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Treasury & Taxation

EC Apple Ruling Could Foil Other Tax Efforts

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October 11, 2016

EC’s move against Apple may damage tax reform efforts like BEPS.

EU FlagThe European Commission’s ruling in late August requiring Apple Inc. to pay $14.5 billion in back taxes plus interest may ultimately erode broader efforts to require multinational corporations (MNCs) to pay taxes where they generate economic activity. In the meantime, MNCs may still want to reconsider aggressive tax strategies.

The EC’s August 30 decision, which prompted sharp criticism in the US, followed the publication six days earlier of a white paper by the US Treasury that specifically criticized the European governmental body’s state aid investigations, initiated in 2014. The European Union’s (EU) state aid rules were first implemented in the late 1950s and prohibit giving unfair tax benefits to selected companies. ,

In the case of Apple, the company split record profits from sales outside the US between the Irish branch and the “head office,” which existed only on paper and had no employees or premises. Margrethe Vestager, EC Commissioner for Competition, noted in a statement issued August 30 that the Irish branch was subject to the normal Irish corporation tax while the head office avoided Irish and other taxes altogether, under an Irish tax law that allowed for “stateless companies.”

The vast majority of profits were attributed to the head office, so as a result Apple’s effective tax rate in 2011 was 0.05%, and it dropped further in 2014 to 0.005%. “Our decision concludes that splitting the profits did not have any factual or economic justification,” she said.

Critics of the EC’s decision contend that it was a “novel” interpretation, arguing that state aid rules had never been interpreted in such a fashion over their nearly 60 years of existence.

“This is non-tax officials at the EU second guessing a tax ruling by a member country, and they seem to be coming up with a new interpretation of the transfer pricing rule and the arms length principle that everybody had agreed on previously,” said David Ernick principal in the transfer pricing practice of PricewaterhouseCoopers. “No one really knows what the EU’s interpretation of transfer pricing is at this point, due to this ruling.”

The US Department of the Treasury expressed a similar sentiments in a white paper published a week before the EC’s decision, titled “The European Commission’s Recent State Aid Investigations of Transfer Pricing Rulings.” In addition to expressing concern about the decision’s departure form prior European Union case law and commission decisions, the paper said the EC should not seek retroactive recoveries under its new approach, and that the new approach is inconsistent with international norms and undermines the international tax system. Furthermore, imposing retroactive recoveries would undermine the G20’s efforts to improve tax certainty and set an undesirable precedent for tax authorities in other countries.

The paper also says the OECD transfer pricing guidelines are used widely by tax authorities to ensure consistent application of the arm’s length principal that governs transfer-pricing determinations. However, instead of sticking to the OECD transfer pricing guidelines, the EU is employing a different arm’s length principle derived from EU treaty law. Consequently, the paper argues, “The [EC’s] actions undermine the international consensus on transfer pricing standards, call into question the ability of Member States to honor their bilateral tax treaties, and undermine the progress made under the OECD/G20 Base Erosion and Profit Shifting (BEPS) project.”

Mr. Ernick said that the EC has loosely coordinated BEPS with its own anti-tax-avoidance initiative, taking the shape of an anti-tax-avoidance package approved in June in which four of its six parts implement BEPS recommendations. Using the state aid rules against Apple, however, may ultimately harm both initiatives.

“This is really a unilateral action by EU, essentially saying that all that work [constituents] agreed to as part of the BEPS project within the OECD is going to be disregarded, and the EU will go its own way,” Mr. Ernick said, “so they may really ending up undermining support for the BEPS recommendations.”

Mr. Ernick pointed to other instances where jurisdictions have chosen to act on their own, regardless of OECD recommendations. The UK, for example, introduced the diverted-profits tax that essentially ignores OECD rules and the tax treaty standards determining when a company has a permanent establishment, whose income should be taxed.

Ironically, BEPS may be harmed by just the type of tax-avoidance scheme it is meant to discourage. “Apple’s tax planning was extremely aggressive, resulting in most of its overseas profit being stateless, meaning taxed by no one,” said Pascal Sant-Amans, director, Center for Tax policy and Administration at the OECD. “It is because of these types of schemes and practices that the OECD, with the support of the G20, launched the BEPS project in 2013.

Mr. Saint-Amans went on to note that the debate on tax avoidance pushed by the BEPS initiative already prompted Ireland to dismantle laws that facilitated the “stateless” structure that was a core element of the Apple arrangement.

Rebutting the Treasury white paper’s claims about the novelty of the EC decision, an EC spokesperson said that EU state aid rules and the relevant legal principles have been in place for several decades.
“It is a well-established principle in EU case law that member states cannot give any selective advantages, fiscal or otherwise, to certain companies that are not available to other companies,” the spokesperson said.

He added that to determine a company’s taxable profits, those profits must be allocated between companies in a corporate group, and between different parts of the same company, in a way that reflects economic reality. This means, he said, that the allocation should be in line with arrangements that take place under commercial conditions between independent businesses—the so-called arm’s length principle.

“Already in 1998 the [EC] indicated in a communication that it would look into tax rulings if they conferred a selective advantage to certain companies. Moreover, a couple of years later the EC clarified that companies must apply the arm’s length principle when setting their tax bill,” he said. “This was made clear, for example, in the decision on the Belgian Coordination Centres regime in 2003 and confirmed by the EU courts.”

Both the Irish government and Apple plan to appeal the ruling, and there may be other actions. The US Treasury said in the white paper that it is considering potential responses, and talk has emerged about potential action by the World Trade Organization. US governmental and private-sector officials have exclaimed that the EC’s action appears aimed specifically at US corporations, and some have pointed to a long-time rule in the US taxed code that, while never used before, empowers the US president to double the tax rate on foreign corporations or individuals, in the event of discrimination against US companies.

An appeal by Apple reportedly won’t stay the need to cough up the $14.5 billion, which will be put into an escrow account until the appeal is resolved. A resolution, however, may be some time off. Mr. Ernick said it’s too soon for any party to take action.

“We’ll probably have a lot more insight into this with the next few years,” he said.

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