The US Treasury were obviously unimpressed with the response to Asst. Treasury Secretary Robert Stack’s recent visit to Brussels with Competition Commissioner Margrethe Vestager responding that “it is the same argument as we have heard before”.
The US clearly feels it is an argument worth making and now Treasury Secretary Jacob Lew has written a letter to Commission President Jean-Claude Juncker. It is largely a repetition of the arguments heard before but there are some interesting elements.
On the State Aid case against Ireland in relation to Apple, Lew is pretty clear:
Third, DG COMP’s approach appears to target, in at least several of its investigations, income that Member States have no right to tax under well-established international tax standards. U.S. multinationals generally do not conduct the cutting-edge research and development that creates substantial value in the European Union, and as a result, comparatively little of their income is attributable to their European operations. We recognize that the U.S. system will only tax this income upon repatriation, and many U.S. firms are choosing to defer paying tax liabilities by keeping income overseas in low-tax jurisdictions. This is a serious problem that we seek to address through President Obama’s business tax reform plan and the BEPS project. This problem, however, does not give Member States the legal right to tax this income. Doing so would directly harm U.S. taxpayers. When U.S. companies repatriate revenue- as tax reform proposals from both U.S. political parties would require them to do within a fixed timeframe any assessments paid to Member States could be eligible for foreign tax credits. This loss of revenue would impose a direct cost on American taxpayers.
Whether right or wrong the current system of corporate income taxation allocates a large share of the profit made by Apple to the research and development that generates Apple’s intellectual property (patents, design, brand, reputation etc.). The most crucial aspect of the strategies used by many US MNCs is the ability to divide the rights to exploit their intellectual property into US and non-US divisions and have the non-US rights held by a subsidiary that is considered “offshore” for US tax purposes.
These are cost-sharing agreements where the offshore subsidiary contributes a portion of the R&D expense incurred by the parent company and in return gets the right to use the IP that results from that R&D in a particular region. These agreements were initiated before these companies became hugely profitable and any attempts to put in place such agreements after the IP has been created and profits flows identified would trigger large capital gains tax payments on origination and much higher ongoing royalty payments into the US. The implementation of a cost-sharing agreements before the profits flow reduces the amount of capital gains tax and limits the required inbound payments to the R&D expense incurred by the company. This is the crucial aspect of these strategies.
If this division under US law was not possible the strategies used by US MNCs would be wholly ineffective. Google Inc. has an agreement to grant the ex-US rights to its technology to Google Ireland Holdings and Apple Inc. has an agreement with Apple Operations International for the ex-US rights to Apple’s intellectual property. Both companies have operations in Ireland where the work to exploit the intellectual property is undertaken. Google through a subsidiary of GIH, Google Ireland Limited, and Apple through a branch of the AOI subsidiary, Apple Sales International.
Lew fudges somewhat when he says that “many U.S. firms are choosing to defer paying tax liabilities by keeping income overseas in low-tax jurisdictions.” That is true but Apple is not keeping the income overseas; in Apple’s scheme the income goes directly to the US but it is deemed “offshore” and the US allows a deferral because Apple keeps it in a company that is Irish-incorporated.
In her response to Stack’s visit Vestager further added that “just as it is an obvious right for U.S. tax authorities to tax revenues when they are repatriated, it is also for European tax authorities to tax money that is made in the member states." But just because something is “offshore” under US tax law does not necessarily mean it is “onshore” somewhere else. International agreements allocate taxing rights and it is up to each country how they want to utilise the taxing rights that such agreements grant to them.
The Commission are attempting to prove, or are just going to say without proving, that the profits earned by Apple Sales International are taxable in Ireland. The reality, based on substance, is that these are profits earned by Apple Inc and should be taxable in the US. That the US allows these to go untaxed should be their business but who wouldn’t be obsessed by a potential pot of untaxed gold?
Our own Oireachtas Finance Committee took a look and when before them, the OECD’s point man on tax Pascal Saint Amans, said the following:
Pascal Saint-Amans: Assuming the best action plan translates into domestic legislation in all countries, including the US, the companies in question would be taxable in the US and would not benefit from what they currently enjoy, which is double non-taxation.
Pascal Saint-Amans: Ireland should also consider it is not the only country in the world and there is an interaction with other countries. For example, part of the tax is due in the US rather than in Ireland for the simple reason that the intangible has been developed in the US, is owned by the US and should be taxable in the US, so there is a reason not to tax profit which is not accruing in Ireland. Therefore, this issue cannot be solved unilaterally and there is need for interaction with another country in order to deal with this.
The US are concerned by such unilateral action – even if such action by Ireland is result of a decision by the European Commission. In his letter Lew doesn’t even try to veil the threatened response to this:
Fourth, DG COMP’s approach could undermine U.S. tax treaties with EU Member States. As you know, Member States have exclusive authority over income tax under EU law. Accordingly, the United States does not have an income tax treaty with the European Union. DG COMP’s new assertion of authority raises serious questions about this relationship and the finality of income taxation-related dealings with Member States. We expect that this new uncertainty could damage the business climate in Europe and deter foreign direct investment.
A ‘toughened stance’ from Ireland is no surprise. Though it should be remembered that the US-Ireland tax treaty is not applicable in the case of Apple. The structure is such that the subsidiaries are deemed non-resident in Ireland (because they are not managed and controlled here) and are non-resident in the US (because they are not incorporated there). One of the consequences of being ‘stateless’ is that Apple cannot avail of the provisions of the US-Ireland tax treaty to relieve a tax liability that might be due in Ireland. Tax risk anyone?
The ratcheting up by the US through this letter from the Treasury Secretary to Juncker shows what the US believes the European Commission is about the do. The Commission know that the US is not going to do anything to address the problem regardless of any “robust business tax reform plans” that Lew says have been proposed by US President Obama. And the US has hugely pulled back from its engagement with the BEPS project. But saying something and doing something are very different things. Will the Commission pull the trigger?