Written by Cécile Remeur,
In late August 2016, the adoption by the European Commission of a state aid decision on Ireland’s tax rulings in favour of tax-resident companies related to Apple raised substantial debate, with regard to the multinational enterprise (MNE) concerned and the amount to be recovered.
Taxation and state aid relating to MNEs
Taxation of MNE in a global environment
With regard to MNEs’ taxes, corporate aggressive tax planning and tax avoidance have been in the spotlight. ‘Tax avoidance’ generally remains within the limits of the law, unless deemed illegal by the competent authorities or, ultimately, by the courts, in particular as an abuse of law; tax avoidance can be described as a risk-taking decision. In contrast, tax evasion and fraud are both illegal.
In short, corporate aggressive tax avoidance uses loopholes, asymmetries and mismatches of tax rules that allow MNEs to stay ‘One step ahead’. Such schemes are based on MNEs’ size and their structure which allows them to organise in such a way as to shift profits to low, or no-tax locations, resulting in a reduced tax bill (see EPRS briefing on ‘erosion of the tax base’.
In some cases, a tax ruling covers the underlying operations. A tax ruling is a statement provided by the competent tax authorities to a taxpayer, regarding the interpretation or application of tax laws before a specific transaction takes place. It provides the taxpayer with legal certainty. A specific type of advance tax ruling, the advance pricing agreement (APA), relates to ‘transfer prices’ between two related parties within a company. Such an agreement is based on information provided by the company, which they can expect the tax authority concerned to analyse in detail.
The top ten companies ranked by market capitalisation shows that among the biggest companies are information technology firms, and that among them seven were US companies in 2015, nine in 2014 and eight in 2013.
Key elements to state aid framework
The EU state aid regime is based on Treaty provisions (Articles 107-108 TFEU), and further detailed in secondary legislation. The Commission is tasked to ‘keep under constant review all systems of aid existing in those States’, to ‘propose to the Member States appropriate measures required’, and may ‘decide that the State concerned shall abolish or alter such aid’. The features of incompatible state aid are: 1. intervention by the state or through state resources (positive benefits, as subsidy but also a reduction of the tax burden which ‘mitigate(s) the charges’); 2. selective advantage granted over other undertakings; 3. competition has been or may be distorted; and 4. the intervention is likely to affect trade between Member States.
The Commission’s competence covers the area of direct business taxation, as the European Court of Justice stated as early as 1974, drawing a distinction between fiscal measures of a general nature that apply to all undertakings without distinction (in the fiscal autonomy of a Member State, and do not constitute state aid), and fiscal measures that discriminate between taxpayers likely to constitute a state aid.
Guidance is provided in the Commission notice on the notion of state aid covering tax rulings specifically, and there is background information in a working paper on ‘State aid and tax rulings’. As commentators have noted, though public attention of tax rulings and state aid is recent, ‘one cannot say that the EC’s recent use of state aid control to challenge EU member states’ application of tax rules is totally unprecedented’.
The Apple state aid decision
On 12 June 2013, the Commission requested Ireland to submit information on tax rulings in Ireland and in favour of companies related to Apple which are tax-resident in Ireland (but in practice covering sales throughout the entire Single Market). The investigation period covers tax rulings granted by Ireland in 1991 and 2007, but which ended in 2015 with a change of structure. The assessed measures relate to the pricing arrangements covered by the tax rulings between Apple companies located in Ireland, some of them tax resident and others non-tax resident. The Irish rules consider as tax resident companies managed and controlled in Ireland. When this is not the case, the Irish company is not tax-resident in Ireland because it is not managed and controlled in Ireland.
The structure investigated includes head offices in tax-resident company branches, the head offices being described in the Commission investigation as not based in any country, with no employees or own premises, their activities consisting solely of occasional board meetings. Only a fraction of their profits were allocated to tax-resident Irish branches, with the remaining vast majority of profits allocated to the non-tax-resident ‘head offices’. What is at stake (the contested measure) are the rulings on profit allocation to branches, and whether that allocation is in line with arrangements that take place under market conditions (between independent businesses) and the ‘arm’s length principle’.
The 30 August 2016 decision concluded that the ‘two tax rulings issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991’ by endorsing the attribution of almost all sales profits recorded by the tax-resident companies to non-tax-resident ‘head offices’, which could not in themselves have generated such profits. This resulted in taxable profits which did not correspond to economic reality, and a lower effective corporate tax rate. The decision orders the recovery of the unpaid taxes. However, other Member States could subsequently reassess the tax paid by Apple in their jurisdictions, in the light of the investigation.
Other state aid investigations in the tax field relating to transfer pricing
On 21 October 2015, the Commission adopted two decisions relating to advance pricing arrangements, concerning respectively: the ruling granted by the Netherlands to Starbucks (decision appealed by the Netherlands, case T-760/15) and the ruling granted by Luxembourg to Fiat (decision appealed by Luxembourg, case T-755/15, and Fiat, case T-759/15). The proceedings are still pending. Another ongoing investigation relating to advance pricing arrangements granted to Amazon by Luxembourg was initiated in October 2014.
The decision attracted reactions even before it was adopted. Some welcomed the decision and some reactions stressed among others the innovative feature, the fact that recovery of state aid is a politically sensitive issue. Finally some others some see it as a game-changer for multinational tax structuring. Some further elements may contribute to increased understanding of the context.
Corporate tax avoidance schemes covered by state aid rules because of their acceptance in tax rulings
The problem is not rulings in themselves, but the fact that they may accept a taxation methodology which provides a selective advantage resulting from corporate tax avoidance. The assessment of the latter to ascertain if it is legal or not results from a factual case-by-case analysis to assess if it may be abusive. A question is whether state aid and tax analysis are identical or similar, especially when it comes to transfer-pricing analysis and the application of the arm’s length principle, which is the basis for the OECD transfer-pricing guidelines, revised by relevant BEPS final reports, which are themselves soft law instruments.
Ambiguity in the ‘nationality’ of a MNE
The term MNE is not a legal concept; it refers to an economic entity spanning different countries and legal systems where different legal entities (subsidiaries, branches, etc.) connected to the multinational corporation operate. There is a parent company incorporated in a specific country, but the MNE is made up of entities taxed in different countries creating intra-group operations. The MNE does not share the ‘nationality’ (tax jurisdiction) of its parent company. When considering profits generated in another country, national and international tax rules apply. Taxation of non-repatriated profits which can be used as a method of corporate tax avoidance by MNEs is a matter for the country providing the option not to repatriate those profits; it is distinct from the taxation of the parent company’s branches (i.e. resulting from a decision on the tax bases which does not involve profits directed to the parent company, and consequently does not raise double taxation questions or reduction of the tax paid through a tax credit).