It’s just over a week since Commissioner Vestager announced the state-aid ruling on the tax treatment of Apple in Ireland. We only have the press release and the Commissioner’s statement to go by so it’s still too early to be definitive on what the Commission are actually doing. It could be months before the full ruling is available here but that doesn’t mean we can’t have a stab at what might be going on.
There has been a lot of reaction to what the ruling means for Ireland’s Corporation Tax regime. While there has been massive reputational damage (possibly irreparably so) the ruling does not have any implications for Ireland’s Corporation Tax rate or even for any of the rules that Ireland applies to Corporation Tax.
Unlike previous instances the Commission is not looking for any change in Ireland’s Corporation Tax regime. In this instance looking for changes would likely have been overreach but that is not what the Commission is seeking. Nor is the Commission seeking to retrospectively impose alternative transfer pricing standards which was a central focus of the recent White Paper from the US Treasury. If the Commission’s case required a change of rules or the application of new standards it would have had little hope of standing up to an appeal.
However, the Commission’s case is one it can win. It comes down to the correct interpretation and implementation of Ireland’s Corporation Tax legislation. The Revenue Commissioners have applied one interpretation; the European Commission have come down in favour of a different interpretation. There is nothing retrospective about the Commission’s ruling. They are looking for Irish legislation as it applied at the time to be implemented as was intended. This is something we should all be looking for.
At the heart of the ruling is Apple Sales International (ASI). This company accounts for 99.6 per cent of the headline €13 billion figure. The publicly available information on ASI is assessed here.
[Aside: For an appeal it might actually be helpful to ignore the other company, Apple Operations Europe (AOE), altogether. It represents only a small amount of the recovery amount and its inclusion would just add another layer to an already complex issue. AOE was actually the more important company when the 1991 ruling was put in place and was the subject of a large part of the discussions, and subsequent meeting notes, at that time. In the period since, ASI became the much more significant entity and really is where all the action is.]
Apple Sales International is a non-resident company that has an Irish branch. The disputed opinions concern the allocation of profits to the Irish branch.
The Revenue Commissioners looked only at the branch and accepted that the risks, functions and assets in the branch warranted a taxable income equal to 12.5 per cent of the costs incurred by the branch. This is the view that the Irish branch is not central to the profitability of the company and that as the Irish branch carries out more of the functions under its remit then its taxable income would increase in line with its size and expenditure.
On the other hand the European Commission focused on the only other element of the company – the non-resident head office. The EC argue that as the head office has no substance it cannot be responsible for the profits earned by ASI and therefore the profits of the company can only be attributed to the Irish branch (bar some minor passive income such as interest receipts).
And that is it really. Who is right? Without seeing the full basis for the Commission’s ruling it is hard to know. But Irish law on this is pretty straightforward: if a non-resident company has an Irish branch the branch is subject to Irish Corporation Tax on all of its profits, wherever earned. And that gives us our key question: what are the profits of the Irish branch?
From the press release the Commission do not seem to be arguing that the risks, functions and assets that generate ASI’s profits are located in the Irish branch. And there is no evidence that they are located in Ireland:
- We know that the R&D does not take place in Ireland and the intellectual property or economic rights derived from that was not located in Ireland for the period under investigation.
- All of the key management decisions, such as the cost-sharing agreements with Apple Inc., the manufacturing contract with Chinese producers and the price the products sold at, were made outside of Ireland.
- The sales were not booked in Ireland [or at least no evidence has been provided that the sales were booked in the Irish branch].
When the Revenue Commissioners looked at the Irish branch they saw none of these risks, functions and assets and set the taxable income based on the activities in the branch. So where did the activities that generated the profits take place?
We know it was the United States (for the first two points above at any rate). And if the sales are booked in the United States, which seems likely, how is it that the tax due on the profits from those sales was not levied and collected by the United States? The answer is somewhere in here!
But the US has a problem which results from the desire to have its cake and eat it. The US has no issue with the taxes being deferred (as that is what their system allows/encourages) but it does have an issue if someone else tries to collect the taxes instead. The problem is that the ‘stateless’ nature of ASI means that the Ireland-US tax treaty does not apply. The taxing authority that is responsible for losing billions of tax revenue for its country is not the Revenue Commissioners; it is the IRS.
If Irish Revenue had held the position that the European Commission now says should have applied, then there is no way Apple would have put the structure in place such that 60 per cent of Apple’s profit would be subject to 12.5 per cent tax in Ireland. If the Revenue had given this opinion then Apple would have gone away for a couple of days and come back with an alternative structure that would have resulted in almost the same tax outcome as did occur. Ireland would levy tax on the activities of the Irish branch and Apple would enjoy a deferral of the US taxes due on its profits. Thinking that Apple would have paid €13 billion in tax to Ireland in the absence of the disputed Revenue opinion is viewing the world through a very static lens.
Of course, if Apple decides to locate the risks, functions and assets that generate its profits in Ireland they should be taxed here at the appropriate rates. The press release tells us that the rulings in question ended in 2014 due to a restructuring within the company at the start of 2015. If this resulted in intangible assets being located in Ireland then the appropriate profits associated with holding those assets should be taxed in Ireland. And if these assets are worth a couple of hundred billion it is up to US laws to ensure that the appropriate capital gains taxes are paid on the transfer. [They didn’t.] But those assets weren’t in Ireland for the period under investigation.
The Commission’s argument appears to be that the head office of ASI is a non-entity and that virtually all of the company’s profits should be attributed to the Irish branch as that is the only substance in the company. The profits are the company’s but the Commission want to turn the Irish branch into the residual claimant of ASI’s profits. The press release tells us:
The “head office” did not have any employees or own premises. The only activities that can be associated with the “head offices” are limited decisions taken by its directors (many of which were at the same time working full-time as executives for Apple Inc.) on the distribution of dividends, administrative arrangements and cash management. These activities generated profits in terms of interest that, based on the Commission’s assessment, are the only profits which can be attributed to the “head offices”.
If the head office does not do anything it cannot exercise management and control (which is the key provision of the applicable residency rules). This is not the first time we have heard this argument. The position was also put forward by former senator Carl Levin at the US Senate hearing into Apple’s tax affairs in 2013. Here is Levin talking about AOI but at the conclusion he says similar arguments apply to ASI:
The evidence shows that AOI is active in just two countries, Ireland and the United States. Since Apple has determined that AOI is not managed or controlled in Ireland, functionally that leaves only the United States as the locus of its management and control. In addition, its management decisions and financial activities appear to be performed almost exclusively by Apple Inc. employees located in the United States for the benefit of Apple Inc. Under those circumstances, an IRS analysis would be appropriate to determine whether AOI functions as an instrumentality of its parent and whether its income should be attributed to that U.S. parent, Apple Inc.
Vestager and Levin are making the same point but use it to reach different conclusions. Levin argues that because ASI is controlled by Apple Inc. it should be deemed an “instrumentality of the parent”. Vestager argues that because ASI is controlled by Apple Inc. the only management and control within ASI can be exercised by the Irish branch. Levin wants the profits taxed in the US; Vestager wants the profits taxed in Ireland.
Neither Levin or Vestager argue that the management decisions that make ASI profitable are made in Ireland. This is the position taken by the Revenue Commissioners who only assessed the taxable income of the functions within the Irish branch. And we can find support for this view. For example:
All strategic decisions taken by ASI, including in relation to IP, are taken outside of Ireland. As with AOE, ASI is a party to the R&D cost sharing agreement with other Apple Inc. subsidiaries under which the total costs of the group’s worldwide R&D are pooled. ASI’s Irish branch has no authority to make decisions relating to Apple IP or the cost sharing agreement. No rights in relation to the Apple IP concerned are attributed to the Irish branch.
Who said this? The European Commission did! By the principles of taxation the Revenue position is correct – they have collected the tax based on the risks, functions and assets in Ireland. However, it is not the principles of taxation that matter; it is the letter of the law that matters.
But on principles let’s say that the board of ASI had decided to outsource the activities of the Irish branch to a third-party service supplier in Cork – just as they have done with the manufacturing activities in China. Would anyone be making the argument that this service supplier should have made €100 billion or more of profit over the past decade? What would be different about what ASI’s head office and board of directors is doing in this scenario?
Of course, ASI did not outsource the activities. They were carried out by the Irish branch and the Commission want to attribute €100 billion of profit to it. The Commission does not dispute the presence of a non-resident head office – but they only associate “limited decisions” to it. Nor does the Commission appear to be taking issue with the stateless nature of the head office. There is nothing preferential about that as lots of companies can achieve it. For example, if a relevant company is registered in Ireland and managed and controlled in Bermuda where is it tax resident? What is preferential about Apple achieving a deferral of the US taxes due on its foreign earnings in Cupertino, California compared to Google achieving the same result in Hamilton, Bermuda?
What the Commission are disputing is the allocation of profits within ASI. Were the Revenue Commissioners correct that the key decisions that make ASI profitable do not take place in Ireland? Yes. Even the European Commission agree with that. But are the European Commission correct that the key decisions that make ASI profitable do not take place in ASI? Yes.
We know from the US Senate that “Apple’s offshore affiliates operate as one worldwide enterprise, following a coordinated global business plan directed by Apple Inc.” Is that enough to mean we can discount the actions of ASI’s US-based board of directors who implement the business plan and enter agreements on ASI’s behalf? A co-ordinated business plan is something we would expect in a large company but Apple Inc. and ASI are separate legal entities. The US Senate reports also tells us:
In fact, the last two versions of Apple’s cost-sharing agreement were signed by Apple Inc. U.S.-based employees, each of whom worked for multiple Apple entities, including Apple Inc., ASI, and AOE.
and on the agreement with the manufacturer in China:
The individual who signed the relevant agreements for Apple Sales International was a U.S.-based Apple Inc. employee who signed the agreement in his capacity as Director of Apple Sales International.
These obviously didn’t happen in Ireland which supports the position of the Revenue Commissioners. But they were carried out under a coordinated plan directed by Apple Inc. so to the extent that ASI did actually exercise management and control where was that carried out? The European Commission are arguing this was only in Ireland such that ASI did not have a non-resident component to which profits should have been allocated.
The courts will decide who is right and both sides will feel they have a chance. Before that we’ll get the full ruling which will show whether any of this is right.