On August 30, 2016, the European Commission announced its finding that tax rulings obtained by two Irish subsidiaries of Apple constitute illegal State aid. The Commission concluded that Apple must pay Ireland an amount equal to the alleged tax benefits, plus interest, amounting to some €13 billion.
This is the fourth Commission case concerning tax ruling in less than one year. Two other ongoing cases involve tax rulings in Luxembourg, and the Commission has announced plans to open further investigations. The Commission's initiatives may cast doubt on the validity of a host of past tax rulings obtained by multinational companies from EU Member States, as well as on new or renewed rulings in the future.
A Brief Refresher
In 2013, in response to concerns that certain EU Member States were issuing favorable tax rulings to multinationals in order to attract foreign direct investment in violation of EU competition rules, the Commission launched a number of State aid investigations. It began investigating the tax ruling practices of seven EU Member States, including The Netherlands and Luxembourg, which it then broadened to all 28 EU Member States in 2014. The Apple decision, as well as previous decisions relating to tax rulings in the Netherlands and Luxembourg and a specific Belgian tax scheme, reflects the Commission's critical approach to tax rulings. On various occasions and most recently in a working paper issued on June 3, 2016, the Commission has announced plans to pursue further investigations, focusing on cases where there is a "manifest breach" of the so-called arm's-length principle.
Various appeals have been brought by the Member States and/or the affected companies against the three decisions from the past year, and, more broadly, the use of State aid tools in this field has faced criticism. In particular, the Commission's perceived bias against U.S.-based multinationals has drawn a special criticism from the U.S. government, academics, and taxpayers. Last week, the U.S. Treasury even issued a comprehensive White Paper criticizing the EU's approach.
Multinationals navigating these waters will need sound and integrated advice on both tax and State aid implications.
The Apple Case
The formal decision has not yet been published, and the full reasoning of the Commission therefore is not yet available. From the initial decision opening the investigation, however, we know that the Commission attacked the so-called "Double Irish" structure, which allegedly allowed Apple to shift profits from high-tax to low-tax jurisdictions. But this, in and of itself, was not a State aid. The Commission had preliminarily concluded that the tax ruling on the pricing of transactions between the various Apple affiliates (and hence how much income remained subject to tax in Ireland) was not based on an objective transfer pricing report, but was rather devised to fit the results of Apple's negotiations with the Irish tax authorities. In addition, the long duration of the agreement under the tax ruling (15 years), without review, appeared highly questionable to the Commission.
The Commission's main argument is that Apple received a selective advantage as compared to domestic companies because the transfer pricing accepted in the tax ruling did not correspond to an "arm's-length" result that—according to the EU—would be the market terms that a domestic company would have to pay. Significantly, the Commission's arm's-length principle does not itself correspond to the OECD principles nor to any transfer pricing principle enshrined in Irish law. Rather, it is a sui generis EU law principle that the Commission derives from Article 107 of the Treaty, i.e., the provision prohibiting State aid.
The amount to be recovered from Apple by Ireland is not precisely set forth in the decision, but it is clear that it will be the highest amount ever to be recovered under EU State aid law. It should be noted, however, that the Commission, in its press release, indicates a new approach in calculating the amount to be recovered.
According to the press release, "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."
This seems to deviate from prior decision practice and will also likely lead to some practical problems, given that the Member State is generally required to order the repayment of the advantage within four months. It remains unclear how Ireland could take into account taxation by other countries within that period of time.
As with the other tax ruling cases before, this case is likely to be appealed both by the Member State concerned—Ireland—and by the alleged aid beneficiary. The eventual court action will likely revolve around the question of whether the Commission's approach to compare multinational companies to domestic companies is correct or if the Commission should have compared the treatment of Apple with the treatment of other multinational companies in Ireland.
Decisions in Three Other Investigations
This new ruling highlights the Commission's continued interest and resolve to seek repayment of what it perceives to be illegal State aid in tax ruling cases. The Commission has already closed its investigations into two other tax rulings granted by the Netherlands and Luxembourg and the Belgian "Excess Profit" scheme and has ordered repayments in each of these cases.
- As one example, in a decision from October 2015, the Commission primarily objected to Fiat's remuneration of intra-group services, as endorsed by a Luxembourg tax ruling. Fiat Finance and Trade ("FFT") provides intra-group loans and other services to other group companies, and its remuneration is determined as return on capital. However, the Commission concluded that FFT's capital base was artificially lowered, and its rate of return fell below market benchmarks, which deflated its tax base. The Commission again ordered an amount of about €20–30 million to be repaid. Fiat and Luxembourg separately appealed the decision in December 2015, which appeals are currently pending.
- In another example, in the Belgian Excess Profit case, the Commission challenged a Belgian tax regime that allows multinational corporations to reduce their tax base by an amount of what are allegedly "excess profits." The system is based on the premise that multinationals may derive "excess profits" resulting from being part of a group of companies (due to synergies, economies of scale, etc.) as compared to profits of stand-alone companies. In some cases, the provision allowed companies—based on company-specific tax rulings—to reduce their tax base by as much as 50–90 percent. The Commission's January 2016 decision ordered the suspension of the tax scheme and ordered the recovery of some €850 million (Belgian tax authorities are to determine the exact amount) from more than 30 multinationals. Several appeals against the decision are currently pending.
Other Ongoing Investigations
The Commission is still pursuing its investigation in two cases in Luxembourg.
- In one case, the Commission challenges a Luxembourg tax ruling, which endorsed a practice whereby the Luxembourg entity reporting much of the company's European profits pays a "tax deductible royalty to a limited liability partnership established in Luxembourg but which is not subject to corporate taxation in Luxembourg." In addition, the Commission criticizes the fact that the ruling was granted in the absence of a transfer pricing report to support it. Furthermore, the ruling request was assessed and granted in only 11 working days and made no reference to any of the OECD-accepted transfer pricing methods, raising the Commission's doubts as to how substantive and solid the analysis was before the ruling was granted.
- In the other case, the Commission alleges that rulings enabled double non-taxation of the company's profits in Luxembourg and the United States. Under the tax arrangement, the company's Luxembourg head office internally transferred revenues to a U.S. branch. Under Luxembourg law, the U.S. branch constitutes a "permanent establishment," and profits should be taxable in the United States. Under U.S. law, however, the U.S. branch does not constitute a "permanent establishment" and should therefore be taxable in Luxembourg. As a result, profits were not taxed in either jurisdiction, as validated by the challenged Luxembourg tax ruling.
Important Implications for Multinational Companies
The Commission has repeatedly stated its resolve to pursue tax rulings based on State aid rules. The recently published Commission Notice on the notion of State aid (a blueprint of the Commission's interpretation of State aid rules) expressly mentions tax rulings as a methodology for granting State aid, and in particular where a tax administration applies more "favorable" treatment over other taxpayers in issuing such tax ruling.
In a Working Paper dated June 3, 2016, the Commission also indicated that it may open additional investigations if it finds that other tax rulings may grant State aid. In particular, the Commission would focus on cases where there is a "manifest breach" of the arm's-length principle. Various public statements by Commission officials over the last several months confirm this.
These cases, and the anticipated judgments of the European Court of Justice ("ECJ"), will have important implications for multinational companies and even for the tax competence of the European Member States. If the ECJ upholds the Commission's decisions, this will likely significantly affect all other multinational companies benefiting from tax rulings issued by EU Member States. In addition, it would then appear that the Commission could reserve the right to scrutinize the application of all national tax rules to multinational companies, in the same way as in these tax ruling cases.
Further background on the EU tax ruling investigations and their implications for multinational companies can be found in the related " European Commission Tax Ruling Investigations: Frequently Asked Questions."
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.