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:
- No adverse finding is made,
- 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
- 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?