On Monday, December 19, 2016, the European Commissioner for competition, Margrethe Vestager, published the full text of the Apple State Aid Case/ Decision as already crystallized in August this year. The European Commission (‘EC’) concludes that Apple in two advance pricing agreements (“APA”) benefitted from unlawful State aid granted by Ireland, and it orders full recovery of the aid in an amount of up to €13 billion (the unpaid taxes in Ireland from Apple for the years 2003 to 2014) plus compounded interest. It is for the Irish tax authorities to now determine the exact amount and the modalities of payment. As a reaction, the Irish Department of Finance of legal arguments objecting to the Case.
Background in a nutshell
Apple Sales International (‘ASI’) is an Irish incorporated entity but non-Irish resident and holds the right to use Apple’s intellectual property to sell and manufacture Apple products outside the USA. In exchange of this right, it makes payments to Apple USA to contribute to the development of this intellectual property.
The EC’s investigation related to two tax rulings issued by Ireland to Apple. The first as granted in 1991, and was replaced in 2007 by a similar second ruling. Both rulings endorsed an internal split of ASI’s profits for tax purposes, they allocated the profits between its Irish branch and the company’s head office that only exists on paper: the head office, it has no employees, no premises and no real activities and has no operating capacity to handle and manage the distribution business, in other words, no substance.
The Irish branch was subject to the normal Irish corporation tax regime. However, the head office was not subject to tax at all. This was possible under the Irish tax law, until 2013 they allowed so called ‘Stateless companies’. As a result of the allocation method, only a fraction of ASI’s profits were attributed to its Irish branch. The remaining profits were attributed to its head office and were subsequently not taxed. Apple’s effective tax rate in 2014 was according to the European Commission 0.005%.
The second company, Apple Operations Europe (‘AOE’), makes Apple computers in Ireland. Under the same two tax rulings, the majority of its profits were also artificially allocated to a head office with no substance, and which profits were not taxed.
The sales profits of ASI and AOE should have been recorded with the Irish branches of ASI and AOE and taxed there, according the EC.
This selective tax treatment of Apple in Ireland perceived to be illegal under EU state aid rules according to the EC. It gave Apple a significant benefit compared to other businesses. According to the European Commission tax rulings cannot endorse a method to calculate taxable profits of a business that fails to reflect economic reality. The European Commission believes economic reality is a justifiable approach to fulfil the selectivity criterion.
Full text of the Apple State Aid Case
The full text of the Apple State Aid Case from the EC describes the findings which lead to the conclusion that State Aid was available to Apple in Ireland and this State Aid is not compatible with the EU Treaties. This appears to be mainly on the grounds that an allocation of profits for companies not resident in the state conferred a selective advantage on two Apple group entities, AOE and ASI, which reduced their Irish corporation tax liability. Given the lack of relevant substance at the level of the head offices the income should be allocated to the branches in Ireland rather than to the head offices. Secondly the EC argues that, even if the allocation can be considered to be correct, the Irish branches profit should have been higher in order for it to be considered at arm’s length. The EC disagrees with the qualification of the activities as a less complex party, the cost based profit level indicator and selection of comparables. Finally the EC disagrees with the position that Ireland was not required to follow the OECD Transfer Pricing Guidelines. In the decision the EC also provides a methodology for the quantification of the advantage enjoyed by Apple.
Legal arguments by the Department of Finance
As a reaction, the Irish Department of Finance published a list of legal arguments objecting to the Case. The legal arguments published by the Department of Finance include that the Commission misapplied State Aid law and that opinions given by Revenue in 1991 and 2007 did not depart from normal taxation rules, because ASI and AOE did not pay any less tax than was properly due under the applicable law. Furthermore expert evidence on the arms-length principle was wrongly rejected by the Commission. Furthermore, the Department issued a statement saying; “Ireland does not accept the Commission’s analysis, which is why we have lodged an application with the General Court of the European Union to annul the whole Decision. Ireland did not give favorable tax treatment to Apple – the full amount of tax was paid in this case and no State aid was provided. Ireland does not do deals with taxpayers.”
As expected, the Irish government announced that it will appeal the EC’s decision. Apple indicated to appeal the decision as well. Consequently, a final decision can take years, as is the case for the other state aid procedures in relation to tax rulings.
The full decision did not contain many new arguments compared to the earlier decisions published. With the full allocation of profit to the branch the EC continues with their own version of the at arm’s length principle, the European Court of Justice will ultimately have to decide whether that is acceptable but as mentioned before that will take a few years.
The decision seems to indicate that apparent transfer pricing mistakes are treated as State Aid by the EC. We believe this not to be the case, however if the fact pattern is so different from what to be expected under the OECD principles, State Aid conclusions according to the EC cannot be ruled out.
If you have any questions regarding the above, please do not hesitate to contact us.