Apple's Irish tax bill has broad implications
Ireland ordered to recover $14 billion in past tax benefits
TAX ALERT |
The European Commission (EC) recently announced that Apple Inc. would be required to pay back Ireland an estimated $14 billion, plus interest, in tax benefits that Ireland had agreed were available to Apple but the EC now considers illegal. Both Apple and Ireland have stated that they will appeal. The EC’s ruling has resulted in significant media coverage because $14 billion is a large number, Apple is a large company, and there has been an increased public focus on perceived corporate tax evaders. However, getting beyond the sheer size of Apple and $14 billion, the EC ruling raises several more nuanced issues that may have a much broader impact on the generally accepted principles of international taxation.
Overview of the EC ruling
The EC, the executive body of the European Union (EU), formally launched its investigation into preferential tax rulings in 2014 under the theory that certain tax agreements between Member States and certain businesses constituted illegal state aid. Under EU law, Member States are prohibited from offering certain financial incentives that distort competition and trade between Member States by favoring certain activities or businesses over others. After several years of investigations—initial requests for information issued in 2013—the EC has identified over 1,000 tax rulings granted by several EU Member States that are receiving additional scrutiny. Before the Apple ruling, other findings of illegal state aid involved Starbucks, Fiat and others. However, these prior rulings only amounted to about $30 million in back taxes due for each company.
In the Apple ruling, the EC concluded that Ireland granted Apple undue tax benefits, which allowed Apple to pay substantially less tax than other businesses, therefore, Ireland must recover the illegal aid. Specifically, the EC ruling found that Apple and Ireland entered into an agreement as to how profits from Apple’s international operations would be allocated and therefore taxed in Ireland. Apple’s European operations are generally structured such that Apple Sales International, an Irish entity, owns the rights to exploit the intellectual property of Apple Inc., the U.S. parent, throughout the EU. Apple’s sales in the EU are structured in a way that customers buy Apple products directly from Apple Sales International; the local country stores simply operate as marketing displays for the Irish entity’s products. Ireland, like most other foreign countries, operates under a territorial tax regime and only imposes tax on revenues allocated to Ireland. The agreement between Ireland and Apple Sales International simply clarified that non-Irish sales, in accordance with Irish law, would not be subject to Irish tax.
According to the EC ruling, non-Irish profits were, for accounting purposes, allocated to a ‘head office’ within Apple Sales International. The EC ruling focused on how the head office, which was simply an accounting entry, had no employees and no separate office. The head office was called an “artificial internal allocation of profits ... which has no factual or economic justification.” It was Apple’s position that all non-Irish sales were not subject to Irish tax because they generated foreign (or non-Irish) income, which under Irish law was not taxable. Apple also took the position that such sales were not subject to tax anywhere else. Because the ‘head office’ of Apple Sales International lacked operating capacity to handle and manage its distribution business, the EC ruling found that all EU sales revenue should be considered Irish sales of Apple Sales International’s Irish branch and subject to Irish tax as if the local Irish Apple store processed all EU sales. The EC ruling did not address whether Apple’s Irish branch had the actual capacity or ability to process all EU sales but rather assumed that it must because there were no other Apple employees in Ireland that could have.
The $14 billion of illegal state aid represents the tax that would be owed by Apple to Ireland if all EU sales from 2003 through 2014 were subject to Irish tax. EU law limits state aid recovery to the 10-year period preceding the first information request, which dates back to 2013. Apple changed its structure in Ireland as of 2015 and the Irish tax ruling no longer applied. The EC ruling did not call into question Ireland’s general tax system, corporate tax rate, or Apple’s tax structure in Europe.
Broad implications of the EC ruling
While Apple and Ireland have both stated that they will appeal the EC ruling, the actions of the EC have triggered a standoff between United States and EU tax authorities and threatened the stability of globally accepted international tax policies. Over the past several years, the U.S. Treasury and Congress have repeatedly attacked U.S.-based multinational entities for their supposedly abusive international tax structures. However, in anticipation of the EC ruling, the Treasury released a whitepaper addressing the EU state aid investigations that, in a way, comes to Apple’s defense. In the report the Treasury said that state aid investigations could reduce U.S. tax revenue, increase barriers to cross-border investment, and undermine the progress of multilateral projects such as base erosion and profit shifting (BEPS). Members of Congress, from both sides of the aisle, were quick to denounce the EC ruling, calling it predatory and accusing the EU of targeting U.S. companies. The underlying message from the United States to the EU: do not mess with Apple because Apple’s profits are ours to tax.
The EC recognizes that the $14 billion may not all go to Ireland. The EC ruling states that other EU Member States, and even the United States, may have a claim to some of the back taxes Apple owes. However, the EC ruling fails to consider if Ireland, or any country for that matter, could even collect the back taxes. Most countries have a statute of limitations on income tax assessments that only goes back a few years. Generally, that period is extended in cases involving fraud, but the EC ruling does not allege fraud. Calling the amount Apple owes ‘state aid’ as opposed to ‘tax’ should not require Ireland to set aside its laws in order to collect a 13-year old underpayment of tax.
Furthermore, the tax agreement between Ireland and Apple is actually a nonbinding opinion that merely interprets and applies Irish law to Apple. In theory, without the tax ruling, Apple would have owed the same amount of tax. The EC ruling acknowledges that tax rulings are perfectly legal and calls them “comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated.” Arguably, the tax ruling simply codified a tax result that would otherwise result under Irish law, and if so, then Apple should not be liable for additional taxes because the tax ruling did not give Apple any advantage that did not also extend to other similarly situated taxpayers.
What the EC ruling is really attacking is not the tax agreement itself but rather the established principles of transfer pricing that underpin the income allocations of the tax ruling. Generally speaking, transfer pricing is how multinational companies allocate profits between their controlled subsidiaries. Undermining established principles of transfer pricing would be detrimental to the progress being made by the Organisation for Economic Co-operation and Development and the BEPS initiative. BEPS is a coordinated international effort to develop better coherence among, and more rigorous standards in, taxing regimes along with heightened transparency into the operating results and taxes paid by multinational companies. To this end, BEPS supports what is called the arm’s-length standard under which pricing between related parties must be similar to pricing between unrelated parties. By disregarding the contractual allocations of functions and risks across Apple’s EU operations and assigning all revenue to Apple’s Irish branch, the EC ruling may undermine the progress of BEPS and the traditional arm’s-length standard.
Apple and Ireland will evaluate their options for appealing the EC ruling. However, a final outcome may not come for some time. In the meantime, the EC may continue to issue rulings as a part of their ongoing state aid investigations. The United States and other countries are undoubtedly reviewing their options for what may turn into a large tax base ‘land grab.’ Unfortunately for businesses, the international tax landscape has become even more uncertain than before.