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The EU, tax and the Apple of its ire

07 November 2017 by Robert Bell and Roman Madej

The EU, tax and the Apple of its ire - Read more

The European Commission is suing Ireland over failure to recover ‘illegal state aid’ from Apple

The European Commission will soon take Ireland to the European Court of Justice (ECJ) over its alleged failure to recover €13 billion, plus interest, of ‘illegal state aid’ paid to the US technology firm Apple through years of ‘selective’ tax treatment.

Ireland already lodged an appeal before the ECJ to overturn the decision, but the commission argued this does not suspend Ireland’s obligation to recover the money.

As Ireland has not taken steps to recoup the sum in dispute, it is, according to the commission, breaching its obligations under the Treaty for the Functioning of the European Union. The purpose of the commission’s application is to censure Ireland’s inaction, mandate its collection and seek penalties in the event of further contraventions.

This is a controversial case with widespread implications for international corporate tax planning. It strikes at the heart of member states’ powers to legislate and enforce domestic tax systems, while raising questions over whether the commission has the power to challenge tax rulings based on Ireland’s own methodologies which establish transfer prices.

This is not the first time the commission has used its state aid powers to act against an EU country’s alleged favourable taxation treatment.

However, the sheer size of the repayment ordered in this case (which amounts to nearly the whole of Ireland’s annual healthcare budget) as well as the potential consequences for Ireland’s low business taxation economy put this case in its own league.

The dispute is further dogged by the political tensions with the US government. The commission’s move to get tough with Ireland, and indirectly Apple, is another step in an international power struggle with no end in sight.

It also flags international governments’ inability to agree a harmonised approach to taxing multinational companies.

Artificial advantages

To recap, back in 11 June 2014, the commission announced that it had opened an investigation into decisions made by Irish tax authorities, examining whether the corporation tax paid by Apple had involved selective advantages and, if so, whether these complied with EU rules on state aid.

Specifically, the main subject of the investigation was whether the transfer pricing arrangements agreed between Apple and Ireland amounted to unlawful state aid.

Apple had two Irish incorporated subsidiaries, Apple Sales International and Apple Operations Europe, while the ultimate parent was the company Apple Inc, based in the US.

The subsidiaries held rights to use Apple’s intellectual property to sell and manufacture Apple products outside the Americas under a special cost-sharing formula with Apple Inc.

“The decision required them to recoup all tax which lawfully should have been paid without the offending rulings”

Under this agreement, the subsidiaries made yearly payments to Apple in the US to fund research and development (R&D) efforts, which were allegedly conducted on behalf of the Irish companies. These payments amounted to about $2 billion in 2011 and significantly more by 2014.

These R&D costs were mainly borne by Apple Sales International and it is believed that they funded more than half of all research efforts by the Apple group in the US to develop its intellectual property worldwide.

These expenses were deducted from the subsidiaries’ profits in Ireland each year, in line with applicable tax rulings approved by the Irish tax authorities.

A rotten core

At the centre of the commission’s case was whether two Irish tax rulings approved a method to artificially allocate profits within Apple Sales International and Apple Operations Europe.

In its decision of 30 August 2016, the commission condemned the Irish government for allowing their tax rulings to endorse an allocation of profits within the subsidiaries that had no factual or economic justification.

The outcome was that Apple was allowed to pay substantially less tax than other companies, which gave them an undue advantage and thus constituted unlawful state aid.

The decision required them to recoup all tax which lawfully should have been paid without the offending tax rulings, and if justifiable transfer pricing and profit allocation rules had been followed – equating to €13 billion, plus interest.

In an attempt to deflect criticism from other EU member states and the US government, the decision pointed out 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 the subsidiaries over this period.

Court referral

Announcing the referral of Ireland to the ECJ in Luxembourg on 4 October 2017, Margrethe Vestager, the European Union’s commissioner for competition, set out the commission’s position succinctly:

‘Ireland has to recover up to €13 billion in illegal state aid from Apple. However, more than one year after the commission adopted this decision, Ireland has still not recovered the money, also not in part.

‘We, of course, understand that recovery in certain cases may be more complex than in others, and we are always ready to assist. But member states need to make sufficient progress to restore competition. That is why we have today decided to refer Ireland to the EU court for failing to implement our decision.’

This statement betrays the commission’s frustration that one of their highest profile state aid decisions and, arguably their flagship case on member state favourable tax treatment, has so far been not been implemented.

The deadline for Ireland to implement the commission’s decision on Apple’s tax treatment was 3 January 2017, in line with standard procedures of four months from the official notification of the commission decision.

Tax recovery is now some nine months overdue, and the commission believes the intervention of the ECJ is needed.

Political squabbles

The case is complex and represents an international power struggle.

The commission believe it has the force of law behind them and moral authority. It is simply enforcing state aid policy to stop a company enjoying advantages others do not, thereby safeguarding the free market in the EU. It is doing so entirely within the confines of EU state aid law to which Ireland and Apple must adhere.

“Ireland says it needs more time for its calculations and recovery”

The issue for the commission is that Ireland believes it has a lot more to lose than the €13 billion it would gain in adhering to the commission’s ruling.

Favourable tax deals for companies are well-known tactics for growing the economies of smaller EU countries such as Ireland, and the EU attacking such arrangements seriously undermines those economic models.

The case is complicated for the commission by the US and corporate America, which are understandably hostile to the ruling and sympathetic to Apple and Ireland.

Although Ireland says it is adhering to the ruling and needs more time for its calculations and recovery, to many observers it is clearly delaying ahead of the substantive hearing of its appeal to the ECJ.

The most supportive thing Ireland can do for Apple and multinational business in the country is to continue being as obstructive as possible until legal options are exhausted, even if that means taking heat from the commission and being fined for non-implementation.

It has been reported, but not confirmed, that Apple is heavily supporting Ireland and the two are in discussions to eventually put the €13 billion in escrow, with assurances from Apple to Ireland that if the value of the currency dropped over the next five years, Apple would make up any shortfall.

Five years is being touted as the likely timeframe to resolve the appeal against the August 2016 decision.

The case is important for the EU at this fragile time in that it tests the extent of the EU’s power. Non-implementation will be seen as an assault on its authority.

Waiting game

Both Ireland and the European Commission will now await the ECJ’s decisions, both on non-compliance but also the appeal of the original decision.

If a member state does not comply with the judgment, the commission may ask the ECJ to impose penalty payments under Article 260 of the Treaty for the Functioning of the European Union. Such penalties can include lump sums and other penalties, which would perhaps ironically deny Ireland some of the benefit of the billions it could have collected from Apple.

Robert Bell is a partner and Roman Madej is an associate at Bryan Cave

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