EU Apple Tax Decision Ducks Arm's-Length Controversy

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Kevin A. Bell

Sept. 1 — The European Commission decision requiring Ireland to retroactively recoup $14.5 billion in unpaid taxes from Apple Inc. suggests the commission didn't want to become embroiled in a spat over the international arm's-length standard.

The commission's Aug. 31 four-page summary of its final decision didn't delve into the details of profit margins between related-parties covered in the two Irish advance pricing agreements like it did in its 2014 preliminary findings. Instead, it focused on the larger picture and found the whole setup a sham, saying the overall attribution of profits to one of the entities covered in the APAs—Apple Sales International (ASI), the group's international sales arm—didn't correspond to economic reality.

In doing so, the decision avoids a potential legal battle over whether the commission in its state aid cases is effectively creating a second arm's-length standard, as argued by the U.S. Treasury.

“It is difficult to read into why the Commission in its 2014 preliminary findings focused on the arm’s length principle, but did not do so in the August 30 decision,” said John Warner, a shareholder specializing in international tax and financial instruments at Buchanan Ingersoll & Rooney PC, in an e-mail to Bloomberg BNA.

The problem the commission addressed in its Aug. 30 decision was that, although Apple’s Irish subsidiaries may have booked an arm’s-length price with respect to their EU sales, the Irish tax authorities permitted those subsidiaries internally to allocate a substantial amount of those profits to “head offices” not subject to tax anywhere and whose profits weren't subject to Irish company tax under a territorial aspect of Ireland’s company tax regime, Warner said.

Not Transfer Pricing

Technically, the type of internal allocation made under the ruling isn't transfer pricing—which is explicitly subject to the “arm’s-length principle”—because it doesn't involve more than one entity, Warner said. “Instead, it is an internal allocation, which is analogous to the determination of how much of a company’s business profits is attributable to a foreign permanent establishment—which determination is not, under OECD treaty principles, literally subject to the arm’s-length principle.”

PricewaterhouseCoopers said the summary of the decision focused on the fact that a large proportion of the profits generated from sales across the EU weren't subject to current tax.

“On this basis, coupled with the limited activity at the head office, the EC appears to be saying that residual profit should be taxed in Ireland rather than allocated to the head office,” the accounting firm said. “It is not clear to what extent this is consistent with, for example, the OECD guidelines on transfer pricing or branch profit attribution and how that interacts with the State aid analysis. We must wait for the detailed decision to answer this important question.”

Conor Hurley of Irish law firm Arthur Cox said the commission in its full decision is likely to argue that the “head offices” of Apple's two Irish subsidiaries didn't have real substance, and therefore the Irish branches of the two subsidiaries “were in substance the companies” and should have been liable for the tax.

“Some might say the Commission's approach is more grounded on economic reality while the tax approach is necessarily more complex and legalistic,” Hurley said. “It is difficult to say which argument might ultimately hold sway before the European courts where it will be argued as a state aid case and not as a tax case.”

International Chaos

Robert Stack, deputy assistant secretary for international tax affairs with the U.S. Treasury Department, a vocal critic of the EU state aid cases, has consistently said the European Commission appears to have its own particular view of the arm's-length price as “the right market price to protect the EU market.” Creating a second arm's-length standard thus would create international tax chaos, Stack argued (25 Transfer Pricing Report 176, 6/16/16).

“Rather than adhere to the OECD TP Guidelines, the Commission asserts it is employing a different arm’s-length principle that is derived from EU treaty law,” Treasury said in its Aug. 24 white paper.

The commission in a May 19 notice conditionally endorsed the OECD transfer pricing guidelines, which are based on the international arm's-length standard, and asserted that it has the legal authority under EU state aid law to ultimately determine whether a taxpayer's arm's-length pricing results in a “reliable approximation of a market based outcome.”

However, the commission did say that if the OECD guidelines are complied with, it is unlikely that the commission would make a finding that an EU member state tax ruling had granted a selective advantage to a multinational company under EU state aid law.

The commission's full thinking on the decision won't be seen in its entirety until after Apple and Ireland have agreed on the redaction of confidential information, which may take months.

Two Theories

EU Competition Commissioner Margrethe Vestager said Aug. 30 the commission concluded that ASI's Irish non-resident entity, considered the “head office,” had no employees, no premises and no real activities. “Only the Irish branch of Apple Sales International had any resources and facilities to sell Apple products,” she said.

But under the tax rulings, it was this “head office” that was attributed almost all of the company's profits—in fact, due to Apple's set-up, it was attributed almost all of the profits Apple made from selling products throughout Europe, the Middle East, Africa and India.

The commission's 2014 preliminary decision found that the profit markups Ireland accepted in both Apple APAs were arbitrary based on the lack of economic analysis because they resulted “from a negotiation rather than a pricing methodology” (25 Transfer Pricing Report, 9/15/16).

Further, the preliminary finding found “that a prudent independent market operator would not have accepted the remuneration allocated to the branches” of Apple Sales International in the same situation, setting up a question about whether a third-party unrelated party would have accepted remuneration at such prices.

Authorized OECD Approach

Warner said the current OECD Model Income Tax Treaty standard for allocating a company’s business profits to a permanent establishment—the so-called “Authorized OECD Approach,” or “AOA”—has gotten fairly close to the arm’s-length principle, even if that principle does not explicitly apply to the appropriate attribution of business profits to a PE.

But even that standard literally does not apply to the Apple case, because it is used to determine how much income of a treaty country corporate resident may be taxed by that country’s treaty partner where the first country’s resident has a PE in the treaty partner, Warner said. Here, the Commission was analyzing Ireland permitting Apple’s subsidiaries to allocate income away from Irish territorial taxing jurisdiction—although not necessarily to any taxing jurisdiction.

“Although there were not any tax treaties here, as ASI is not tax resident anywhere, let me draw an analogy with the OECD Model Treaty,” said Steve Towers of Deloitte LLP's Singapore office. The Apple case involves analogies to Article 7 and not Article 9 of the model treaty.

Towers, speaking on Dbriefs Bytes broadcast Sept. 2, said the Apple case involves principles analogous to Article 7, whereas the other pending transfer pricing state aid cases involve Article 9, or traditional transfer pricing principles.

Allocating Profits to PEs

Towers said the OECD transfer pricing guidelines apply exclusively to Article 9 situation and don't deal with the Article 7 situation of the allocation of profits to permanent establishments.

The commission's prior statements regarding the arm's-length principle don't refer to branch situations, Towers said. “At the very least, this current case appears to be an expansion of the so-called EU-only arm's-length principle, applying it not just to transactions between related parties, but also to the allocation of profits within a single entity.”

Towers said the OECD didn't articulate a robust methodology for the allocation of profits to PEs until 2008, after Apple's arrangements with Ireland were agreed.

“I am sure these and other issues will be explored during the appeal that will likely be made by Apple and possibly also on appeal by the Irish government,” Towers said.

Reallocating Income

Warner noted that the commission's Aug. 30 press release makes the point that the permitted allocation of income away from Irish taxing jurisdiction was to “ ‘head offices’ [that] existed only on paper” and therefore “did not correspond to economic reality.”

The notion expressed by that language is very similar to concepts that go into the arm’s-length principle, Warner said. However, the quoted language is also consistent with “economic substance” concepts, under which—even outside of transfer pricing statutes—taxing authorities are often thought to have inherent or statutory authority to reallocate income.

Pot of Gold?

Vestager, a former Danish finance minister, said other countries might be inclined to seek some of the $14.5 billion of tax on profits Apple filtered through Ireland to achieve the low-tax result. “[I]t may be that not all the unpaid taxes are due in Ireland,” she said.

“Other countries, in the EU or elsewhere, can look at our investigation,” Vestager said. “If they conclude that Apple should have recorded its sales in those countries instead of Ireland, they could require Apple to pay more tax locally. That would reduce the amount to be paid back to Ireland.”

Former U.S. Sen. Carl Levin said the royalties Apple collects for its overseas sales of products designed and developed in the U.S. should be taxed in the U.S. “But Apple has avoided the billions of dollars of taxes it owes the U.S. by transferring its intellectual property to itself in Ireland.”

Levin, who chaired the Senate Permanent Subcommittee on Investigations when it conducted a series of inquiries into multinational corporate tax avoidance, including Apple, said in a statement: “When Apple used those tax avoidance schemes, it is understandable that Europe would try to go after them.”

Levin: Shame on Apple, Shame on IRS

The IRS has failed to stake a claim for U.S. taxes on those revenues for a decade or more, Levin said. “It has been passive and so Europe attempts to fill the vacuum. Shame on Apple for dodging U.S. taxes. Shame on the IRS for failing to challenge Apple’s tax avoidance.”

Hurley said some countries might try to reopen past tax assessments but it will be quite difficult for them to do so because of procedural and other issues.

Under the tax rules as they applied at the time, Apple was probably on the right side of the line from its perspective, Hurley said. “Certainly it will not be in Apple's interest, or for that matter the U.S. government's interest, for other countries to reopen past assessments.”

Broader Agenda

Kai Struckman, a Brussels-based competition attorney with White & Case LLP who previously served in the commission competition authority, told Bloomberg BNA that the European Commission's statement that Apple's back tax could be reduced if other countries come forward and demand some of the money gives the impression the EU executive body is pushing its tax policies on other countries.

While that seemed to put a positive spin on the decision, he said, that “may well backfire as being perceived as patronizing other countries about how they should run their independent tax policies,” Struckman said.

“These statements, which specifically acknowledge that this is an issue outside the remit of EU state aid control, confirm that the European Commission is using the state aid rules to pursue a broader agenda against what it perceives to constitute harmful taxation or tax avoidance,” Struckman said.

With assistance from Joe Kirwin

To contact the reporter on this story: Kevin A. Bell in Washington at

To contact the editor on this story: Rita McWilliams at

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