On 19 September 2018, the European Commission concluded that a tax ruling granted by Luxembourg to McDonald’s Europe Franchising did not constitute illegal State aid. The Commission acknowledged that Luxembourg had correctly applied the Luxembourg-United States tax treaty. While this decision concerns an individual case, it suggests that State aid rules are not an appropriate tool to tackle hybrid mismatches relating to permanent establishments.
McDonald’s Europe Franchising, a Luxembourg resident company, had set up a branch in the United States (US) to which it allocated intellectual property rights. The related royalty income was correspondingly allocated to the branch. Luxembourg viewed the branch as a permanent establishment (PE), but the US did not. Accordingly, the activities were not taxed in the US. At the same time, the assets and income were exempt from tax in Luxembourg, as Luxembourg applied the provisions of the Luxembourg-US tax treaty to the PE’s income and assets. Effectively, this resulted in a hybrid mismatch outcome (double non-taxation of the royalty income).