Apple and state aid rules: a tax bill of €13 billion

Written on 29 Sep 2016

The tax practices and deals of the giant hi-tech manufacturer Apple have
come under fire, resulting in one of the most spectacular EU decisions of the
last few years. The present article provides a comment to the Commission
decision and a brief explanation of the structure of the Apple group which would
have allowed such staggering tax savings.

The European
Commission thus announced, on the 30th August 2016, that Ireland granted undue
tax benefits to Apple, amounting to state aid prohibited under EU law. Ireland
should, therefore, recover the resulting unpaid taxes from Apple to the tune of
€ 13 billion, plus interest. This amount covers the period 2003 until 2014 and
represents more than 40 times the amounts which the Netherlands should claim
back from Starbucks or Luxembourg from FIAT as a result of similar Commission
decisions on state aid.

At the time of
writing, the formal Commission decision on Apple had not yet been published
and, therefore, the complete reasoning of the Commission is not available. However,
the Commission does make a few statements, in its press release, which are
undoubtedly important. First and foremost, the Commission makes clear that its
decision does not call into question the Irish taxation system and, more
specifically, its 12.5% rate. Additionally, the Commission acknowledges that
the particular structure to which Apple has resorted (called a “double
Irish” structure and which will be explained further below) is outside the
remit of EU state aid control. What the Commission considers is that the
rulings issued by the Irish tax authorities endorsed a way to establish taxable
profits which was not consistent with the economic reality of the group. As
such, the rulings were allegedly tailored to suit Apple as a result of negotiations
between the tech group and Ireland. Given that such arrangement would not be
available to other undertakings operating in Ireland, the rulings should be
considered as amounting to illegal state aid. In this respect, the statements
of Commissioner Vestager are clear: state aid rules are designed to guarantee
that companies compete on equal terms and this also applies to taxation in each
Member State.

Before explaining the
facts of the Apple case and the structure which has raised the concerns of the
EU Commission, a few more figures should be given to put the amount claimed
back by the Commission ruling into context. The European Commission press
release makes clear that Apple’s effective corporate tax rate declined from 1%
in 2003 to 0,005% in 2014 on the profits derived from the sale of Apple
products outside of the American continent. Effectively and according to the EU
Commission numbers, only € 50 of tax would have been collected in Ireland each
€ 1,000,000 in profits in 2014. It has also been reported that the Commission
“tax bill” should not stretch Apple’s financial position, since the
Group would allegedly be holding currently $ 230 billion outside of the US.
Apple, in a surprising volteface, has since announced that it is considering repatriating
at least some of its “cash reserves” to the US and pay tax on them.

The “double
Irish” structure at the heart of the controversy is specially designed for
US groups with a view to preventing the application of stringent US
anti-deferral and CFC rules which, very broadly, would bring income earned from
sales abroad within the US tax net. At a very basic level, the
“double-Irish” structure allows the shifting of income from an Irish
operating subsidiary (OpCo) to an Irish-incorporated holding company (HoldCo).
In a “typical” “double-Irish”, HoldCo would be managed from
a low tax jurisdiction and, therefore, would not be considered resident for
Irish tax purposes.

From a U.S. tax
perspective, the picture is very different: OpCo makes a check the box election
and is disregarded for tax purposes. The US does not question the Irish
residency of HoldCo and disregards OpCo and all the transactions between HoldCo
and OpCo. These transactions are indeed important since they impact directly on
the Irish the tax base.

HoldCo holds title
over important IP embedded in the products sold by OpCo and licences such IP to
OpCo for a fee. Ireland lacking solid transfer pricing rules, the fee charged
by HoldCo can be of such an amount as to leave in OpCo a narrow profit margin.
These are the profits on which tax will be borne in Ireland, whereas the
profits derived by HoldCo would be outside the Irish tax net. The tax treatment
of such structure is further supported through a ruling issued by the Irish tax
authorities, whereby tax authorities confirm that the amount of the fee paid by
OpCo to HoldCo would not be challenged. Such rulings are at the heart of the
controversy between Apple and the EU, since the Commission considers that these
arrangements would not reflect the economic reality of the group.

It is worth noting
that the Apple structure presents some features of its own, which make it
different from a typical “double-Irish”. For instance, the Commission
mentions a head office of the corresponding Apple OpCo, so perhaps the taxable
base at OpCo level was (further?) eroded by transactions between an Irish
permanent establishment and a head office in a low-tax jurisdiction.
Additionally, it seems that the corresponding Apple HoldCo was considered a US
resident for Irish tax purposes and Irish resident for US tax purposes. At any
rate and as previously stated, the Commission does make clear that the
structure itself is “outside the remit of EU state aid control”.

The position adopted by the Commission is of course not news: the Commission has repeatedly stated that it is committed to pursue undue tax rulings on the basis of state aid rules. The Commission has thus decided that advance pricing arrangements in place between Starbucks and the Netherlands, on the one hand, and between Fiat and Luxembourg, on the other hand, amount to illegal state aid. Both decisions are currently on appeal before the European court of Justice. Additionally, the Commission is currently investigating and still has to rule on the practices of Amazon and McDonald’s in Luxembourg. An announcement has also been made whereby the practices of GDF Suez in Luxembourg would be reviewed to determine whether they contravene state aid provisions. The importance of these cases cannot be downplayed and their outcome will not only require multinational groups to change their tax structures, but also undoubtedly shape the future of the commercial relations between the US and the EU.