Following on from the Fiat and Starbucks State Aid decisions on transfer pricing, discussed in our September Global Tax Insights magazine, Apple then hit the headlines when the European Commission decided that it too had benefitted from unlawful State Aid and should repay some €13bn to the Irish government. In this case, however, the state aid took the form of rulings endorsing profit allocation methods which the Commission considered did not reflect economic reality.
A new investigation has also been recently launched into GDF Suez (now ENGIE), the French energy company. The concern here was that certain rulings given by Luxembourg did not apply national tax law consistently and therefore gave rise to a discretionary double non-taxation.
Multinational enterprises with tax rulings granted by EU Member State tax authorities, whether relating to transfer pricing, profit allocation or otherwise, should review those tax rulings and consider whether any could be vulnerable to challenge.
Such MNEs (particularly those based in the US) should also consider whether the established existence of State Aid on facts similar to their own tax rulings requires disclosure in financial statements.
The Apple rulings
The offending tax rulings in this case were issued by the Irish tax authorities in favour of two Apple subsidiaries, which operated in Ireland through a branch until 2015.
In general terms, customers purchasing Apple products throughout Europe would contract with one of the Irish based companies, rather than the shop at which the purchase was physically made. Almost all of the profits from these sales were then internally attributed to a "head office". The head office was not based in any country, had no employees and did not own premises. Its activities consisted solely of occasional board meetings.
Although this resulted in the profits not being subject to tax in any country, the Irish rulings endorsed this approach with the outcome being a reported 0.005 per cent effective tax rate paid by Apple in 2014 (although it is unclear if these figures have been substantiated).
The Commission concluded that the allocation of profits was artificial and had no factual or economic justification and "enabled Apple to pay substantially less tax than other companies, which is illegal under State Aid rules".
The GDF Suez rulings
Rulings issued by Luxembourg are said to "selectively derogate" from provisions of national tax law in treating financial transactions between companies of GDF Suez in an inconsistent way, i.e. both as debt and as equity.
These transactions were zero interest convertible loans, under the terms of which, the borrower would record in its accounts a provision for interest payments, without actually paying any interest to the lender. The provisioned amounts represented a large proportion of the profit of each borrower and were deductible for tax purposes.
Instead of the lender receiving the taxable interest income, the loans were converted into company shares in the lender's favour. The shares incorporated the value of the provisioned interest payments and thereby generated a profit. However, this profit was not taxed because it was considered to be a dividend-like payment, associated with equity investments.
Comment
Details have not yet been released of the Apple decision, but it has already come in for heavy criticism.
Like the Fiat and Starbucks decisions, it is not the case that different rules were applied to Apple but that the Commission did not like the end result of the application of the rules. We noted in Global Tax Insight that even tax rulings which comply with OECD transfer pricing guidelines may not necessarily prevent the existence of unlawful State Aid, and it seems that profit allocation methods will be similarly up for debate.
Specifically, the two companies at issue in the Apple case operated in Ireland through an Irish branch, rather than being tax resident in Ireland. This means that only those profits attributable to their Irish branch were within the charge to Irish tax, whereas the result of the State Aid decision is that Ireland is obliged to tax these non-resident companies on their worldwide profits, to the extent not taxed elsewhere.
Whereas earlier State Aid fiscal decisions largely focused on deviations from the arm's-length principle in advance rulings, the recent investigations and opening decision, including that in McDonalds, indicated a significant widening in scope from the European Commission.
The Commission appears to be effectively ignoring the selectivity condition which is at the heart of the concept of State Aid, and instead imposing its own view of what is "good" or "bad" without reference to the national system as a benchmark and without any real consistency in determining what is a comparable operator in the same legal or factual situation by which to judge whether aid is selective.
Subject to more detail that may emerge from the full decision, the implications of the press release are that the Commission is using State Aid in its fight against tax avoidance by plugging the gap where profits fall between two or more taxing regimes.
However flawed these State Aid decisions appear conceptually, it seems likely that there will be further investigations to come.
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