In a press release of August 30, 2016 issued by the European Commission, the Commission held that Ireland granted undue tax benefits of up to €13 billion to Apple pursuant to an agreement (rulings) that it entered into with Apple in 1991. This was “improper illegal aid” in clear violation of the EU state aid rules which state quite simply that “Member States cannot give tax benefits to selected companies..”. See Article 107(1) of the Treaty on the Functioning of the European Union (TFEU).
Under this agreement with Ireland, Apple enjoyed a striking competitive advantage over other businesses and for many years. Apple was found by the Commission to have paid an effective corporate an effective corporate tax rate of 1% on its European profits in 2003 which reduce to .005 % in 2014. The tax treatment in Ireland enabled Apple to avoid taxation on almost all profits generated by sales of Apple products in the entire EU single market. This is due to Apple's decision to record all sales in Ireland rather than in the countries where the products were sold. The Commission noted that if other countries, including the United States, were to require Apple to pay more tax on profits of the two companies over the same period under their national taxation rules, this would reduce the amount to be recovered by Ireland.
The state aid investigation was started in 2014. The Commission concluded that two tax rulings issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991. The rulings endorsed a way to establish the taxable profits for two Irish incorporated companies of the Apple group (Apple Sales International and Apple Operations Europe), which did not correspond to economic reality: almost all sales profits recorded by the two companies were internally attributed to a "head office". The Commission's assessment showed that these "head offices" existed only on paper and could not have generated such profits. These profits allocated to the "head offices" were not subject to tax in any country under specific provisions of the Irish tax law, which are no longer in force.
The Commission can order recovery of illegal state aid for a ten-year period preceding the Commission's first request for information in 2013. Ireland must now recover the unpaid taxes in Ireland from Apple for the years 2003 to 2014 of up to €13 billion, plus interest. The taxable profits of Apple Sales International and Apple Operations Europe in Ireland were determined by a tax ruling granted by Ireland in 1991, which in 2007 was replaced by a similar second tax ruling. This tax ruling was terminated when Apple Sales International and Apple Operations Europe changed their structures in 2015.
Apple's European Tax Structure
Apple Sales International and Apple Operations Europe were the two Irish companies wholly owned by the Apple group which is ultimately controlled by the U.S. parent corporation, Apple Inc. The two Irish companies held the rights to use Apple's intellectual property to sell and manufacture Apple products outside North and South America under a so-called 'cost-sharing agreement' with Apple Inc. Under this agreement, Apple Sales International and Apple Operations Europe made yearly payments to Apple in the US to fund research and development efforts conducted on behalf of the Irish companies in the US. These so-called “buy-in” payments under the cost sharing agreements (Treas. Reg. §1.482-7) amounted to approximately $2 billion (US) in 2011 and significantly increased in 2014. These expenses, mainly borne by Apple Sales International, contributed to fund more than half of all research efforts by the Apple group in the US to develop its intellectual property worldwide. These expenses are then deducted from the profits recorded by Apple Sales International and Apple Operations Europe in Ireland each year.
After completing its investigation, the Commission concluded that the tax rulings issued by Ireland improperly validated the artificial allocation of the sales profits from the Irish companies to their “head offices” where they were not taxed since such head offices were situated in a tax haven or, as was alleged in the Apple situation, its intermediate foreign affiliate, Ireland Holdco, had “no” tax residence “anywhere”. Now that’s something for tax jocks to enjoy, a company with no tax residence. Stated in technical language, just how far can you take the check-the-box regulations with respect to defective or hybrid entities?
As a result of gaming so to speak the tax residency rules in Ireland combined with the favorable rulings and soft type transfer pricing rules, Apple was allowed to pay substantially less tax in Ireland while avoiding tax in other Member States in which it was doing business than the taxes paid on EU based sales by other companies, which, as noted, is illegal under the EU state aid rules. The Commission did not comment on Ireland’s general tax system or its corporate tax rate on trading income of 12.5%.
The amount of unpaid taxes to be recovered by the Irish authorities would be reduced if other countries were to require Apple to pay more taxes on the profits recorded by Apple Sales International and Apple Operations Europe for this period. This could be the case if they consider, in view of the information revealed through the Commission’s investigation, that Apple's commercial risks, sales and other activities should have been recorded in their jurisdictions. This is because the taxable profits of Apple Sales International in Ireland would be reduced if profits were recorded and taxed in other countries instead of being recorded in Ireland. Indeed the buy-in payment amounts under the cost sharing regulations in effect at the time may permit, subject to applicable statutes of limitations, the U.S. to impose tax on unreasonably low amounts of the buy-in paid by the Irish controlled affiliates to the U.S. subsidiary company which was a party to the CSA. Again, the right of other countries to tax and therefore reduce the amount of the recovery required to be made from Appel by Ireland was specifically noted in the Commission’s ruling.
The European Commission’s decision is subject to review by the EU courts. Were in this instance Ireland to challenge or appeal the decision, it is still required to recover the illegal state aid but could, for example, place the recovered amount in an escrow accounting pending the determination of the EU courts.
Ireland’s Response in 2014 To the EU Investigation
Knowing that its dual residence test and soft transfer pricing rules were now being challenged by the EU Commission, in October, 2014 the Finance Minister of Ireland announced that Ireland would consider eliminating the “management and control” exception to the tax residency rules so that any incorporated business entity in Ireland would be an Irish tax resident liable for its worldwide income. Still, the Finance Minister reaffirmed Ireland’s competitive 12.5% tax rate on trading income which, as mentioned, the EU Commission did not challenge.
Other EU Commission Investigations of Member Tax Ruling Practices
Since June 2013, the Commission has been investigating the tax ruling practices of Member States. It extended this information inquiry to all Member States in December 2014. In October 2015, the Commission concluded that Luxembourg and the Netherlands had granted selective tax advantages to Fiat and Starbucks, respectively. In January 2016, the Commission concluded that selective tax advantages granted by Belgium to least 35 multinationals, mainly from the EU, under its "excess profit" tax scheme are illegal under EU state aid rules. The Commission also has two ongoing in-depth investigations into concerns that tax rulings may give rise to state aid issues in Luxembourg, as regards Amazon and McDonald's.
As a direct result of this investigation on illegal state aid and similar initiatives on base erosion suffered by Member States, Member States have agreed to tackle the most prevalent loopholes in national laws that allow tax avoidance to take place and to extend their automatic exchange of information to country-by-country reporting of tax-related financial information of multinationals. A proposal is also on the table to make some of this information public.
Treasury White Paper on EU State Aid
Just prior to the EU Commission ruling on Ireland’s improper grant of state aid to Apple for a mere €13 billion, the Treasury issued its White Paper on EU state aid investigations of transfer price rulings of member states. Despite the Treasury’s express understanding of why the EU Commission was deeply concerned with member state sponsored “give-aways” to some multi-national companies, there were several areas of concern highlighted by the Treasury.
First, the EU Commission’s approach to second guess Ireland’s long-standing rulings with Apple was new if not a radical departure from prior practice. Second, given the magnitude of the EU Commission’s response, the Treasury’s White Paper stated that the new approach being taken should not be applied retroactively. Imposing retroactive recoveries might (would) undermine the G20’s efforts to improve tax certainty. Third, the Commission’s “new” approach is inconsistent with OECD transfer pricing guidelines. Indeed the Commission’s actions in calculating the amount of the improper benefit undermine the transfer pricing regime under the OECD and tax treaty norms. It therefore puts into question the ability of Member States to honor their bilateral tax treaties, and may (will) undermine the progress made under the OECD/G20 Base Erosion and Profit Shifting (“BEPS”) Project.
Ireland’s Finance Minister Committed to Appealing EU Commission’s Decision
It should be expected that Ireland will appeal the Commission’s ruling. This was indeed the point made by Finance Minister Noonan before the Irish Senate on October 4, 2016. He stated that the Irish government felt that there was no breach of state aid present in this case. Inconsistencies were noted in the ruling issued by the Commission including the point that the recovery of €13 billion would be reduced were Apple to pay more taxes to other countries or to the United States as part of the CSA. In other words, the Commission itself recognizes that other countries may indeed be entitled to collect taxes. It was acknowledged that the EU Commission may have indeed engaged in issuing a tough as well as dramatic ruling to get the Member States and the G20 and others to agree to a common consolidated corporate tax base set of rules. But Senator Rose Conway-Walsh of Sinn Féin was more interested in having Ireland obtain and use the awarded monies and told the Senate that Ireland should keep the €13 billion in recouped taxes and avoid spending any more taxpayer money on appeals. "We in Sinn Féin say that we should take the €13 billion owed to us for the betterment of our people and to send out a clear message that while we welcome multinationals, we have a fair approach to taxation”. She further questioned why Ireland should appeal, it should be Apple that appeals (provided it has standing).
Apple CEO Tim Cook also had some quotes reported by the press. He stated that the ruling was “maddening” and “political” and was “very confident” the ruling would be overturned on appeal. Cook further noted that “in 2014 our worldwide income tax rate was 26.1%”.
Recent Comments by Treasury Secretary Lew That EU State Aid Issue Could Lead to ‘Perfect Storm’ for Tax Reform
As reported in the October 7, 2016 issue of Tax Notes, Secretary of the Treasury, Jacob Lew, in comments delivered the previous day at the Peterson Institute for International Economics at a conference held in Washington, D.C., stated that the impact as well as the degree of criticism generated by the EU Commission’s recent Appel ruling may have created the right conditions for fixing the “broken business tax system in the United States”. In particular, Secretary Lew stated that the United States recognizes it has to fix the U.S. tax code and referred to the present Administration’s proposal for a 19% global minimum tax on U.S. companies’ future foreign earnings and a 14% deemed repatriation rate on previously accumulated foreign earnings. Lew further challenged the EU Commission that its ruling violated principles of sovereignty whereby one sovereign entity should not be permitted to reach into another sovereign entity’s tax base, which is exactly what it did in the Apple state aid decision. Indeed there is no “illegal state aid” principle or doctrine present in U.S. tax law.
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