ECJ Rules Against Portugal On Azores Tax Cut In Key State Aid Case

by Ulrika Lomas, Tax-News.com, Brussels

07 September 2006

The European Court of Justice has ruled that Portugal cannot allow the Azores islands to cut income and corporate tax because the measures breach European Union rules on state aid, a decision which could have ramifications for taxation in other member states.

Portugal had permitted the legislative assembly of the Azores to cut rates of income tax by as much as 30% in 1999 in recognition of the unique structural difficulties of its economy.

Located in the mid-Atlantic about 1,500km to the west of Portugal, the Azores are isolated from Europe both geographically and economically and the small economy is almost totally dependent on tourism, fishing and agriculture.

However, under European Union state aid rules, member states are only permitted to grant special tax regimes to certain regions or industries if they are proportionate and in keeping with the current tax system in place in that country, in the interests of maintaining a level tax playing field.

Consequently, in 2002, the European Commission told Portugal that the Azores must increase its tax rates because the tax cuts were not in proportion with the economic problems they were aiming to alleviate, and were therefore unjustified.

The Commission's decision was challenged by Portugal in the ECJ, but was upheld in Wednesday's ruling.

"The court finds that the Portuguese government has not proved that the adoption of the measures at issue was necessary for the functioning and effectiveness of the general tax system," the court stated.

"Consequently, the court dismisses the action brought by Portugal," it added.

The ruling will be keenly scrutinised by other member states, particularly Spain and the UK who intervened in the case in support of Portugal.

In the case of Spain, the ruling could conflict with special tax powers in the Spanish constitution directed towards the Basque and Navarre regions, while the UK fought the European Commission for a number of years over the tax regime in place in Gibraltar, which the EC argues is a region of the UK.

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