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Widespread repercussions

26 September 2016 by Robert Bell

Competition law: Widespread repercussions - read more

The European Commission’s state aid decision against Apple and Ireland could have consequences for other multinational companies

In a highly politically charged decision, the European Commission has decided that Ireland granted Apple illegal state aid amounting to €13 billion as a result of selective tax treatment.

It is believed that the Commission is currently reviewing more than a thousand similar types of tax rulings, involving other EU member states and companies, as part of its ongoing investigation into their granting of favourable tax treatment. The Apple decision therefore could have significant consequences for other multinational companies which allocate profits to low cost jurisdictions.

It is not the first time the Commission has used its state aid powers to act against an EU country’s alleged favourable taxation treatment towards multinational companies. However, the sheer size of the repayment ordered in this case, the potential consequences for Ireland’s low business taxation economy and the political tension with the US Government has placed the Apple decision in a league of its own.

Since the Commission passed its decision, the Irish Government has confirmed that it will appeal to the European Court of Justice against the Commission’s decision.

Transfer pricing

The Commission has, since 2013, been gathering information on tax rulings in several member states to ascertain whether the Irish Government has breached EU law on state aid.

Problems can arise if tax rulings provide a selective advantage to specific companies or groups of companies. In such a case, this can amount to state aid within Article 107(1) of the Treaty on the Functioning of the European Union.

On 11 June 2014, the Commission announced that it had opened an in-depth investigation into the decisions by tax authorities in Ireland. This related to whether the corporate income tax paid by Apple had involved selective tax advantages and, if so, whether these comply with the EU rules on state aid. Similar investigations were opened against the Netherlands and Luxembourg.

The tax rulings of particular relevance in this case involved confirmation about Apple’s transfer pricing arrangements. This refers to where prices are set for goods sold or services provided between subsidiaries within the same group. This is highly important because transfer pricing influences the allocation of taxable profit between subsidiaries of a group located in different countries. This can result in companies not paying full tax on goods or services in the jurisdiction in which they were provided.

On 30 August 2016 the Commission announced its decision in relation to Ireland’s tax treatment of Apple. According to the Commission, tax rulings are not allowed to use methodologies which establish transfer prices with no economic justification and unduly shift profits to reduce the taxes paid by the company. It would give that company an unfair competitive advantage over other companies that are taxed on their actual profits because they pay market prices for the goods and services they use.

The subsidiaries

Apple had two Irish incorporated subsidiaries, Apple Sales International and Apple Operations Europe. The ultimate parent company was the US parent, Apple Inc. The subsidiaries held rights to use Apple’s intellectual property to sell and manufacture Apple products outside North and South America under a special cost-sharing formula with Apple Inc. Under this agreement, the subsidiaries made yearly payments to Apple in the US to fund research and development efforts which were allegedly conducted on behalf of the Irish companies in the US. These payments amounted to about $2 billion in 2011 and amounted to significantly more by 2014.

These 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.

The taxable profits of Apple Sales International and Apple Operations Europe in Ireland are determined by a tax ruling granted by Ireland in 1991 and replaced in 2007 by a similar second tax ruling. The main elements of those rulings were:

  • Apple Sales International was responsible for buying Apple products from equipment manufacturers around the world and selling these products principally in Europe but also in other international markets. It set up its sales operations in Europe in such a way that customers were contractually buying products from Apple Sales International in Ireland rather than from the countries where they physically purchased the products. In this way, Apple recorded all sales, and the profits stemming from these sales, in Ireland.
  • Two specific Irish tax rulings concerned the internal allocation of these profits within Apple Sales International. These rulings approved a division of the profits for purposes of calculating tax liability in Ireland. Pursuant to those rulings it is alleged that most profits were internally allocated away from Ireland to a ‘head office’ within Apple Sales International. This head office was not based in any country and did not have any employees or own premises. Its activities consisted solely of occasional board meetings. In this way only a small part of the profits of Apple Sales International were allocated to its Irish branch and subject to tax in Ireland. The remaining vast majority of profits were allocated to the head office, where they were not taxed.
  • Accordingly, only a small percentage of Apple Sales International’s profits were taxed in Ireland, and the rest were not subject to tax anywhere. Figures released during the US Senate’s public hearings into Apple’s taxation affairs in the US showed that Apple Sales International recorded profits of $22 billion (about €16 billion) in 2011, but under the terms of the Irish tax ruling only around €50 million were considered taxable in Ireland. This left a total of €15.95 billion of profits untaxed. 
  • Similar tax treatment was accorded to Apple Operations Europe over a similar time period. This company was responsible for manufacturing certain types of computers for the Apple group. The majority of the profits of this company were also allocated internally to its head office and not taxed anywhere.

The tax rulings of 1991 and 2007 ceased to have effect when the subsidiaries were subject to a corporate reorganisation in 2015.

State aid

At the centre of the Commission’s case was whether the two Irish tax rulings approved a method to artificially allocate profits within Apple Sales International and Apple Operations Europe that gave Apple an undue advantage over other companies and thus constituted unlawful EU state aid.

In its decision the Commission condemned the Irish Government for allowing its tax rulings to endorse an artificial internal allocation of profits within the subsidiaries which had no factual or economic justification. It therefore allowed Apple to pay substantially less tax than other companies and amounted to illegal state aid. The main points of the Commission’s case are:

  • The majority of profits of Apple Sales International were allocated to its head office when that head office had no real functions (e.g. it did not handle and manage any distribution business or any other significant trading functions). The only activities that were carried on by the head office were certain limited decisions taken by its directors on the distribution of dividends, administrative arrangements and cash management. Therefore the Commission concluded that the only legitimate profits generated by these activities were interest income.
  • The Irish branch of Apple Sales International was the only part of the company which had the ability to generate any income from trading from the distribution of Apple products. Accordingly the sales profits of this company should have been fully recorded in the Irish branch and subject to Irish tax at 12.5%.
  • A similar case was made against Apple Operations Europe. The sales profits of Apple Operation Europe arising from operations throughout Europe should have been fully recorded within the Irish branch and similarly subject to Irish tax.


The decision finds the Irish Government guilty of conferring illegal state aid upon Apple. The decision is therefore addressed to the Irish Government and requires it to recoup all tax which should have been paid, absent the offending tax rulings and if justifiable transfer pricing and profit allocation rules had been followed. Ireland must therefore recover from Apple the unpaid tax of €13 billion, plus interest.

In an attempt to deflect criticism from other EU member states and the US Government, the decision makes the point 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.

Rewriting the rule book

Many commentators accuse the Commission of trying to rewrite the rule book of international tax and international tax treaties with this and other state aid decisions against Luxembourg and the Netherlands. They claim the Commission’s decisions are an attack on the national sovereignty of each of these member states and will cause confusion and a lack of legal certainty for multinational companies in their tax planning. The Commission denies any assault on national sovereignty and claims it is attacking selective tax treatment which is ‘lavished’ on certain high profile companies to the expense of other companies and which distorts competition.

The appeal of this case (and the other cases referred to above) before the European Court of Justice will be crucial in deciding whether the Commission has acted legitimately. If upheld it is likely to be the beginning of a large number of investigations into so-called sweetheart tax deals accorded by a number of EU member states with widespread repercussions for corporate tax payers.

Robert Bell is a Partner at Bryan Cave LLP

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