A week before Christmas, the European Commission released its full decision in the Apple case. Running to 452 paragraphs spread across 130 pages, it doesn’t make for light bedtime reading. But the following passage from para 228 leaps out:
‘From the perspective of the aforementioned rules [i.e., Ireland’s corporate tax regime], all companies having an income are considered to be in a similar factual and legal situation, since the objective of those rules is the taxation of profit subject to tax in Ireland. Consequently, all companies subject to tax in Ireland, whether resident or non-resident, are in a comparable factual and legal situation as regards the ordinary rules of taxation of corporate profit in Ireland.’
This proposition will raise eyebrows among those who have been taught that the distinction between residents and non-residents is the very essence of international tax law. But it forms a central plank of the Commission’s argument that tax rulings by the Irish tax authorities in 1991 and 2007, dealing with the corporation tax liability of two Apple companies incorporated in Ireland, constituted unlawful state aid.
To establish that a tax measure constitutes state aid, it’s generally necessary to prove, among other things, that it constitutes a ‘derogation’ from the ‘reference system’, i.e., that it creates a difference in treatment between companies that are in a comparable factual and legal situation. This in turn means that the identification of the correct reference system is crucial.
It is central to the case put forward by the Irish authorities and Apple that the appropriate reference system in this instance is not the Irish corporate tax system as a whole, but one particular part of it – section 25 of the Tax Consolidation Act 1997. Under that provision, which replaced an earlier provision in substantially similar terms, a non-resident company is liable for Irish corporation tax only if it carries on a trade in Ireland through a branch or agency. If the non-resident does carry on such a trade, its chargeable profits are its trading income arising directly or indirectly through or from the branch or agency. This, of course, is the classical approach to the taxation of non-resident companies, found not only in numerous tax treaties, but also in the domestic legislation of many countries.
What was unusual about the Irish law applicable at the time of the impugned rulings was its definition of tax residence. Under that definition (now repealed), the relevant Apple companies in Ireland were regarded as the Irish branches of a non-resident company, even though they were incorporated in Ireland (see the previous blog article here). This meant that the Apple companies’ charge to corporation tax in Ireland was subject to the rules relating to non-residents. Accordingly, Ireland and Apple maintained that the appropriate reference system was the Irish tax regime applying to non-resident companies with Irish branches.
The Commission’s response was that the non-resident status of the Irish Apple companies simply didn't matter when identifying the reference system. True, there was a distinction between resident companies, taxable on worldwide income, and non-residents, taxable only on trading income arising from an Irish agency or branch. But that distinction, said the Commission (para 237), did not
‘justify the identification of a separate reference system distinct from the ordinary rules of taxation of corporate profit in Ireland. The fact remains that, for the purposes of determining their taxable base and determining their corporation tax liability, both types of companies are in a comparable factual and legal situation as regards the intrinsic objective of those rules, which is to tax the profit of all companies, resident or non-resident, subject to tax in Ireland.’
It therefore followed ‘that the reference system against which the contested tax rulings should be examined is the ordinary rules of taxation of corporate profit in Ireland . . . which have as their intrinsic objective the taxation of profit of all companies subject to tax in Ireland’ (para 242). Section 25, continued the Commission, ‘should therefore be considered to form an integral and necessary part of that reference system, but not a separate reference system unto itself.’
Can this be right? Is a non-resident company with limited tax liability really in a comparable factual and legal situation to a resident company with unlimited tax liability? If it is, doesn't that mean that any tax rule applying only to non-residents must by definition be a derogation from the reference system? And if that's the case, why wouldn't the core principle of international tax law – that a non-resident's trading profits are taxable by the host country only to the extent that they arise from a permanent establishment in that country – itself fall foul of the EU's rules against state aid?
Given the achingly slow pace of litigation in the EU courts, it is likely to be several years before we receive definitive answers to these questions. In the meantime, they will hang like the Sword of Damocles over the central concept in international tax law.
By Dr Craig Rose, Technical Editor, Global Tax Guide
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