EUROPEAN COMMISSION. State Aid SA (2017/N) United Kingdom Inverness Airport entrustment of a service of general economic interest

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1 EUROPEAN COMMISSION Brussels, C(2017) 4942 final PUBLIC VERSION This document is made available for information purposes only. Subject: State Aid SA (2017/N) United Kingdom Inverness Airport entrustment of a service of general economic interest Sir, 1. PROCEDURE (1) By letter dated 27 April 2017, the United Kingdom notified to the Commission the entrustment to Inverness Airport of a service of general economic interest (the "SGEI"). The measure was registered under the State aid case number SA (2017/N). 2. DETAILED DESCRIPTION OF THE MEASURE 2.1. Inverness Airport (2) Inverness Airport is located to the east of the city of Inverness in the Highlands and Islands region of Scotland in the United Kingdom. (3) The airport is operated by Highlands and Islands Airports Limited (the "HIAL"). 1 HIAL was incorporated in Edinburgh on 4 March 1986 under the Companies Act 1985 and is wholly owned by the Scottish government. The Scottish government as the owner delegates the daily operations of HIAL to its Board. The Scottish government appoints the chair of the Board and four of its seven directors. 1 In addition to the Inverness Airport, the company also operates and manages ten other airports at Barra, Benbecula, Campbeltown, Dundee, Islay, Kirkwall, Stornoway, Sumburgh, Tiree and Wick as services of general economic interest. The present notification concerns only the Inverness Airport. The Rt Hon Boris Johnson MP The Foreign and Commonwealth Office King Charles Street London SW1A 2AH Commission européenne/europese Commissie, 1049 Bruxelles/Brussel, BELGIQUE/BELGIË - Tel

2 (4) In addition to the operation of Inverness Airport as a SGEI, HIAL also carries out commercial activities which are related to the airport operation, such as renting of commercial space for retail, car parks and similar. The revenues from commercial activities account for less than 20% of the total revenues of Inverness Airport. (5) Inverness is the largest conurbation in the Highlands and Islands region of Scotland with a population of around The Highlands and Islands cover a large geographical area but are sparsely populated. The Highland Council area covers square kilometres but with a population of has a population density of only nine persons per square kilometre 2. The EU average 3 is inhabitants/km. 2 (6) Inverness provides an access point for some of Scotland's most remote islands, in particular the Shetland Islands, the Orkney Islands and the Western Isles (also referred to as the Outer Hebrides). The Shetland Islands cover square kilometres with a population of , giving a population density of 16 persons per square kilometre. This population is spread over 16 different islands. The Orkney Islands cover 989 square kilometres with a population of , giving a population density of 22 persons per square kilometre. This population is spread over 20 different islands. The Western Isles (Eilean Siar) cover square kilometres with a population of , giving a population density of nine persons per square kilometre. This population is spread over 15 different islands. 4 (7) Air passenger services operate between Inverness and Shetland (one direct service per day and one via Orkney, with a total number of passengers in 2015), Orkney (two services per day, with a total number of passengers in 2015) and the Western Isles (two services per day, with a total number of passengers in 2015). These services also all carry freight. The total freight carried in the year to 31 July 2016 was kg. Inverness Airport enables the quick transport of high priority, low weight freight. (8) Inverness Airport also enables residents from the wider Highlands and Islands to access services that cannot be provided in their areas. For example, the National Health Service (the "NHS") Highland has a service level agreement with NHS Western Isles for patients in the Western Isles to be treated at Inverness s Raigmore Hospital in cases where treatment is not available in the Western Isles (for example most cancer surgery and treatments including radiotherapy and chemotherapy). (9) In addition, there is a daily mail flight between Inverness and Stornoway which enables residents of the Western Isles to receive the same delivery times as the rest of the United Kingdom. (10) Air travel is the only practical means to travel from the islands to Inverness with journey times by other modes prohibitively long. For example, if travelling from Stornoway in the Western Isles to Inverness Airport, the flight time is 40 minutes EU Average: inhabitants/km 2 ; 2012 data; source: Eurostat. Scotland; Average 68 inhabitants/km 2 ; 2015 data; source: Office for National Statistics UK. Source: Eurostat. Population Density by NUTS 3 Region, National Records of Scotland: Mid-2014 Population Estimates Scotland 2

3 A total surface journey time would be three hours 52 minutes, made up of a two hour 30 minute ferry journey followed by a 102 kilometre car journey taking one hour 22 minutes. This assumes clear travelling conditions. It should be noted that ferries are regularly disrupted due to bad weather, in particular during the winter. Air services, overall, are less impacted by bad weather. (11) The table below shows passenger numbers for Inverness Airport over the last five years: Year Passengers (12) The nearest airports to Inverness itself are: Aberdeen International Airport: around 161 kilometres, two hours 25 minutes by car; traffic approximately 3.5 million passengers/year; Edinburgh Airport: around 246 kilometres, two hours 58 minutes by car; traffic approximately 11.1 million passengers/year; Glasgow Airport: around 286 kilometres, three hours 24 minutes by car; traffic: approximately 8.7 million passengers/year. (13) There is no high speed rail in Scotland. The total journey times by regular train are longer than by car. Inverness rail station to Aberdeen rail station is around two hours 15 minutes, to Edinburgh rail station it is around three hours 46 minutes and to Glasgow rail station it is around three hours 25 minutes. Additional time is then needed to travel from the train station to the airport or to any behind or beyond destinations. Travel from Inverness to London by train takes eight hours 17 minutes. Any travel from the islands also involves a sea crossing. (14) No improvements to the rail links can be expected in the near future. The nearest airport to Inverness involves a two hour 15 minutes rail journey (with an additional 45 minute bus journey to the airport itself). Furthermore, the only option available for inhabitants of the highlands of Scotland to the North and West of Inverness would be by car. This would take more than two hours. (15) In view of the United Kingdom, air transport connectivity is crucial to the region because rail travel to London takes around over eight hours, by car this can be expected to be over ten hours (914 km). Connections for the Islands can be in excess of 23 hours to London using a mixture of ferry and road connections. The United Kingdom also mentions the travel distances and times set out in paragraphs (10) to (14) above. (16) Scheduled flights operate from Inverness Airport to London, Amsterdam, Belfast, Birmingham, Bristol, Dublin, Manchester, Stornoway in the Western Isles, Kirkwall in Orkney and Sumburgh in Shetland. There is some charter traffic and seasonal flights to Geneva. 3

4 (17) The United Kingdom considers that the existence of Inverness Airport is necessary for the region for socio-economic reasons. However, it is not possible, due to economic reasons, to operate the airport without systematic public support. (18) The United Kingdom stresses that Inverness's services to London, Manchester and Amsterdam are essential for the economy of Inverness and the surrounding area. It has also highlighted the importance of tourism to the economy of the region having accounted for 11.1% of all jobs in the region in (19) The United Kingdom argue the importance of the connections provided by Inverness to the Scottish Islands as mentioned in recitals (10) to (14)(15) above and in particular the importance to access to education for the inhabitants of some of the islands and the importance for access to medical care as mentioned at recital (8) above. The United Kingdom stressed the importance also of postal service as mentioned in recital (9). (20) The United Kingdom considers that without public funding Inverness Airport would close to scheduled passenger services. Without public funding the airport charges necessary to cover the costs of operating the airport would be so high as to mean that it would not be economic to operate services. HIAL does not make a profit overall, public funding serves only to allow the company to break even each year. The United Kingdom considers that direct subsidy limits the market intervention to the minimum necessary. (21) Inverness Airport has received the following in terms of public funding in previous years 6 : Period Amount ( ) 1 February 2012 to 31 March April 2012 to 31 March April 2013 to 31 March April 2014 to 31 March April 2015 to 31 March Entrustment of Service of General Economic Interest (22) In 2016, the Scottish government decided to create a new entrustment for Inverness Airport entrusting it with the provision of an SGEI. (23) The new act of entrustment consolidates and codifies past practice towards Inverness Airport and the other HIAL airports. As regards Inverness Airport, in 2012 the Scottish government formally entrusted HIAL with the provision of an SGEI at Inverness Airport by way of an overarching Management Statement and Financial Memorandum governing the provision and use of public funds to ensure the operation of Inverness Airport. This act was supplemented by an annual specification of the budget allocation and terms of spending of the allocation, 5 6 Local Authority Area Growth Sector Database, Scottish Government: The figures include an overhead allocation for Inverness Airport s contribution towards the cost of HIAL s Head Office operations. 4

5 informed by the annual budget plan which was approved by the Scottish government. 7 (24) The new act of entrustment specifies that the SGEI is established by reason of and pursuant to conditions that follow from the requirements of the European Union State aid rules, including the Commission Communication on a European Union framework for State aid in the form of public service compensation 8 (the "SGEI Framework"). The notification included the draft of the new act of entrustment. The new version of the act of entrustment will be adopted following the adoption of this Commission decision. (25) According to the act of entrustment: the SGEI is the obligation on HIAL to maintain the safe operation of the airport and ensure that it remains open to commercial air traffic; HIAL shall be compensated by the Scottish government from public funds at an amount less than the operating loss each year; the act of entrustment shall apply until 2022; it requires compliance with Directive 2006/111/EC (recital (33) of the entrustment act). (26) The entrustment does not cover the development of commercial air transport services. (27) The United Kingdom notified a compensation model based on the following principles: (i) (ii) (iii) Each year HIAL will assess its budgetary requirement for the given period based on its forecast cost and revenue. HIAL will calculate the cost and revenue of fulfilling the public service obligation. The costs included in this calculation will be strictly limited to those necessary to fulfil the SGEI. HIAL will be required to provide evidence-based forecasts for its income and expenditure. The Scottish government will then decide on the allocation of budgets and will send to HIAL a formal statement of its budgetary provision. This amount shall be less than HIAL's assessment of its budgetary requirement (i.e. less than the net cost of discharging the SGEI). HIAL's revenue from commercial activities is taken into account when calculating the budgetary provision. If HIAL's commercial revenue in a given period is less than projected, then expenditure should be reduced by a corresponding amount. If HIAL's commercial revenue during a given period is more than projected, then this will reduce the budgetary provision by the Scottish government. The grant shall be paid out monthly. Should any overcompensation occur, this will be reconciled 7 8 The United Kingdom has supplied the overarching entrustment act of the Management Statement and Financial Memorandum and the budget allocation and conditions for ; ; and OJ C 8 of , p.15. 5

6 against the next grant claim after the overcompensation has been identified. (iv) (v) (vi) In order to achieve efficiency, the public funding will be less than the net cost of discharging the SGEI, with an obligation on HIAL to achieve cost coverage by increasing commercial revenue or making costs savings to meet the difference. Additionally, HIAL is required to follow the Scottish Public Finance Manual issued by Scottish government. The manual, in addition to setting out the requirements on proper handling and reporting of public funds, emphasises the need for economy, efficiency and effectiveness, and sets duties on continuous improvement in efficiency. 9 The compensation granted to HIAL does not include a reasonable profit. Any revenues are allocated solely to reduce funding of the SGEI. 10 HIAL shall be subject to both internal and external audit and will be subject to the Government Financial Reporting Manual requirements, 11 with accounts provided to both the Auditor General for Scotland and the Scottish government and published annually. (28) The United Kingdom committed to publish the SGEI compensation to HIAL as described in the act of entrustment on the Scottish government web site and the HIAL website, with due reference to the information listed under paragraph 60 of the SGEI Framework. (29) The United Kingdom specified that all relations between HIAL and airlines, other than public service obligations insofar as HIAL is responsible for them, must comply with the market economy operator (the "MEO") test as specified in part 3.5 of the Commission Guidelines for State aid to airports and airlines 12 (the "Aviation Guidelines"). 3. ASSESSMENT OF THE MEASURE 3.1. Presence of aid within the meaning of article 107(1) TFEU (30) According to Article 107(1) TFEU 13 "any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market". (31) The criteria laid down in Article 107(1) TFEU are cumulative. Therefore, in order to determine whether the notified measure constitutes State aid within the meaning of Article 107(1) TFEU, all the above mentioned conditions need to be fulfilled cumulatively. Namely, the financial support should: - be granted by a Member State and through State resources, This is contained in recitals (36) to (37) of the entrustment act. OJ C 99 of , p.3. The Treaty on the Functioning of the European Union; consolidated version: OJ C 326 of , p.1 (the "TFEU" or the "Treaty"). 6

7 - favour certain undertakings or the production of certain goods, - distort or threaten to distort competition, - affect trade between Member States Economic activity and notion of undertaking (32) As regards the criterion of any advantage being granted to an undertaking, the Commission must first establish whether HIAL is an undertaking within the meaning of Article 107(1) TFEU. The Commission notes that the concept of an undertaking covers any entity engaged in an economic activity, regardless of its legal status and the way in which it is financed. 14 Any activity consisting in offering goods and services on a given market is an economic activity. 15 (33) In its "Leipzig-Halle airport" judgment the Court of Justice confirmed that the operation of an airport for commercial purpose and the construction of the airport infrastructure constitute an economic activity. 16 Once an airport operator engages in economic activities, regardless of its legal status or the way in which it is financed, it constitutes an undertaking within the meaning of Article 107(1) TFEU, and the Treaty rules on State aid therefore apply. 17 (34) In this regard, the Commission notes that the airport in question is operated on a commercial basis as any air carrier that wants to use the airport can do it against payment of applicable airport fees, as established in the airport's schedule of charges. It follows that the entity operating the airport constitutes an undertaking for the purposes of Article 107(1) of the TFEU State resources and imputability to the state (35) The financing is granted by the Scottish government from its budget. Therefore, the measure is financed by public funds constituting State resources. Since it is granted by the decisions of the devolved authority, it is imputable to the State Economic advantage (36) The Commission recalls that SGEI compensations granted to a company may not constitute an economic advantage under certain strictly defined conditions Case C-35/96 Commission v Italy, ECLI:EU:C:1998:303; C-41/90 Höfner and Elser, ECLI:EU:C:1991:161, paragraph 21; Case C-244/94 Fédération Française des Sociétés d'assurances v Ministère de l'agriculture et de la Pêche, ECLI:EU:C:1995:392; Case C-55/96 Job Centre, ECLI:EU:C:1997:603. Case 118/85 Commission v Italy, ECLI:EU:C:1987:283, paragraph 7; Case 35/96 Commission v Italy, ECLI:EU:C:1998:303, paragraph 36. Joined Cases T-443/08 and T-455/08, Freistaat Sachsen and Land Sachsen-Anhalt and Others v Commission, ECLI:EU:T:2011:117, upheld on appeal in Judgment of the Court of Justice of 19 December 2012, Mitteldeutsche Flughafen AG and Flughafen Leipzig-Halle GmbH v Commission, C- 288/11 P, ECLI:EU: C:2012:821; see also Judgment of the Court of 24 October 2002, Aéroports de Paris v Commission, case C-82/01 P, ECLI:EU:C:2002:617 and Ryanair v Commission, case T- 196/04, ECLI:EU:T:2008:585. Cases C-159/91 and C-160/91, Poucet v AGV and Pistre v Cancave,, ECLI:EU:C:1993:63. 7

8 (37) In particular, in its Altmark judgment, 18 the Court of Justice held that where a State measure must be regarded as compensation for the services provided by the recipient undertakings in order to discharge public service obligations, so that those undertakings do not enjoy a real financial advantage and the measure thus does not have the effect of putting them in a more favourable competitive position than the undertakings competing with them, such a measure is not caught by Article 107(1) TFEU. (38) However, the Court also made clear that for such public service compensation to escape qualification as State aid in a particular case, the four cumulative criteria ("Altmark Criteria") summarized below must be satisfied: 1. The recipient undertaking must actually have public service obligations to discharge and those obligations must be clearly defined (the "First Altmark Criterion"); 2. The parameters on the basis of which the compensation is calculated must be established in advance in an objective and transparent manner (the "Second Altmark Criterion"); 3. The compensation cannot exceed what is necessary to cover all or part of the costs incurred in the discharge of the public service obligations, taking into account the relevant receipts and a reasonable profit (the "Third Altmark Criterion"); 4. Where the undertaking which is to discharge public service obligations, in a specific case, is not chosen pursuant to a public procurement procedure, which would allow for the selection of the tenderer capable of providing those services at the least cost to the community, the level of compensation needed must be determined on the basis of an analysis of the costs which a typical undertaking, well run and adequately provided with means to meet the public service obligations, would have incurred, taking into account the relevant receipts and a reasonable profit from discharging the obligations (the "Fourth Altmark Criterion"). (39) The Commission specified how it applies the Altmark Criteria in its Communication on the application of the European Union State aid rules to compensation granted for the provision of services of general economic interest (the "SGEI Communication"). 19 (40) Given that the conditions of applicability of the Altmark case-law are cumulative, noncompliance with any one of these conditions would lead to the qualification of the measure under review as State aid within the meaning of Article 107 TFEU. (41) In view of the above, therefore, for the purposes of finding whether the measure granted an advantage within the meaning of Article 107 TFEU, the Commission Case C-280/00 Altmark Trans GmbH and Regierungspräsidium Magdeburg v Nahverkehrsgesellschaft Altmark GmbH, ECLI:EU:C:2003:415. See also paragraphs 42 et seq. of the Communication from the Commission on the application of the European Union State aid rules to compensation granted for the provision of services of general economic interest Official Journal C8, , p OJ C 8 of , p. 4. 8

9 will first assess whether the compensation complies with the Fourth Altmark Criterion. (a) First sub-criterion: Appropriate public procurement procedure (42) The Commission notes that Inverness Airport is operated by HIAL which is owned by the Scottish government. The operator was not selected by a public procurement procedure for the public service obligations it is entrusted with. The Commission therefore concludes that the operator was not selected through a public procurement procedure responding to the standards of the Fourth Altmark Criterion as laid down in points 63 to 68 of the SGEI Communication (b) Second sub-criterion: Comparison with typical, well-run undertaking (43) Therefore, for the Fourth Altmark Criterion to be fulfilled, it has to be further verified whether the assessed compensation was determined on the basis of an analysis of the costs which a typical undertaking, well run and adequately provided with means to meet the public service obligations, would have incurred, taking into account the relevant receipts and a reasonable profit from discharging the obligations. (44) According to point 75 of the SGEI Communication "If the Member State can show that the cost structure of the undertaking entrusted with the operation of the SGEI corresponds to the average cost structure of efficient and comparable undertakings in the sector under consideration, the amount of compensation that will allow the undertaking to cover its costs, including a reasonable profit, is deemed to comply with the fourth Altmark criterion". (45) The Commission notes that United Kingdom did not provide any analysis showing that the cost structure of HIAL corresponds to the average cost structure of efficient and comparable undertaking operating an airport. (46) The Commission also notes that the efficiency mechanism, foreseen for the act of entrustment, is not relevant in this respect, especially because the United Kingdom did not provide any analysis to support such a contention. (47) Consequently, the Commission considers that the Fourth Altmark Criterion is not complied with in this case. As the conditions set out in the Altmark judgment are cumulative, failure to comply with any one of the four conditions necessarily leads to the conclusion that the financing measures under review grant an economic advantage within the meaning of Article 107(1) TFEU Selectivity (48) Article 107(1) TFEU requires that a measure, in order to be defined as State aid, favours "certain undertakings or the production of certain goods". The Commission notes that the public funding in question will be granted to the HIAL only. Hence, the measure is selective within the meaning of Article 107(1) TFEU Distortion of competition and effect on trade (49) The Commission notes that when aid granted by a Member State strengthens the position of an undertaking compared with other undertakings competing in intra- Union trade, the latter must be regarded as affected by that aid. 9

10 (50) In accordance with settled case law, 20 for a measure to distort competition, it is sufficient that the recipient of the aid competes with other undertakings on markets open to competition. (51) The Commission considers that any undue economic advantage granted to an airport operator from public resources can strengthen the beneficiary's position vis-à-vis its competitors on the market of providers of airport services. (52) The Commission notes that many operators are in competition for the management of airport infrastructure in Europe, including local and regional airports. In addition, airport operators compete for air carriers to operate from their airports. Aid to the operator of Inverness Airport may therefore distort competition in the markets for airport infrastructure operation by reinforcing its economic position and by reducing business opportunities for competing airports. (53) Therefore, the public funding under examination distorts or threatens to distort competition and affects trade between the Member States Conclusion on the existence aid (54) For the reasons set out above, the Commission concludes that the compensation granted to HIAL constitutes State aid within the meaning of Article 107(1) TFEU Legality of the measure (55) Pursuant to the standstill clause of Article 108(3) TFEU and to Article 3 of Council Regulation No 2015/1589 of 13 July 2015 laying down detailed rules for the application of Article 108 of the Treaty on the Functioning of the European Union, 21 new aid measures must not be put into effect before the Commission has taken a decision authorising such aid. In this context, aid measures can be considered to be put into effect when the legally binding act providing for the aid is adopted. (56) The Commission notes that the acts of entrustment on which compensation has been paid out to HIAL until the date of the notification procedure were adopted prior to the date of this decision and the granting acts did not contain any clause which would have made the granting of the aid conditional on the approval by the Commission. (57) The new consolidated act of entrustment for the compensation paid out as of 27 April 2017 is subject to the adoption of a Commission decision authorising such aid. (58) Therefore, the Commission is of the opinion that the compensation up until 27 April 2017 was granted in breach of the standstill clause and is to be considered as illegal aid Compatibility of the aid (59) Article 106(2) TFEU provides that "Undertakings entrusted with the operation of services of general economic interest or having the character of a revenue Case T-214/95 Het Vlaamse Gewest v Commission, ECLI:EU:T:1998:77. OJ L 248 of , p.9. 10

11 producing monopoly shall be subject to the rules contained in this Treaty, in particular to the rules on competition, in so far as the application of such rules does not obstruct the performance, in law or in fact, of the particular tasks assigned to them. The development of trade must not be affected to such an extent as would be contrary to the interests of the Union." (60) In accordance with the Aviation Guidelines, the compensation of the operation of an airport as a SGEI can be considered compatible under Article 106(2) TFEU. (61) Pursuant to Article 106(3) TFEU, it is for the Commission to ensure the application of that provision. In accordance with the Aviation Guidelines, the compensation for the operation of an airport as an SGEI can be considered compatible under Article 106(2) TFEU if the criteria laid out in section 4 of the Aviation Guidelines are fulfilled, in particular if the operation qualifies as genuine and correctly defined service of general economic interest within the meaning of points 69 and 72 of the Aviation Guidelines, and if it fulfils the compatibility criteria as laid out in section 4.2 of the Aviation Guidelines in conjunction with the relevant rules of the SGEI Communication and, for airports with an annual traffic over passengers, of the SGEI Framework. (62) It is in light of the above (recitals (23) and (24)) that the Commission will perform a compatibility assessment both of the notified measure and of the illegal aid Genuine service of general economic interest (63) As a first condition for the compensation of airport management services to be compatible with the State aid rules, the service provider must be entrusted with a genuine and correctly defined service of general economic interest. This requirement is laid down in point 69 of the Aviation Guidelines in conjunction with section 2.2. of the SGEI Framework and section 3.2. of the SGEI Communication. (64) According to point 69 of the Aviation Guidelines, an SGEI should exhibit special characteristics as compared with ordinary economic activities and the general interest objective pursued by the public authorities cannot simply be that of the development of certain economic areas or economic activities provided for in Article 107(3)(c)of the Treaty. (65) Point 72 of the Aviation Guidelines further defines this requirement by specifying that it is possible for the overall management of an airport to be considered an SGEI only in well-justified cases, that is if part of the area potentially served by the airport would, without the airport, be isolated from the rest of the Union to an extent that would prejudice its social and economic development. Such an assessment should take due account of other modes of transport, and in particular of high-speed rail services or maritime links served by ferries. In such cases, public authorities may impose a public service obligation on an airport to ensure that the airport remains open to commercial traffic. (66) In point 73 of the Aviation Guidelines, the Commission adds that the scope of public service obligations imposed on airports should not encompass the development of commercial air transport services. 11

12 Assessment (67) The first question is thus whether the United Kingdom committed a manifest error in considering that, without the Inverness Airport, the region would be isolated from the rest of the Union to an extent which would prejudice its social and economic development. (68) The Commission notes that potential alternative airports to the Inverness Airport, i.e. the closest airports to it in terms of travelling distance and travelling time, involve journey times in excess of two and half hours or more, depending on location, as set out in recital (12) above. Recital (13) provides that the nearest other airport to Inverness is two hours 15 minutes by rail journey (with an additional 45 minute bus journey to the airport itself) and would be a considerably longer journey by car, the only realistic option available to the inhabitants of the Highlands of Scotland to the north and west of Inverness. (69) It should be noted the Highland area Inverness serves is some square kilometres, excluding the islands for which it acts as hub. (70) As far as other means of transport are concerned, including rail, the Commission considers that they do not provide a real alternative to air transport. As mentioned in recital (13), there is no high speed rail connection in Scotland. The United Kingdom authorities submitted that there are no improvements to the rail links expected in the near future (recital (14)). (71) The Commission notes in particular the travelling distance of 8 hours 17 minutes by train from Inverness to London, three hours 46 minutes to Edinburgh and around three hours 25 minutes to Glasgow. The connection to London by car can be expected to be over ten hours, with a distance of 914 km. The connectivity for the islands to London can be in excess of 23 hours, using a mixture of ferry and road connections (recital (15)). (72) Furthermore, the Commission takes into account the immediate limitation of such train connection to cities on the mainland United Kingdom, due to the mainland itself being located on an island. This would, without the airport, isolate the region from the rest of Europe. Likewise, the Commission notes that due to geographical reasons, any maritime connections would also not be able to satisfactorily connect the discussed regions with the main United Kingdom cities and the rest of Europe. (73) The Commission places particular significance on the importance of the function of Inverness Airport in providing access to the islands and affording access to medical care, specifically Inverness's Raigmore Hospital used by residents of the islands (recitals (8)) and education provision (recital (19)). (74) The Commission considers that a lack of acceptable connections to the rest of Europe would significantly deteriorate the standard of living to the inhabitants of the region in question and would reduce the current activities and business perspectives to a number of companies existing there, especially international and/or export oriented. This would, for obvious reasons, prejudice the social and economic development of the region. The United Kingdom has also highlighted the importance of tourism to the economy of the region, as it accounted for 11.1% of all jobs in the region in 2014 (recital (18)). 12

13 (75) The Commission therefore considers that United Kingdom did not commit a manifest error of appreciation in finding that the region would be isolated from the rest of the Union without the Inverness Airport to an extent that would prejudice its social and economic development. (76) The second question is whether the United Kingdom committed a manifest error of appreciation in considering that the airport could disappear without public support in the form of SGEI compensation, i.e. in considering that the overall management of Inverness Airport is not a service which would be provided satisfactorily and on the same conditions, consistent with the public service, by undertakings operating under normal market conditions. (77) In this respect, the Commission points at the possibility of a gradual phasing out of public support until 2024, which is normally foreseen for regional airports under the Aviation Guidelines. The Commission recognised there that airports with annual passenger traffic between and passengers, i.e. also Inverness Airport, may not be able to fully cover their operating costs. (78) The Highland Council area covers square kilometres but with a population of has a population density of only nine persons per square kilometre 22. The EU average is inhabitants/km 2 (recital (5)). There is only one city with around inhabitants in the catchment area of Inverness Airport. The distance to nearest city Aberdeen (population of around ) is around 167 km and two hours 30 minutes by car and around two hours 15 minutes by train (travel to the airport at Aberdeen is over three hours from Inverness rail station (recital (13)). (79) Inverness is at the north-western extreme of the European Union and as such at the peripheral edge. The low population density limits prospects to attract significant numbers of air passengers. (80) The low population density in the catchment area in combination with the geographic location at the outer border of the European Union and the burden of the requirement to ensure connectivity to all the inhabited islands supports the argument of the United Kingdom that there is a risk that the airport will not be able to attract significantly higher number of passengers or significantly increase revenues and therefore to survive without continuous public support. (81) In the light of the foregoing, the Commission considers that United Kingdom also did not commit a manifest error of appreciation in considering that the Inverness Airport could disappear without public support in the form of SGEI compensation. The Commission therefore considers that the conditions of point 72 of the Aviation Guidelines are fulfilled. (82) The Commission also notes that the entrustment in question does not cover the development of commercial air transport services (recital (26)). Therefore, the Commission considers that point 73 of the Aviation Guidelines is complied with As mentioned in this decision at recital (5), 2012 data; source: Eurostat. Scotland; Average 68 inhabitants/km 2 ; 2015 data; source: Office for National Statistics United Kingdom data; source Office for National Statistics UK. 13

14 (83) In light of the above, the Commission considers that the aid is to be granted for a genuine and correctly defined SGEI, in line with the SGEI Framework in conjunction with points 69 and 72 of the Aviation Guidelines Need for an entrustment act specifying the public service obligations and the methods for calculating compensation (84) Pursuant to points 15 and 16 of the SGEI Framework, responsibility for the operation of an SGEI must be entrusted by way of one or several acts, the form of which may be determined by the Member State. The act or series of acts must specify at least: the content and duration of the public service obligations; the undertaking and, where applicable, the territory concerned; the nature of any exclusive or special rights assigned to the undertaking by the authority in question; the parameters for calculating, controlling and reviewing the compensation; and the arrangements for avoiding and recovering any overcompensation. (85) The Commission notes that the SGEI was entrusted to HIAL through a series of entrustment acts adopted by the Scottish government. The Scottish government decided to adopt a new entrustment act in 2016 which consolidates and formalises past practice towards the Inverness Airport. (86) The act of entrustment specifies that the SGEI is established by reason of and pursuant to conditions that follow from the requirements of the European Union State aid rules. It indicates the undertaking, the content and the duration of the public service obligation as well as the compensation method. (87) The United Kingdom committed that the Scottish government will adopt the new act of entrustment following the adoption of this Commission decision. (88) In light of the above, the Commission considers that the requirements of the SGEI Framework set out in points 15 and 16 thereof are met Duration of the period of entrustment (89) Point 17 of the SGEI Framework requires that the duration of the period of entrustment is "justified by reference to objective criteria such as the need to amortise non-transferable fixed assets", whereby the duration should not exceed the depreciation for the most significant assets required to provide the SGEI. (90) The United Kingdom informed the Commission that the five year period specified in the entrustment act is to provide for regular review of the entrustment, governing as it also does the smaller airports on the islands. After the five year period, the United Kingdom authorities will review the decision to entrust an SGEI to HIAL. (91) The Commission notes that operating of an airport requires a large number of tangible assets that depreciate over a long period, therefore, the five year period can be considered as appropriate. (92) In light of above, the Commission considers that the five year period of entrustment is acceptable for the assessed case and point 17 of the SGEI Framework is complied with. 14

15 Compliance with Directive 2006/111/EC (93) Point 18 of the SGEI Framework requires that the undertaking complies, where applicable, with Directive 2006/111/EC on the transparency of financial relations between Member States and public undertakings. 24 (94) The entrustment act specifically requires compliance with Directive 2006/111/EC (recital (25)). (95) HIAL is a public corporation that is wholly owned by Scottish government. A variety of transparency measures are therefore already in place; 25 information relating to the company can be found at Companies House in the United Kingdom, 26 audit information is available on request to the general public. Financial statements, including annual accounts, are published. 27 Financial statements required by statute are also published. 28 All other details about expenditure by HIAL, including board member expenses, are also available on request. 29 (96) The Commission therefore considers that Directive 2006/111/EC is applicable in this case and is complied with Compliance with Union public procurement rules (97) Pursuant to point 19 of the SGEI Framework, aid will be considered compatible with the internal market on the basis of Article 106(2) of the Treaty only where the responsible authority, when entrusting the provision of the service to the undertaking in question, has complied or commits to comply with the applicable Union rules in the area of public procurement. This includes any requirements of transparency, equal treatment and non-discrimination resulting directly from the Treaty and, where applicable, secondary Union law. (98) The Commission notes that the EU Court of Justice has, in its case-law, established a concept of in-house provision of services 30, according to which if an economic operator is controlled by public authorities and commits the major part of its activities towards these controlling authorities, it is considered to be an inhouse entity in relation to these authorities. According to the Court, such a relation falls outside the scope of the Union public procurement rules. (99) In the present case, the Commission notes that the Scottish government fully owns and control HIAL. Airport operation is HIAL's sole economic activity. Other commercial activity is strictly related to the airport operations only (such as renting of retail space at the airport (recital (4)). In any case, the revenues relating to the operation of Inverness Airport as a service of general economic interest Commission Directive 2006/111/EC of 16 November 2006 on the transparency of financial relations between Member States and public undertakings as well as on financial transparency within certain undertakings. OJ L 318 of , p E.g. section 31 of the Public Service Reform (Scotland) Act Case C-107/98, Teckal Srl v Comune di Viano and Azienda Gas-Acqua Consorziale (AGAC) di Reggio Emilia ECLI:EU:C:1999:562, paragraph

16 represent more than 80% of the total revenues of Inverness Airport. Therefore, the Commission considers that the concept of in-house provision of services applies in this case and the entrustment in question is not covered by the Union rules on public procurement. (100) Therefore, the Commission considers that the public procurement rules, referred to in the SGEI Framework, are not applicable in this case Absence of discrimination (101) Point 20 of the SGEI Framework requires that where an authority assigns the provision of the same SGEI to several undertakings, the compensation should be calculated on the basis of the same method in respect of each undertaking. (102) The Commission notes that since the overall management of Inverness Airport was entrusted to one entity, HIAL, point 20 of the SGEI Framework is not applicable in this case Amount of compensation (103) Point 21 of the 2012 SGEI Framework states that "( ) the amount of the compensation must not exceed what is necessary to cover the cost of discharging the PSOs, including a reasonable profit". The amount of compensation can be established on the basis of either the expected costs and revenues or the costs and revenues actually incurred or a combination of the two (point 22 of the SGEI Framework). Where the compensation is based, in whole or in part, on expected costs and revenues, they must be specified in the entrustment act. They must be based on plausible and observable parameters concerning the economic environment in which the SGEI is being provided and rely, where appropriate, on the expertise of sector regulators or of other entities independent from the undertaking. Member States must indicate the sources on which these expectations are based (point 23 of the SGEI Framework). (104) The United Kingdom submitted that the expected costs will be used as a basis for calculating the amount of compensation, with the compensation being set below the expected costs. The expected costs will then be periodically adjusted to the actual costs, in order to avoid overcompensation. Net cost necessary to discharge the public service obligation (105) Pursuant to point 24 of the SGEI Framework the net cost of discharging the public service obligations should be calculated using the net avoided cost methodology 31 where this is possible. However, as laid down in point 27 of the SGEI Framework, the Commission allows to apply alternative methods for calculating the net cost necessary to discharge the public service obligation in cases where the use of the net avoided cost methodology is not feasible or appropriate. (106) The net avoided cost methodology requires the establishment of the company's costs and revenues in a hypothetical scenario in which there is no SGEI. In the current context, however, the SGEI is the essence of the activity carried out by the 31 Net avoided cost methodology is summarised in points of the SGEI Framework. 16

17 Inverness Airport. The services not covered by the act of entrustment depend on the existence of the SGEI. Therefore, no relevant hypothetical scenario can be applied in which only the other activities are conducted at the airport. The net avoided cost methodology can therefore not be applied. (107) The net costs incurred in discharging the public service obligation must therefore be established on the basis of the cost allocation methodology as further laid down in points 28 to 32 of the SGEI Framework. According to point 28 of the SGEI Framework, the net costs are calculated as the difference between the costs and the revenues for a designated provider of fulfilling the public service obligations, as specified and estimated in the entrustment act. (108) In the present case, profits are allocated solely to reduce the funding provided in pursuance of the SGEI (recital (27)). The amount of compensation will not exceed the net costs associated with providing the SGEI. (109) The revenue to be taken into account must include at least the entire revenue earned from the SGEI. In this case, the revenue earned by HIAL for the SGEI is the revenue from operation of the airport. There is no profit retained by HIAL as all revenue generated from activities is used to reduce the public funding required to provide the SGEI (recital (27)). (110) As submitted by the United Kingdom authorities (recital (27)), each year HIAL will assess its budgetary requirement for the given period based on its forecast cost and revenue. The costs included in this calculation will be strictly limited to those necessary to fulfil the SGEI. HIAL will be required to provide evidencebased forecasts for its income and expenditure. (111) The Scottish government will then decide on the allocation of budgets and will send to HIAL a formal statement of its budgetary provision. This amount shall be less than HIAL's assessment of its budgetary requirement (i.e. less than the net cost of discharging the SGEI) (recital (27)). (112) HIAL's revenue from commercial activities is taken into account when calculating the budgetary provision. If HIAL's commercial revenue in a given period is less than projected, then expenditure should be reduced by a corresponding amount. If HIAL's commercial revenue during a given period is more than projected then this will reduce the budgetary provision by the Scottish government. The grant shall be paid out monthly. Should any overcompensation occur, this will be reconciled against the next grant claim after the overcompensation has been identified (recital (27)). Reasonable profit (113) A reasonable profit can be included in the calculation of the net cost for discharging the public service obligation. 32 (114) There is no reasonable profit included in the compensation for the SGEI to HIAL (recital (27)). Efficiency incentives 32 Point 21 of the SGEI Framework. 17

18 (115) Point 39 of the SGEI Framework stipulates that Member States, in devising the method of compensation, must introduce incentives for the efficient provision of an SGEI of a high standard, unless the Member State can duly justify that it is not feasible or appropriate to do so. (116) The Commission notes that allowing for a compensation which is below the forecast costs provides an efficiency incentive to HIAL. Overcompensation (117) Pursuant to points 47 to 50 of the SGEI Framework, the methodology described in the entrustment act must also provide for a mechanism which ensures that the discharging of the public service obligation is not overcompensated. (118) Point 49 of the SGEI Framework states that Member States must ensure that the compensation granted for operating the SGEI meets the requirements set out in this Communication and in particular that undertakings are not receiving compensation in excess of the amount determined in accordance with the requirements set out in this section. They must provide evidence upon request from the Commission. They must carry out regular checks, or ensure that such checks are carried out, at the end of the period of entrustment and, in any event, at intervals of not more than three years. For aid granted by means other than a public procurement procedure with publication, checks should normally be made at least every two years. (119) The Commission notes the arrangements described at recital (27) and considers that this requirement is met. In particular, the Commission notes that a calculation of the compensation taking into account adjustments depending on the costs actually incurred reduces the possibility of overcompensation. (120) The Commission furthermore considers that the annual review by the Scottish government of the grant amount and the mechanism to reduce the grant by the amount of any overcompensation meets this requirement Transparency (121) Pursuant to point 60 of the SGEI Framework, the Member State concerned must publish on the internet or by other appropriate means information on: the results of the public consultation or other appropriate instruments referred to in paragraph 14 of the SGEI Framework, the content and duration of the public service obligations, the undertaking and the territory concerned, the amounts of aid granted to the undertaking on a yearly basis. (122) The Commission notes the transparency measures in place described at recital ((95)), in particular the publication of the accounts and all financial data of HIAL. Additionally HIAL has adopted the Single Model Publication Scheme 2015 produced by the Scottish Information Commissioner ionscheme.aspx. HIAL s Framework Document (which includes the act of entrustment) will be available in paper on request from Transport Scotland or any HIAL airport. It will also be published on the websites of HIAL (a new sub page at and Transport Scotland ( 18