The Rt Hon Boris Johnson MP the Foreign and Commonwealth Office King Charles Street London SW1A 2AH

Home , Inverness Airport, Scatsta Airport, Sumburgh, Sumburgh Airport, Tingwall Airport

EUROPEAN COMMISSION

Brussels, 25.4.2018 C(2018) 2400 final

PUBLIC VERSION

This document is made available for information purposes only.

Subject: State Aid SA.49482 (2017/N) – United Kingdom Sumburgh Airport – entrustment of a service of general economic interest

Sir,

1. PROCEDURE

(1) By letter dated 6 November 2017, the United Kingdom notified to the Commission the entrustment to Sumburgh Airport of a service of general economic interest ("SGEI") by the Scottish government. By letter of 12 December 2017, the Commission requested further information, which was provided by the United Kingdom on 7 February 2018. This decision covers the SGEI entrustment to Sumburgh Aiport during the period 2012-2022.

2. DETAILED DESCRIPTION OF THE MEASURE

2.1. Sumburgh Airport

(2) This section summarizes the information and arguments put forward by the United Kingdom in the notification regarding Sumburgh Airport ("Sumburgh Airport" or the "Airport") and the SGEI.

(3) Sumburgh Airport is located at the southern end of the Shetland Mainland within the Shetland Islands archipelago in the United Kingdom. The United Kingdom states that it is the only airport within the Shetland Islands to provide scheduled passenger services to destinations outside the Shetland Islands.

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. +32 22991111 (4) 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.

(5) The Board has corporate responsibility, inter alia, for establishing the overall strategic direction of HIAL within the policy, planning and resources framework determined by the Scottish Ministers.2

(6) The Shetland Islands are made up of around 100 islands of which 16 are inhabited. The Shetland Islands cover 1,467 square kilometres with a population of 23,230, giving a population density of 16 persons per square kilometre.3 The Shetland Islands are geographically remote. The direct distance from its main population centre, Lerwick, to the nearest major urban area, Aberdeen, is 400 kilometres and includes a sea crossing.

(7) Scheduled air passenger services are operated by Loganair4 between Sumburgh Airport and Inverness Airport (1 direct service per day and 1 via Orkney/12,5895 passengers in 2016), Orkney Airport (up to 2 services per day/8,509 passengers in 2016), Aberdeen Airport (4 services per day/72,111 passengers in 2016), Edinburgh Airport (3 services per day/42,594 passengers in 2016) and Glasgow Airport (2 services per day/28,381 passengers in 2016).

(8) The air services from Sumburgh Airport carry also freight. The total general freight carried in 2016 was 41 169 kg. Sumburgh Airport enables the quick transport of high priority, low weight freight.

(9) Sumburgh Airport also enables residents from the Shetland Islands to access services that cannot be provided in their areas. For example, the National Health Service (the "NHS") Shetland has a service level agreement with NHS Grampian for patients in the Shetland Islands to be treated at Aberdeen Royal Infirmary Hospital in cases where treatment is not available in the Shetland Islands.

(10) In addition, there is a daily mail flight between Aberdeen Airport and Sumburgh Airport which enables residents of the Shetland Islands to receive the same delivery times as the rest of the United Kingdom.

1 In addition to the Sumburgh Airport, the company also operates and manages ten other airports at Barra, Benbecula, Campbeltown, Dundee, Inverness, Islay, Kirkwall, Stornoway, Tiree and Wick as services of general economic interest. The present notification concerns only the Sumburgh Airport.

2 Scottish Ministers have delegated operational decision making to a Board of Directors. This delegation of authority is limited and its scope is set out in HIAL’s Framework Document. Even in areas where the Board does have delegated authority, however, Scottish Ministers may direct the Board to a particular course of action if they deem it appropriate. 3 Population figure from Table 9, National Records of Scotland: Mid-2014 Population Estimates Scotland http://www.nrscotland.gov.uk/statistics-and-data/statistics/statistics-by- theme/population/population-estimates/mid-year-population-estimates/mid-2014/list-of-tables 4 All services are operated on a commercial basis by Loganair. Loganair’s commercial code share agreements enable onward travel from all destinations using through ticketing. Flybe also have code share agreements enabling onward travel using through ticketing. 5 All passenger numbers from Loganair Limited.

2 (11) The Shetland Islands’ geographic location limits alternative transport options. Travelling from the Shetland Islands to the United Kingdom mainland, the only alternative to air travel is ferry travel. There are daily return ferry services from Lerwick in the Shetland Islands to Aberdeen on the United Kingdom mainland. On four days a week, these services operate via Kirkwall in the Orkney Islands. The ferry travels overnight with a direct journey time of 12 hours and 30 minutes. This compares to a journey time by air from Sumburgh Airport to Aberdeen Airport of 1 hour. Ferry services are subject to disruption in adverse weather, particularly in the winter. Air services, overall, are less impacted by bad weather.

(12) The table below shows passenger numbers for Sumburgh Airport over the last five years:

Year 2012-13 2013-14 2014-15 2015-16 2016-17

Passengers 217,502 287,525 311,429 312,061 355,667

(13) The nearest airports to Sumburgh Airport are: • Tingwall Airport: around 45.9 kilometres, 38 minutes by car; and

• Scatsta Airport: around 79.3 kilometres, 1 hour 4 minutes by car.

(14) Tingwall Airport is a small airport linking the Shetland Islands. The airport's operator, Airtask Group Limited, provides inter-island services from Tingwall to Foula, Papa Stour, Skerries and Fair Isle. The runway length at Tingwall Airport is 764 m. This limits the type and size of aircraft that can use the airport and makes scheduled passenger services out of the Shetland Islands impractical.

(15) Scatsta Airport is a private airport which is contracted by Enquest (operator of Sullom Voe oil terminal) for commercial transport of offshore oil workers and staff to the nearby Sullom Voe oil and gas terminal. No scheduled passenger services operate to or from Scatsta Airport.

(16) London Heathrow Airport is the United Kingdom’s main hub airport. A flight from Aberdeen Airport to Heathrow Airport takes around 1 hour 45 minutes. Through ticketing options are available when travelling from Sumburgh Airport to Heathrow Airport via Aberdeen Airport.

(17) Furthermore, the United Kingdom considers that, if air services were to cease, there is not sufficient capacity on the ferry services to offset that lost air service capacity. Such a drop in overall capacity would have a detrimental impact on community sustainability.

(18) The United Kingdom is of the view that the existence of Sumburgh 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.

(19) The United Kingdom stresses that Sumburgh's services to Aberdeen, Edinburgh, Glasgow and Inverness are essential for the economy of the Shetland Islands. It has also highlighted the importance of tourism to the economy of the region, having created 1300 new jobs in 2014 in the Shetland Islands, equivalent to 0.7%

3 of all jobs in the region in 2014.6 Tourism is one of the largest economic sectors for the Highlands and Islands. In 2016, it generated over 20 million pounds in Gross Value Added in the Shetland Islands.7

(20) According to the United Kingdom, without the airport, the Shetland Islands would be less attractive for businesses with the resulting impact on employment levels. The Airport also helps to retain and attract young people to live and work in the Shetland Islands through the provision/availability of improved transport linkages for work and leisure. The United Kingdom believes that the presence of Sumburgh Airport has contributed to the population of the Shetland Islands increasing from 22,000 in 2002 to 23,230 in 2014.8

(21) The United Kingdom considers that the low population in the Shetland Islands is insufficient to generate the passenger numbers necessary to enable the Airport to operate profitably. 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. Thus, without public funding, Sumburgh Airport would close to scheduled passenger 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.

(22) Sumburgh Airport has received the following in terms of public funding in previous years:

Year 2012-13 2013-14 2014-15 2015-16 2016-17

Amount (£) 3,613,571 11,811,376 7,287,249 7,512,687 5,159,178

2.2. Entrustment of Service of General Economic Interest

(23) HIAL was created in 1986 and has operated Sumburgh Airport since then on behalf of the Scottish ministers.

(24) The United Kingdom submitted that the Airport has always been loss making and has required public funding to offset the difference between its commercial income and its operating costs.

(25) Since 2012, the SGEI was entrusted to HIAL through a series of entrustment acts adopted by the Scottish government. Recently, the Scottish government decided to adopt a new entrustment act which consolidates and formalises past practice towards the Sumburgh Airport and other HIAL airports.

(26) Therefore, the new act of entrustment, called the Framework Document, consolidates and codifies past practice towards Sumburgh Airport (jointly with the past entrustments acts, the "Entrustment Act"). The Framework Document has

6 Local Authority Area Growth Sector Database, Scottish Government: http://www.gov.scot/Topics/Statistics/Browse/Business/Publications/GrowthSectors/LADatabase 7 GVA is a measure of the increase in the value of the economy due to the production of goods and services. 8 Source: National Records of Scotland – Scottish Parliamentary Constituencies Data 2002-2014.

4 been drawn up by the national transport agency of Scotland, Transport Scotland, in consultation with HIAL. The Framework Document was adopted on 14 January 2018 and it is published on both HIAL and Transport Scotland websites.9

(27) The Framework Document 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 compensation10 (the "SGEI Framework").

(28) The Entrustment Act overall covers the period 2012 to 2022. Its latest update, the Framework Document, covers the period 2017-2022.

(29) According to the Entrustment Act:

– 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;

– HIAL is not assigned any exclusive or special rights in relation to the SGEI; and

– HIAL complies with Directive 2006/111/EC.

(30) According to the United Kingdom, the SGEI only covers the basic activities of HIAL that are required to keep the Airport open to commercial traffic. Any other activities undertaken by HIAL, i.e. leasing of land and building, car parking, the operation of catering facilities, are done on a commercial basis and are funded from HIAL's commercial revenues or loans provided on a commercial basis. In addition, these activities account to less than 20 % of the activities of the HIAL.

(31) Any profit generated by HIAL’s commercial activities is recycled into the company to cross subsidise its SGEI activities. Compensation is only provided to offset the difference between HIAL’s commercial income (including both aeronautical and non- aeronautical revenues) and the costs of its SGEI activities.

(32) The activities that HIAL may undertake as part of the SGEI are limited to:

– Construction of airport infrastructure and equipment (runways, terminals, aprons, control tower) or facilities that directly support them (fire-fighting facilities, security or safety equipment);

– Operation of the infrastructure, comprising the maintenance and management of airport infrastructure; and

– Provision of airport services ancillary to air transport, such as ground handling services and the use of related infrastructure, fire-fighting services, emergency services, security services etc.

9 HIAL – http://www.hial.co.uk/hial-group/about-us/strategic-amp-corporate-plans/ Transport Scotland – https://www.transport.gov.scot/public-transport/air-travel/highlands-and-islands- 10 OJ C 8 of 11.1.2012, p.15.

5 (33) The United Kingdom notified a compensation model based on the following principles:

a) Each year, in the light of decisions by the Scottish government on the allocation of budgets for the forthcoming financial year, HIAL is provided with a formal statement of its budgetary provision (grant letter), a note of any related matters and details of the budget monitoring information required by Transport Scotland.

b) In calculating the budget allocation, the overarching aim is for HIAL to break even on a cash basis both in any given financial year and over the lifetime of the period of entrustment of the SGEI. This calculation is informed by HIAL’s assessment of its budgetary requirements for the given period based upon its forecast costs and revenue. The methodology based on cost allocation, as set out in paragraphs 28 to 32 of the SGEI Framework, should be used for this assessment. All revenues from both aeronautical and non-aeronautical activities must be taken into account when forecasting subsidy requirement. HIAL is required to provide evidence based forecasts for its income and expenditure (both for activities covered and not covered by the SGEI) to assist in the budget setting process.

c) If the trading and other resource income, or the net book value of disposals of non-current assets, realised is less than included in the most up to date agreed budget HIAL shall, unless otherwise agreed with Transport Scotland, ensure a corresponding reduction in its gross expenditure. If income realised is more than that included in the most up to date agreed budget HIAL must obtain the prior written approval of Transport Scotland before using any excess to fund additional expenditure.

d) The award and/or payment of grant will be suspended if HIAL still has at its disposal earlier unlawful aid that was declared incompatible by a Commission Decision (either as individual aid or aid under an aid scheme being declared incompatible), until HIAL has reimbursed or paid into a blocked account the total amount of unlawful and incompatible aid and the corresponding recovery interest.

e) In order to achieve efficiency, the budget allocation referred to in point (a) will be less than HIAL’s assessment of its budgetary requirement. HIAL will make cost savings and/or increase its commercial revenue in order to offset the difference between the budget and its projected costs. The exact difference will be calculated on an annual basis taking into account HIAL’s work programme and the wider Scottish government financial position.

f) No reasonable profit is included in the compensation for the SGEI to HIAL. Should any overcompensation occur, this will be reconciled against the next grant claim after the overcompensation has been identified.

g) HIAL shall be subject to both internal and external audit and will be subject to the Government Financial Reporting Manual requirements,11

11 https://www.gov.uk/government/publications/government-financial-reporting-manual-2017-to-2018

6 with accounts provided to both the Auditor General for Scotland and the Scottish government and published annually.

(34) 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 airlines12 (the "Aviation Guidelines").

(35) In 2012, the Transport Planning Service of the Shetland Islands Council carried out a study to assess the comparative merits of Tingwall and Sumburgh as the base for the inter- island air service. The study also consulted residents and community groups with Fair Isle and Foula residents.13

(36) Furthermore, the Shetland Islands Council undertook a study into inter-island transport ("SIITS") in the Shetland Islands to find out what levels and types of transport links will be needed for the next 30 years. The study was completed and published in 2016. The purpose of the SIITS was to analyse the internal Shetland air and ferry network considering current and future connectivity needs in the light of the current provision of vessels, harbours, services, aircraft, airstrips and human resources on each island. The study noted the importance of the air and ferry services, which provide lifeline connections where there is no alternative should the service fail. The public consultation in relation to the SIITS was also undertaken. The study is publicly available on the website of the Shetland Islands Council.14

(37) In addition, HIAL will undertake an annual customer survey at Sumburgh Airport. This survey will seek customers’ views on, but is not limited to, whether the airport is satisfactory in terms of the facilities provided, accessibility and customer service. The conclusions of the annual customer survey will be published on the HIAL's website.

2.3. Transparency

(38) Financial statements including annual accounts are published on HIAL's website.15 HIAL will also publish on its website the agendas and minutes of all Board meetings.16

3. ASSESSMENT OF THE MEASURE

3.1. Presence of aid within the meaning of Article 107(1) TFEU

(39) According to Article 107(1) of the Treaty on the Functioning of the European Union (the "TFEU" or the "Treaty")17 "any aid granted by a Member State or

12 OJ C 99 of 4.4.2014, p.3. 13 https://www.shetland.gov.uk/transport/documents/AppendixASumburghTingwall.pdf 14 https://www.shetland.gov.uk/transport/siits.asp See also the Scoping paper on Intra- Scotland Air Services carried out in 2016 by the three island councils (the Highland Council, Argyll and Bute Council) in collaboration with, inter alia, the Transport Scotland, Highlands and Islands Airports Ltd and current air service operators: https://www.transport.gov.scot/media/4029/itf-29-sep-2016-air- services-scoping-paper.pdf 15 http://www.hial.co.uk/hial-group/about-us/annual-report-board-minutes/ 16 http://www.hial.co.uk/hial-group/about-us/annual-report-board-minutes/

7 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".

(40) 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,

– favour certain undertakings or the production of certain goods,

– distort or threaten to distort competition,

– affect trade between Member States.

3.1.1. Economic activity and notion of undertaking

(41) 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.18 Any activity consisting in offering goods and services on a given market is an economic activity.19

(42) In its "Leipzig-Halle airport" judgment the Court of Justice (the "Court") confirmed that the operation of an airport for commercial purpose and the construction of the airport infrastructure constitute an economic activity.20 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.21

(43) 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

17 Consolidated version: OJ C 326 of 26.10.2012, p.1. 18 Judgment of the Court of Justice of 18 June 1988, Commission v Italy, C-35/96 ECLI:EU:C:1998:303; judgment of the Court of Justice of 23 April 1991, Höfner and Elser, C-41/90, ECLI:EU:C:1991:161, paragraph 21; judgment of the Court of Justice of 16 November 1995, Fédération Française des Sociétés d'Assurances v Ministère de l'Agriculture et de la Pêche, C-244/94, ECLI:EU:C:1995:392 and judgment of the Court of Justice of 11 December 1997, Job Centre, C-55/96, ECLI:EU:C:1997:603. 19 Judgment of the Court of Justice of 16 June 1987, Commission v Italy, Case 118/85, ECLI:EU:C:1987:283, paragraph 7; judgment of the Court of Justice of 18 June 1988, Commission v Italy, Case 35/96, ECLI:EU:C:1998:303, paragraph 36. 20 Judgment of the General Court of 24 March 2011, Freistaat Sachsen and Land Sachsen-Anhalt and Others v Commission, Joined Cases T-443/08 and T-455/08, 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 Justice of 24 October 2002, Aéroports de Paris v Commission, C-82/01 P, ECLI:EU:C:2002:617 and judgment of the General Court of 17 December 2008, Ryanair v Commission, T-196/04, ECLI:EU:T:2008:585. 21 Judgment of the Court of Justice of 17 February 1993, Poucet v AGV and Pistre v Cancave, Joined Cases C-159/91 and C-160/91, ECLI:EU:C:1993:63.

8 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.

3.1.2. State resources and imputability to the state

(44) 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.

3.1.3. Selective economic advantage

(45) The Commission recalls that SGEI compensations granted to a company may not constitute an economic advantage under certain strictly defined conditions.

(46) In particular, in its Altmark judgment,22 the Court 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.

(47) 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,

22 Judgment of the Court of Justice of 24 July 2003, Altmark Trans GmbH and Regierungspräsidium Magdeburg v Nahverkehrsgesellschaft Altmark GmbH, C-280/00, 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, 11.01.2012, p. 4-14.

9 taking into account the relevant receipts and a reasonable profit from discharging the obligations (the "Fourth Altmark Criterion").

(48) 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 interest23 (the "SGEI Communication").

(49) 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.

(50) In view of the above, therefore, for the purposes of finding whether the measure granted an economic advantage, the Commission will first assess whether the compensation complies with the Fourth Altmark Criterion.

(a) First sub-criterion: Appropriate public procurement procedure

(51) The Commission notes that Sumburgh 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 corresponding 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

(52) 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.

(53) 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".

(54) The Commission notes that the United Kingdom did not provide any analysis showing that the cost structure of HIAL corresponds to the average cost structure of an efficient and comparable undertaking operating an airport.

(55) 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.

(56) 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

23 OJ C 8 of 11.1.2012, p. 4.

10 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.

3.1.4. Selectivity

(57) 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 a single service provider only. Given that the SGEI concerns an individual aid measure, the identification of the economic advantage (see recital (56)) is sufficient to support the presumption that it is selective.

(58) In any event, it does not appear that other undertakings in the same or other sectors in a comparable factual and legal situation benefit from the same advantage. Hence, the measure is selective within the meaning of Article 107(1) TFEU.

3.1.5. Distortion of competition and effect on trade

(59) 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.

(60) In accordance with settled case law,24 for a measure to distort competition, it is sufficient that the recipient of the aid competes with other undertakings on markets open to competition.

(61) 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.

(62) 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 HIAL, the operator of Sumburgh 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.

(63) Therefore, the public funding under examination distorts or threatens to distort competition and affects trade between the Member States.

3.1.6. Conclusion on the existence aid

(64) 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.

24 Judgment of the Court of Justice of 30 April 1998, Het Vlaamse Gewest v Commission, T-214/95 ECLI:EU:T:1998:77.

11 3.2. Legality of the measure

(65) 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,25 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.

(66) The Commission notes that the compensation paid out to HIAL until 14 January 2018 and its granting act did not contain any clause which would have made the granting of the aid conditional on the approval by the Commission.

(67) The compensation paid out as of 14 January 2018 on the basis of the Framework Document is subject to the adoption of a Commission decision authorising such aid.

(68) Therefore, the Commission is of the opinion that the compensation up until 14 January 2018 was granted in breach of the standstill clause and is to be considered as illegal aid.

3.3. Compatibility of the aid

(69) Article 106(2) TFEU provides that "Undertakings entrusted with the operation of services of general economic interest or having the character of a revenue 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."

(70) In accordance with the Commission Guidelines on state aid to airports and airlines ("the Aviation Guidelines")26, the compensation of the operation of an airport as a SGEI can be considered compatible under Article 106(2) TFEU.

(71) 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 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 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 200 000 passengers, of the SGEI Framework.

(72) In light of the above, the Commission will perform a joint compatibility assessment of both the aid granted prior to and after 1 January 2018.

25 OJ L 248 of 24.9.2015, p.9. 26 OJ C 99, 4.4.2014, p. 3.

12 3.3.1. Genuine service of general economic interest

(73) 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.

(74) 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".

(75) 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".

(76) 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.

(77) The first question is thus whether the United Kingdom committed a manifest error in considering that, without Sumburgh Airport, the region would be isolated from the rest of the Union to an extent which would prejudice its social and economic development.

(78) The Commission notes that potential alternative airports to Sumburg Airport, i.e. the closest airports to it in terms of travelling distance and travelling time (Tingwall or Scatsta), do not provide scheduled flights to the United Kingdom mainland (see recitals (14) and (15)).

(79) Considering that the closest airports Tingwall or Scatsta do not represent an adequate alternative for residents of Sumburgh and its direct vicinity, the Commission considers that it is not necessary to assess whether these two airports would be able to absorb the current traffic existing at Sumburgh Airport.

(80) As far as other means of transport are concerned, including ferries, the Commission considers that they do not provide an adequate alternative to air transport. As mentioned in recital (11), the ferry services from Shetland Islands to the United Kingdom mainland take 12 hours and 30 minutes. This compares to a journey time by air from Sumburgh Airport to Aberdeen Airport of 1 hour. Furthermore, the United Kingdom considers that, if air services were to cease, there is not sufficient capacity on the ferry services to offset that lost air service capacity (see recital (17)).

13 (81) The Commission places particular significance on the importance of the function of Sumburgh Airport in providing access to the islands and affording access to medical care and education provision, specifically Aberdeen's Royal Infirmary Hospital used by residents of the islands (see recital (9)).

(82) The Commission considers that a lack of acceptable connections to the rest of Union would significantly deteriorate the standard of living to the 23,230 inhabitants of the region in question and would reduce the current activities and business perspectives of 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.

(83) The Commission therefore considers that the 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 Sumburgh Airport to an extent that would prejudice its social and economic development.

(84) 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 Sumburgh Airport is not a service which would be provided satisfactorily and at the same conditions, consistent with the public service, by undertakings operating under normal market conditions.

(85) The low population density in the catchment area of Sumburgh Airport 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 Shetland 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 (see recitals (6) and (21)).

(86) Pursuant to point 14 of the SGEI Framework, Member States should show that they have given proper consideration to the public service needs supported by way of a public consultation or other appropriate instruments to take the interests of users and providers into account.

(87) As indicated in recitals (35) and (36), the Shetland Islands Council undertook two studies in order to analyse the internal Shetland air network and the comparative merits of Tingwall and Sumburgh as the base for the inter- island air service. The SIITS was completed and published in 2016, i.e. before adoption of the Framework Document. The purpose of the SIITS was to analyse the internal Shetland air and ferry network considering current and future connectivity needs in the light of the current provision of vessels, harbours, services, aircraft, airstrips and human resources on each island. The Commission notes that both the 2012 study and the SIITS took into account the considerations of residents of the Shetland Islands.

(88) The Commission therefore considers that point 14 of the SGEI Framework is complied with.

(89) In the light of the foregoing, the Commission considers that United Kingdom also did not commit a manifest error of appreciation in considering that Sumburgh

14 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.

(90) The Commission also notes that the entrustment in question does not cover the development of commercial air transport services (see recital (30)). Moreover, the United Kingdom confirmed that all financial links between Sumburgh airport and airlines shall be compatible with the MEO test, as defined in the Aviation Guidelines (see recital (34)). Therefore, the Commission considers that point 73 of the Aviation Guidelines is complied with.

(91) 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 73 of the Aviation Guidelines.

3.3.2. Need for an entrustment act specifying the public service obligations and the methods for calculating compensation

(92) 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.

(93) The Commission notes that the SGEI was entrusted to HIAL through the Entrustment Act (see recitals (25) and (26)).

(94) The Entrustment Act indicates the undertaking, the content and the duration of the public service obligation as well as the compensation method.

(95) In light of the above, the Commission considers that that the requirements of the SGEI Framework set out in points 15 and 16 thereof are met.

3.3.3. Duration of the period of entrustment

(96) 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.

(97) The United Kingdom informed the Commission that the entrustment act should be reviewed and updated as necessary at least every 5 years.

(98) The Commission notes that the operating of an airport requires a large number of tangible assets that depreciate over a long period, therefore, the 5-year period can be considered appropriate.

(99) In light of above, the Commission considers that point 17 of the SGEI Framework is complied with.

15 3.3.4. Compliance with Directive 2006/111/EC

(100) 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.27

(101) The entrustment act specifically requires compliance with Directive 2006/111/EC (see recital (29)).

(102) HIAL is a public corporation that is wholly owned by Scottish government. HIAL is subject to both internal and external audit. A variety of transparency measures are therefore already in place.28 Financial statements including annual accounts are published on HIAL website (see recitals (33) and (38)).

(103) The Commission therefore considers that Directive 2006/111/EC is applicable in this case and is complied with.

3.3.5. Compliance with Union public procurement rules

(104) 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, public procurement Directives.29

(105) The Public Procurement Directives provide explicit legislative rules for determining which contracts can be awarded between public sector entities without a call for tender.

(106) The rules for in-house relationships (also known as vertical cooperation) follow the basic principles developed by the Court. A contracting authority can award a public contract to a given undertaking without applying a procurement procedure if three conditions are met:

• The contracting authority must exercise control over the undertaking in similar manner to its own departments, i.e. it must have decisive influence on the strategic objectives and important decisions of the controlled company.

• More than 80 % of the activities of the controlled legal person are carried out in the performance of tasks entrusted to it by the controlling

27 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 17.11.2006, p. 17-25. 28 http://www.hial.co.uk/hial-group/about-us/annual-report-board-minutes/ 29 Directive 2014/23/EU of the European Parliament and the Council of 26 February 2014 on the award of concession contracts; Directive 2014/24/EU of the European Parliament and the Council of 26 February 2014 on public procurement and repealing Directive 2004/18/EC; Directive 2014/25/EU of the European Parliament and the Council of 26 February 2014 on procurement by entities operating in the water, energy, transport and postal services and repealing Directive 2004/17/EC, OJ L94.

16 contracting authority or by other legal persons controlled by that contracting authority;

• There must be no direct private participation in the capital of the controlled undertaking.

(107) In the present case, the Commission notes that the Scottish government fully owns and exercises decisive influence over both strategic objectives and significant decisions of the controlled HIAL (see recitals (4) and (5)). The operation of the airport activity is HIAL's sole economic activity. Other commercial activity, if any, is strictly related to the operation of the airport only (such as renting of retail space at the airport) and in any case accounts to less than 20 % of the activities of the HIAL (see recital (30)). The Commission also notes that there is no direct private participation in the capital of HIAL. Therefore, the Commission considers that the rules on in-house relationships apply in this case and the entrustment in question is not covered by the EU rules on public procurement.

(108) Therefore, the Commission considers that the public procurement rules, referred to in the SGEI Framework, are not applicable in this case.

3.3.6. Absence of discrimination

(109) 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.

(110) The Commission notes that since the overall management of Sumburgh Airport was entrusted to one entity, HIAL, point 20 of the SGEI Framework is not applicable in this case.

3.3.7. Amount of compensation

(111) 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).

(112) 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 (see recital (33)).

17 3.3.8. Net cost necessary to discharge the public service obligation

(113) 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 methodology30 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.

(114) 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 Sumburgh 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.

(115) 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".

(116) In the present case, profits are allocated solely to reduce the funding provided in pursuance of the SGEI. The amount of compensation will not exceed the net costs associated with providing the SGEI.

(117) The revenue to be taken into account must include the entire revenue earned from the SGEI as well as full non-aeronautical revenue (see recital (33)). 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.

(118) As submitted by the United Kingdom authorities (see recital (33)), 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 evidence-based forecast for its income and expenditure.

(119) 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) (see recital (33)).

(120) 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

30 Net avoided cost methodology is summarised in points 25-26 of the SGEI Framework.

18 more than projected then this will reduce the budgetary provision by the Scottish government. The grant shall be paid out monthly (see recital (33)).

(121) Based on the above, the Commission considers that point 27 of the SGEI Framework is complied with.

3.3.9. Reasonable profit

(122) Pursuant to point 21 of the SGEI Framework, a reasonable profit can be included in the calculation of the net cost for discharging the public service obligation.

(123) There is no reasonable profit included in the compensation for the SGEI to HIAL.

(124) The Commission therefore considers that point 21 of the SGEI Framework is complied with.

3.3.10. Efficiency incentives

(125) 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.

(126) The Commission notes that setting a compensation which is below the forecasted costs provides an efficiency incentive to HIAL.

(127) The Commission therefore considers that point 39 of the SGEI Framework is complied with.

3.3.11. Overcompensation

(128) 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.

(129) 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”.

(130) The Commission notes the arrangements described at recital (33) 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. Should any overcompensation occur, this will be reconciled against the next grant claim after the overcompensation has been identified.

19 (131) 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.

(132) The Commission therefore considers that points 47 to 50 of the SGEI Framework are complied with.

3.3.12. Transparency

(133) 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.

(134) As indicated in recital (37), HIAL will undertake an annual customer survey at Sumburgh Airport, which will be published on the HIAL's website.

(135) The Commission notes the transparency measures in place described at recital (38), in particular the publication of the accounts and all financial data of HIAL.

(136) Furthermore, HIAL will publish on its website the agendas and minutes of all Board meetings (see recital (38))

(137) The Commission therefore considers that the transparency requirements of the SGEI Framework are met.

3.3.13. Additional Observation

(138) Since the United Kingdom notified on 29 March 2017 its intention to leave the Union, pursuant to Article 50 of the Treaty on European Union, the Treaties will cease to apply to the United Kingdom from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification, unless the European Council, in agreement with the United Kingdom, decides to extend that period. As a consequence, and without prejudice to any provision of the withdrawal agreement, this decision only applies until the United Kingdom ceases to be a Member State.

4. CONCLUSION

The Commission regrets that the United Kingdom put part of the aid in question into effect, in breach of Article 108(3) of the Treaty on the Functioning of the European Union.

However, it has decided, on the basis of the foregoing assessment, not to raise objections to the aid on the grounds that it is compatible with the internal market pursuant to Article 106(2) of the Treaty on the Functioning of the European Union.

If this letter contains confidential information which should not be disclosed to third parties, please inform the Commission within fifteen working days of the date of receipt. If the Commission does not receive a reasoned request by that deadline, you will be deemed to agree to the disclosure to third parties and to the publication of the full text of

20 the letter in the authentic language on the Internet site: http://ec.europa.eu/competition/elojade/isef/index.cfm. Your request should be sent electronically to the following address:

European Commission, Directorate-General for Competition State Aid Greffe B-1049 Brussels [email protected]

Yours faithfully For the Commission

Margrethe VESTAGER Member of the Commission