THE EU TAKES A BITE OUT OF APPLE – BUT IS THE COMMISSION’S LEGAL ANALYSIS FLAWED?

This week’s news has been dominated by the long-awaited ruling of the EU’s executive arm, the Commission, on Apple’s tax affairs in Ireland. The Commission concluded that Ireland had granted selective tax benefits to Apple in breach of EU state aid rules. It therefore ordered the Irish authorities to recoup the unlawful aid–unpaid tax of up to EUR13 billion (approximately $14.56 billion) plus interest.

The benefits took the form of tax rulings made by the Irish revenue authority in 1991 and 2007. According to the Commission, those rulings “endorsed a way to establish the taxable profits of two Irish incorporated companies of the Apple group . . . which did not correspond to economic reality” (a concept that the Commission seems to equate with the “arm’s-length principle”). Profits that should have been attributed to the Ireland-based Apple companies were instead allocated to an offshore “head office”, existing only on paper. As a result, says the Commission, Apple’s effective tax rate in Ireland was just 1 percent in 2003, falling to a mere 0.005 percent in 2014, giving it “a significant advantage over other businesses that are subject to the same national taxation rules”. It is the “unpaid tax” in that period that the Irish government has now been ordered to recoup.

Money Grab

What added grist to the Commission’s mill is that the profits that went “untaxed” in Ireland were effectively Apple’s entire profit from its EU sales. This is because Apple booked all of its EU sales in Ireland, regardless of the country where the sales were made. It was the profits from those sales that were allocated to the offshore “head office” under the now defunct “double Irish” structure.

The Commission acknowledged that it had no jurisdiction to challenge that arrangement, but it’s hard not to believe that this was the nub of the issue–the transfer, as the Commission sees it, of profits from the EU to an offshore “head office” via Ireland. According to the Commission, this arrangement meant that those profits were not taxed anywhere.

The Commission did not point out that those “untaxed” profits would, in fact, be subject to U.S. taxation in the (admittedly unlikely) event that Apple repatriated them to the U.S. Hence the angry response of U.S. politicians, left and right, to the Commission’s decision. “This is a cheap money grab by the European Commission, targeting U.S. businesses and the U.S. tax base”, said Democratic Senator Chuck Schumer. “By forcing their member states to retroactively impose taxes on US companies, the EU is unfairly undermining our ability to compete economically in Europe while grabbing tax revenues that should go toward investment here in the United States. This is yet another example of why we need to reform the international tax system to ensure these revenues come home.” 

Encroachment on Sovereignty

Apple immediately vowed to fight the Commission’s decision in the EU courts. “The European Commission has launched an effort to rewrite Apple’s history in Europe, ignore Ireland’s tax laws and upend the international tax system in the process”, said CEO Tim Cook. “The opinion issued on August 30 alleges that Ireland gave Apple a special deal on our taxes. This claim has no basis in fact or in law. We never asked for, nor did we receive, any special deals. We now find ourselves in the unusual position of being ordered to retroactively pay additional taxes to a government that says we don't owe them any more than we've already paid.”

Apple’s appeal is likely to be supported by Ireland which sees the Commission’s decision as an attack on its sovereignty. “I disagree profoundly with the Commission’s decision”, said the country’s Finance Minister Michael Noonan. “The decision leaves me with no choice but to seek Cabinet approval to appeal the decision before the European Courts. This is necessary to defend the integrity of our tax system; to provide tax certainty to business; and to challenge the encroachment of EU state aid rules into the sovereign Member State competence of taxation.” The appeal was given Cabinet approval today, and is expected to receive parliamentary endorsement next week.

State Aid

When the case comes to court, it will focus on the Commission’s application of Article 107(1) of the EU Treaty. This provides, subject to various exceptions, that “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings . . . shall, in so far as it affects trade between Member States, be incompatible with the internal market”. Although the EU has no jurisdiction over corporate tax per se, there is no dispute that the state aid jurisdiction can apply to the grant of selective tax benefits.

Until recently, state aid tax cases focused primarily on their natural habitat–statutory provisions that gave domestic businesses tax breaks that were not available to competitors based in other EU countries. But in 2014, in the wake of public demands for multinationals to pay their “fair share” of tax, the EU Commission turned its attention to tax rulings, launching investigations into rulings given to Apple in Ireland, Starbucks in the Netherlands and Fiat and Amazon in Luxembourg. In December 2015 the Commission also launched an investigation into a ruling given to McDonalds by the Luxembourg tax authority. By that time, the Commission had already ordered the recoupment of “state aid” in the Starbucks and Fiat cases (amounting to EUR20–30 million in each case). Appeals in those cases are already under way.

Footing the Bill

It did not escape the attention of the US Treasury that most of these investigations related to US multinationals. In December 2015 Deputy Assistant Secretary (International Tax Affairs) Bob Stack, told the Senate Finance Committee that the Treasury was “concerned that the EU Commission appears to be disproportionately targeting U.S. companies”, and that it was “reaching out to tax income that no member state had the right to tax under internationally accepted standards”. Indeed, the Commission appeared to be “seeking to tax income of U.S. multinational enterprises that . . . is deferred until such time as the amounts are repatriated to the U.S.” If it were ultimately decided that the settlement payment gave rise to creditable foreign taxes, “U.S. taxpayers would wind up footing the bill.”

In February Treasury Secretary Jack Lew followed this up with a letter to the President of the EU Commission Jean-Claude Juncker urging him to reconsider the Commission’s approach to its state aid investigations. When this proved to no avail, the Treasury deployed its heavy artillery–a 25-page white paper–published on August 24, just a few days before the Commission’s decision in the Apple case.

Collapsing Two Requirements

The white paper reiterates and amplifies the points previously made by Bob Stack and Jack Lew. The Commission’s actions, it says:

  • undermine U.S. efforts in developing transfer pricing norms and implementing the BEPS project;
  • cast doubt on the ability of EU Member States to honour their bilateral tax treaties with the U.S.;
  • could lead to a loss of U.S. tax revenue;
  • could have a chilling effect on U.S.-EU cross-border investment; and
  • set an unwelcome precedent for tax authorities worldwide to take retrospective action against both U.S. and EU companies.

The document also provides a detailed legal analysis to support the contention that the Commission is going beyond the legitimate bounds of its state aid jurisdiction. The EU’s case law, it says, makes it clear that the aid must provide an undertaking with an advantage, that such an advantage must be selective and, crucially, that “advantage” and “selectivity” must be considered separately. According to the white paper, in the transfer pricing cases the Commission had, for the first time, departed from that principle by “collapsing” the two requirements into one–a consideration of whether the ruling conferred a “selective advantage”. The result was a circular analysis–a transfer pricing ruling would confer an advantage if it didn’t meet the arm’s length principle and, if it didn’t, the advantage would by definition be selective.

This in turn enabled the Commission to circumvent the question of how a tax ruling could be selective when such a ruling was generally available to all taxpayers, and granted on the basis of a Member State’s general tax law. True, a transfer pricing ruling was available only to multinationals as opposed to standalone companies. But, according to the white paper, both EU case law and the Commission’s previous rulings had made it clear that the “selectivity” requirement was not met merely because a multinational received a tax benefit that wasn’t applicable to a standalone company. In reaching a determination on the issue of “selectivity”, the established and legitimate comparison was between one multinational and another, not, as the Commission appeared to suggest in the transfer pricing cases, between multinationals and standalone companies.

This “new approach”, says the white paper, “reduces a state aid inquiry to whether the Commission believes that a transfer pricing ruling satisfies its view of the arm’s length principle.”  As a result, the role of the Commission’s Directorate-General for Competition was apparently being expanded “beyond enforcement of competition and state aid law . . . into that of a supra-national tax authority that reviews Member State transfer price determinations”.

Departing from International Norms

What made this particularly troubling, continues the white paper, was that the Commission was now applying an arm’s-length principle of its own invention, independent of the international norms established by the OECD in its detailed transfer pricing guidelines. As the Commission itself explained in its full decision in the Starbucks case, “the arm’s length principle that the Commission applies in its State aid assessment is not that derived from Article 9 of the OECD Model Tax Convention, which is a non-binding instrument, but is a general principle of equal treatment in taxation falling within the application of Article 107(1) of the Treaty, which binds the Member States and from whose scope the national tax rules are not excluded” (para 264 of the decision).

That general principle appears to be so obvious to the Commission that it has not felt the need to spell out what it is – as the white paper is at pains to point out. “The Commission will now have its own concept of the arm’s length principle without having previously provided any guidance on what the arm’s length principle under [the EU Treaty] means. As a result, the Commission now appears to have become an arbiter of when a transfer price relevant for determining taxable income in a Member State satisfies the arm’s length principle.”

Tangled Language

To my mind, this is a compelling analysis. It broadly reflects the views of some European legal commentators, such as Dr Liza Lovdhal Gormsen, Senior Research Fellow at the British Institute of International and Comparative Law and Senior Lecturer in Law at Manchester University. “In trying to compare multinationals with standalone companies,” she writes, “the Commission ignores the fact transfer pricing rules only apply to multinationals and consequently will always show an advantage in favour of them, i.e., they are not available to companies who don’t operate across international borders.”

Dr Gormsen also criticises the Commission’s approach to the arm’s-length principle as being “at odds with the international standards set out by the OECD”. Those standards recognise that transfer pricing was not an exact science, and that a degree of estimation and approximation was required. In contrast, the EU Commission “believe there is a precise formulation that it alone can determine and that any deviation from this may represent a breach of state aid rules. This undermines national tax authorities, creates uncertainty and threatens to make the EU the final arbiter in an area where it has no jurisdiction.”

It remains to be seen whether the EU courts will agree with the Commission’s critics. Anyone who has had the misfortune to spend a substantial portion of their adult life reading judgments from those courts will know that their language is often tangled and their logic far from clear. There is therefore likely to be ample room for the Commission to argue that its actions fall squarely within the remit of its state aid jurisdiction.

By Dr Craig Rose, Technical Editor, Global Tax Guide

Access even more in-depth analysis and expertise with a free trial to the Premier International Tax Library.