INDOORS ECONOMY – STATE OF EMERGENCY AID in SERBIA

Introduction

Covid 19 pandemic hit the global economy hard, businesses in the EU and Serbia are in a steep decline [1], a massive economic downturn is expected yet hard to fathom. [2]

In less than a month, the coronavirus reduced much of the global trade into the indoors economy, i.e. a distribution limited to supply of goods and services to consumers locked in their homes.

Unlike 2008 financial crisis, the disaster is not a result of a failure of markets to deliver 

What clogged the global economy is a joint effect of a chain of states’ measures, locking down countries from outside and within, with an immediate impact on the movement of consumers, trade and demand across the board and across the globe adopted in an attempt to contain and control the coronavirus outbreak.

Serbian economic operators are exposed to a sudden demand shock, liquidity constraints, uncertainty on investment plans, loss of workdays and the disruption of supply chains. [3]

Due to limited access to credit and less cash in the bank, smaller businesses are expected to be hit harder than large ones and the layoffs will most likely spread.

The economic damage in Serbia will be determined not just by what it does on the medical front but also by what it does to get the air to the economy to bridge the downturn until consumer demand rebounds.

The business community and think tanks already proposed to the Government to arrive with the swift economic counter punch [4] against pandemic to support the economy with the package of macroeconomic blanket measures and targeted fiscal supports to the SMEs and most affected sectors to remedy sudden shortage or even unavailability of liquidity and unprecedented drop in demand.

On 22 March 2020, the European Commission approved Portuguese guarantee schemes for SMEs and midcaps affected by Coronavirus outbreak worth €3 billion.

That said, an immediate surge of financial incentives may be reasonably expected to help entire sectors of the outdoors economy (airline and transport, logistics, tour and venue operators, the HORECA sector, etc.) to survive.

Is there a legal dimension to the issue?

Yes.

Serbian State aid legislation, a system of rules mimicking the EU state aid control regime, in principle, disallows any form of selective financial advantage transferred to the certain undertaking(s) from the state resources capable of distorting competition and Serbian trade with the EU.

The form of the measure is irrelevant. Any direct transfer of public funds (direct subsidies) or relief from economic burdens can also constitute an illegal advantage, if sourced from (or affects) public resources, may be caught by the state aid rules, including tax advantages or reductions of social security contributions.

Indeed, many exemptions may apply, qualifying certain financial transfers to economic operators compatible with the State Aid Act and not subject to an administrative recovery order from a beneficiary.

On the other hand, some other direct financial transfers to the business, or mitigation of operating costs, if designed properly, may as well be out of the regulatory reach of the State Aid Control Commission (the “Commission”):

  • if directed to non-economic activity performed by the undertaking,
  • due to their applicability to all undertakings (lack of the selectivity), or
  • due to their negligent intensity (lack of the appreciable effect on the competition and trade), etc.

Covid 19 Notice of the Commission [5] issued on 17 March 2020 provides important legal clarifications to the state aid granting authorities, financial intermediaries and beneficiaries

Aid to reduce undertaking’s current expenditure and lack of cash flow (operating aid) in the most cases is the most distortive measure incompatible with the market and subject to the recovery orders.

In ordinary circumstances, the aid targeting market failures is a preferred state aid policy, favoring aid to investments in underdeveloped regions, R&D, training aid, etc.

Covid 19 is not normal circumstance, and legal avenues to distribute aid to target market failures are impractical.

As a result, the Covid 19 Notice indicates availability of infrequently used legal avenues for distributing operating aid compatible to the State Aid Act to fight the dire results of natural disaster to the state aid authorities and beneficiaries

Nevertheless, in the first place, the Notice snapshots financial transfers that fall outside the scope of State aid control and that can be put in place by the Government, immediately, without the involvement of the Commission:

  1. granting of public funds for health services or other public services aimed at fighting the pandemic;
  2. general measures applicable to all companies which do not contain State aid such as “wage subsidies and suspension of payments of corporate and value-added taxes or social contributions”;
  3. financial support directly to consumers/citizens.

Furthermore, it reminds us that the de minimis aid (i.e. aid up to RSD 23 million and RSD 11.5 million to road transport sector granted at any time within three consecutive fiscal years, from any source, and for any purpose) is a useful tool for channeling operating aid not subject to prior notification to the Commission.

The Notice in addition offers other legal avenues suitable for distributing the operating aid compatible with the state aid regime in case of an abnormal economic occurrences and serious disturbances in operation of the economy, albeit subject to the prior notification to the Commission.

Therefore, the authorities may design the state aid schemes or grant individual aid:

  • to compensate companies for the damage suffered due to the exceptional circumstances, e.g. companies in sectors that have been particularly hard hit, airlines, transport, tourism, hospitality, etc. (Art. 5.1 of the State Aid Act);
  • in response to a serious disturbance that affects the entire economy (Art. 5.2(2) of the State Aid Act);
  • to meet acute liquidity needs and support companies facing bankruptcy (Art. 5.2(3) of the State Aid Act).

The Commission also indicated that under article 5.1 the authorities may compensate the damage directly caused by the COVID-19 outbreak to undertakings that have already received rescue and restructuring aid.

Will overcompensations be subject to the partial recovery orders?

The Commission indicates that it will closely observe if the aid granted to make good the damage caused to the economic operator goes beyond the actual harm, indicating that overcompensations will be subject to the partial recovery order (recovery of the “surplus”) with the interest accrued.

Indeed, the State Aid Act provides the specific concept of the partially compatible aid [6], unknown to the EU law. [7]

However, the close reading of the State Aid Act would suggest that only incompatible aid may be subject to the recovery decision, doubtless, in its entirety. [8]

Indeed, if measure is incompatible than entire financial advantage distributed through the measure must be recovered with the interest.

However, the Notice provides, somewhat, flexible interpretation suggesting that incompatible part of the aid may be subject to the partial recovery, i.e. recovery of the “surplus” of the advantage received.

What is extraordinary in the Commission’s approach compared to the normal circumstances?

Extraordinary occurrences, rarely strike entire territory of the state and cause the disturbance of the entire economy.

In “normal” circumstances aid provider must establish that some occurrence is indeed exceptional or the serious disturbance affecting the entire economy exist before the aid scheme or individual aid is approved by the Commission on respective grounds.

Though it could have been stated more directly, Covid 19 Notice implies that pandemic qualifies as the exceptional occurrence and that there is the serious disturbance that affects the entire [Serbian] economy, suggesting that the state aid grantor will not be hassled by the Commission to provide evidence of their existence to the requisite standard.

Furthermore, the Commission has provided some pointers on how it will interpret state transfers to incentivize credit institutions and other financial intermediaries to continue to play their role in continuing supporting economic activity.

Namely, aid measures adopted on grounds the exceptional occurrence (Art. 5.1), which are channeled through banks as financial intermediaries, to benefit companies affected by Covid 19, will not be considered as an (indirect) advantage to the banks.

This is an important declaration.

Namely, in normal circumstances, any public funds channeled through financial institutions and targeting undertakings facing a sudden liquidity shortage may also constitute an indirect advantage to the former.

The Commission statement means that, for the purposes of the unprecedented crisis, the banks will be presumed as not being the indirect aid beneficiaries (and subject to the recovery order) in case their services are used to distribute the aid measure.

As a result, aid in the form of public guarantees and reduced interest rates could be provided to the undertakings facing a sudden liquidity shortage directly or through credit institutions and other financial institutions as financial intermediaries, without being overly scrutinized.

What is not clear?

Unfortunately, the Notice does not indicate if the financial institutions will not be considered indirect aid beneficiaries in case of the aid targeting the serious disturbance that affects the entire [Serbian] economy channeled through them – Article 5.2(2)) measures.

Namely, the state aid grantors could resort to measures aimed at targeting serious disturbances due to the outbreak channeled through the financial intermediaries.

As a result, it is reasonable to expect that the Commission will threat this avenue for aid equally free from the indirect aid to the banks.

Could measures proposed by the business community fit in the applicable state aid rules?

Yes, provided they are made transparent (possible to calculate precisely the gross grant equivalent of the aid ex ante), appropriate, proportional, and limited in time, it is possible to fit them in the state aid rules.

However, as indicated in the Covid 19 notice, if applied to all companies, measures introduced to alleviate financial strains on undertakings, such as:

  • wage subsidies,
  • suspension of payments of corporate and value added taxes or social contributions [9],

fall outside the scope of State aid control and can be put in place by the Government, immediately, without involvement of the Commission.

Namely, nonselective financial transfers from public resources or fiscal reliefs applicable to all companies escape state aid regime, since they do not favor production of certain goods or services.

As a result, if applied as blanket measures, actions proposed by the business community such as:

  • reduction of taxes and contributions;
  • reduction of corporate income tax;
  • subsidized collaterals;
  • suspension of interest accrual is proposed for late payment of liability taxes, during the state of emergency, etc.

shall fall outside the state aid regime.

The fact that the non-selective public financial transfers escape the state aid definition means that such financial transfers are discounted from:

  • calculation of applicable de minims aid ceilings;
  • calculation of applicable maximum aid intensities for other types of aid; and
  • to the significant effect, from scrutiny of compatibility of individual state aid schemes (for example rescue and restructuring aid or other types of operating aid).

Other measures proposed by the business community, to help SMEs or affected sectors such as:

  • reduced taxes and contributions for SMEs and entrepreneurs;
  • reduced VAT for tour and venue operators, the HORECA sector, transport, logistics;
  • direct grants for lease of premises for HORECA sector, etc.,

being selective qualify as the state aid according to the law.

Nevertheless, given the relatively generous de minimis ceilings (200.000,00 EUR applied horizontally and 100.000,00 EUR for road freight transport, respectively) they could fit in the appropriate de minimis aid schemes provided that they:

  • do not pierce the applicable de minimis ceiling over any period of three fiscal years, and
  • assuming that is transparent (the gross grant equivalent of the aid can be defined ex ante).

The scheme(s) could provide flexibility to a beneficiary to opt between different aid instruments subject to a claw-back mechanism to prevent aid exceeding the applicable ceilings.

Indeed, the selective financial public transfers that do not fit in the de minimis box could follow other legal avenues proposed by the Commission:

  • the state aid measures to make good the damage caused by natural disasters or exceptional occurrences (Art. 5.1) provided that a beneficiary establishes a direct causal link between the aid granted and the damage suffered by each beneficiary; the aid is limited to the cost of the damage and; any insurance pay-out must be deducted from the cost of the damage and the amount of compensation;
  • the state aid measures to remedy a serious disturbance in Serbian economy (Art. 5.2(2)); and
  • to meet acute liquidity needs and support companies facing bankruptcy (Art. 5.2(3)).

The European Commission’s Covid-19 Temporary Framework [10] adopted on 19 March provides a useful source of inspiration 

The European Commissions released guidance to the Member States for developing compliant measures targeting acute liquidity needs, companies facing bankruptcy, and job layoffs:

Accordingly, Member States will be able to:

  1. set up schemes to direct grants or selective tax advantages up to €800,000 to a company for urgent liquidity needs;
  2. give state guarantees, at subsidised premiums, for bank loans taken by SMEs and non-SMEs for investment and working capital, subject to certain maximum amounts;
  3. enable public and private loans with subsidised interest rates.

Covid-19 Temporary Framework facilitates the transfers of aid to SMEs and other customers via banks providing that indirect advantage accrued to the bank from the measure channeled through them will not be qualified as the aid by the European Commission, provided that he advantages of the measure are passed on to the largest extent possible to the final beneficiaries.

What will be the challenge for the Commission, state aid grantors and beneficiaries? 

The legal regime lacks procedural flexibility and safe harbor rules needed in the face of the unparalleled urgency.

Namely, the State Aid Act requires pre-notification of most of the aid measures, which otherwise are presumed compatible with the market without the need to be notified before granted to the European Commission under the EU law, including the aid to compensate for the damage caused to the undertakings by a natural disaster and exceptional occurrences.

That said, the Commission operates in the context of the declared state of emergency, where measures are adopted rapidly.

To provide its rapid response, and observe the rule of law in dire circumstances, the Commission could provide flexible guidance to the state aid grantors on the minimum information needed for complete notification of measures specifically aimed at remedying Covid 19 effects. 

Aid in the form of selective fiscal reliefs could be pragmatic instrument to channel the aid, since for their implementation, it is not necessary to provide funds immediately, it is sufficient to approve tax credits.

Some beneficiaries may prefer fiscal measures over direct grants as aid instruments through which the aid is distributed, as well as other types of incentives channeled through the financial intermediaries (guarantees with subsidized premiums for quick loans, subsidised interest rates, etc.).

However, the State Aid Act and Regulation on Rules for Granting the Aid lack guidance on the transparency of the aid instruments, other than direct grants.

Indeed, state aid authorities may incline to direct grants as preferred method of distribution of aid, often, not because it is assessed as the most efficient method for particular scheme, but because it is easier.

Nevertheless, the Commission could guide the state aid grantors on the transparent use of alternative aid instruments to the direct grant.  

Finally, it is reasonable to assume that the Government or ministries will adopt measures with the state aid element without prior notification to the Commission and without referencing the measure to any of the legal grounds provided in the State Aid Act.

Indeed, in case of the non-notified aid the Commission may resort to soft mechanisms available under the State Aid Act (Art. 10(8) – opinion on the compatibility of act with the State Aid Act, art 29 -declaration of the partial compatibility, etc.) to provide the guidance to the state aid grantor to fix the measure, to keep the beneficiaries clear from the unnecessary risk of recovery order, once the state of emergency is lifted.

What further clarifications from the Commission will be needed?

To complement the above-mentioned possibilities, the Commission must provide further pointers on

  • type of measures and instruments that could be considered compatible with Art. 5.2(2) – measures to remedy a serious disturbance in the Serbian economy; and
  • in case of aid schemes to make good the damage, the directions on proxies to calculate the damage.[11]

That said, and akin to the measures based on Art. 5.1, the Commission must provide clear guidance that aid measures to benefits undertakings affected by the serious disturbance (Art. 5.2(2)) and channeled through the financial institutions will be considered free from the risk of the indirect aid for financial intermediaries of the measure.

Namely, in normal circumstances, any aid channeled through financial institutions and targeting undertakings facing a sudden liquidity shortage may also constitute an indirect advantage to the former.

Due to the extraordinary circumstances, and to clear the air further, the Commission must be more robust in the conclusion that such indirect advantage will not be considered aid under the State Aid Act as it does not have the objective to preserve or restore the viability, liquidity or solvency of the credit institutions.

On the other hand, to win such presumption, the financial intermediary must be able to demonstrate that it operates a mechanism that ensures that the advantages of the measure are passed on to the largest extent possible to the final beneficiaries for example in the form of higher volumes of financing, riskier portfolios, lower collateral requirements, lower guarantee premiums or lower interest rates, as a result of the measure.

The Commission could also clarify if public transfers to source additional capacities from private providers of health services for testing, taking care of infected or fighting Covid 19 outbreaks in the private sector are free from the state aid element.

We truly hope the Commission will do so in a due course.

Conclusion

The rapid and robust response of Serbia to contain the pandemic is expected to be followed up by an equally rapid and robust economic response. The business community arrived with a number of proposals some of which may contain elements of the state aid and many in the form of selective fiscal reliefs. The choice of instruments proposed by the economy is pragmatic for their implementation it is not necessary to provide funds immediately, it is sufficient to approve tax credits. If applied as blanket measures they will escape the scrutiny of the state aid regime. On the other hand, the measures targeting SMEs or particular economic sectors will certainly qualify as the state aid as being selective. Indeed, in order to be complaint and escape the risk of administrative recovery, both, state aid grantors and beneficiaries, are advised to follow the guidance of the Commission. However, the compatibility is only one side of the story. The key is in the effectiveness of the aid schemes and aid instruments. The most efficient aid measures must be deployed. To that end, the Commission’s Notice provided a number of useful directions. Further clarifications should be expected. Yet, in the times of the accelerated reality, the Commission will struggle to find the appropriate means to safeguard the rule of law.

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[1] AmCham, Survey Results: Current and expected economic impact of COVID-19 and the measures to be taken;

[2] The New York Times, Coronavirus Recession Looms, Its Course ‘Unrecognizable’, March 21, 2020; 

[3] AmCham, ibid;

[4] AmCham, ibid; Tomislav Momirović, Kontraudar Published on March 23, 2020 ; Marko Obradović; Houston, we have a problem…  (CEP, Published on March 23, 2020);

[5] Commission for the State Aid Control, Covid 19 Notice, 17 March 2020;

[6] State Aid Act. Art. 29;

[7] In accordance with the EU State aid law the measure can be declared unlawful, compatible or incompatible with the internal market. Only, incompatible aid can be subject to the recovery decision of the European Commission. Once declared incompatible the entire financial advantage distributed through incompatible measure is subject to the recovery decision. Namely, the recovery is not a punishment but a measure of restitution of the conditions of the competition which would have existed, but for the incompatible state aid. As a result, there is no such thing as the recovery of “surplus” or incompatible part of advantage under the EU law;

[8] State Aid Act, Art. 52;

[9] COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK, THE EUROPEAN INVESTMENT BANK AND THE EUROGROUP Coordinated economic response to the COVID-19 Outbreak, para. 9;

[10] COMMUNICATION FROM THE COMMISSION Temporary Framework for State aid measures to support the economy in the current COVID-19 outbreak;

[11] Article 50 of the General Block Exemption Regulation provides a useful reference.