Legal Eye: State aid and SEZs

Beautifully illustrated books contained the answers to all those nagging questions, such as "Why is the grass green?" and "Why do airplanes fly?"

As we get older the questions become less easy to answer. "How do cats instinctively know who is allergic and insist upon sitting on that person's lap?" "Why does my line always move the slowest?" "How can post-EU accession Poland still have special economic zones?" Okay, maybe that last question is not one of those great mysteries of life because it is possible to cull through European Union official documentation to find an answer.

Permitted state aid

The Treaty Establishing the European Community allows member states (such as Poland) to grant certain forms of aid. Article 87 (3)(c) of the Treaty goes so far as to say that "aid to facilitate the development of certain economic activities or of certain economic areas..." may be permissible state aid. Poland, and others, have made use of this opening to set up special or free economic zones or to offer other incentives to potential investors. But the incentives must be compatible with the overall rules for the functioning of the common EU market. In particular, they may not distort competition.

This is where the EU watch-dog steps in. Poland (or any other EU member state, for that matter) is not allowed to dream up and establish new incentive programs at will. Any country wanting set up a new incentive program must notify the European Commission and obtain its blessing that the proposed program is compatible with the common market.

Tax test

As tax reduction is a particularly attractive incentive, the EU has issued some guidelines on when tax incentives qualify as permissible state aid, and not as impermissible general relief.

First, the incentive must relieve an investor from some burden that it would normally pay. Taxes, including corporate income tax, are a painful budgetary item for investors. Second, the incentive must come from the state or its resources. As taxes are collected by various levels of government, relief from these taxes potentially means less money in the tax coffers. Third, the measure must affect competition and trade. In others words, a business should become more competitive by receiving the incentive. Finally, the incentive must be specific or selective. The incentive should be limited in some manner, such as type of businesses or certain economic areas. In this last prong of the test, a special economic zone fills the role beautifully.

In good company

For now, special and free economic zones are alive and well. In fact, not only Poland is using special economic zones to promote investment, this type of device is being used by several of the new EU member states, including Latvia, Lithuania, and Romania.

But permissible state aid as tax reduction is not limited to investments in special or free economic zones. Other new EU entrants do not tie incentives to special economic zones, but offer significant tax incentives for specific types of investment. As examples, the Czech Republic, Hungary, and Slovakia follow this model.

Now, if I could just find some answers to the truly great mysteries. Perhaps advanced medical research has found an answer as to why my cat is such a keen, but perverse, detector of allergies.

Judith Gliniecki is a partner with Rymar and Partners; j.gliniecki@rymar.pl