The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
The European Commission’s decision telling Ireland to retroactively recoup $14.5 billion in unpaid taxes from Apple Inc. sets the stage for a game of tax chess in the European courts that could go on for years.
Public statements from the central protagonists—the commission, Apple and Ireland—show the parties wedded to their legal positions with virtually no chance of settlement. The losing party before the EU General Court will almost certainly appeal the decision to the European Court of Justice.
In its decision released Dec. 19, the commission said tax rulings issued by the Irish Revenue to two Apple subsidiaries “confer a selective advantage on those companies that is imputable to Ireland and financed through State resources, which distorts or threatens to distort competition and which is liable to affect trade between Member States.”
Ireland’s Department of Finance immediately reacted with a three-page document arguing the commission misapplied the EU law prohibiting the granting of favorable tax treatment to specific corporations, including the concept of “selective advantage.”
“It is a bold decision,” Heather Self, a London-based tax partner with global law firm Pinsent Masons, told Bloomberg BNA. “It reaches beyond what is happening in Ireland and questions whether the U.S. head office has any substance.”
“Apple was very aggressive in allocating entrepreneurial profit to stateless entities, so the profits were apparently not taxed anywhere,” Self said.
The evidence from Apple and Ireland “is weaker than I would have expected, particularly the lack of a transfer pricing study, and the apparently inconsistent ruling practice,” the London practitioner said. “This will run for years, and at this stage I would not like to predict the outcome. It is far from a slam dunk for either side.”
Self said the decision “does not discuss the key selective advantage point in much detail.”
Apple Inc. responded to the decision by charging that the company had been singled out by the commission as a “convenient target.”
“Because our products and services are created, designed and engineered in the U.S., that’s where we pay most of our tax,” Apple said in a Dec. 19 statement. “This case has never been about how much tax Apple pays, it’s about where that tax is paid.”
A U.S. Treasury spokesperson, in a statement, said “We continue to believe the Commission is retroactively applying a sweeping new State aid theory that is contrary to well-established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe.”
The commission’s decision followed a three- year investigation into two tax rulings issued by Ireland in favor of two Apple group companies: Apple Sales International (ASI) and Apple Operations Europe (AOE). Both companies were carrying on a trade in Ireland through a branch.
Self said these companies were both incorporated in Ireland and, although they didn’t have any taxable presence in the U.S. or any other tax jurisdiction, they weren’t treated as Irish tax resident because Irish law at the time regarded them as U.S. tax resident.
Irish law has since been amended and Apple has now changed its operating structure.
Self said the tax rulings concerned the method of allocation of profit to the Irish branches of ASI and AOE. The rulings meant that almost all of the sales profits recorded by the two companies were internally attributed to a head office of ASI that the commission said, in a statement issued in August, “existed only on paper and could not have generated such profits.”
Self pointed out the profits allocated to the head office weren’t subject to tax in any country and as a result, the commission said Apple only paid an effective tax rate of between 0.005 percent and 1 percent.
The key issue the EU General Court will have to rule on is the EU law concept of “selective advantage.”
“The Commission has no competence, under state aid rules, unilaterally to substitute its own view of the geographic scope and extent of the member state’s tax jurisdiction for those of the member state itself,” the Irish government said in a Dec. 19 statement.
The government said the purpose of the EU state aid rules is to tackle state interventions that confer a selective advantage. “The state aid rules by their nature cannot remedy mismatches between tax systems on a global level.”
Self said under EU rules it is unlawful for any EU country to give financial help to selected companies in a way which would distort fair competition. If a tax ruling contravenes market principles so as to confer a selective advantage, it could be considered to be state aid.
“Selective advantage issue is at the heart of the decision,” Steve Towers of Deloitte LLP’s Singapore office said in an e-mail. Kai Struckmann, a Brussels-based competition lawyer with White & Case LLP who previously worked as an antitrust lawyer with the European Commission, agreed. “The question of selectivity will be at the heart of the case,” he told Bloomberg BNA in an e-mail Dec. 20.
Struckmann questioned “whether the appropriate reference framework indeed is the general tax system, as the EC claims can be deduced from the Belgian Coordination Centres Forum 187 case.” The Apple case is “certainly not in line with other case law of the Court.”
The commission, in its decision, identified a complicated, lengthy three-step analysis to determine whether a tax measure is selective.
Apple and Ireland are likely to attack each and every conclusion set forth in the commission’s analysis.
The first step is to identify the common or normal tax regime in a member state. Towers said the commission calls this the “reference system,” but perhaps “benchmark” would have been a better term.
In its opinion, the commission said the “reference system” to be used in the case is the “ordinary rules of taxation of corporate profit in Ireland.”
The second step is to determine whether the relevant tax measure is a “derogation” from that reference system, on the basis that it differentiates—that is gives a different tax treatment—between businesses that are in a comparable factual and legal situation.
If there is a derogation, the third step is to determine whether the measure is justified by the nature or general scheme of the reference system.
The commission said the second analytical step involves identifying a derogation from the reference system by virtue of the incorrect application of the arm’s-length principle.
Under the relevant Irish tax legislation, the two companies were therefore taxable in Ireland on any trading income arising directly or indirectly through or from the branch, and any income from property or rights used by, or held by or for, the branch.
Towers said the Commission decided that this provision requires the use of a profit allocation method based on the arm’s-length principle. “This is very important, because Ireland argued that its tax law, prior to 2011, did not include the arm’s-length principle.”
According to the commission, the European Court of Justice has held that a reduction in the taxable base resulting from a tax measure that enables a taxpayer to employ transfer prices in intra-group transactions that don’t resemble prices “which would be charged in conditions of free competition between independent undertakings negotiating under comparable circumstances at arm’s length” confers a selective advantage on the taxpayer. Towers pointed out that the commission referred to the 2006 Belgian coordination center cases as its authority.
The commission said the same principle should apply to intra-entity transactions: “The same principle applies to the internal dealings of different parts of the same integrated company, such as a branch that transacts with other parts of the company to which it belongs.” Towers said the commission doesn’t cite any authority for this statement.
Towers said the commission emphasized that the source of the arm’s-length principle, in this case, is Article 107 of the Treaty on the Functioning of the European Union, not the OECD transfer pricing guidelines or the OECD Article 7 report.
The commission said the Irish Revenue incorrectly applied the arm’s-length principle by accepting the unsubstantiated assumption that the Apple IP licenses held by ASI and AOE should be allocated outside Ireland. “Given the lack of functions performed by the head offices and/or the functions performed by the Irish branches, the Apple IP licenses for the procurement, manufacturing, sales and distribution of Apple products outside of the Americas should have been allocated to the Irish branches for tax purposes,” the decision said.
The incorrect application of the arm’s-length principle led to a selective advantage to ASI and AOE because it resulted in a lowering of their corporation tax liability under the ordinary rules of taxation of corporate profit in Ireland, the commission found.
Towers said the commission concluded that the derogation—that is, the selective advantage—wasn’t justified by the nature or general scheme of the Irish tax system.
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