EFTA SURVEILLANCE AUTHORITY DECISION

No 97/10/COL

of 24 March 2010

regarding the taxation of captive insurance companies under the Liechtenstein Tax Act (Liechtenstein)

THE EFTA SURVEILLANCE AUTHORITY (‘楾HE AUTHORITY‘�;

HAVING REGARD to the Agreement on the European Economic Area (‘the EEA Agreement‘�, in particular to Articles 61 to 63 and Protocol 26,

HAVING REGARD to the Agreement between the EFTA States on the Establishment of a Surveillance Authority and a Court of Justice (‘the Surveillance and Court Agreement‘�, in particular to Article 24,

HAVING REGARD to Protocol 3 to the Surveillance and Court Agreement (‘Protocol 3‘�, in particular to Article 1(2) of Part I and Articles 4(4), 6, 7(5) and 14 of Part II,

HAVING REGARD to the Authority‘檚 Guidelines on the application and interpretation of Articles 61 and 62 of the EEA Agreement (1), and in particular the chapter dealing with the application of State aid rules to measures relating to direct business taxation,

HAVING REGARD to the consolidated version of the Authority‘檚 Decision No 195/04/COL of 14 July 2004 on the implementing provisions referred to under Article 27 of Part II of Protocol 3 (‘the Implementing Provisions Decision‘� (2), and

HAVING ADOPTED Decision No 620/08/COL to initiate the procedure provided for in Article 1(2) of Protocol 3, and having called on interested parties to submit their comments pursuant to those provisions and having regard to their comments,

Whereas:

I. FACTS

1. PROCEDURE

By letter dated 14 March 2007 (Event No 393563), the Authority sent a request for information to the Liechtenstein authorities, inquiring about various tax derogations for certain forms of company under the Liechtenstein Tax Act. The Liechtenstein authorities replied by letter dated 30 May 2007 (Event No 423398).

There then followed an exchange of correspondence and meetings between representatives of the Authority and of the Liechtenstein authorities, and eventually on 24 September 2008, the Authority adopted Decision No 620/08/COL to initiate a formal investigation procedure. This Decision was published in the Official Journal of the European Union and the EEA Supplement to it (3). The Authority called on interested parties to submit their comments and received such comments from 12 interested parties. By letter dated 22 July 2009 (Event No 525074) the Authority forwarded these to the Liechtenstein authorities, who were given the opportunity to respond. This was done by letter dated 2 October 2009 (Event No 532480).

2. SPECIAL TAX PROVISIONS CONCERNING CAPTIVE INSURANCE COMPANIES

By virtue of an Act dated 18 December 1997 amending the Liechtenstein Tax Act (4), the Liechtenstein authorities introduced special tax rules applicable to captive insurance companies: new Articles 82a and 88d(3) were introduced into the Tax Act with effect from 1 January 1998 onwards and still apply today.

2.1. Income and capital tax

Part 4, heading B of the Tax Act ‘�Special company taxes (‘楤esondere Gesellschaftssteuern‘� ‘�Articles 82 to 88, contains special tax provisions for certain forms of company such as insurance companies, holding companies, domiciliary companies and investment undertakings. Article 82a of the Tax Act refers to captive insurance companies.

Article 82a paragraph 1 of the Tax Act states as follows: ‘榠nsurance companies in accordance with the definition of the Insurance Supervision Law, which exclusively engage in captive insurance (‘淓igenversicherung‘�, pay a capital tax of 1 ‘�on the company‘檚 own capital, cf. Article 82a(1) of the Tax Act. For capital exceeding 50 million the tax rate is reduced to 戮 ‘�and for capital in excess of 100 million to 陆 ‘扳� (5).

In other words, instead of paying the normal 0,2 % capital tax, captive insurance companies are only obliged to pay 0,1 %, and this rate is further reduced for amounts exceeding CHF 50 million and CHF 100 million.

Under paragraph 2 of Article 82a of the Tax Act, insurance companies which engage in both captive insurance and ordinary insurance activities for third parties are liable to pay the standard capital and income tax (set out in Articles 73 to 81 of the Tax Act) for that part of their activities which concerns insuring third parties.

As Article 82a of the Tax Act constitutes a lex specialis with respect to Article 73 of the same Act, it can be concluded that captive insurance companies do not pay income tax (6).

In conclusion, captive insurance companies only pay a reduced capital tax as described in Article 82a(1) of the Tax Act and no income tax.

2.2. ‘楥ouponsteuer‘�(coupon (withholding) tax)

Under Liechtenstein legislation, a coupon tax is levied on the coupons of securities or documents equal to securities issued by a ‘榥ational‘�at a rate of 4 % on any distribution of dividends or profit shares. By virtue of Article 88d(3) of the Tax Act, shares or parts of captive insurance companies are exempted from payment of the coupon tax.

2.3. The objective of the aid measure

The Liechtenstein authorities have stated that these provisions were introduced in order to attract companies to Liechtenstein and establish and develop the captive insurance sector as a new field of economic activity.

2.4. Grounds for initiating the procedure

In its decision opening the formal investigation, the Authority raised doubts regarding the compatibility of the tax classification of captive insurance companies with the State aid rules. Contrary to the arguments brought forward by the Liechtenstein authorities, the Authority took the initial view that the provision of insurance is a service which is an economic activity, and that any entity carrying out an economic activity qualifies as undertaking irrespective of its corporate form, subsidiary status or financing. Furthermore, the Authority had doubts as to whether the tax exemption in favour of captive insurance companies could be said to fall within the nature and logic of the tax system as argued by the Liechtenstein authorities.

On this basis, the Authority could not exclude that the tax rules applicable to captive insurance companies (full exemption from payment of income and coupon tax and a partial exemption from payment of capital tax) constitute State aid within the meaning of Article 61(1) of the EEA Agreement. The Authority also had doubts that these measures could be considered compatible with the State aid provisions of the EEA Agreement, in particular Article 61(3)(c).

3. COMMENTS FROM THIRD PARTIES

The following comments were received from third parties during the course of the formal investigation.

3.1. Comments from Company A

Company A commented in two letters dated 22 May and 9 September 2009, received from their legal representatives. Company A RE has operated a captive reinsurance company in Liechtenstein since 1997 through its subsidiary Company A RE Aktiengesellschaft.

It is Company A‘檚 view that the Liechtenstein captive insurance company tax measures do not involve State aid. In the alternative Company A argued that should the Authority conclude that aid is present it should be considered to be existing aid, failing which the company contends that it had legitimate expectations that the tax legislation was lawful and no recovery of aid should therefore be ordered.

Company A argued that the tax measures do not involve State aid for the following reasons:

Company A also argued that the Liechtenstein tax measures on captive insurance companies, introduced in 1997, preceded the evolution of any assessment by the Authority or European Commission that such taxation on intra-group activities could involve State aid. In the alternative, it argued that in light of the principles of legitimate expectations and legal certainty, the Authority should not order recovery if it concludes that State aid has been granted.

In its second submission, Company A expanded upon its contention that captive insurance companies are not in a legally and factually comparable position to that of insurance companies providing services to unrelated companies, and that a differential tax treatment is justified, by making reference to the Commission‘檚 decision concerning the Dutch Groepsrentebox scheme (10).

3.2. Comments from Company B

Company B is a Liechtenstein based direct writing captive insurance company owned by Company C. Company C makes use not only of its captive, but also purchases both insurance and reinsurance on the international markets. It stressed, however, that it is unable to insure all of its risks either because such insurance cover is not available or because it is not financially efficient.

Company B was founded in Liechtenstein in 2004 as a reaction to adverse insurance market developments after 2001 when commercial insurers and reinsurers began to demand higher retentions, limited their capacities, and sold insurance and reinsurance at higher prices and at more restrictive terms and conditions.

Company C argued in particular that a commercial risk transfer (to a general insurer) always involves the customer retaining a certain portion of the risk. It stated that it is considered uneconomic and inefficient to seek risk transfer up to a certain level of risk retention. The company contended that there is market consensus on levels of risk that companies keep and that below this level ‘one cannot speak of a liquid insurance market‘�

Company C also considered certain risks to be uninsurable and are therefore forcibly retained by companies, and that in this area captive insurance companies do not substitute commercial insurers.

Company C explained that in its opinion forming captives is merely one way of formalising and organising retained risk within a company, and that it is not an option limited to large corporations, and does not confer an economic advantage in comparison to companies that do not form captives. Although Company C stated that it is not an option limited to large companies, it also accepted, however, that larger companies have a lower cost of risk (due to economies of scale, capital structure and risk diversification) than smaller ones, and are more likely to own captive insurance companies.

Company C emphasised that Company B is only able to operate within its group of companies, and that it does not participate in the commercial direct insurance market.

Finally, Company C contended that its captive does not compete with other market recipients, and, as Company C is unable to procure the services offered by its captive from other market recipients, there is no effect on cross-border competition.

3.3. Comments from Company D

Company D described itself as the leading captive manager in Liechtenstein, providing management services to six of the 12 captive insurance companies currently located in the principality.

In its letter received on 11 May 2009, Company D stated that in its opinion the tax measures to which captive insurance companies are subject do not distort competition as the companies do not have competitors and there is, therefore, no market.

Company D acknowledged that in terms of supply-side substitution, ‘榤any commercial insurers can insure the risks captives insure‘� but contended that in terms of demand-side substitution, buyers of insurance do not view captives and commercial insurers as alternatives, but as separate products. This is because commercial insurance is considered not to be as effective a risk management tool as using a captive; as the insurable risks are different (the products being complementary rather than interchangeable); and because in some countries commercial insurers and captives face different licence and regulatory requirements (Company D was of the view that it is unreasonable to classify captives as operating in the same market as commercial insurers when they do not have the same opportunity to participate in that market).

Company D also argued that any decision by the Authority ordering recovery of unlawful State aid from captives in Liechtenstein would be contrary to general principles of law, as it would be retrospective and in breach of the legitimate expectation of the companies that they would not be subject to an increased tax burden.

3.4. Comments from Company E

Company E is a captive insurance company located in Liechtenstein. In its letter received by the Authority on 12 May 2009, Company E claimed that the Authority had made incorrect assumptions in its decision to open the formal procedure. Company E argued that a captive insurance company does not offset risk through the purchase of reinsurance as stated by the European Commission (and referred to by the Authority) in its decision concerning aid for captive insurance companies in 脜land (Finland) (11) explaining that a captive carries all of the risks of its parent. Company E also argued that insurance through a captive is not an alternative to obtaining insurance on the ‘榞eneral market‘� and indeed that captives are at a disadvantage compared to general insurers as they are unable to pool risks, and should be compared not with general insurers but with the uninsured risks that companies carry.

Company E stated that it does not currently provide insurance to its group that cannot be bought on the international market. Company E stated that establishing a captive involves substantial costs and can only be justified on commercial grounds. One of the reasons, it informed the Authority, that the company was formed in Liechtenstein was that the principality was ‘榥ot disadvantageous‘�in tax terms in comparison to other locations, and a change to the tax regime ‘榳ill adversely affect the viability of Liechtenstein as a captive location‘�

3.5. Comments from Company F

Company F firstly explained how captive insurance and reinsurance companies, and in particular Company F as part of the [‘ Holding, are organised. It stressed the fact that captives constitute a pooling of risks within a company group to allow for efficient risk management and financing. It also considered that the establishment of a captive creates greater transparency of risks within the group.

Company F referred to the lesser requirements of market integration that exist among the EFTA States of the EEA compared to the EU. It referred in particular to Articles 113, 114(2), and 115 TFEU regarding approximation of laws in the area of taxation, which do not have analogous provisions in the EEA Agreement.

Company F argued that the tax measures in favour of captive insurance companies in Liechtenstein do not constitute State aid within the meaning of Article 61(1) of the EEA Agreement. This statement was based on two reasons: captives are not undertakings, and the tax measures do not selectively benefit any undertaking.

Referring to a decision of the Authority concerning the Norwegian Road Administration M酶re and Romsdal District Office (12), Company F argued that captives are not undertakings because they only provide insurance services ‘榠n-house‘� Moreover, the activity carried out by captive insurance companies does not have an economic nature as it is exclusively limited to the transfer of internal risks from the activities of the remainder of the [‘ Holding Group. Disagreeing with the arguments put forward by the Authority in the opening decision, Company F contended that the reason for establishing a captive was not that it is economically advantageous but because it means that the risks of the group are pooled for more efficient risk management and increased transparency. This specific function cannot be assumed by an ‘榚xternal‘�company and in consequence there is no market for this specific type of activities. Company F also contended that there is no open market alternative to the service it provides.

Company F also argued that the reference to the 脜land Decision of the European Commission is questionable since the Authority is not bound by the decisions of the Commission, but must assess the measures independently and solely based on the provisions of the EEA Agreement.

Company F also argued that the tax measures are not linked to a given undertaking but to a particular function and are, therefore, not selective. Company F considered that selectivity does not relate to the economic strength of the undertaking and the question of whether it could establish a captive insurance company was wrongly argued both by the Authority and by the Commission in the 脜land case. Company F argued that in the latter case the Commission had not fully assessed selectivity as it did not assess whether the measures fell within the nature and logic of the tax system. Referring in this context to the Commission‘檚 Decision in the Irish Holding Company Regime case (13), Company F argued that the Authority should have assessed whether captive insurance companies are factually and legally in a similar situation and come to the conclusion that the specific regulatory provisions applicable to them (in particular Directive 2005/68/EC of the European Parliament and of the Council (14) which provides a definition of captive insurance companies, as well as the Solvency II Directive) prove that they are not. With reference to the case-law of the EFTA Court, Company F argued that ‘榓ny direct or indirect discrimination which is to be considered justified must derive from the inherent logic of the general system and result from objective conditions within that general system‘�

As secondary arguments, Company F considered that the tax measure existed prior to the entry into force of the EEA Agreement in Liechtenstein, and that the company has been subject to the same tax rules since its establishment in 1990. These rules were explicitly applicable to captive insurances companies from January 1998 and have not been substantially modified since. Company F contended that it is only the evolution of EEA rules that has led to the tax measures applicable to captives in Liechtenstein being considered to be State aid. The decision-making practice of the Commission from 1960 to 1990, during which time the Liechtenstein scheme was introduced, did not consider tax measures to constitute State aid.

Finally, referring to previous Commission decisions, some of which had considered similar tax arrangements not to constitute State aid, Company F considered that no recovery should be requested in this case because of legal certainty and the protection of legitimate expectations.

3.6. Comments from Company G

In letters dated 1 December 2008 and 25 May 2009, Company G expressed its surprise at the investigation given that it had trusted the legality of the Liechtenstein tax system for more than 10 years, and that to date there had been no indications that the rules applicable to captive insurance companies could be State aid. In its opinion, an undertaking cannot be expected to verify whether legislation in place for more than 10 years had been notified to the Authority. Moreover, the retroactive payment of taxes, it said, is questionable from a legal perspective and counterproductive from an economic point of view, in particular in the context of the current financial crisis. Company G referred also to the principles of legitimate expectations and legal certainty.

3.7. Comments from Company H

In letters dated 17 October 2008 and 27 May 2009, Company H expressed its concern that the tax legislation in favour of captive insurance companies in Liechtenstein could be considered incompatible State aid. The company stated that it had trusted the legality of the legislation in place for more than 10 years, and it would not be realistic to require it to ensure that it is compliant with the State aid rules of the EEA Agreement. Recovery of taxes would violate the principles of legitimate expectations and legal certainty, and would contravene the principle of equal treatment within the EEA at time in which the European Commission has allowed millions of euro of State aid to alleviate the financial crisis.

3.8. Comments from Company I

Company I communicated its concern that the taxation of captive insurance companies in Liechtenstein may constitute incompatible State aid, and stressed its trust in the legislation applicable in Liechtenstein for 10 years. This, in its opinion, justified the application of legitimate expectations and legal certainty in the context of recovery.

3.9. Comments from Company J

Company J presented its concerns regarding the possible incompatibility of the Liechtenstein taxation for captive insurance companies with the State aid rules in letters dated 13 November 2008 and 20 April 2009.

Company J argued that special provisions for captive insurance companies in new Solvency II legislation are an indication that captives are not active on the same market, and are not subject to the same regulatory mechanisms, as other insurance companies. Company J also argued that any undertaking can establish a captive insurance company and in consequence the measure is not selective.

The company was of the view that taxing captive insurance companies ‘榓cross the board‘�on their net earnings would lead to unequal treatment of undertakings. Captives, the company argued, are an instrument of self insurance and should only be taxed on their income from insurance branches liable for a legal insurance obligation in the country of the insurer. Otherwise, it was said, undertakings that create a captive will be worse off from a tax point of view than those that do not have a captive insurance company, and choose not to insure risks which do not have to be insured by law. Captives take insurance policies for risks for which there is no market and income from these activities should, therefore, not be taxed.

The company argued that it would contradict the principle of legal certainty to expect an undertaking to question legislation that had applied for more than 10 years. It stated that it had legitimately trusted the legality of the tax measures and contended that should the Authority come to the conclusion that State aid is involved, the measures qualify as existing aid, or (alternatively) recovery would contravene fundamental principles of law.

Finally, Company J referred to the financial crisis and how it has had an impact on the assessment of State aid. In its view, many of the measures adopted by several Member States of the European Union will not have a temporary character but will become permanent. Against this background, Company J expected that the Authority will not request the amendment of the Liechtenstein tax legislation applicable to captives.

3.10. Comments from Company K

Company K provided comments in December 2008 and April 2009. It expressed its surprise that the tax legislation applicable in Liechtenstein for the last 10 years would entail the grant of incompatible State aid. It argued that any order to repay aid would contravene the principle of legal certainty (pointing out that Liechtenstein law has a limitation period of five years for challenging tax liabilities). Company K explained the history of the foundation of the company, which would be tax exempted in Switzerland and only insures risks within the Company K group. It is not profit making, it insures also risks that are not or not fully covered in the insurance market and its premiums are calculated on the basis of the claims history/experience. Should the Authority conclude that incompatible State aid was granted, the Company K considers that a recovery would violate the principles of legal certainty, homogeneity and legitimate expectations.

4. COMMENTS BY THE LIECHTENSTEIN AUTHORITIES

4.1. Comments on the opening decision

In a letter dated 25 November 2008, the Liechtenstein authorities referred to the evolution of the assessment of State aid in the context of business taxation from the beginning of the 1980s to the issue of a notice on the application of the State aid rules to direct business taxation in 1998, and to the European Commission‘檚 decisions in the early 2000s (for example on the Belgian coordination centres (15)).

The Liechtenstein authorities argued that captive insurance companies are not active on an open market as their activities are limited to managing intra-group risks, i.e. the risks of its own corporate group. Any income generated by the captive insurance through transactions within the group is not ordinary income that should be subject to income taxation, as the administration of own assets does not constitute a commercial activity subject to taxation. In their view, an entity that does not exercise its activity on a market in competition with other market players cannot be considered as engaging in economic activity as an undertaking (16). Even if they were to provide services on the ‘榝ree‘�market, the Liechtenstein system ensures that the regular tax rates apply to these free market activities. In the opinion of the Liechtenstein authorities, it is only to the extent that the companies engage in those ‘榝ree‘�activities that they should qualify as undertakings.

The Liechtenstein authorities argued that captive insurance companies (like reinsurance companies) constitute a separate market from direct insurance due to the risk allocation within a group, the different regulatory framework, and the management function captives undertake within the group to which they belong. Captive insurance companies only insure their own group‘檚 risks (where there is no market or where costs are too high) and not the risks of third parties.

As far as selectivity is concerned, with reference to the 脜land captive insurance system and the Irish Company Holding Regime, the Liechtenstein authorities submitted that the tax regime applicable to captive insurance companies is not materially selective. This is because the conditions for these companies are horizontal in nature and could be achieved by any undertaking, i.e. no specific economic strength is required from undertakings to set up a captive insurance company and it, therefore, applies to all sorts of companies. On that basis any legal person, irrespective of the sector of activity or size of operations, could qualify for the tax reduction through ownership of a captive insurance company.

In line with the Gil Insurance (17) case-law, the Liechtenstein authorities argued in the alternative that the measures are justified by the nature and general scheme of the tax system, arguing that: ‘榃hat matters is whether the apparent exception is actually in line with the internal logic of the measure. [‘ A tax measure is specific only if it unreasonably discriminates between situations being legally and factually comparable in the light of objectives set by the tax system.‘�Under Liechtenstein law, captive insurances may be defined as a limited-purpose insurance entity established with the specific objective of financing risks emanating from their corporate group: ‘楬ence, it is an in-house self-insurance vehicle. The captive insurance is made out of the own means of its corporate groups. Hence, the captive insurance follows the principle that the coverage of liabilities out of own means should be treated differently for tax purposes.‘�/p>

Furthermore, the Liechtenstein authorities highlighted the different treatment of captive insurance companies in comparison with conventional insurance companies by reference to Community/EEA law examples under the reinsurance directive and the Solvency II directive. These, it is said, take note of the specific nature of captive insurance and reinsurance undertakings. They argued that it is acknowledged that as those undertakings cover only risks associated with the industrial or commercial group to which they belong, account is taken of their specific (and different) position.

Finally (in the alternative), the Liechtenstein authorities considered that the 1997 Tax Act constitutes existing aid because at the time it was put into effect it did not constitute an aid, but subsequently became aid due to the evolution of EEA law. If the Authority characterises the measures as new aid, they argued that there are sufficient grounds for not recovering the aid. This is for two reasons. The first is legitimate expectations based on a reliance on the approach taken by the Commission in its decisions relating to the tax incentives for intra-group financial treasury centres in France and the tax incentives for international financial activities in the Netherlands. The second is legal certainty, since at the time Liechtenstein joined the EEA in 1995, the Commission‘檚 State aid practice (which is part of the acquis communautaire) did not consider taxation of intra-group activities to be a matter subject to the State aid rules.

4.2. Comments on third party submissions

The Liechtenstein authorities stressed that nearly all captive insurance companies operating in Liechtenstein submitted comments during the formal investigation, reflecting the importance of the issue. They emphasised that the decision to open a formal investigation came as a surprise to the companies since Liechtenstein‘檚 tax regime had been adopted more than 10 years ago. Agreeing with the comments submitted by third parties, the Liechtenstein authorities argued that:

4.2.1. Captives do not qualify as undertakings

The Liechtenstein authorities considered that the comments submitted by Company B provided a good overview of captive insurance operations. They agree, in particular, that there is no ‘榣iquid insurance market‘�for all of the activities of captives. In this context the Liechtenstein authorities referred to an International Association of Insurance Supervisors (IAIS) Captive Issues Paper stating that:

The Liechtenstein authorities reiterated that all captives established in Liechtenstein are confined to managing intra-group risks only. Further, the risks insured by captives are often not transferable to other commercial insurers. Captives are therefore in a position to cover risks for which the traditional insurance market does not offer economically viable solutions. In addition, captives differ considerably from direct insurance companies as the latter insure many sorts of risks and therefore hold a risk pool to balance claims. A captive on the other hand only insures its own companies‘�risks and is not able to balance those risks. The Liechtenstein authorities argue, therefore, that the captive insurance market is distinct from conventional insurance market operations and that captive insurances do not compete with insurance companies. Reference was also made to Court of Justice case-law concluding that an entity which does not exercise its activity on a market ‘榠n competition with other market players‘�cannot be considered as operating an economic activity as an undertaking, and to the Authority‘檚 decision in the Norwegian Road Administration case which ‘�it is argued ‘�shows that entities engaged only in in-house activities are not undertakings as they do not engage in economic activities.

4.2.2. The tax treatment of captives constitutes a general measure

4.2.2.1. Material selectivity

The Liechtenstein authorities argued that the tax treatment of captives is not materially selective as it is an option available to all and does not require a certain economic strength. The tax measures are not limited to certain sectors, certain types of companies, or certain parts of the Liechtenstein territory ‘�there are also no restrictions regarding turnover, size, the number of employees or a necessity to be part of a multinational group. They argue, therefore, that their tax provisions for captive insurance companies are not materially selective.

The Liechtenstein authorities referred to the European Commission‘檚 Decisions regarding the 脜land Islands captive insurance tax system, the Irish Company Holding Regime, the Spanish reduced tax from intangible assets, and the Dutch reduced tax on revenue from intra-group loans (Groepsrentebox) (18), in order to support the claim that the taxation of captive insurance companies in Liechtenstein is not materially selective. The Dutch decision was quoted as follows:

4.2.2.2. Justification by the nature and general scheme of the system

Even if the Authority were to consider the measures at stake to be materially selective, the Liechtenstein authorities argue that they are, in any event, justified by the nature and general scheme of the Liechtenstein tax scheme. In doing so, they agree with the views expressed by third parties on this point.

The Liechtenstein authorities supported arguments relating to the definition and treatment of captive insurance companies under the EU Reinsurance and Solvency II Directives, claiming that captive insurance should be distinguished from classical insurance business. The Liechtenstein authorities agreed that different treatment of the captives is justified given the limited area of operation of captives and their specific intra-group nature.

4.2.3. No distortion of competition and no effect on trade between Contracting Parties

The Liechtenstein authorities concurred with Company A RE that the services provided by captives are not tradable since there is no ‘榝ree market solution‘�available for some risks. Consequently, the measures in question neither distort competition nor affect trade between the Contracting Parties to the EEA Agreement.

4.2.4. If aid is present it is existing aid

The Liechtenstein authorities argued that the measures in question should be regarded as existing aid within the meaning of Article 1(1) of Part I and Article l(b)(v) of Part II of Protocol 3 if they are to be characterised as State aid at all. In doing so, they again shared the opinion of third parties on that point.

They argued that captives have been taxed at a reduced capital tax of 0,1 % since 1989 before any specific legislation was enacted for captive insurance companies. Further, the Liechtenstein authorities supported arguments that the tax measures became aid as a result of the evolution of the EEA Agreement. Agreeing with Company F, the Liechtenstein authorities considered that the evolution which took place at the end of the 1990s occurred after the specific measures relating to captive insurance companies were introduced by the Act of 18 December 1997.

4.2.5. Recovery of aid would be incompatible with the general principles of Community law

Agreeing with Company A and Company F‘檚 statements, the Liechtenstein authorities submitted that the captives could not have anticipated that the measures, when adopted in 1997, could be State aid given the similarities between their position and cases on intra-group activities. All interested parties claim that there were no indications at the time that any of the Authority‘檚 preliminary findings were likely, or foreseeable.

In line with the statements of all interested parties, the Liechtenstein authorities also expressed their opinion that recovery would be in contravention of the principle of legal certainty. The fundamental requirement of legal certainty is to ensure that the application of European Union/EEA law is certain and foreseeable. It is also argued that this necessity must be enforced all the more strictly where there are financial consequences. It is submitted that when Liechtenstein joined the EEA Agreement in 1995 the acquis communautaire (including the Commission‘檚 State aid decision practice) did not designate the taxation of intra-group activities as State aid, and that there were no developments between 1995 and 1997 (when the measures were adopted) to suggest that this position would change.

II. ASSESSMENT

1. THE PRESENCE OF STATE AID

Article 61(1) of the EEA Agreement reads as follows:

1.1. Presence of State resources

The aid measures must be granted by the State or through State resources.

While the capital tax rate in Liechtenstein is currently set at 0,2 %, captive insurance companies are subject to a reduced rate of 0,1 % (and 0,075 % for capital exceeding CHF 50 million and 0,05 % for capital in excess of CHF 100 million). Captive insurance companies are also fully exempted from payment of income tax and the coupon tax.

The granting of a full or partial tax exemption involves a loss of tax revenues for the State which is equivalent to consumption of State resources in the form of fiscal (tax) expenditure (19). The Liechtenstein authorities forego revenue corresponding to the non-payment of income tax, the payment of a reduced capital tax rate as well as the non-payment of coupon taxes.

For these reasons, the Authority considers that the special tax rules applicable to captive insurance companies are granted through State resources.

1.2. Favouring certain undertakings or the production of certain goods

1.2.1. Undertaking

State aid can only be granted to undertakings that are engaged in economic activity.

According to the European Court of Justice, the notion of an undertaking within the meaning of Article 87 EC (now Article 107 of the Treaty on the Functioning of the European Union), which corresponds to Article 61(1) of the EEA Agreement, encompasses ‘榚very entity engaged in an economic activity, regardless of the legal status of the entity and the way in which it is financed‘�a href="#ntr20-L_2012261EN.01000101-E0020" id="ntc20-L_2012261EN.01000101-E0020" shape="rect"> (20)