly better than many Commission phase 2 investigations (and the Commission has difficulties of translation that the CMA will not have).

Enforcement and procedure

The powers given to the CMA to order termination and recovery of unlawful aid look very familiar, as does the limited basis on which recovery orders can be resisted (10 year limitation period; legitimate expectation created by the CMA: regulation 40(2)).

One aspect of concern is that little is done in the Regulations to improve the procedural position of the beneficiary of aid. The beneficiary has no power to notify what it suspects may be an aid (though, in practice, a refusal to proceed with the project unless the aid grantor notifies is likely to be effective). More seriously, the beneficiary is treated simply as an “interested party” and is not, for example, given the right enjoyed by the aid grantor to comment on representations made by others (regulation 10) or the right to be informed of a complaint (regulation 33). Since the beneficiary is the entity most seriously affected by the finding of unlawful and incompatible aid, that is a serious flaw (albeit one that the EU Courts have systematically turned their face against addressing). It may be noted that there is powerful argument that the lack of procedural protection for the beneficiary in the EU regime is inconsistent with Article 6 ECHR: a question on which the Strasbourg court has yet to opine.

Appeals

The Regulations are entirely silent about appeals from decisions of the CMA (apart from a reference in Schedule 5 to appeals to the court against administrative penalties). It follows – as §7.15 of the Explanatory Notes makes clear – that the only remedy for anyone wishing to challenge a CMA decision will be judicial review in the High Court or Court of Session. The decision not to give the power of judicial scrutiny to the Competition Appeal Tribunal is presumably a conscious decision by the Secretary of State, though it is not explained in the Explanatory Notes. It is a somewhat odd decision given the CAT’s expertise in competition and economic analysis and the fact that most CAT judges (unlike High Court judges) will have had some exposure to State aid law in the course of their practice. One hopes that the reason for avoiding the CAT is not the concern that the CAT would be more inclined to scrutinise the reasoning of CAT decisions than would be a High Court or Court of Session judge: if it is, the tactic may backfire if, as is quite possible, the CMA finds the High Court to be less inclined to accept generally understood notions of how the concept of “aid” is to be applied than the CAT.

Conclusion

There are a large number of detailed points about the Regulations that one could make, and those interested should certainly read, with care, the Explanatory Notes. Given their importance, they certainly call for scrutiny by Parliament under the Withdrawal Act mechanisms. If – as most hope – they never come into effect, the work done will not be wasted as it is likely to inform the final UK State aid regime set up after the expiry of transition.

George Peretz QC

19 February 2019

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Damp squib or shot across the bows?: the General Court gives judgment on the first of the advance ruling tax cases

The General Court today gave judgment on the first of the current round of advance tax ruling (“ATR”) cases (the most famous of which is probably the Apple/Ireland case). The case before it concerned the taxation of excess profits by Belgium (Joined Cases T-131/16 and T-263/16 Belgium and Magnetrol International v Commission ECLI:EU:T:2019:91).

As those following these cases will know, the key issue is the question of selectivity: did the treatment of the taxpayer under the ATR amount to a selective advantage?

Unfortunately for those seeking enlightenment on the General Court’s approach to that fascinating and controversial question, the General Court did not consider that issue at all. That was because it was able to quash the Commission’s decision on another point, namely the Commission’s description of the Belgian regime under which the ATRs were issued as an “aid scheme”. The key requirement of an “aid scheme” is that it sets out who is entitled to the aid and what the conditions of entitlement are, leaving the granting authority with no discretion other than to apply the technical criteria of the scheme. The General Court analysed the Belgian legislation at issue and found that it did not meet those tests: too much discretion was left to each individual ATR decision.

That aspect of the judgment is of interest to those needing to apply the general concept of “aid scheme” (and to those interested in the particular Belgian tax legislation at issue): but it does not throw any light on how the Court will approach case such as Apple/Ireland, where what is alleged is an individual aid rather than an aid scheme.

The only point which is of relevance to the Apple/Ireland and similar cases is the Court’s firm dismissal of submissions by Belgium and the beneficiary (supported, unsurprisingly, by Ireland) to the effect that the Commission’s approach to ATRs interfered with the power of Member States to determine their direct taxes. The Court repeats the general response, namely that that power nonetheless has to be exercised in conformity with the State aid rules. That is the only clue to the Court’s likely approach to Apple/Ireland – though only a very faint clue, given that the point is well-settled.

George Peretz QC

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Study on State aid and the use of cooperation tools

As some of you may be aware, a study is in hand on State aid and the use of judicial cooperation tools. The survey response is going well. Arranging phone interviews with judges who have experience of State aid cases has, however, turned out to be rather difficult, and for several countries those doing the study lack any response. In particular input is missing for Ireland, the United Kingdom, Austria, Hungary and the Czech Republic.

Those carrying out the study have therefore turned to the Association of European Competition Law Judges for help, and UKSALA has been contacted to help get the word out.

Is anyone aware of any State aid activity in the above jurisdictions that might mean that a judge/judges working in any of those countries might be willing to participate in an interview ? If so please send an e-mail to aeclj@catribunal.org.uk

 

 

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Government publishes State aid rules if there’s no deal

The Government has laid regulations under the EU Withdrawal Act setting out the domestic State aid regime that will apply on a no deal.

The CMA’s guidance is here.

I hope to comment on the regulations on this blog in the next few days.

 

George Peretz QC

 

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Ensuring a level playing field post-Brexit: State aid control

UKSALA members may be interested in a very good article by Vincent Verouden and Pablo Ibanez-Colomo available here.

One issue leapt out at me, which concerns the backstop.  (Readers who have decided that the backstop, or indeed the withdrawal agreement itself, will never happen can switch off now.)

Under the backstop, the CMA will apply EU State aid rules in relation to measures affecting EU/UK trade.  In considering compatibility, it will be obliged to consider the interests of the EU27+the UK as a whole.  But it doesn’t seem to be as obvious as one would have thought it should be that the Commission has to consider the UK interest when applying the State aid rules in the EU27 during the backstop period.  This point was picked up (in slightly sensational terms) by a recent piece in the Financial Times (£).

The authors of the paper refer to Article 7(1) of the body of the Withdrawal Agreement.  But I am not sure that that provision helps.  It provides that “For the purposes of this Agreement, all references to Member States … in provisions of [EU] law made applicable by this Agreement shall be understood as including the United Kingdom.”  But when the Commission is applying Articles 107 and 108 TFEU after Brexit, it is not, in any sense, applying legal provisions that are “made applicable by this Agreement”.

The apparent asymmetry of obligation here is so odd that one suspects that any court would simply read in to the provisions of the Agreement a symmetrical obligation of the EU to consider the UK interest in applying Articles 107 and 108 TFEU.  But the position is somewhat unsatisfactory.

George Peretz QC

 

 

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House of Commons briefing paper on EU State and WTO subsidies

For those of you who didn’t catch this earlier, here is a link to the House of Commons briefing paper 06775 of 7 November 2018 on the EU State Aid Rules and WTO Subsidies Agreement, which also includes a discussion of the implications of Brexit.

http://researchbriefings.files.parliament.uk/documents/SN06775/SN06775.pdf

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State-aid handcuffs in Brexit backstop?

Lewis Crofts and Matthew Holehouse from MLex have written an interesting article about the State aid provisions in the Brexit backstop, which can be read here: MLex_Content

For further discussion on this hot topic of State aid after Brexit, we hope to see some of you at the Shearman & Sterling/UKSALA seminar on Monday evening, full details here.

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STATE AID AND THE WITHDRAWAL AGREEMENT: KEY POINTS

The UK Government’s intention to maintain the EU State aid rules has been clear for some time.  I briefly discussed the reasons why it has taken that view – and done so without significant opposition – in a piece I wrote here.  The intention to hold onto the State aid rules was strong enough for the Government to commit to maintaining them even on a “no deal” Brexit.  But we now have a deal, subject to the vagaries of UK politics (which I shall not attempt to predict).  What has it got to say about State aid?

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