The European Commission opened up its investigation last year and it focuses on a tax deal struck by Luxembourg and Amazon in 2003 and whether it is in violation of EU state aid rules by letting Amazon pay extremely low tax through its business structure.

The U.S. online retailer is being investigated for its tax arrangements in Luxembourg alongside three other companies including Starbucks . The tiny European state – at 999 square miles it's smaller than the U.S. state of Rhode Island -- has come under intense scrutiny for its tax regime and disproportionately large financial industry. Luxembourg's gross domestic product per person comes in at 83,400 euros – the EU average is 25,000 euros.

Amazon's tax arrangement in Luxembourg may have run foul of European Union (EU) rules by giving it an unfair advantage over its competitors, regulators said on Friday.

"The Commission has no indication at this stage that the contested measure can be considered compatible with the internal market," it said in a 23-page document on its preliminary findings.

The move highlights the crackdown on tax avoidance in the 28-nation bloc, a topic that has been high on the agenda for policymakers. Further fuel was added to the fire when documents released last year showed hundreds of favourable tax deals were made under the tenure of the current Commission president Jean-Claude Juncker.

Luxembourg denies that it has done anything wrong.

"Luxembourg is confident that the allegations of State aid in this case are unsubstantiated and that it will be able to convince the Commission in due time of the legitimacy of the tax ruling and that no selective advantage has been granted," the government said in a statement.

Amazon also said it has not received any special deal from the grand duchy.

"Amazon has received no special tax treatment from Luxembourg—we are subject to the same tax laws as other companies operating here," a spokesperson said in a statement.

The Commission questioned whether Luxembourg had properly assessed what Amazon would be required to pay in tax as it approved a deal in 11 days, which the regulators deemed a "very short period of time".

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At the center of the investigation is so-called transfer pricing that Amazon is accused of deploying. This involves subsidiaries of one company selling goods to each other in order to shift profit and therefore move the tax base to pay a lower rate.

The Commission looked at fee paid between Amazon's European head office, Amazon EU Sarl, to another Luxembourg-based subsidiary, which owns the Seattle-based firm's intellectual property for its websites. This subsidiary known as Amazon Europe Holding Technologies SCS, did not have to pay Luxembourg or U.S. corporate tax. The payment therefore essentially reduces the ecommerce giant's tax liabilities.

The EU document laid bare Amazon's complex European operating structure and raised concerns about how royalty payments are made and the way that Amazon's tax liabilities are calculated.

Amazon paid between 4-6 percent tax on Amazon EU Sarl's operating expenses. Apple and Starbucks paid more than double this, according to the Commission, who added that Amazon's rate seems "relatively low".

Interested parties now have several weeks to respond to the report and hand over any requested documents to the European Commission before the final ruling is made.