Let the tax wars begin! A little too dramatic? Perhaps, but maybe not. The significance of the European Commission's decision effectively imposing a €13 billion (yes, €13 billion!) Irish back-tax bill on Apple should not be underestimated. While it may take a little time for the consequences to be fully worked through, the decision raises many issues. Both Apple and Ireland have indicated they will appeal the decision.
The global action in recent years, including especially (but not only) the BEPS Project, on attacking international tax evasion had led many to query whether more than one country would or could claim taxing rights over the same income. Indeed, as Apple CEO Tim Cook pointedly noted, the European Commission's case "is not about how much Apple pays in taxes [but] … is about which government collects the money." One corporation recently dramatically noted that if revenue authorities around the world obtained their so-called "fair share" of tax from the company, it's effective tax rate would be 200%! Add to this the likely lengthy time for the appeal process to play out and we have a recipe for tax uncertainty that will be a concern for many corporations.
Apple CEO Tim Cook and Washington have denounced the Commission ruling as an unjust raid on tax that should be paid in the United States. Cook has even been reported as saying the EU ruling is "total political crap"! Adding weight to the criticisms, the Commission's decision has been branded as "fundamentally unfair" by its former Competition Commissioner, Neelie Kroes (see further below under "Other reactions").
At the same time, many are asking if the EC decision might cause the U.S. to finally take action over its international tax laws. Notwithstanding that, U.S. Senate Finance Committee Chairman Orrin Hatch released the following statement on August 30, 2016 regarding the EC's ruling:
"Any ruling that is inconsistent with international tax standards and harms American business abroad with retroactive measures is inherently unfair and encroaches on US tax jurisdiction. Further examination of today's ruling is needed, but it appears the European Commission has issued an extraordinary decision that targets US business by rewriting already existing tax policies. That stakeholders have already announced that they will act swiftly to appeal makes this questionable at best."
What did the EC decide?
After a lengthy investigation, the European Commission has ruled that Ireland granted undue tax benefits of up to €13 billion to Apple. This is illegal under EU state aid rules, because it allowed Apple to pay substantially less tax than other businesses, the Commission said in finding that Ireland must now recover the illegal aid. The amount of the EC's ruling is far higher than anyone, including Apple, expected.
Commissioner Margrethe Vestager, in charge of competition policy, said: "Member States cannot give tax benefits to selected companies – this is illegal under EU state aid rules. The Commission's investigation concluded that Ireland granted illegal tax benefits to Apple, which enabled it to pay substantially less tax than other businesses over many years. In fact, this selective treatment allowed Apple to pay an effective corporate tax rate of 1% on its European profits in 2003 down to 0.005% in 2014."
In announcing its decision, the Commission also outlined Apple's tax structure in Europe.
The fight as to what country taxes what income of corporations has been coming to a head for a number of years and the OECD/G20 BEPS Project has accelerated and highlighted the importance of the issue. Concerns about slicing up the MNE tax pie between countries, and even of double taxation, had been regularly expressed during the development of the BEPS Project. Now, the final result of the EC's decision regarding Apple might well have an impact on how the BEPS Project pans out. Indeed, Ken Almand, Partner, Head of Transfer Pricing at RSM UK, has already commented that the US-Europe tensions over the decision could harm the recent cooperation by countries under the BEPS Project. It may also affect the tax policies of other corporates and the tax and reputational risks that they feel comfortable bearing, he warned. Differing views in the EU and the U.S. are significant.
The strong comments by Apple CEO Tim Cook are also worth noting – among other things, he said the EC decision is attempting to overturn a fundamental principle that is recognised around the world i.e. a company's profits should be taxed in the country where the value is created. Apple, Ireland and the United States all agree on this principle, he said. See his further comments below. As already noted, the EC decision is set to cause uncertainty in international tax circles and uncertainty for MNEs.
Following an in-depth state aid investigation launched in June 2014, the European Commission has concluded that 2 tax rulings issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991. The Commission said the rulings endorsed a way to establish the taxable profits for 2 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 2 companies were internally attributed to a "head office." The Commission said its 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. As a result of the allocation method endorsed in the tax rulings, Apple only paid an effective corporate tax rate that declined from 1% in 2003 to 0.005% in 2014 on the profits of Apple Sales International.
The Commission said this selective tax treatment of Apple in Ireland is illegal under EU state aid rules, because it gives Apple a significant advantage over other businesses that are subject to the same national taxation rules. The Commission can order recovery of illegal state aid for a 10-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 Commission said.
According to the Commission, 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. This structure is however outside the remit of EU state aid control, the EC said. If other countries were to require Apple to pay more tax on profits of the 2 companies over the same period under their national taxation rules, this would reduce the amount to be recovered by Ireland.
The Commission acknowledged that tax rulings as such are perfectly legal. They are comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated or on the use of special tax provisions.
The role of EU state aid control is to ensure Member States do not give selected companies a better tax treatment than others, via tax rulings or otherwise. More specifically, profits must be allocated between companies in a corporate group, and between different parts of the same company, in a way that reflects economic reality. This means that the allocation should be in line with arrangements that take place under commercial conditions between independent businesses (so-called "arm's-length principle").
In particular, the Commission's state aid investigation concerned 2 consecutive tax rulings issued by Ireland, which endorsed a method to internally allocate profits within Apple Sales International and Apple Operations Europe, 2 Irish incorporated companies. It assessed whether this endorsed method to calculate the taxable profits of each company in Ireland gave Apple an undue advantage that is illegal under EU state aid rules.
The Commission said its investigation showed that the tax rulings issued by Ireland endorsed an artificial internal allocation of profits within Apple Sales International and Apple Operations Europe, which has no factual or economic justification. As a result of the tax rulings, most sales profits of Apple Sales International were allocated to its "head office" when this "head office" had no operating capacity to handle and manage the distribution business, or any other substantive business for that matter. Only the Irish branch of Apple Sales International had the capacity to generate any income from trading, i.e. from the distribution of Apple products. Therefore, the sales profits of Apple Sales International should have been recorded with the Irish branch and taxed there, the Commission said.
Recovery of tax by Ireland
As a matter of principle, EU state aid rules require that incompatible state aid is recovered in order to remove the distortion of competition created by the aid. There are no fines under EU State aid rules and recovery does not penalise the company in question. It simply restores equal treatment with other companies, the Commission said.
The Commission has set out in its decision the methodology to calculate the value of the undue competitive advantage enjoyed by Apple. In particular, it said that Ireland must allocate to each branch all profits from sales previously indirectly allocated to the "head office" of Apple Sales International and Apple Operations Europe, respectively, and apply the normal corporation tax in Ireland on these re-allocated profits. The decision does not ask for the reallocation of any interest income of the 2 companies that can be associated with the activities of the "head office."
The Commission noted that 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, the Commission said.
The amount of unpaid taxes to be recovered by the Irish authorities would also be reduced if the U.S. authorities were to require Apple to pay larger amounts of money to its U.S. parent company for this period to finance research and development efforts. These are conducted by Apple in the U.S. on behalf of Apple Sales International and Apple Operations Europe, for which the 2 companies already make annual payments. Vestager said if Washington chose to tax the profits reported by Apple's Irish operation, she would reduce her demand accordingly. The U.S. could do this she said by forcing Apple to have its Irish units pay more in fees to Apple in California for the right to license Apple patents. "If the U.S. tax authority found that the monies paid due to the cost-sharing agreement were too few … so that they should pay more in the cost-sharing agreement, that would transfer more money to the States and that may change the books and the accounts in the States," Vestager said.
Vestager said, however, that the bill would not be affected if Apple next year moved funds from its Irish units to the United States by paying dividends, even though in this case, the dividends would be taxed.
The Commission said all its decisions are subject to scrutiny by EU courts. Significantly, it said that if a Member State decides to appeal a Commission decision, "it must still recover the illegal state aid but could, for example, place the recovered amount in an escrow account pending the outcome of the EU court procedures."
Apple and Ireland will appeal Commission decision
In a statement on August 30, 2016, Apple CEO Tim Cook said the European Commission opinion alleging that Ireland gave Apple a special deal on its taxes "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." Both Apple and Ireland have indicated they will appeal the Commission's decision. According to Reuters, both Apple and Ireland said the U.S. company's tax treatment was in line with Irish and European Union law and they would appeal the ruling, which is part of a drive against what the EU says are sweetheart tax deals that usually smaller states in the bloc offer multinational companies to lure jobs and investment.
Cook said the European Commission had "launched an effort to rewrite Apple's history in Europe, ignore Ireland's tax laws and upend the international tax system in the process." "A company’s profits should be taxed in the country where the value is created," he added.
Mr. Cook went on:
"The Commission’s move is unprecedented and it has serious, wide-reaching implications. It is effectively proposing to replace Irish tax laws with a view of what the Commission thinks the law should have been. This would strike a devastating blow to the sovereignty of EU member states over their own tax matters, and to the principle of certainty of law in Europe. Ireland has said they plan to appeal the Commission’s ruling and Apple will do the same. We are confident that the Commission’s order will be reversed.
At its root, the Commission's case is not about how much Apple pays in taxes. It is about which government collects the money.
Taxes for multinational companies are complex, yet a fundamental principle is recognized around the world: A company's profits should be taxed in the country where the value is created. Apple, Ireland and the United States all agree on this principle.
In Apple's case, nearly all of our research and development takes place in California, so the vast majority of our profits are taxed in the United States. European companies doing business in the U.S. are taxed according to the same principle. But the Commission is now calling to retroactively change those rules."
Reuters said Apple Chief Financial Officer Luca Maestri decried the effective tax rate cited by Vestager as "a completely made-up number."
Irish Finance Minister Michael Noonan said he profoundly disagreed with the decision and in order to preserve Ireland’s attractiveness for investment he would appeal. "There is no economic basis for this decision. It's bizarre and it's an exercise in politics by the Competition Commission," Noonan said.
"They don't have responsibility for taxes and they are opening a back door through state aid to influence tax policy in European countries when the European treaties say tax policy is a matter for sovereign governments," he added.
The U.S. feels its firms are being targeted by the EU and a U.S. Treasury spokesperson warned the move threatens to undermine U.S. investment in Europe and "the important spirit of economic partnership between the U.S. and the EU."
Tax experts say the European Commission faces a tough battle to convince courts to back up its stand. While the EU has found that certain tax regulations are anti-competitive, it has never before ruled whether countries have applied tax regulations fairly in the way it has with Apple, Starbucks and others.
As a result, some lawyers and accountants said they doubted Apple would end up paying back any tax. "I am not persuaded by the reasoning the EU has applied," said Tim Wach, Global Managing Director at international tax advisers Taxand.
Are other MNEs in the EC firing line?
Other multinationals which do not employ as extreme Irish tax schemes as Apple but shift profits via the country to tax havens could also be breaching EU rules, Commissioner Vestager has said. She told Reuters in an interview that other firms' arrangements, which involve routing profits to Irish registered subsidiaries tax resident in places like Bermuda, might fall foul of the Commission on similar grounds.
"Taxes have been paid nowhere due to the Irish tax code," she said. Asked if the tax bill would have been different if the head office of Apple's Irish unit been registered and paid tax in Bermuda, Vestager said: "not much."
Apple CEO Tim Cook and Washington have denounced the Commission ruling as an unjust raid on tax that should be paid in the United States. However, Commissioner Vestager said that while U.S. companies have been investigated, most of 35 firms investigated by the Commission were from Europe, and those still being looked at were a broad sample.
The European Commission's decision has been branded "fundamentally unfair" by its former Competition Commissioner, Neelie Kroes. Writing for the Guardian, Kroes attacked the ruling by her successor Margrethe Vestager. Kroes said state-aid rules should not apply to tax matters. "EU member states have a sovereign right to determine their own tax laws," she said. "State aid cannot be used to rewrite those rules. However, the current state-aid investigations into tax rulings appear to do exactly that." Kroes argues that the Commission's use of state-aid laws to force companies to pay more tax also risks undermining the work of the OECD.
Ken Almand, Partner, Head of Transfer Pricing at RSM UK, said a number of key questions arise from the EC decision. For example:
- Should a large international corporation be able to do a special deal with a tax authority resulting in it paying less tax?
- Should the European Commission be able to use state aid rules if it considers such deals distort fair competition?
- Is the European Commission right to use state aid rules and is it acting as an international tax police force? The rules were intended to ensure a level competition playing field between countries and using them to enforce national tax rules has raised eyebrows.
- What are potential wider implications of the ruling? For a start, Almand said this may be the signal for other tax authorities, both US and European, to decide whether they want to fight for a larger share of the Apple tax pie. Indeed, at the press conference announcing the EC decision, he said Commissioner Vestager issued what seemed to be an open invitation to tax authorities, both in the EU and outside it, to re-examine Apple's tax filings. [Vestager said that "if other countries were to require Apple to pay more tax on profits of the 2 [Apple] companies over the same period under their national taxation rules, this would reduce the amount to be recovered by Ireland".] The investigation has highlighted a number of facts that may lead them to open their own enquiries if they feel their country has earned less than its "fair share" of profits from Apple's operations, Almand said.
In its initial comment on the EC decision, PwC said the EC seemed focused on the fact that a large proportion of the profits generated from sales across the EU were not subject to current tax. On this basis, coupled with the limited activity at the Apple head office, the firm said the EC appeared to be saying that residual profit should be taxed in Ireland rather than allocated to the head office.
PwC says it is not clear to what extent this is consistent with, for example, the OECD guidelines on transfer pricing or branch profit attribution and how that interacts with the State aid analysis. "We must wait for the detailed decision to answer this important question," it said.
Australian Tax Office view
In commenting on the EU Apple ruling, an ATO spokesperson told Thomson Reuters that, given the differences between jurisdictions, Australia's tax system is not immediately comparable with European Union nations. The ATO noted that Australia has strong transfer pricing rules, a new Multinational Anti-Avoidance Law, a proposed Diverted Profits tax, a coming Tax Avoidance Taskforce and is implementing CbC reporting and is developing legislation for the hybrid mismatch rules (CbC reporting and hybrid mismatch rules are both part of the OECD's BEPS action plan).
The ATO says Australia's robust legislative framework, supported by robust administration by the ATO, is required in a global tax environment where competition in relation to corporate tax rates provides incentives for companies to invest capital, shift functions and their natural associated profits to lower taxed countries (generally acceptable tax competition)" but also to transfer mis-price to artificially boost profits in lower taxed countries" which the ATO says is unacceptable. This is even more critical where countries provide "tax holidays" to particular companies or industries, the ATO spokesperson said.
The ATO says it is "committed to ensuring that taxpayers pay the right amount of tax using whatever tools are at its disposal." A key component of ATO compliance assurance strategy is the use of Advance Pricing Arrangements (APAs) to mitigate transfer pricing risk. The ATO said APAs are only entered into where it has a "constructive working relationship with the company based on full disclosure." The spokesperson said the ATO "rigorously assesses a company holistically as to both structure and price before entering into an APA, with a focus not simply on the price directly paid to the related party, but on a full understanding of the global supply chain and the global allocation of profits." As the relative balance of an organisation's functions conducted in Australia change over time, the appropriate profits to be taxed in Australia will also change, the ATO said. As such, it reviews all APAs regularly to ensure they remain relevant and appropriate to the business actually being carried on in Australia, and not simply "rolled forward."
Empowering you with knowledge. Preparing you for action.
Thomson Reuters BEPS research and technology solutions empower you with up-to-date knowledge, analysis and documentation tools to respond, comply and advise as new laws and standards are passed on a country-by-country basis. Learn more at tax.tr.com/BEPS.