European Commission decision on Apple state aid raises broader concerns for multinationals

The European Commission’s recent decision on Apple Inc.’s Irish tax benefits raises concerns for U.S. multinationals with similar rulings about the European Commission’s effort to extend its authority to dictate the sovereign tax matters of its member states.

On Aug. 30, 2016, the European Commission, the executive body of the European Union (EU), concluded that Ireland must recover up to €13 billion (approximately $14.5 billion) excluding interest in tax benefits provided to Apple. The commission found that Ireland granted illegal tax benefits to Apple, which enabled the company to pay substantially less tax than other businesses over many years. Selective tax treatment that provides a company with advantages over other businesses that are subject to the same national tax laws and regulations is illegal under EU state aid rules.

At the center of the investigation are tax rulings granted by Ireland in 1991 and 2007. The commission’s investigation found that as a result of the internal allocation method endorsed in the tax rulings, Apple paid an effective corporate tax rate that declined from 1% in 2003 to 0.005% in 2014 on its European profits.

The text of the full ruling has not yet been published. Therefore, additional details may be forthcoming. Prior to the decision, the Irish Department of Finance had asserted that “Ireland is confident that there is no state aid rule breach in this case and we will defend all aspects vigorously. Disagreeing with the commission’s findings, Michael Noonan, Irish finance minister, responded to the ruling saying he “disagrees profoundly with the Commission’s decision” and that “[t]he decision leaves [Noonan] with no choice but to seek Cabinet approval to appeal the decision before the European Courts.”

Background Apple Sales International and Apple Operations Europe are two Irish incorporated companies that are wholly owned by their U.S. parent, Apple Inc. The Irish entities were not tax residents in Ireland, and were subject to Irish tax only on certain branch activities. The profits of these two Irish entities were subject to the tax rulings granted by Ireland.

The rulings allowed Apple to operate in Europe through a structure that allocated certain profits to a “head office.” The commission found that this head office was not based in any country, did not have any employees or its own premises, and engaged in activities that consisted solely of occasional board meetings. The commission also found that only a small amount of the profits of the Irish-based entities were allocated to their respective Irish branch and subject to tax in Ireland. The remaining profits were allocated to the head office and were not subject to tax.

The commission stated that although tax rulings are legal, the Irish rulings in question endorsed an artificial internal allocation of profits, which had “no factual or economic justification.” As a result, the commission believes the tax rulings enabled Apple to pay substantially less tax than other similarly situated companies, which is illegal under EU state aid rules.

The U.S. response The ruling is the most significant in a series of EU state aid investigations that have occurred over the course of the past several years. This ruling is likely to add fuel to the ongoing dispute between the U.S. and the EU over taxation policies.

In a Feb. 11, 2016, letter to the president of the commission, U.S. Treasury Secretary Jacob Lew urged the commission to reconsider its approach. In the letter, Lew challenged the EU’s “sweeping interpretation” of the EU legal doctrine of state aid, and stated that the approach could “undermine the well-established basis of mutual cooperation and respect that many countries have worked so hard to develop and preserve.”

Treasury further expressed concerns regarding EU state aid investigations in a white paper released on Aug. 24, 2016.  In this document, Treasury said, “[T]hese [state aid] investigations, if continued, have considerable implications for the United States—for the U.S. government directly and for U.S. companies—in the form of potential lost tax revenue and increased barriers to cross-border investment. Critically, these investigations also undermine the multilateral progress made towards reducing tax avoidance.”

On Capitol Hill, tax writers from both parties have expressed their concerns about the investigations to Secretary Lew, warning that the investigations could result in retroactive taxation for U.S. multinationals.

International perspective from Grant Thornton Ireland In working out how much tax is owed, the commission examined the allocation of profits between the company’s “head office” and its “Irish branch.” Ireland had limited transfer pricing legislation in place in the years relevant to this state aid case. While such state aid rules apply across the EU, countries retain their sovereign right in terms of setting domestic tax legislation. Thus, the amount of tax owed should be calculated under equivalent Irish tax measures that existed at that time. The commission’s conclusions in this regard will be examined closely.

Given the nature of the commission’s ruling, it is difficult to see Ireland having any option other than to defend its position. The outcome will likely result in an appeal by Ireland, ultimately to the European Court of Justice. In the meantime, it appears Ireland will be obliged to collect a significant amount of tax from Apple, with the suggestion that the money is managed by Ireland’s National Asset Management Agency in an escrow account.

It is worth noting that the commission’s focus in the Apple case was on a legacy tax structure, one of several that have since been amended in Irish tax legislation, primarily as a result of the Organisation for Economic Co-operation and Development’s base erosion and profit shifting project, but also as part of Ireland’s desire to retain a transparent tax regime. Therefore, the impact of this ruling on future investments in Ireland may be limited. For additional perspective from Grant Thornton Ireland, please see this release by Grant Thornton Ireland.

Next steps The commission’s ruling creates further uncertainty for U.S. multinationals with tax rulings in place in the EU and raises the question whether companies can rely on such rulings given that the commission may challenge the legitimacy of a ruling.

The impact of state aid cases are retroactive and could impact U.S. taxable income by directly or indirectly affecting foreign tax credits, earnings and profits, and other U.S. federal income tax items such as allocations that rely on foreign attributes. Accordingly, U.S. multinational’s with tax rulings and similar arrangements should carefully monitor the developments in this case and other similar rulings. When a tax ruling or similar arrangement is the subject of investigation, a U.S. multinational with a comparable ruling should carefully review such an arrangement and evaluate any risk associated with the commission’s findings.

CONTACT David Sites
Washington National Tax Office
+1 202 861 4104

Cory Perry
Washington National Tax Office
+1 202 521 1509

Peter Vale
Grant Thornton Ireland, Dublin
+353 (0)1 6805 952

Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.

Grant Thornton Ireland, a member firm of Grant Thornton International Ltd, provided the international perspective above. Grant Thornton Ireland is an independent member firm, and its views do not necessarily represent those of Grant Thornton LLP.