Analysis: EU Commission Tax Probes Focus on Unilateral APAs

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By Kevin A. Bell

Sept. 16 — Unilateral transfer pricing agreements are at the heart of four of the European Commission's six recent state aid tax investigations, a Bloomberg BNA analysis shows.

The directorate-general for competition's pending cases against Inc., Apple Inc., Fiat Chrysler Automobiles NV and Starbucks Corp. involve unilateral APAs.

Unilateral APAs between Apple and Ireland were at the center of the commission's recent $14.5 billion August decision against the iPhone maker (172 ITM, 9/6/16).

Luxembourg's 2003 APA with Amazon and its 2012 APA with Fiat Chrysler are at issue in two more cases. The Netherlands' 2008 negotiated APA with Starbucks is the fourth.

The commission said the unilateral agreements gave a selective advantage to the companies and therefore constituted unlawful state aid under European Union law.

Moreover, the commission found that the agreements didn't reflect economic reality and the prices set didn't reflect market conditions, leading to a taxable base for the company that is lower than the one that would result from the correct application of the arm's-length standard.

The case involving alleged state aid to McDonald's Corp. by Luxembourg involves an issue of tax treaty interpretation. The Belgian excess profit scheme involves an entire ruling system, with the commission saying Belgium must collect approximately 700 million euros ($791 million) from 30 companies (07 ITM, 1/12/16).

A chart detailing the status of the six state aid cases appears below.

Targeting Outliers

The commission's June 3 DG Competition Working Paper on State Aid and Tax Rulings said its “focus is on cases where there is a manifest breach of the arm's length principle.”

The working paper said government aid in the form of low-tax rulings is unlikely to be found in cases where two-sided approaches are used to split profits between jurisdictions on the basis of the profit split method or a bilateral advance pricing agreement.

However, the commission is concerned about whether there is a reliable approximation of the market outcome when:

  •  profit margins of financing companies lack an underlying economic analysis; or
  •  one-sided methods such as the transactional net margin method (TNMM) are used where the remaining profit is automatically allocated to another company—often without any information about that other company’s activities.

Under TNMM, operating expenses are often retained when the taxable base is determined as a markup on a performance indicator, the commission said.

“In some cases, it seems that this choice of operating expenses as a performance indicator is made systematically, without necessarily representing the commercial value of the functions of the company. An appropriate indicator is the one that best captures the commercial value of the activity.”

Pending Commission State Aid Tax Cases Case Issue Status Alleged state aid to Inc. by Luxembourg (SA.38944). The European Commission is investigating a 2003 unilateral APA granted by Luxembourg to Amazon EU Sarl, based in Luxembourg, which records most of Amazon's European profits. Amazon EU Sarl pays a tax deductible royalty to a Luxembourg limited liability partnership that isn't subject to corporate tax. On Oct. 7, 2014, the commission issued a preliminary decision that the APA constituted state aid (199 ITM, 10/8/14). Alleged state aid to Apple Inc. by Ireland in the amount of 13 billion euros (SA.38373). On June 11, 2014, the commission initiated an investigation of two unilateral APAs granted by Ireland in 1991 and 2007 to Apple Sales International (ASI). That company is incorporated in Ireland and carries on a trade through its branch in Ireland but is not tax resident in Ireland. The commission Aug. 30 announced its final decision concluding that Apple Inc. benefited from unlawful state aid granted by Ireland, and ordered recovery of up to 13 billion euros plus compound interest. The decision found most profits of ASI's European sales of Apple branded finished goods, including the iPhone, were allocated to ASI’s stateless “head office” and thus remained untaxed (169 ITM, 8/31/16) . Ireland and Apple have both said they will appeal the decision (170 ITM, 9/1/16) . Alleged state aid to 36 mainly EU companies by Belgium under excess profit tax ruling system, in the amount of 700 million euros (SA.37667). The commission said the Belgian excess profit scheme, applicable since 2005, allowed multinational companies to reduce their corporate tax base by 50 percent to 90 percent to discount for “excess profits” that allegedly result from being part of a multinational group. The group's profit is compared with the hypothetical average profit a stand-alone company in a comparable situation would have made. The commission issued a final decision Jan. 11, 2016 that Belgium’s entire “excess profits tax ruling system” constituted state aid (07 ITM, 1/12/16) . Belgium appealed the commission's decision to the General Court of the European Union on March 22, 2016 (66 ITM, 4/6/16) . Alleged state aid to Fiat Chrysler Automobiles N.V. by Luxembourg in the amount of 20 million to 30 million euros (SA.38375). The commission is investigating a 2012 APA granted by Luxembourg to Fiat Finance & Trade Ltd. (FFT). FFT provides financing to Fiat group companies and manages several group cash pools. The APA used the transactional net margin method to calculate the interest rates charged by FFT. The commission issued a final decision Oct. 21, 2015, that the arrangements constitute state aid (205 International Tax Monitor 205, 10/16/15) .Luxembourg on Dec. 4, 2015 appealed the decision to the EU General Court (241 ITM, 12/7/15) Alleged state aid to McDonald's Corp. by Luxembourg (SA.38945). The commission is investigating a 2009 Luxembourg tax ruling granted to McD Europe Franchising Sarl (Luxembourg). McD Sarl owned group franchising rights and derived royalty income from its U.S. branch. McDonald's argued that the branch was a permanent establishment of McD Sarl in the U.S. under the Luxembourg-U.S. tax treaty, which doesn't require the profits to be taxed in the other state. The commission's Dec. 3, 2015, preliminary decision is that the rulings constitute state aid (239 ITM, 12/3/15) . Alleged state aid to Starbucks Corp. by Netherlands in the amount of 20 million to 30 million euros (SA.38374). On June 11, 2014, the commission initiated an investigation of a 2008 Dutch unilateral APA relating to the markup of royalty payments paid by Starbucks Manufacturing EMEA BV to its U.K. affiliate, Alki LP. In the U.K. the payments were tax-deductible royalties. The commission said instead of using the transactional net margin method, the APA should have used the comparable uncontrolled price method. The commission Oct. 21, 2015, issued a final decision that the arrangements constitute state aid (124 ITM, 6/28/16) .The Netherlands appealed the decision to the EU General Court of the European Union Feb. 16, 2016.

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