On 30 August, 2016, the European Commission (EC) announced its decision that Ireland must recover up to EUR 13 billion plus interest from local Apple subsidiaries. The EC holds the view that “sweetheart” tax deals between Ireland and these Apple subs are illegal under EU state aid rules. The Apple ruling and earlier rulings on fiscal state aid, coupled with legislative developments and shifting views on international tax planning, will have, and in fact already have, significant implications for many multinationals.
This ruling confirms the need for multinationals that benefit or benefitted from a favourable tax arrangement to carry out a careful and objective analysis of risks associated with current or past favourable tax arrangements and prepare for potential enforcement action by the EC or by domestic – e.g. source country – tax authorities. These risks are not restricted to state aid recovery and tax reassessment risks but extend to, for instance, disclosure obligations towards (prospective) investors and reputational risks. Further, there is the need to consider or reconsider the strategic approach to tax planning and formulate the criteria to be applied, taking a holistic view that not only considers compliance with (new) tax rules and tax re-assessment and recovery risks but also corporate governance, legal, regulatory, accounting and reputational aspects.
This decision follows the earlier EC’s decisions declaring tax deals involving FIAT and Starbucks and the entire Belgian “excess profits scheme” as illegal state aid. Investigations against McDonald’s and Amazon have been announced and are pending. The long-awaited decision on the Apple case stands out, particularly because of its sheer size. So far, there is only a press conference and a press release, a redacted version of the full decision is still to be published.
Why has the EC taken this decision?
Apple paid very limited taxes in Europe and the US in respect of sales in Europe in and before the period that was subject to the investigation, 2003 to 2014. This was the result of tax planning involving Irish incorporated but non-Irish tax resident companies and utilising specific features of the US tax system, thereby creating huge amounts of “stateless income”. The EC takes the view that the Irish Revenue’s decision to allow these profits to remain virtually untaxed provided Apple with a selective advantage over other businesses, distorted competition within the EU and therefore constituted illegal state aid by Ireland. The press release puts emphasis on these European sales profits being taxed at an effective tax rate of down to 0.005% in 2014.
What is the intended tax treatment of these structures?
Core to these structures is that most of the non-US sales profits are routed to Irish incorporated but non-tax resident companies with the objective to keep the vast majority of these profits untaxed until remittance to the US. Ireland does not consider these companies tax resident in Ireland and only taxes a small margin over, for instance, the local costs incurred by the Irish operations of these companies. The US does not consider these companies tax resident in the US either and does not require immediate inclusion of these profits in the tax base of the US parent. The US will tax these profits only upon distribution by the Irish companies to the US parent. However, distributions that would effectively result in US taxation are typically deferred, indefinitely or until another US tax break for foreign profits repatriation, like the one in 2004, or adoption of a fundamental reform of the US tax system. These Irish companies have entered into cost sharing arrangements with US group companies carrying out related R&D activities pursuant to which the Irish companies receive a royalty free licence to use R&D outside the US in exchange for a contribution to the R&D costs.
Has the EC retroactively introduced new rules?
No, the state aid rules are not new. The EC bases its decision on EU state aid rules that date back to the Treaty of Rome of 1957. Long-standing case law from the European Court of Justice confirms that these rules also apply to a wide variety of fiscal aid. This is why prudent taxpayers typically make a state aid assessment before entering into an individual arrangement with authorities within the EU or relying on special tax regimes not vetted by the EC.
What is novel about the EC’s decision then?
Application of EU state aid rules to these kind of transfer pricing related cases is a novelty. Another, more specific, development is that the recent EC decisions for the first time suggest that an EU arm’s length principle can be derived from the state aid rules, which in the view of the EC could result in different outcomes than application of the arm’s length principle based on OECD standards. This may play a role in the Apple case as well.
Is the EC right or wrong?
That depends on the perspective you take. From a legal point of view, there will probably be arguments in favour of and against the EC’s analysis but these depend on the EC’s full analysis, which has not been published so far. An interesting feature of the EC’s decision as referred to in the press release is the following. On the one hand, the EC says that all these profits must be attributed to and taxed in Ireland. On the other hand, it openly invites both the US – as country where the R&D took place – and countries where Apple sells its products to claim a bigger share of the pie, accepting that this reduces the Irish share. It will be interesting to learn what the legal and factual bases are for this approach and how it is implemented in practice.
From a political and public interest perspective, it is hard to argue against the aforementioned premise. However, Ireland and Apple will presumably argue that the actions by the EC fall outside its mandate, taking into consideration the current scope of the state aid rules, EU member states’ fiscal sovereignty and rule of law based arguments, and must be left to the legislators around the world. It is up to the European Court of Justice to take a decision on this.
What will happen next?
Both Ireland and Apple announced that they will appeal the decision. It will take years before the European Court of Justice will finally rule. In the meantime, Ireland must recover the state aid plus interest, unless an extension is granted, which is not likely.
Will the decision change anything?
Yes, even if eventually the EC did lose in court. In fact, these investigations coupled with recent legislative action taken by the EU and other legislators and shifting views on international tax planning have already caused many multinationals to start re-thinking their tax planning strategies.
What should taxpayers do?
Our view is that any multinational that benefits or benefitted from a favourable tax arrangement should take a twofold approach. First, there is the need for a careful and objective analysis of risks associated with current or past favourable tax arrangements and preparing for potential enforcement action by the EC or by domestic – e.g. source country – tax authorities. These risks are not restricted to state aid recovery and tax reassessment risks but extend to, for instance, disclosure obligations towards (prospective) investors and reputational risks. Enforcement risks will significantly increase because of new disclosure and information exchange rules, such as the Country-by-Country Reporting rules and the automatic exchange of a wide variety of tax rulings and arrangements within the EU.
Second, there is the need to consider or reconsider the strategic approach to tax planning and formulate the criteria to be applied, taking a holistic view that not only considers compliance with (new) tax rules and tax re-assessment and recovery risks but also corporate governance, legal, regulatory, accounting and reputational aspects. On that basis, a plan for implementation of structural changes can be prepared.
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