On 19 December 2016, the European Commission (Commission) published its final decision in the formal state aid investigation into two advance pricing agreements (APAs) obtained by Apple in Ireland in 1991 and 2007. According to the Commission these APAs amounted to unlawful state aid to be recovered from Apple. The press release dated 30 August 2016 announcing the decision left many questions concerning the Commission’s arguments for the decision. The now published non-confidential version of the final decision provides more insight on the Commission’s reasoning. Ireland already appealed the Commission’s decision and Apple has announced it will do so as well
The APAs issued by the Irish tax authorities confirmed that nearly all sales profits recorded by two Irish incorporated but non-Irish resident Apple group companies were attributable to head offices outside Ireland, rather than to their Irish trading branches. The Commission’s analysis is that the allocation of profit to the foreign head office of the two Apple group companies is in violation of the arm’s length principle and amounts to unlawful state aid. According to the Commission Ireland should have taxed a higher portion of the profits.
The Commission’s arguments can be summarized as follows:
- Firstly, the Commission argues Irish Revenue should have examined whether the allocation of Apple intellectual property licenses could be considered at arm’s length on the basis of a two-sided functional analysis. Given (i) the absence of employees at head office level and (ii) what the Commission perceives a lack of involvement of the companies’ boards in intellectual property matters, it considers that the head offices did not control or manage the relevant Apple intellectual property licenses. According to the Commission, the related trading income should be allocated to the branches in Ireland, rather than to the head offices.
- By a subsidiary line of reasoning, the Commission argues that, even if the allocation of intellectual property to the head offices were justified, the profit of the Irish branches departs from a reliable approximation of a market-based outcome in line with the arm’s length principle because the applied allocation methods are perceived not correct. First of all, the Commission challenges the choice for the branches as less complex party, given the limited capacity of the head offices to control risk as compared to the scope of the activities of the Irish branches. Secondly, the Commission considers that the choice of operating expense as profit level indicator instead of sales (for the one branch) or total costs (for the other branch) inappropriately lowered the annual taxable profits of the Irish branches. Thirdly, the Commission rejects the selection of comparables.
- Finally, the Commission observes that although Ireland argued that the relevant Irish tax rules do not require Irish Revenue to follow the guidance provided by the OECD framework when issuing tax rulings, the one-sided profit allocation methods actually endorsed by the contested APAs as well as in other Irish tax rulings appear to be based on and in line with the OECD Transfer Pricing Guidelines. Therefore the Commission submits that the arm’s length principle is inherent in the application of the relevant Irish tax rules and must, therefore, be followed by Irish Revenue.
In its decision the Commission sets out its methodology to calculate the value of the undue competitive advantage enjoyed by Apple. In particular, Ireland must allocate to the Irish branch of each company all profits from sales previously allocated to the head offices and apply the normal corporation tax in Ireland on these re-allocated profits. The amount of unpaid taxes to be recovered by the Irish authorities would be reduced if other countries were to require Apple to pay more taxes on the sales profits recorded by the two Irish companies or if the US were to require an increased contribution of the two companies to Apple’s R&D expenditure. Notably, the decision does not ask for the reallocation of any interest income of the two companies that can be associated with the head offices.
The decision, accessible here, confirms that the Commission remains determined to challenge potential state aid elements arguably embedded in tax rulings. The published decision does not contain many new arguments compared to previous similar state aid decisions that were published.
There is widespread criticism on the Commission’s novel approach, claiming that the Commission developed its “own” version of the arm’s length principle, which should not be the benchmark for state aid purposes. Ultimately, it will be the Court of Justice of the European Union that will decide on whether or not this approach is in line with the provisions of the Treaty on the Functioning of the European Union.
Three other formal state aid investigations into individual tax rulings are still ongoing involving Amazon (Luxembourg), McDonald’s (Luxembourg) and Engie (Luxembourg). More formal state aid investigations in relation to tax rulings are expected to follow.