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Why and How the European Commission Picked the Apple

Why and How the European Commission Picked the Apple

Everybody’s Doing It!

It’s been over a month since the bombshell dropped and many are still in the dark of why and how the European Commission (‘EC’) has imposed a €13 billion-tax bill on the US’s most dominant corporation in terms of profits earned offshore (reported at $187bn in 2015 by the Financial Times).

As befits their name, multinational corporations are spread around the world. This expansion across borders summons establishing a family of entities comprised of mother and sister companies, which of course ultimately act in harmony to promote the group entity’s overall interests. Due also to the commercial-nomad nature of these interlinked entities that operate in various jurisdictions, they must respond to different tax laws all over the globe. These often vary in friendliness, with some applying low-to-no corporate tax rates, whilst others apply a significant levy.

With this knowledge, multinationals do their best to avoid being exposed to high tax impositions – if any. They do so by adopting corporate structures that allow them to shift taxable profits from one entity to another, one that is settled in a more tax-friendly jurisdiction (i.e. a ‘tax haven’). It is worth bearing in mind that this is in no way prohibited around the world as indeed, transferring and repatriating funds is an essential attribute of today’s globalised world.

For years now, corporations around the world have been capitalising on this permissive attitude towards profit shifting. Apple, however, is a prominent and perhaps pioneering example of performing intra-group transactions that facilitate shifting profits from one place to another. It does so by attributing all of its EU profits to its Irish subsidiaries. So whether it be London’s Covent Garden store or the Puerta Del Sol branch in Madrid, those costly iPhone 7 instalments are all headed to one destination: the Irish town of Cork. This relieves them of the onerous UK and Spanish corporate tax duties (20% and 35% respectively).

Some might consider such practice to defy the theoretical principle that an entity should pay tax where it profits. However, moving earnings from a jurisdiction to another with more favourable tax conditions has never been deemed illegal for various reasons with the main one being that this act does not constitute tax evasion, but rather avoidance. Furthermore, and fortunate for multinationals, tax avoidance is not criminalised by the modern day legislatures around the world – yet.

So Why Apple?

But what exactly separates Apple from the rest of the corporate pack when it comes to tax manoeuvring? Why did their actions lead to the EC placing it under its radar? Perhaps audacity.

Unlike other multinationals that shift profits from one entity to another, Apple transferred its EU earnings from its Irish branch (Apple Sales International)- to that exact same branch’s headquarters which is located offshore of Ireland (probably in a no-tax jurisdiction such as the Bahamas or Cayman Islands).

So in contrast to other corporations, Apple was not transferring those funds to a separate offshore entity- shunning away the logic that the transferor and the transferee should be two different persons. By virtue of this transfer, it was able to avoid paying the 12.5% Irish corporate tax such that it has been reported to only pay an annual 1% and less for the period spanning between 2003 and 2014.

The Irish tax authorities were not only content with those payments, but they even ratified them through issuing tax decisions that allowed Apple to shift its profits from a branch to an undetermined head office (i.e. from Apple Sales International to Apple Sales International).

So it can be said that, despite so many multinationals shifting profits from one company to another located in an offshore tax haven, it is Apple’s audacity embodied in internally shifting those profits that placed it under the EC’s radar.

How the EC Managed to Intervene

But what exactly were the legal grounds for intervening? It’s not as if the EC is in charge of imposing tax levies across the EU as this is usually left to each individual state, under their own domestic law.

Although perfectly legal and usually issued to give clarity as to how a certain company will be taxed; the Irish tax rulings (1991 and 2007) were held by the EC to acknowledge an imaginary head office that was receiving all of Apple’s EU profits from its Irish branch. This facilitated Apple’s avoiding the 12.5% Irish corporate tax rate. And due to the very fact that no other multinational corporations enjoyed the privilege of internally allocating their earnings in the manner that Apple did by virtue of those tax rulings, the EC saw a window to end Apple’s tax avoidance.

They did this by invoking the State Aid rules provided in Article 107 of the Consolidated Version of the Treaty on the Functioning of the European Union (TFEU), which prohibits:

“…any aid granted by a Member State or through State resources in any form whatsoever which  distorts or threatens to distort competition by favouring certain undertakings…”.

The EC stated, in its 30th of August press release, that both the 1991 and 2007 decisions granted Apple an unfair advantage by acknowledging its right to internally allocate profits, which it considers to have “no factual or economic justification”. So it was not the fact that Apple was shifting profits that made the EC intervene but that, with Ireland’s consent, it was shifting them to the same company’s mysterious headquarters, which had no employees or premises. This was ultimately construed to provide an unfair competitive advantage, an advantage that saved Apple billions.

And therefore, Ireland’s approval was considered to amount to State Aid, which allows the EC to exercise its powers provided via Article 108(2) of the TFEU. Henceforth this allowed the EC to decide on the illegality of such State Aid and to order Ireland to abolish it, which is what led to the EC’s request that Ireland collect from Apple an estimated €13 billion that would have been paid if the tax rulings hadn’t allowed otherwise.

Aftermath

Ireland stated its intent of challenging the EC’s decision through the EU courts. This is motivated by wanting to please Apple, a company that employs several thousands of its citizens and of course the latter’s CEO has stated his plans of overturning the decision for obvious reasons. However, the legal outcome of such a challenge is unclear, as the pendulum could swing either way. Political considerations will certainly surface, particularly as the US has already voiced its condemnation of this decision that ultimately takes away a significant portion of Apple’s income, income which could also be taxable in the US.

The Apple experience should serve as a lesson for multinationals that were thinking of getting cosy with local tax authorities, as any tax rulings deemed too ‘favourable’, could fall within the claws of the State Aid watchdog that is the EC.

Additionally, the EC’s dogged approach to tackling tax avoidance through its State Aid powers should be applauded as, despite the lack of tax rules preventing avoidance – an issue constantly pushed for by the OECD – the EC managed to pull a rabbit out of its hat in a viable attempt to ensure that the EU gets its fair share of tax.

 

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