The purpose of these rules was to allow economic operators in the region to overcome the structural disadvantages deriving from their insular situation on the periphery of the European Community.
In 2000, Portugal notified the Commission of this tax scheme. As the scheme was thought to have entered into force before being authorised it was considered as non notified aid.
Following various requests for additional information, the Commission decided to initiate an Article 88(2) procedure, on the ground that the measures classified as selective aid (Art. 87(1)).
In Case C-88/03, Portugal sought the annulment of this decision, arguing that (1) the contested decision was vitiated by an error of law in the application of Art. 87(1) EC, (2) that that decision was not sufficiently reasoned, hence breached Art. 253 EC, and (3) that it was vitiated by a manifest error of assessment of the facts which influenced the application of Art. 87(3)(a) EC.
The Court held the determination whether a constituted selective aid required an examination of whether that measure constituted an advantage for certain undertakings in comparison with others which were in a comparable legal and factual situation.
The ‘normal’ tax rate was the rate in force in the geographical area constituting the reference framework.
When an infra-State body sufficiently autonomous in relation to the central government of a Member State, the legal framework appropriate to determine the selectivity of a tax measure might be limited to the geographical area concerned where the infra-State body, in particular on account of its status and powers, occupied a fundamental role in the definition of the political and economic environment in which the undertakings present on the territory within its competence operated.
The Court stipulated three conditions in order to establish whether an infra-State body was "sufficiently autonomous".
(1) the decision must, first of all, have been taken by a regional or local authority which had, from a constitutional point of view, a political and administrative status separate from that of the central government.
(2) It must have been adopted without the central government being able to directly intervene as regards its content.
(3) Finally, the financial consequences of a reduction of the national tax rate for undertakings in the region must not be offset by aid or subsidies from other regions or central government.
Autonomous Region of the Azores did, however, not fulfil all these conditions
Although, under the Constitution of the Portugal the Azores formed an autonomous region with its own political and administrative status and its own self-government institutions which had the power to exercise their own fiscal competence and adapt national fiscal provisions to regional specificities, the two aspects of the fiscal policy of the regional government, namely the decision to reduce the regional tax burden by exercising its power to reduce tax rates on revenue and the fulfilment of its task of correcting inequalities deriving from insularity, were inextricably linked and depended, from the financial point of view, on budgetary transfers managed by central government.
Therefore, the disputed measures must be assessed in relation to whole of Portuguese territory, which implied that the Commission rightfully classified them as selective aid.
The Court also rejected the other pleas of Portugal.