Brexit and State Aid: what should the UK do?
Updated: Nov 25, 2020
In 2017, Prime Minister Theresa May stated that the EU and UK ‘share the same set of fundamental beliefs…that trying to beat other countries’ industries by unfairly subsidising one’s own is a serious mistake’. However, the recent resumption of post-Brexit deal talks, where a key area of disagreement has focused on post-Brexit competition rules, seems to suggest otherwise. The competition rules fiasco largely revolves around the issue of state aid. This article will explore what state aid is, the specificities of the Brexit state aid disagreement, and whether the UK should accept a more stringent set of state aid rules than the no-deal outcome.
What is state aid?
According to the EU state aid system, any subsidy that could, in theory, ‘distort competition’ and ‘have an effect on trade between member states’ must be pre-approved by the European Commission. State aid can take various forms, such as grants, loans, tax breaks, and using or selling a state asset for free or at less than market price. The state aid measures must not be selective; for example, a country-wide tax break would be exempt from state aid rules, whereas a tax-break to a few businesses would not. In 2016, the European Commission ruled that the Republic of Ireland had given tax rulings to Apple Inc that acted as a form of illegal state aid because it allowed Apple to pay far less tax than other businesses; as a result, the European Commission stated that Apple would have to pay €13bn in Irish taxes, plus interest penalties, to the Irish government.
What is the Brexit bickering about?
If the UK leaves without a deal, it will be subject to the WTO’s Anti-subsidy and Countervailing Measures Agreement, which is similar to the EU’s definition of ‘state aid’. However, there are important differences: for example, the WTO system needs to show that actual harm has been done; in contrast, the EU system often only requires that a subsidy might potentially harm trade between member states for it to be deemed illegal.
The EU and UK have different views regarding state aid with relation to Brexit. In February 2020, the EU argued that a deal should include requirements for the UK to adopt EU state aid rules, whilst the European Court of Justice (ECJ) should act as the final arbiter of any dispute. Moreover, the UK would be required to set up a counterpart to the European Commission as a day-to-day enforcement mechanism. The EU suggests that this is necessary due to the far greater size of the UK economy and proximity to the EU compared with the EU’s other partners. It also argues that the UK is asking for freer access to the EU than what has been offered to other countries, such as Canada.
In contrast, the UK would like a trade deal similar to the EU-Canada Comprehensive Economic and Trade Agreement. This deal would only set an obligation to consult with the other party if the subsidies paid harmed its interests, and to make best endeavours to resolve those concerns. One reason that the UK is taking this stance is because it believes that the EU’s offer is too restrictive of the UK’s future autonomy, especially over the role of the ECJ. Taking back control – whether this is in terms of setting rules on immigration or imposing competition laws – was a major reason for why ‘Leavers’ voted for Brexit, according to the British Election Study. As a result, it is unsurprising that UK negotiators are reluctant to budge on this issue.
Should the UK impose state aid rules anyway?
Subsidies can, in certain instances, be beneficial from an economics perspective. For example, subsidies can be used to correct positive externalities present in green energy technology businesses. This is because there is a positive spill-over effect of producing green energy since we all benefit from less pollution. Subsidies can then be used as an incentive to increase production. However, poorly designed subsidies can be wasteful and harmful. This includes the possibility of giving money to projects that would occur anyway, curbing the growth of a better domestic competitor, and distorting local economies. Without state aid rules, inter-regional ‘subsidy races’ can also take place, where different parts of the same country compete to attract businesses. This is especially prevalent in the US, where large amounts of public funds are used to attract companies to a specific state. Examples include GlobalFoundries (a semi-conductor manufacturer) in New York, and The Boeing Corporation in Washington and Carolina.
However, government pledges and Covid-19 developments perhaps suggest that imposing state aid rules would not benefit the UK economy. Boris Johnson was elected in 2019 partly on the promise to spend big in order to ‘level up’ traditional Labour heartlands. This, perhaps, would be aided by firm- or region-specific subsidies. Covid-19, especially with regional lockdowns, has also highlighted the need for a flexible approach to help struggling businesses. Indeed, in light of the pandemic, the European Commission created a temporary framework for state aid in March 2020, which lifted many of the usual constraints on targeted support.
Yet a publication by the Institute for Government argues that a legally enforceable state aid regime is in the UK’s interest. On top of the general, non-crisis-times economic appeal, it is attractive politically. The fallout of Brexit has resulted in worsening relations between Westminster and developed governments, meaning that it is more difficult for the UK to rely on an informal inter-governmental approach to reach an agreement on state aid. Moreover, an advisory-based system lacks the necessary means of enforcement to succeed. A group of lawyers co-led by Alexander Rose and James Webber sent an open letter to Boris Johnson in September suggesting that the UK ‘will need to build on the WTO subsidy rules’ because ‘[the WTO subsidy rules] are not of themselves enough’.
Looking to the future
Even if an agreement is made regarding state aid, there are still many more pieces in the Brexit puzzle to solve, such as fishing rules. Given that the UK and EU only have until the end of the year to sort out the numerous disputes, it will be interesting to see what happens next.
HERBERT SMITH FREEHILLS
HSF and Brexit
Herbert Smith Freehills offers valuable resources to help understand the legal implications of Brexit. These resources can be viewed in their latest thinking Brexit hub. For example, the Brexit Webinar Series provides expertise on subjects ranging from the impact on Brexit on German business, to how Brexit may affect the TMT and Data sector.
HSF and competition, regulation & trade
One of Herbert Smith Freehills’ areas of expertise is competition, regulation & trade. They are ranked amongst the top 25 competition practices globally. The complex legal nature of Brexit indicates that this area of the law is constantly evolving. HSF stands at the forefront of this.
One interesting competition (and merger) case that HSF has recently been involved in is advising TPG Corporation Limited (formerly TPG Telecom Limited) on its successful AS$16.5bn merger of equals with TPG Telecom Limited (formerly Vodafone Hutchison Australia Limited). This merger was implemented on 13 July 2020, two years after TPG and VHA agreed to merge and challenge Telstra and Optus’ dominance in Australia’s telco market. It was one of the largest mergers in the past 10 years in Australia. On 13 February 2020, the Federal Court of Australia declared that the proposed merger would not have the likely effect of lessening competition in the retail mobile market by a substantial degree. This meant that it would not break section 50 of the Competition and Consumer Act 2020. Subject to any ACCC appeal, this effectively overruled the ACCC’s decision in the previous year to oppose the transaction, enabling the two companies to go ahead with the proposed merger.