The key issue in the Apple decision is that the European Commission considered there to be a lack of ‘economic or factual justification’ for the arrangements, the effect of which was that the vast majority of the profits of Apple’s Irish subsidiaries were not subject to tax in Ireland. The decision should be seen as continuing the line of cases, including Starbucks and Fiat, through which the Commission has challenged intra-group pricing adopted by multinational companies, where this produces results that do not (in the Commission’s eyes) appear to reflect the economic reality of the situation.
1. What has the Commission decided in Apple?
On 30 August, the European Commission announced that rulings granted by Ireland on the appropriate profit allocation to the Irish branches of Apple Sales International (ASI) and Apple Operations Europe (AOE) amounted to illegal state aid. The Commission has ordered Ireland to recover this state aid from Apple.
The amount at stake dwarfs the amounts in the earlier state aid decisions on tax rulings. For example, Starbucks involved only €28m of state aid to be recovered by the Dutch government, whereas Ireland has been ordered to recoup €13bn from Apple. Put another way, the Apple recovery would be enough to fund the Irish government’s entire healthcare budget for a year.
2. Why does the Commission believe the transfer pricing ruling amounts to state aid?
State aid arises, broadly, when a business that is operating in a competitive market is given a selective benefit ‘out of state resources’.
In tax ruling cases involving international businesses, it is obvious that most of the state aid criteria are met: the ruling is issued by the state; it uses state resources (it is well established that foregoing potential tax revenues amounts to the use of state resources); and it has the potential to distort competition and affect trade between EU member states. The debate in these cases therefore turns on whether the measure grants a ‘selective advantage’; that is, an advantage which is not open to taxpayers in a comparable situation. The Commission considers that any transfer pricing ruling that does not result in a ‘reliable approximation of a market-based outcome’ confers a selective advantage.
The decision in Apple centres on two Irish incorporated ‘stateless’ companies, ASI and AOE. As the issues facing each company are broadly identical, and far more is at stake in ASI’s case (€13bn compared to €50m for AOE), this explanation focuses on ASI.
ASI was incorporated in Ireland but managed in the United States, so that it was resident neither in Ireland nor the US (or anywhere else, for that matter). ASI carried on two different functions:
It owned Apple’s iPhone and iPad IP outside the Americas, under a cost sharing agreement with Apple Inc. in the US. ASI appeared to be a passive owner of this IP, and did not have any employees (in Ireland or elsewhere) engaged in developing or managing the IP.
Through a branch in Ireland, ASI purchased Apple products from equipment manufacturers and sold Apple products to end users across Europe. Therefore, all sales in Europe were recorded in Ireland, rather than in the outlets that physically delivered the products. ASI had a large workforce in Ireland supporting this activity.
As the company selling iPhones and iPads across Europe, ASI generated significant revenues and profits. The Commission reported that, in 2011, ASI had revenues of €47bn and profits of €22bn.
The Irish Revenue agreed a basis for attributing profits to the Irish branch of ASI, under which the Irish branch was rewarded on the basis of its operating costs plus a margin. This meant that, in 2011, the taxable profits attributed to ASI’s Irish branch were €50m. The remaining profits were attributed to the Apple IP, to which ASI’s Irish branch had no claim. As the IP profits were allocated to the head office of a ‘stateless’ company, they were not subject to any immediate taxation. Under US tax law, those profits would eventually be taxed in the US (at 35%); however, that charge is deferred until the profits are remitted to the US.
The Commission held that this allocation had ‘no factual or economic justification’. As all of ASI’s employees were based in the Irish branch, the Commission concluded that only the Irish branch, and not the stateless head office, had the capacity to generate any trading income. Accordingly, it considered that ASI’s profits should have been allocated almost entirely to the Irish branch.
The Apple press release does not explain the reasoning in detail (for that, we will have to wait for the formal decision). However, it is clear that the thinking is consistent with the recent Fiat and Starbucks decisions, which also focused on the lack of apparent economic rationale for the intra-group pricing.
3. Is the Irish government laughing all the way to the bank?
No. Tempting though it may be to accept a €13bn windfall, the Irish government recognises that Ireland’s attractiveness to foreign investors is based on a predictable tax system – and that to pocket the windfall would, to quote the Irish finance minister, ‘be like eating the seed potatoes’. Ireland has confirmed that it will appeal.
4. How has the US government reacted?
The US government has made no secret of its opposition to the state aid investigations into tax rulings. Indeed, six days before the Apple decision, the US Treasury published a lengthy paper criticising these decisions. It argued that the Commission’s approach departs from earlier EU case law, imposes retroactive tax and ‘undermines the international tax system’.
5. What happens now?
The Commission decision requires Ireland to recover state aid granted to Apple from 2003 to 2014. This reflects the limitation period for state aid recovery, which looks back ten years from the Commission’s first enquiries into these rulings. Changes to Apple’s business structure in 2015 mean that the tax rulings were no longer relevant after 2014.
Calculation of the exact amount of recovery is normally a matter for the member state, although the Commission decision sets out the methodology that should be used. Unusually, the Commission press release also notes that the level of recovery in Apple reflects the decision to record all sales in Ireland, rather than where the products were sold. If other countries can establish that Apple profits should have been recognised and taxed in their jurisdictions, however, that would correspondingly reduce the appropriate taxable profits in Ireland and thus the amount of state aid recoverable by Ireland.
However, the Commission decision is subject to appeal to the EU General Court either by Ireland or by Apple. Given the significance of this case, a further appeal to the CJEU seems almost inevitable. Ireland and Apple have already indicated their intention to appeal. Bringing an appeal does not automatically suspend the obligation on Ireland to recover the aid, although the funds may be held in escrow until the appeals are resolved (which will take several years).
6. Does the decision ‘undermine the international tax system’ and ‘strike a devastating blow to the principle of certainty in law’?
Given the earlier Starbucks and Fiat decisions, it is not surprising that the Commission has also found against Apple. However, the three decisions certainly mark a more assertive approach by the Commission in policing transfer pricing rulings. The one CJEU case which the Commission cites in support of its approach, Belgium and Forum 187 v Commission Case C-182/03 and Case C-217/03, was a much more extreme case involving a regime which all but ignored the arm’s length standard.
Apple did break new ground in two ways. First, the Commission decided that all of the profits from ASI’s sales should be taxed in Ireland. It is obvious that a significant part of ASI’s profitability was attributable to Apple’s IP, which was not owned by ASI’s Irish branch. (Under the OECD approach to attributing profits to a permanent establishment, ASI’s Irish branch and the ASI head office are treated as separate entities.) The effect of the decision, however, is that ASI’s Irish branch should be treated as having a free right to use that IP. That looks difficult to reconcile with the arm’s length standard, as Apple would plainly not have provided its IP to a third party without charge (see DSG Retail v HMRC [2009] UKFTT 31 (TC)).
Secondly, the Commission’s suggestion that the amount of state aid could be reduced if other countries successfully tax Apple’s sales profits also seems troubling. If, at arm’s length, the sales profits belong in ASI’s Irish branch, why should any other country be entitled to tax those profits? And if, at arm’s length, the profits do not belong in ASI’s Irish branch, why does Ireland’s refusal to tax the profits amount to state aid?
It remains to be seen whether the European courts uphold the Commission’s attempt to play a greater role in tax cases. Notably, the most recent pronouncements on state aid and tax from the General Court (in Santander (Case T-399/11) and Autogrill (Case T-219/10)) and the Advocate General (in Finanzamt Linz (Case C-66/14)) supported a narrower view of the Commission’s power to intervene in tax cases. The Commission has appealed Santander and Autogrill to the CJEU; that judgment should be a clear pointer to whether the Commission’s transfer pricing decisions will be upheld.
7. Does this mean tax rulings aren’t worth the paper they’re written on?
No. The Commission has emphasised that it is not attacking tax rulings as a whole, which it recognises can be a legitimate means of giving businesses certainty as to their legal position. State aid issues only arise in relation to tax rulings where they go beyond simply confirming the application of existing tax rules, and instead involve some form of derogation that would not otherwise be available under the general law.
8. Is the European Commission now the final court of appeal on transfer pricing questions?
Good question. The current line of cases (Fiat, Starbucks and Apple) has focused on arrangements that – in the Commission’s eyes – depart significantly from arm’s length pricing. The recent working paper on state aid and tax rulings published by the Directorate General for Competition emphasises that the focus is on cases where there has been a ‘manifest breach’ of the arm’s length principle. Having said that, we are not aware of any recent cases in which the Commission has accepted that a transfer pricing ruling is within a state’s ‘margin of appreciation’ – and some of the reasoning in Fiat and Starbucks implies that any departure from the Commission’s view of the arm’s length standard amounts to state aid.
9. Does this mean every ‘double Irish’ structure involves illegal state aid?
No. Unlike Apple, most double Irish structures put IP and sales activities into different entities, rather than a ‘head office’ and branch of the same entity. This may make it tougher to argue that profits attributable to a group’s IP should be taxed in the Irish sales company. Furthermore, businesses which produced transfer pricing reports supporting their profit allocation to Ireland should find it easier to demonstrate that they have transacted on arm’s length terms. Of course, the clock is already ticking on these structures: they will cease to work in 2020; and, for sales in the UK, the new royalty withholding tax already undermines the benefit of many such structures.
10. How should other businesses react to this decision?
For the reasons above, the recent Commission investigations do not indicate a systemic issue with tax rulings across the EU – and Apple itself does not significantly change the picture after the Starbucks and Fiat decisions. However, a business that relies on high value transfer pricing rulings (or that is buying a business which does so) may wish to review those rulings and assess the merits of the existing transfer pricing analysis. This is particularly the case for rulings that originate from one of the jurisdictions that has been challenged by the Commission.
The key issue in the Apple decision is that the European Commission considered there to be a lack of ‘economic or factual justification’ for the arrangements, the effect of which was that the vast majority of the profits of Apple’s Irish subsidiaries were not subject to tax in Ireland. The decision should be seen as continuing the line of cases, including Starbucks and Fiat, through which the Commission has challenged intra-group pricing adopted by multinational companies, where this produces results that do not (in the Commission’s eyes) appear to reflect the economic reality of the situation.
1. What has the Commission decided in Apple?
On 30 August, the European Commission announced that rulings granted by Ireland on the appropriate profit allocation to the Irish branches of Apple Sales International (ASI) and Apple Operations Europe (AOE) amounted to illegal state aid. The Commission has ordered Ireland to recover this state aid from Apple.
The amount at stake dwarfs the amounts in the earlier state aid decisions on tax rulings. For example, Starbucks involved only €28m of state aid to be recovered by the Dutch government, whereas Ireland has been ordered to recoup €13bn from Apple. Put another way, the Apple recovery would be enough to fund the Irish government’s entire healthcare budget for a year.
2. Why does the Commission believe the transfer pricing ruling amounts to state aid?
State aid arises, broadly, when a business that is operating in a competitive market is given a selective benefit ‘out of state resources’.
In tax ruling cases involving international businesses, it is obvious that most of the state aid criteria are met: the ruling is issued by the state; it uses state resources (it is well established that foregoing potential tax revenues amounts to the use of state resources); and it has the potential to distort competition and affect trade between EU member states. The debate in these cases therefore turns on whether the measure grants a ‘selective advantage’; that is, an advantage which is not open to taxpayers in a comparable situation. The Commission considers that any transfer pricing ruling that does not result in a ‘reliable approximation of a market-based outcome’ confers a selective advantage.
The decision in Apple centres on two Irish incorporated ‘stateless’ companies, ASI and AOE. As the issues facing each company are broadly identical, and far more is at stake in ASI’s case (€13bn compared to €50m for AOE), this explanation focuses on ASI.
ASI was incorporated in Ireland but managed in the United States, so that it was resident neither in Ireland nor the US (or anywhere else, for that matter). ASI carried on two different functions:
It owned Apple’s iPhone and iPad IP outside the Americas, under a cost sharing agreement with Apple Inc. in the US. ASI appeared to be a passive owner of this IP, and did not have any employees (in Ireland or elsewhere) engaged in developing or managing the IP.
Through a branch in Ireland, ASI purchased Apple products from equipment manufacturers and sold Apple products to end users across Europe. Therefore, all sales in Europe were recorded in Ireland, rather than in the outlets that physically delivered the products. ASI had a large workforce in Ireland supporting this activity.
As the company selling iPhones and iPads across Europe, ASI generated significant revenues and profits. The Commission reported that, in 2011, ASI had revenues of €47bn and profits of €22bn.
The Irish Revenue agreed a basis for attributing profits to the Irish branch of ASI, under which the Irish branch was rewarded on the basis of its operating costs plus a margin. This meant that, in 2011, the taxable profits attributed to ASI’s Irish branch were €50m. The remaining profits were attributed to the Apple IP, to which ASI’s Irish branch had no claim. As the IP profits were allocated to the head office of a ‘stateless’ company, they were not subject to any immediate taxation. Under US tax law, those profits would eventually be taxed in the US (at 35%); however, that charge is deferred until the profits are remitted to the US.
The Commission held that this allocation had ‘no factual or economic justification’. As all of ASI’s employees were based in the Irish branch, the Commission concluded that only the Irish branch, and not the stateless head office, had the capacity to generate any trading income. Accordingly, it considered that ASI’s profits should have been allocated almost entirely to the Irish branch.
The Apple press release does not explain the reasoning in detail (for that, we will have to wait for the formal decision). However, it is clear that the thinking is consistent with the recent Fiat and Starbucks decisions, which also focused on the lack of apparent economic rationale for the intra-group pricing.
3. Is the Irish government laughing all the way to the bank?
No. Tempting though it may be to accept a €13bn windfall, the Irish government recognises that Ireland’s attractiveness to foreign investors is based on a predictable tax system – and that to pocket the windfall would, to quote the Irish finance minister, ‘be like eating the seed potatoes’. Ireland has confirmed that it will appeal.
4. How has the US government reacted?
The US government has made no secret of its opposition to the state aid investigations into tax rulings. Indeed, six days before the Apple decision, the US Treasury published a lengthy paper criticising these decisions. It argued that the Commission’s approach departs from earlier EU case law, imposes retroactive tax and ‘undermines the international tax system’.
5. What happens now?
The Commission decision requires Ireland to recover state aid granted to Apple from 2003 to 2014. This reflects the limitation period for state aid recovery, which looks back ten years from the Commission’s first enquiries into these rulings. Changes to Apple’s business structure in 2015 mean that the tax rulings were no longer relevant after 2014.
Calculation of the exact amount of recovery is normally a matter for the member state, although the Commission decision sets out the methodology that should be used. Unusually, the Commission press release also notes that the level of recovery in Apple reflects the decision to record all sales in Ireland, rather than where the products were sold. If other countries can establish that Apple profits should have been recognised and taxed in their jurisdictions, however, that would correspondingly reduce the appropriate taxable profits in Ireland and thus the amount of state aid recoverable by Ireland.
However, the Commission decision is subject to appeal to the EU General Court either by Ireland or by Apple. Given the significance of this case, a further appeal to the CJEU seems almost inevitable. Ireland and Apple have already indicated their intention to appeal. Bringing an appeal does not automatically suspend the obligation on Ireland to recover the aid, although the funds may be held in escrow until the appeals are resolved (which will take several years).
6. Does the decision ‘undermine the international tax system’ and ‘strike a devastating blow to the principle of certainty in law’?
Given the earlier Starbucks and Fiat decisions, it is not surprising that the Commission has also found against Apple. However, the three decisions certainly mark a more assertive approach by the Commission in policing transfer pricing rulings. The one CJEU case which the Commission cites in support of its approach, Belgium and Forum 187 v Commission Case C-182/03 and Case C-217/03, was a much more extreme case involving a regime which all but ignored the arm’s length standard.
Apple did break new ground in two ways. First, the Commission decided that all of the profits from ASI’s sales should be taxed in Ireland. It is obvious that a significant part of ASI’s profitability was attributable to Apple’s IP, which was not owned by ASI’s Irish branch. (Under the OECD approach to attributing profits to a permanent establishment, ASI’s Irish branch and the ASI head office are treated as separate entities.) The effect of the decision, however, is that ASI’s Irish branch should be treated as having a free right to use that IP. That looks difficult to reconcile with the arm’s length standard, as Apple would plainly not have provided its IP to a third party without charge (see DSG Retail v HMRC [2009] UKFTT 31 (TC)).
Secondly, the Commission’s suggestion that the amount of state aid could be reduced if other countries successfully tax Apple’s sales profits also seems troubling. If, at arm’s length, the sales profits belong in ASI’s Irish branch, why should any other country be entitled to tax those profits? And if, at arm’s length, the profits do not belong in ASI’s Irish branch, why does Ireland’s refusal to tax the profits amount to state aid?
It remains to be seen whether the European courts uphold the Commission’s attempt to play a greater role in tax cases. Notably, the most recent pronouncements on state aid and tax from the General Court (in Santander (Case T-399/11) and Autogrill (Case T-219/10)) and the Advocate General (in Finanzamt Linz (Case C-66/14)) supported a narrower view of the Commission’s power to intervene in tax cases. The Commission has appealed Santander and Autogrill to the CJEU; that judgment should be a clear pointer to whether the Commission’s transfer pricing decisions will be upheld.
7. Does this mean tax rulings aren’t worth the paper they’re written on?
No. The Commission has emphasised that it is not attacking tax rulings as a whole, which it recognises can be a legitimate means of giving businesses certainty as to their legal position. State aid issues only arise in relation to tax rulings where they go beyond simply confirming the application of existing tax rules, and instead involve some form of derogation that would not otherwise be available under the general law.
8. Is the European Commission now the final court of appeal on transfer pricing questions?
Good question. The current line of cases (Fiat, Starbucks and Apple) has focused on arrangements that – in the Commission’s eyes – depart significantly from arm’s length pricing. The recent working paper on state aid and tax rulings published by the Directorate General for Competition emphasises that the focus is on cases where there has been a ‘manifest breach’ of the arm’s length principle. Having said that, we are not aware of any recent cases in which the Commission has accepted that a transfer pricing ruling is within a state’s ‘margin of appreciation’ – and some of the reasoning in Fiat and Starbucks implies that any departure from the Commission’s view of the arm’s length standard amounts to state aid.
9. Does this mean every ‘double Irish’ structure involves illegal state aid?
No. Unlike Apple, most double Irish structures put IP and sales activities into different entities, rather than a ‘head office’ and branch of the same entity. This may make it tougher to argue that profits attributable to a group’s IP should be taxed in the Irish sales company. Furthermore, businesses which produced transfer pricing reports supporting their profit allocation to Ireland should find it easier to demonstrate that they have transacted on arm’s length terms. Of course, the clock is already ticking on these structures: they will cease to work in 2020; and, for sales in the UK, the new royalty withholding tax already undermines the benefit of many such structures.
10. How should other businesses react to this decision?
For the reasons above, the recent Commission investigations do not indicate a systemic issue with tax rulings across the EU – and Apple itself does not significantly change the picture after the Starbucks and Fiat decisions. However, a business that relies on high value transfer pricing rulings (or that is buying a business which does so) may wish to review those rulings and assess the merits of the existing transfer pricing analysis. This is particularly the case for rulings that originate from one of the jurisdictions that has been challenged by the Commission.
The key issue in the Apple decision is that the European Commission considered there to be a lack of ‘economic or factual justification’ for the arrangements, the effect of which was that the vast majority of the profits of Apple’s Irish subsidiaries were not subject to tax in Ireland. The decision should be seen as continuing the line of cases, including Starbucks and Fiat, through which the Commission has challenged intra-group pricing adopted by multinational companies, where this produces results that do not (in the Commission’s eyes) appear to reflect the economic reality of the situation.
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