The commission found that the small European country granted illegal tax benefits to Amazon by allowing it to pay much less in taxes than other companies.
"As a result, almost three-quarters of Amazon's profits were not taxed," said Margrethe Vestager, European commissioner for competition.
The European Commission launched an investigation into Amazon's subsidiary in Luxembourg, Amazon EU, in 2014. That company had been paying a tax-deductible royalty to another legal entity (Amazon Europe Holding Technologies) that was not subject to corporate taxation in Luxembourg.
As a result, most European profits of Amazon were recorded in Luxembourg, but not taxed there.
This tax structure was implemented between May 2006 and June 2014. Amazon's structure of operations in Europe since that period was not part of the current investigation.
Vestager said Luxembourg must recover the approximately 250 million euros in unpaid taxes plus interest.
Both Amazon and Luxembourg defended their action and said they would study the ruling.
"We believe that Amazon did not receive any special treatment from Luxembourg and that we paid tax in full accordance with both Luxembourg and international tax law," Amazon said in a statement.
"We will study the commission's ruling and consider our legal options, including an appeal."
Luxembourg's Finance Ministry noted that the commission's decision referred to a period going back to 2006.
"Over time, both the international and the Luxembourg legal frameworks have substantially evolved," the ministry said in a statement.
"As Amazon has been taxed in accordance with the tax rules applicable at the relevant time, Luxembourg considers that the company has not been granted incompatible state aid."
