State aid, COVID-19 and Brexit: level playing field or UK ploughing its own furrow?

Under EU law, the term "state aid" is capable of covering any advantage conferred on private businesses using state resources on a selective basis, which has distorted or may distort competition.  This is potentially far-reaching but typically includes government grants or subsidies, government loans (unless they are on market terms) and tax breaks.

If an EU Member State wishes to grant state aid, it must normally seek prior approval from the European Commission (and during the Brexit transition period, the UK remains bound by the EU state aid rules). There are, however, detailed exemptions for various categories of aid, for example, regional aid and aid for small or medium-sized enterprises. Provided the conditions for the exemption are met, prior approval from the European Commission is not normally required. The European Commission has the power to investigate aid which it believes may be illegal under EU rules and can order it to be recovered from the recipient. Businesses may also bring private actions in Court for damages or injunctive relief vis-à-vis the harm caused by the grant of unlawful state aid or, more commonly in the UK, may seek for certain aid to be declared illegal further to a judicial review of the public authority's grant.  

The concept of "subsidy" under WTO rules is similar, but as explained in section 5 below, there are some differences which could be important if the UK looks to diverge from the EU in this area after the end of the Brexit transition period.

Most of the COVID-19 support measures introduced by the UK Government would ordinarily be treated as state aid and would therefore potentially be prohibited or restricted under EU state aid rules.

However, the EU has introduced a temporary framework to permit such measures to be taken.  This framework currently applies to schemes introduced since 1 February 2020 until the end of 2020, although this end date may be subject to review. The temporary framework still requires European Commission approval for any schemes that a Member State may propose, but these schemes have tended to be approved quickly.

Since its introduction, the temporary framework has been expanded to permit the following types of aid (the list below includes examples of corresponding UK support schemes, which have benefitted from these exemptions): 

• direct grants, repayable advances or tax advantages (e.g. Business Rate Relief for retail, hospitality and leisure businesses, and the various grants for small businesses);
  
  
• guarantees and subsidised interest rates on loans (including those channelled through credit or other financial institutions) (e.g. Coronavirus Business Interruption Loan Scheme and related support);
  
  
• short-term export credit insurance where there is a lack of export credit insurance available;
  
  
• investment in relation to COVID-19-related research and development;
  
  
• investment in testing and upscaling infrastructures in relation to COVID-19-related products;
  
  
• tax deferrals and social security contributions (e.g. deferral of VAT payments); and
  
  
• wage subsidies for employees to avoid redundancies during the COVID-19 outbreak (e.g. Coronavirus Job Retention Scheme).

For more information in relation to the various COVID-related financial support measures available to businesses, please see our COVID-19: UK Government assistance available to businesses briefing.

Brexit – or more accurately, the end of the Brexit transition period – may mean that the EU state aid rules no longer apply in the UK, but this will depend on the terms of any deal between the EU and the UK on their future trading relationship (which is discussed further below).  However, even if there is no deal, the Withdrawal Agreement gives the European Commission the right to investigate any alleged state aid granted during the transition period, provided it commences its inquiry within four years of the end of the transition period.  Any aid granted before 31 December 2020 (or later, in the unlikely event that the transition period is extended) could therefore be subject to investigation by the European Commission – and if found to be illegal state aid, it may have to be repaid.

Where aid is granted by the UK after the end of the Brexit transition period, it is possible that the Government may have greater freedom of action than it does at present.  However, it is doubtful that this greater freedom will make much difference in practice so far as COVID-19 support measures are concerned (given that a wide range of such measures have already been permitted under the EU state aid rules).  Where it may make a difference is in relation to the UK's approach to subsidising industry more generally. 

This is why the EU is concerned to ensure that any trade deal with the UK contains strong "level playing field" provisions on state aid (among other issues). Without such provisions, the EU will be bound by its own rules on state aid (which go considerably further than WTO rules) whilst the UK will, potentially, have greater freedom to offer subsidies, tax breaks or other forms of aid to its domestic industry.

The EU's opening position in the Brexit negotiations has been that the UK should continue to be bound by EU state aid rules with the European Court of Justice (CJEU) having the final say in respect of any dispute regarding the enforcement of these rules (although there has been press speculation that it may be softening its position). A possible compromise would be for the UK to adopt legislation closely modelled on the EU state rules, but enforced by a UK authority and subject to review by the UK courts (not the CJEU). This was the option envisaged under the draft regulations prepared in the event of a no-deal Brexit last year.  However, following signature of the Withdrawal Agreement, these regulations were never passed.

A second option would be to devise a different system, most likely based on the WTO concept of "subsidy" (as opposed to the EU concept of "state aid"). In a two-page note released by the Conservatives during the election campaign, this was the preferred approach. The WTO model is considered further under section 5.

A complicating factor in all this is the Northern lreland Protocol to the Withdrawal Agreement, which is discussed further in section 7.

UPDATE 22.9.2020:  In September 2020, the UK announced proposals for an Internal Market Bill which, among other things, purported to give the Government power to effectively override the state aid provisions of the Northern Ireland Protocol.  Although this has gone down badly with the EU, as we argue here, a compromise is still possible with the EU on state aid if the UK is prepared to table robust proposals for its own post-Brexit state aid regime.  Indeed, a group of leading state aid lawyers has written to the Prime Minister underlining their belief that a compromise of this nature is feasible and offering to assist the Government in preparing a robust set of proposals to put to the EU in the context of the negotiations.  However, as at the time of this update, the UK had merely committed itself to following WTO rules on state aid and to holding a consultation on a domestic subsidy control regime. It provided no detail on the latter.  From the EU's perspective, this is unlikely to be sufficient to allay its concerns about state aid in the UK after Brexit. 

The main differences between the WTO and the EU rules are that:

• in practice, the threshold in the WTO rules tends to be harder to meet, since you need to show adverse effects and real damage; by contrast, the European Commission is often prepared to accept that illegal state aid must, by definition, be distorting in its effect (and it therefore requires less evidence of harm to persuade it to act);
  
  
• the WTO rules only apply to goods whereas the EU rules apply to both goods and services; and
  
  
• the remedies available under WTO rules are more limited and do not allow compensation to be sought for past damage, whereas there is a wider array of remedies under the EU rules, including requirement to recover the subsidy and the possibility of actions for damages (although the latter is rare in practice).

Some EU Free Trade Agreements use the WTO model as a basis for provisions on subsidies but seek to expand them to cover services as well.  This is the approach taken in the EU's agreement with Canada (although as the relevant provisions are not subject to the dispute resolution mechanism, the options for enforcing the state aid provisions in response to a breach are limited). By contrast, the EU's Association Agreement with Israel refers to a concept of "public aid" which is intended to be developed by the parties. This would potentially allow aspects of the EU model to be imported. However, pending agreement on such detailed implementing rules, that Agreement provides that WTO concepts will apply.

In the case of the UK, the EU is – at a minimum – likely to want provisions which cover services as well as goods, with the possibility of meaningful action in the case of breach by the UK. It will probably also want to see the UK's commitments backed up by a domestic subsidy regime, under which market-distorting subsidies can be challenged by business. The EU is likely to view such a regime as an important additional constraint on the UK's freedom of action to distort competition post-Brexit.

If there is no deal and the UK takes no action to introduce its own state aid law, there would be no domestic state aid regime to replace the EU state aid rules. Accordingly, there would be no requirement for the Government to submit proposals for such aid to any independent body, nor would there be any ability for businesses which felt that they had been harmed by such aid to bring actions before the UK courts. 

In granting aid, the UK would have to take account of WTO rules and might decide not to proceed with certain subsidies for fear of prompting complaints from other WTO members or unilateral action by those states under the WTO regimes relating to anti-dumping or subsidies and countervailing measures.  However, as noted in section 5 above, the WTO rules only apply to goods, not services, and the remedies are relatively weak.

Despite suggesting during the election campaign that "immediate action" would be taken to set up a domestic state aid regime, the UK Government has not (publicly at least) taken any such steps.  It is possible that the Government has simply been too distracted by COVID-19 to focus on state aid, but equally, the lack of concrete steps to develop a domestic state aid regime may be a negotiating tactic designed to encourage the EU to reach a trade deal with the UK. 

Whether this is a credible threat remains to be seen; a number of commentators have pointed out that the UK is likely to want to have a domestic state aid regime in order to prevent "subsidy races" within the UK itself. For example, without such a regime, a devolved government in Scotland could offer subsidies to businesses within its territory, to the detriment of businesses in England (which would potentially be left without recourse).

Whatever the explanation for the lack of action, there is now very little time left to conduct a meaningful consultation on the UK's future state aid regime if it is to be in place by the end of the transition period.  As we have seen with some of the COVID-19 legislation, lack of scrutiny often leads to drafting deficiencies.

Most commentators take the view that the Northern Ireland Protocol to the Withdrawal Agreement, as currently drafted, requires the UK to apply EU state aid rules to any UK measure that affects trade in goods between Northern Ireland and the EU (which would include any aid applicable in the whole of the UK, including Northern Ireland).  This has the potential to lead to a situation where some measures would in theory need to be approved by both the European Commission and – assuming the UK enacts its own domestic subsidy regime – the equivalent UK body.  It is particularly unhelpful to the UK's negotiating position in the current Brexit negotiations over the future relationship, as it enables the EU to point out that the UK has already agreed to the continued application of EU state aid rules after the end of the Brexit transition period in relation to those measures covered by the Northern Ireland Protocol.

UPDATE 22.9.2020: For discussion of the proposed UK Internal Market Bill, which purports to give the Government power to effectively override state aid provisions of the Northern Ireland Protocol, please see section 4. 

For more information on this topic, please contact Ben Chivers or Jonathan Rush in our Commercial team.