Upsetting the applecart

The Apple story rumbles on meaning that almost anyone saying the X multiplied by .125 equals Y can make front-page news (provided Y is a big number of course).  In very rough terms there are three possible outcomes to the investigation:

  1. No adverse finding is made,
  2. The 1991 advance pricing agreement, as revised in 2007, is found to be ‘wrong’ and different parameters are used to allocate profit to Apple’s operations in Ireland, or
  3. Some portion, or all, of Apple’s profits (outside of the Americas) are deemed to be taxable in Ireland.

The headlines are all about #3 though the evidence is that #2 should be more likely.  The longer the investigation goes on the more it seems like a saga that has jumped the shark and getting people’s attention requires bigger and bigger leaps.

But let’s just step back and ask (again!) on what basis could Apple’s global profits be taxable in Ireland.  The starting off point is obviously that the companies at the heart of Apple’s tax structure are Irish incorporated.  But place of incorporation is not the fundamental characteristic that determines where a company pays its income tax – if it was companies would incorporate in no-tax jurisdictions.  Tax residency is important, and place of incorporation may be used to determine that, but it has already been established that these companies are not tax resident in Ireland and there was nothing preferential about the rules under which this was established.

The current system of corporate tax operates on the basis that tax is paid to the jurisdiction where the profit is earned.  So is there evidence that Apple earns its global profits in Ireland?  Possibly.  The companies under investigation by the EU – AOE and ASI – have employees in only one country – Ireland.  So if the Irish employees are generating the profits then maybe they should be taxable in Ireland.  I’m sure Apple’s Irish employees are great but I doubt they are $30 billion dollars a year worth of great.

The key to Apple’s profits is its intellectual property.  Some of this is design and innovation but a lot of it is brand and reputation.  Through various agreements ASI, AOE and AOI acquired the rights to exploit Apple’s intellectual property outside of the Americas.  ASI and AOE have contracted with branches in Ireland using cost-plus agreements to do the underlying work involved in using this intellectual property.

This involves determining how many devices need to be delivered across the EMEA region; engaging in stock management; forecasting demand and directing manufacturing.  There are no legal agreements, transfer pricing agreements, treasury functions or research and development activities undertaken in or managed by ASI and AOE’s branches in Ireland.

Ireland has not codified how activities between parents and branches are dealt with under tax law.  Transfer pricing rules for dealings between associated companies were introduced in 2010 but these did not extend to parent-branch relationships.

However, this relates to how much profit is attributed to the Irish branches and doesn’t establish that all of the profit of these companies is taxable in Ireland.  The ‘arms- length principle’ is intrinsic to EU state-aid law so even in the absence of domestic rules it can be applied to these agreements.

The agreements were on a ‘cost-plus’ basis so essentially were unrelated to the revenues and profits of the overall company.  It could be argued that the agreements should have been on a ‘return of sales’ basis so that the profit allocated to the branch would have increased in line with the overall profits of the company which has accelerated hugely since 2007.  There is merit to this position but this will give an outcome that is a long, long way short of the nine- and ten- digit numbers that have been bouncing around the place.

And this still only means we are in the realm of #2 above.  If place of incorporation and location of employees can’t give us a justification for #3 we need something else.  The next place to look is obviously the ownership of the intellectual property.  The European Commission have already established that it was not held by the Irish branches but that only says where it is not rather than where it is.

The rights to the intellectual property are held by the ASI, AOE and AOI parent companies.  So is this in the US or is this in Ireland?  Even if these companies are not deemed to be tax resident in Ireland can it be established that their profits should be taxable in Ireland?  Is the presence of a branch enough to deem the profits of the parent taxable here?

There are a couple of ways of approaching this but the key aspect is the agreements granting the rights to use Apple Inc.’s intellectual property outside the Americas to these companies.  All of the licensing and cost-sharing agreements were negotiated and signed in the US, at board meetings which took place in the US, and by directors and key decision-makers who were exclusively based in the US.  None of the key risks, functions and assets that underpin the creation and ownership of the intellectual property had a connection with Ireland. 

Why did Apple divide the rights to its intellectual property in this manner?  It was done to avail of deferral provisions in the US tax code.  There are plenty of intricacies to the arrangement so as to avoid triggering an immediate tax payment in the US and not incurring tax liabilities in other countries. 

By having the profits earned in Irish-incorporated companies Apple can defer the payment of the US corporate income tax that is due on those profits until they are transferred to a US-incorporated entity in Apple’s structure.  However, just because the profits are in an Irish-incorporated company does not mean that Ireland, or any other country for that matter, has the right to tax them.

It is hard to know what the basis of the Commission investigation is at this stage.  It is clear that it is not selectivity.  The initial chatter was of a “special two per cent rate” which would obviously be worthy of investigation.  But the Commission have determined that Apple pays the headline 12.5 per cent.  There is no selectivity in the residency rules.  There is merit to a transfer pricing investigation but that can only conclude in a “my number is better than your number” arm wrestle.  It is hard to see what state-aid basis can be used to support a contention that Apple’s global profits should be taxable in Ireland.

The Commission seem, in a manner, to be obsessed with Apple.  The case was started at the same time as other investigations but has not concluded with them.  Although based only on media reporting and speculation the Commission seem determined to rule that Apple’s profits should be included in Ireland’s tax base (and then also in our GDP!).  It is difficult to find support for this through any engagement with the facts.  But are they actually engaging with the facts? And some members of the European Parliament jumped on the bandwagon and suggested that Ireland shouldn’t get the revenue but that it should be divided among the Member States.

The reaction from the US is, predictably enough, in utter contradiction to the nonsense that came out of the US Senate in May 2013.  Back then, the accusations were of  underhand and secret deals through which Ireland allowed these profits to go untaxed.  Now a US Senate committee is raising “serious concerns” about the possibility that these profits may actually be taxed in Ireland.  This position was put forward by Deputy Treasury Secretary, Bob Stack in testimony to the Senate Finance Committee on the 12th of December last.

Finally, and this relates to the EU’s apparent substantive position in these cases, we are greatly concerned that the EU Commission is reaching out to tax income that no member state had the right to tax under internationally accepted standards. Rather, from all appearances they are seeking to tax the income of U.S. multinational enterprises that, under current U.S. tax rules, is deferred until such time as the amounts are repatriated to the United States. The mere fact that the U.S. system has left these amounts untaxed until repatriated does not provide under international tax standards a right for another jurisdiction to tax those amounts. We will continue to monitor these cases closely.

This was more succintly put by Pam Olson, a former U.S. Treasury official now at pwc who, when speaking at an OECD tax conference last summer, said:

“The ‘stateless income’ that is so often referred to is in fact the un-repatriated profits of U.S. companies. … The reality is stateless income isn’t stateless at all — it’s ours, and we have merely delayed taxing it until it’s repatriated. It is nothing for the rest of the world to be obsessed over.

But obsessed over it we are, and in large part because the US wants to have its cake and eat it.  Using the term “repatriated” gives the impression that the profit is in another country. But under US tax law repatriated is the transfer from a non-US-incorporated entity to a US-incorporated entity within a company structure.  It does not mean there are jurisdictional boundaries to be crossed.  In the case of Apple the money is already in the US and never even passed through Ireland.

From an Irish perspective a #3 type ruling from the Commission would actually be  easier to defend when appealed to the General Court of the CJEU. A #2 type ruling on a technical transfer pricing issue has a much better chance of being upheld.  But the motivations of the Commission are unclear and political bellyaching may swing the day. Does the Commission want to be right or does it want to make a splash?



18 thoughts on “Upsetting the applecart”

  1. Thank you, Seamus, for this explanation. From start to finish this is a US problem. The Irish taxation regime simply provided a means -and just one means and certainly not the only means – that Apple used to keep taxable revenue offshore the US.

    There might be some case for tweaking the parameters so that Apple will have to pay (a little) more in Ireland – which is basically your second option. But that’s about it. If consumers around the world are stupid enough to pay over the top for the devices that Apple produces so that it captures enrmous economic rents then it is not the role of the taxation system to expropriate these rents. And DG COMP would be far better employed tackling the egregious frent-seekers in the EU. But they have an uncanny ability to lament loudly the speck in the American while studiously ignoring the beam in their own.

    The solution is to change patent law, to remove any barriers to competition and to fund and promote the education and training that will generate the entrepreneurs who will compete away these rents. And the US will have to recognise that its federal taxation policy will have to adapt to international realities.

  2. I would suggest that the Commission officials concerned are applying the relevant treaty provisions as they see them and exercising the functions delegated to them.

    The relevant Commissioner and Directorate-General clearly have little difficulty in getting the approval of the Commission when it comes to making formal decisions, acting as a college (deciding by simple majority, if a matter is put to a vote).

    When a final ruling emerges, parties that consider it to be incorrect and/or inimical to their interests, can challenge it before the ECJ. Until it does, a fog will continue to envelope the shark, whether jumped or not.

  3. @Seamus Coffey

    “By having the profits earned by Irish-incorporated companies Apple can defer the payment of the US corporate income tax that is due on those profits until they are transferred to a US-incorporated entity in Apple’s structure. However, just because the profits are in an Irish-incorporated company does not mean that Ireland, or any other country for that matter, has the right to tax them.”

    Core point. This is IS ..oops … US ‘deferred US Tax payment’ …. and not only Apple. Must be Trillions of dollars of it rolling around in the globalized finance system ether … which appear to be beyond the recall of any State entity … including USA … where the ‘corporate elite’ controls both houses.

    On transfer pricing …. Commission won’t have any ‘real and verifiable’ data.

    How will De Kommission decide? Not a clue anymore – I wouldn’t buy a used car from them at the mo. Spose the outcome will fit whatever the controlling anti-state neolib ideologues in ‘no minutes’ dictatorial control will accept. Power to the Financial/Corporate System … citizen-serfs no longer count.

  4. Seafoid,
    Avoidance or evasion? As long as a country retains a ridiculous CT rate of 35%, corporates will use every tool at their disposal to swerve paying it,
    Now if the voter in the street could be motivated, facilitated or educated to do the same we would be better off.

  5. Windfall or not, the times are changing and Seamus’ scepticism on reducing corporate tax avoidance may have fans in the Dept of Finance but in recent times, Google’s agreement to pay, back taxes and future higher taxes in the UK, the return of Amazon’s European headquarters from Luxembourg and tax settlements made by Apple in China and Italy coupled with a rise in its overseas tax rate from 2% in 2012 to 6% in 2015, which has benefited Ireland, are early examples of a trend.

    Matt Brittin, Google’s president of business and operations for Europe, said according to the FT that the new tax arrangement “reflects the size and scope of our UK business. The way multinational companies are taxed has been debated for many years and the international tax system is changing as a result.

    Last year Facebook engineered a loss in the UK.

    Emmanuel Macron, France’s economy minister, said Friday that Google is talking with multiple countries, including France, about how to “normalize” its tax relationships with them, adding that he met in Davos with Eric Schmidt, executive chairman of Alphabet, Google’s parent company.

    Seamus quotes a US tax adviser: “The reality is stateless income isn’t stateless at all — it’s ours.”

    US affiliates should pay no overseas taxes?

    Recall when Irish ministers and their cheerleaders sang the mantras about the tax system being “rules based,” “transparent” and Ireland didn’t do “special tax deals”?

    Unlike for example Microsoft and Google, Apple did not use the Double Irish tax dodge routing funds via Amsterdam to Irish shell/ offshore companies in Bermuda. The shell companies used the address of Apple’s Cork campus and Apple Operations International, the principal Irish holding company for foreign subsidiaries, was not always stateless for tax purposes based on the last filed accounts in Ireland.

    Apple was able to keep its tax haven activities secret until a US Senate report in 2013.

    Apple ceased filing a tax return from 2007, with the knowledge of the Irish authorities. Other shell companies also operated as both offshore and onshore, paying tax on some revenues booked through them.

    Irish Government angry at unfair EU treatment of Apple

  6. The fog, at least as far as Belgium is concerned, has been dissipated.

    The Commission must stick to its legal mandate. It is supported in the exercise of it by a definite change in the political mood in the matter of tax evasion.

    “The fight against tax evasion and tax fraud is one of the top priorities of this Commission. The Tax Transparency Package presented by the Commission in March last year had its first success in October 2015 when Member States reached a political agreement on automatic exchange of information on tax rulings following only seven months of negotiations. This legislation will contribute to bringing about a much greater degree of transparency and will act as a deterrent from using tax rulings as an instrument for tax abuse – good news for businesses and for consumers who will continue to benefit from this very useful tax practice but under very strict scrutiny in order to ensure a framework for fair tax competition.”

    The key issue as far as it is concerned, in terms of the action it can legally take, relates to that of unfair advantage or discrimination between companies. It remains to be seen if this is as clear-cut in the Apple case as it was in the Belgian one.

    Debate on all other surrounding issues, including US tax rates, is rather irrelevant.

  7. How one US company has responded to the Commission decision on Belgium.

    The difference in the historic and legal background between the EU and the US is dealt with in this EP research note.

    It took twenty minutes to find this information, freely available, on the Internet. It does not, however, answer the question of whether or not there could be the equivalent of a US “plea bargain” in a state aid context. It would seem not.

    The common denominator on both sides of the Atlantic is that competition rules are primarily a matter of law, but informed by the political and economic context.

  8. Tull
    all that tax avoidance , leverage, buybacks, regulatory capture etc is killing US capitalism. Corporate profits as a % gdp is at record heights while investment is risible. Fiduciary duty is ignored in favour of thoughtless greed.

  9. I think it is more accurate to say that on both sides of the Atlantic competition rules are primarily a matter of the political context, constrained somewhat by the legal framework. The vast majority of activities that are fishy from the perspective of competition rules either never come to attention or are waved through by regulators informed by the political context. As actually enforced, competition rules are mostly about providing politicians and officials with a stick to beat businesses that offend them.

  10. Regulators have been useless. The system is on the verge of an epic crash and regulators are powerless to stop it. On YouTube Google yellen Elizabeth Warren for the key problem

  11. @BCT,

    You may need to distinguish between those with wealth, power and influence (or who attract widespread public attention – either favourable or unfavourable) and the small fry. Most competition bodies will brind their way through the latter largely without fear or favour. But when it come to the former the behaviour of economic regulators and competition bodies in the OECD is a sequence of sick jokes played on ordinary citizens – unless their political masters find it expedient to throw the book at some one or some organisation that has enraged the public.

  12. But when it come to the former the behaviour of economic regulators and competition bodies in the OECD is a sequence of sick jokes played on ordinary citizens


    “Premise No. 4 is the description of what happens in a structural crisis, which the world-system is in at the present time, has been in at least since the 1970s, and shall continue to be in until probably circa 2050. The primary characteristic of a structural crisis is chaos. Chaos is not a situation of totally random happenings. It is a situation of rapid and constant fluctuations in all the parameters of the historical system. This includes not only the world-economy, the interstate system, and cultural-ideological currents, but also the availability of life resources, climatic conditions, and pandemics.”

  13. @seafoid

    Wallerstein is not too optimistic!

    Looks like complex world adaptive systems theory …. beware those feedback loops and dodgy peaks …

    I hear that the wolves are doing well in the Chernobyl human exclusion zone … as are the bison …

  14. If they do go down the TP route it would be a legal mess, as the Commission would be establishing itself as superior to local tax authorities in implementing local tax policy. This means that companies could escalate cases to the Commission in instances where they feel a competitors TP policy is favorable, and puts the EC as a backstop to local authorities. As TP policies are subjective, and offer a range of possible models and outcomes, I really think they haven’t thought this one through.

  15. The Commission’s press release.

    The capacity of the OECD to bind states to do anything in particular is, of course, zero. This is far from the case with regard to the EU. However, the issue of taxation touches on one of the core characteristics of what is generally viewed as defining the sovereignty of the states that make it up. Any decisions are subject to a strict unanimity rule. The pressure on any one state holding out, especially a small one, and more so if seen as one of the main beneficiaries of corporate tax avoidance, would be very difficult to resist.

    The other states must, however, first agree a common position. Their capacity to do so, in near half a century of the EU’s existence, has been shown to be very limited.

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