James Webber[1]
The Government has an announced intention to introduce a subsidy control regime[2]. This will be strongly informed by the Agreement with the EU – which will inevitably need to be reached first. In my view, the subsidy control provisions of an FTA with the EU should only bite on subsidies that appreciably distort competition between the UK and the EU. This is consistent with the findings of the House of Lords Internal Market Sub-Committee; subsidies below this threshold are not the business of a trade agreement[3].
I think such an Agreement should accord to the principles I describe in this note. To stress test the idea I have translated these principles into suggested legal drafting in the attached Annex . No doubt this can be improved on. My goal in doing so is to focus discussion on a detailed compromise proposal and to flush out the trade offs and questions embedded within it. The proposal is intended to be one that respects the sovereignty of each side but which also creates a structured framework for ensuring a level playing field in subsidy control.
Definition of Subsidy
The definition of subsidy would draw on both the EU State aid rules and the WTO SCM Agreement – the only two systems of international subsidy control in the world. This is consistent with the EU’s negotiating directive which states that “the envisaged agreement should uphold common high standards and corresponding high standards over time with Union standards as a reference point in the areas of State aid…” [emphasis added].
The EU definition of State aid has substantial merit as a reference point. In particular, the concepts of advantage, State resources and State imputability are all well developed, relatively stable and overlap almost completely with the WTO concept of subsidy. The legal certainty they bring would be valuable to enterprises and public administration on both sides.
The EU definition however also has frailties that ought not to be brought over. A series of ECJ judgments have altered the definition of “specificity” and made this concept excessively complex and unpredictable. In addition, since the governing principle of the UK/EU subsidy control arrangements is that they should only bite on measures that actually effect trade and competition, the current EU approach to effect on trade and competition within the definition of State aid cannot be used.
Specificity
Specificity is the term used in subsidy control to separate measures that are normal public policy (corporation tax rates or decisions to build a new motorway) from subsidies. The reason it is important is that many Government policies advantage companies unequally. Does building a new motorway junction near an Amazon distribution warehouse constitute a subsidy to them? Does allowing faster amortisation of R&D capital expenses – depressing taxable profit – constitute a subsidy for research heavy companies?
The concept of ‘specificity’ polices this line between general policy (even if not all benefit equally) from actual subsidy. Historically whether a measure was specific was measured against availability. If it was generally available then it was not specific. Recent ECJ case law – mainly in an attempt to tackle disagreeable tax measures – has tried to redefine specificity by moving away from a test of availability and considering whether the measure is an exception to a “reference framework”[4]. This change introduces a great deal of complexity. Broadly speaking, a measure is considered specific if it deviates from a reference framework where that deviation is not justified by the ‘objectives’ of the reference framework. What does that mean? Are a series of tax provisions that differentiate between two taxpayers considered together as ‘the reference framework’ – if so there is no exception or deviation that could be considered a specific measure? Or do we pick out the provision that treats taxpayers in a certain situation more generously and say that is an ‘exception’ to the reference framework? If the latter, how can we predict whether the Court or Commission will consider the exception to be justified by the objectives of the reference framework? Indeed do we even know what the objectives are? In the Brauereri case, Germany, the Commission and the taxpayer had three different (but arguably equally valid) views on what the ‘objectives’ of the tax measures in question were.[5] It becomes excessively difficult to predict whether a measure is a subsidy or not.
Recent cases have also started to see a confusion develop between the concept of advantage and specificity.[6] In these cases, the existence of an advantage results in a presumption of specificity – effectively merging the previously separate criteria together. This is also very undesirable. Specificity is a vital and separate element in the test for State aid. To extend the analogy above, a business may get an obvious advantage from a new motorway junction or flood defences built on the seaward side of their premises. However, it is inappropriate to claw that cost back from the business concerned after the event – which is the implication of finding the advantage is specific and therefore State aid. The business concerned may not even have been asked. Had it known the risks, it may have preferred the extra costs of driving to the next junction or flood insurance etc.
Eventually the ECJ will have to straighten out its jurisprudence in these areas but, in the meantime, there is no reason to import the confusion into a UK/EU FTA.
In my view, specificity should have its traditional meaning in the subsidy control provisions of the UK/EU FTA. A measure is specific if it is not generally available. The WTO SCM Agreement definition of specificity therefore is a more suitable basis for catching such measures.
Effect on trade and competition
The other area where the EU definition of State aid cannot be used in a UK/EU FTA is in relation to effect on trade and competition. While these are two separate limbs of the formal definition of State aid in the TFEU, they do not have either a separate or practical meaning. According to established ECJ case law, any aid measure in a market open to competition can effect trade and competition – regardless of whether there is any actual such effect.
Since the governing principle of the UK/EU subsidy control arrangements, in my view, is that they should only bite on measures that actually effect trade and competition, such a definition is unworkable.
Effect on competition and trade can be dealt with in the FTA using the following framework:
- First, safe harbours should be agreed which would not lead to appreciable effects on competition and trade. This will include any aid below a sum, indexed each year. This sum would have to be material – say in order of €50/€75m per measure. In addition, categories of aid should be noted as not liable to affect competition and trade, for instance competitively tendered infrastructure projects or aid for non-traded goods and services (such as toll roads, 5G rollout or railway franchises).
- Second, there should also be features, which would lead to appreciable effect on competition and trade. These could track what the Commission currently calls “manifest negative effects” in its common assessment principles – such as aid explicitly to move jobs or investment from the UK to the EU or vice versa. Alternatively, aid that is demonstrably unnecessary (such as that paid to support investment where the decision to invest had been made before aid was offered).
- Third, aid outside the safe harbour but not caught by manifest negative effects would be subject to an assessment regarding the effect on trade and competition. At the level of determining whether a particular measure is a subsidy / State aid, such an approach is alien to the EU since the effect on trade and competition criteria in Article 107 TFEU do not have a practical meaning.[7] This said, the Commission’s compatibility assessment (i.e. once aid is notified is it permissible) does look more closely at effects on competition – and the State aid modernisation process over the last decade or so has increased the use of economic analysis to assess effects.
Analytically, therefore, it is perfectly possible to assess the effects on competition and trade of a subsidy. It would require the CMA in the UK and the Commission to investigate and find a reasonable likelihood of trade and competition distortion – a similar evidence-based, forward-looking analysis as used in the merger regime. In a UK context, the Office of Fair Trading and HM Treasury produced a short readable study titled “Guidance on how to assess the competitive effects of subsidies” in 2007, explaining how this can be done in the context of UK Green Book assessment.[8] It is worth noting that – as with EU State aid currently – it is not necessary in my view to attempt to separate the analysis of trade and competition for this purpose. The concepts are best understood and assessed together.
Objectives of Common Interest
Once effects on competition and trade are found, they could then be justified as a proportionate way to achieve agreed common goals – such as sustainable development or climate change. This ‘balancing’ exercise is how the EU State aid regime works today. One potential difficulty is that the WTO SCM Agreement does not anticipate such balancing to make otherwise prohibited or actionable subsidies allowable.
This is a legitimate point, but a UK/EU FTA containing such a provision would be no more egregious than the EU’s system of State aid is today. Moreover, the UK/EU FTA only effects the subsidy arrangements between each other. It does not affect remedies available (including countermeasures) to other signatories to the WTO SCM Agreement against subsidies the UK and EU consider to be proportionate to a common interest.
In any event, the FTA could be expressed as without prejudice to the WTO SCM Agreement.
Competent Authority
Each side will have a competent authority capable of investigating aid to assess effects and considering whether aid is a proportionate way to achieve common objectives. That would be the Commission for the EU and, in my view, the CMA for the UK.
The competent authorities could require changes to the aid proposals – such as awarding it on a non-discriminatory basis or requiring modifications to the scheme – such as reducing its scale, preventing overcompensation or allowing clawback.
The competent authorities would have the ability to order that aid that does create distortive effects and is not a proportionate way to achieve common objectives, shall be prohibited or recovered insofar as paid. In each case, this would be limited by the constitutional position of both competent authorities – i.e. the CMA could not contradict a clear Act of Parliament granting such aid.
Remedies
If either party considers a competitive effect exists that disturbs the level playing field, and which is not justified by an objective of common interest, it could take unilateral action. First, they have the right to appeal through each jurisdiction’s domestic courts. The effectiveness of the system would be enhanced if private parties from each jurisdiction could also bring such claims in the domestic legal system of the UK and before the CJEU respectively.
Second, each side would also then retain unilateral tariff measures to permit proportionate retaliation. Such countermeasures are to the fullest extent possible focused on the same beneficiary or sector that received the aid complained of and should be proportionate, meaning they should not exceed the harm caused to competition by the subsidy complained of – again taking into account any objective of common interest.
The UK should be willing, in my view, to submit the substance of any dispute (i.e. whether a subsidy measure is allowable under the Agreement) to binding independent dispute resolution mechanism (“DSM”). The EU is very unlikely to agree to that as it risks conflicting with the supremacy of the ECJ. A Member State measure that has been approved as State aid by the Commission and upheld by the ECJ could be attacked by the DSM in the UK/EU FTA.
This difficulty can be avoided if the reference to the DSM was limited to arguments that the retaliation is disproportionate or not justified. This takes the EU’s decision to find an aid measure compatible with its single market out of the DSM. Rather it would be the UK or EU’s decision to impose countermeasures against the other that was before the DSM. Such countermeasures are idiosyncratic to the UK/EU FTA – they do not exist under the Treaties. As such, the DSM cannot call into question the Commission and Court’s approval of a State aid measure under the TFEU.
Northern Ireland
This proposal is intended to supersede Article 10 of the Protocol on Ireland and Northern Ireland whether pursuant to Article 13(8) of that Protocol or otherwise.
UK Domestic Regime
The FTA with the EU does not answer – and neither should it answer – all the design questions with respect to a domestic UK subsidy control regime. That topic is beyond the scope of this note except to say that large procedural and substantive improvements over the current State aid regime are possible and can be adopted while complying with the terms of the UK’s obligations under the FTA text below.
1 July 2020
[1] Partner, Shearman & Sterling, Brussels & London
[2] “The UK will have its own regime of subsidy control” : Chapter 20, The Future Relationship with the EU: the UK’s Approach to Negotiations, February 2020
[3] See Letter from Baroness Donaghy to Paul Scully MP, 3 April 2020 at paragraph 44: “We endorse the statement by James Webber that “subsidy control between trading partners only really needs to catch subsidies that distort that trade, and anything that happens beneath it is really not the business of a trade agreement”
[4] The comparison of these two methods is helpfully explained by Advocate General Oe in his opinion in C-374-17 Finanzamt B v A Brauerei
[5] Ibid paragraph 132-134: In the Commission’s view the objective was to maximise the tax take; Germany’s view the objective was to reflect fairly the ability to pay; the taxpayer’s view the objective was to tax the change of control in land (which they said hadn’t occurred)
[6] Joined Cases T‑755/15 and T‑759/15, Luxembourg v Commission and Fiat Chrysler Finance Europe v Commission, Judgment of 24 September 2019, ECLI:EU:T:2019:670
[7] Evidence of George Peretz QC to the House of Lords Internal Market Sub-Committee: Mr Peretz noted that “analysis of [this] effect on trade” takes place “at an astonishingly superficial level”, see Letter from Baroness Donaghy to Paul Scully MP, 3 April 2020
[8] Available at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/191490/Green_Book_supplementary_guidance_assessing_compeition_effects_subsidies.pdf