The Central Bank has published its framework here.
See also the new Economic Letters:
‘Macro-prudential tools and credit risk of property lending at Irish banks’ (Economic Letter Vol. 2014 no. 10) by Niamh Hallissey, Robert Kelly and Terry O’Malley
and
“Housing market developments and household consumption,” by Daragh Clancy, Mary Cussen and Reamonn Lydon
Having read the Commission letter through it is clear that the game has moved to a different pitch. The key issue is not the 1991 transfer pricing arrangement or its subsequently revision in 2007. Yes, there was little objective basis for the 65/20 margins used and there was no reference to the arm’s length principle and the arrangement seemed to be reverse engineered, but there is nothing in the EC letter to say that the margins used were wrong and led to taxable income figures that were significantly out of line if a more careful and objective approach was taken in line with OECD standards (which weren’t introduced here until 2010).
There is no doubt the 1991 advance pricing arrangement (APA) was put together in a pretty arbitrary manner as indicated by the minutes and notes taken by the Revenue official but that was as much the nature of the regime at the time rather than any special or preferential treatment to Apple. The detailed nature of the records kept suggest it was not unusual.
Can it be argued that similar arrangements were not put in place for other companies? APAs on a cost-plus basis for entities that engage in the activities attributed to the Apple’s Irish operations are not unusual.
Apple Operations Europe:
– the "manufacture of a specialised line of personal computers."
- providing "shared services to Apple companies in Europe, the Middle East and Africa (EMEA) region, including payroll services, centralised purchasing and a customer call centre."
Apple Sales International:
– the "procurement of Apple finished goods from third-party manufacturers"
– the "onward sale of those products to Apple-affiliated companies and other customers"
– "logistics operations involved in supplying Apple products from the third party manufacturers to Apple-affiliated companies and other customers."
Manufacturing, shared services, procurement and logistics are not high-profit activities. The Commission can argue that the 65/20 cost-plus margins in the 1991 APA and the updated margins in the revised 2007 agreement were "wrong" but they are unlikely to result in a material difference to the amount of tax Apple would have had to pay in Ireland. In monetary terms, any finding here would be relatively insignificant.
It is pretty clear that the issue has moved on and that these transfer pricing arrangements are no longer central. The key issue is Apple’s intellectual property, or more precisely, the location of Apple’s intellectual property.
If we look at the five items requested by the Commission in June letter published this week none of them relates to the pricing agreements. The information requested was:
– Provide the financial accounts of ASI and AOE for the period 2004-2013, in particular the P&L accounts.
– In the case of ASI single out in the P&L the amount of passive income each year and specifying if such passive income comes from Ireland.
– Provide the number of full time equivalent employees (hereinafter “FTE”) of ASI and of AOE over the same period (each end of reporting period). Provide the FTE of the Irish branch of ASI and of AOE for the same period (each end of accounting period).
– Provide the cost sharing agreement between Apple Inc., ASI and AOE in all its variations since 1989 until the last modification.
– Describe in detail the type of intellectual property covered by the cost sharing agreement.
It is clear the Commission are focusing on the ASI subsidiary as a whole and not just its Irish branch. The key issue is whether any of the intellectual property rights held by ASI are located in Ireland. Last year’s US Senate report contained a good deal of information on ASI. The post continues below the fold with a a selection of quotes relating to ASI, and its parent AOE, in the Senate report.
The document is here.
There is a lot in it and the extracts here just focus on one element of it: a 1991 transfer pricing agreement that was done on a cost-plus basis, i.e. the profit attributed to the Irish operation was based on the costs incurred by the Irish operation. This is not an unusual transfer pricing basis and, as expected, the amounts involved are relatively small, i.e. not billions.
The quirk is the structure of the agreement. For example the 1991 agreement for Apple Operations Europe was [from paragraph 31]:
According to that ruling, the net profit attributable to the AOE branch would be calculated as 65% of operating expenses up to an annual amount of USD [60-70] million and 20% of operating expenses in excess of USD [60-70] million.
In the notes of a meeting (attendees not provided) it was said that (paragraph 37):
Following further discussions it was agreed that, subject to receiving a satisfactory outcome to the capital allowance question, to accept a mark-up of 65% of the costs attributable to the Irish branch. In addition it was agreed to accept a mark-up of 20% on costs in excess of $[60-70]m in order not to prohibit the expansion of the Irish operations.
On the two margins applied the Commission notes the following (paragraph 63):
Second, the margin on branch costs agreed in the 1991 ruling, as described at recital (31), is either 65% or 20% depending on whether the operating costs are below or above USD [60-70] million. According to the excerpt at recital (37), the reduction of the margin after a certain level above USD [60-70] million would have been motivated by employment considerations, which is not a reasoning based on the arm’s length principle. In particular, the two margins of 20% and 65% are relatively far apart and, should the margin of 65% effectively constitute an arm’s length pricing, the margin of 20% would be unlikely to fall within the same range of pricing, while applying the same degree of prudence.
There are other elements as well including transfer pricing for some intellectual property that can be explored in the document.
This report (written Luigi Buttiglione, myself, Lucrezia Reichlin and Vincent Reinhart) will be available here from 9am this morning. The VOX summary article is here. FT report here.
Update: I will present the report in a Policy Institute seminar on Thursday 2nd October, 12-1, in IIIS seminar room at TCD.
Former finance minister and EU commissioner Ray McSharry has contributed a chapter to the book of tributes to the late Brian Lenihan (Brian Lenihan, In Calm and in Crisis, Murphy, O’Rourke and Whelan (eds), Merrion Press 2014).
The chapter contains the following complete paragraph at page 111:
‘Brian had been keen to burn the big bondholders and we discussed this on a number of occasions. One morning I got a call about a quarter past eight and it was Brian. He told me that he was able to burn the bondholders and he was very happy because the European Central Bank President, Jean-Claude Trichet, had told him he could do it. This would have improved Ireland’s position significantly and it was going to be a big story, but later that day a now despondent Brian rang me back. He said Trichet had changed his mind because he realised that the main casualty if the bondholders were burnt would be big German and French banks. This was a disgraceful decision because the ECB is supposed to represent the interests of Europe generally, but they were clearly under the sway of the German and French banks. Even today, I still would not have much confidence in the ECB and until Europe gets a totally independent entity to defend its currency, the euro will remain a fragile currency’.
The context in McSharry’s piece indicates that
(i) the conversation took place in the summer or autumn of 2010, as the bank guarantee was coming to an end or had already ended, but prior to the EU/IMF programme, and
(ii) the bondholders referred to were bank, not sovereign, bondholders.
The phrase ‘…the main casualty if the bondholders were burnt would be big German and French banks…’ refers, it is reasonable to assume, not (or not only) to the direct losses that these banks would suffer as holders of the bonds in question (it is doubtful that they were big holders) but to the impact of default or haircuts in Ireland on their continued access to new debt funding from the bank bond market.
This reported conversation goes to the heart of Ireland’s unfinished business with the ECB. It is reasonable for the ECB president to display concern about the continued access of major European banks to important funding sources. Whether it is within the ECB’s powers under the statute to impose on an individual member state the cost of shoring up debt market access for Eurozone banks generally is not clear and will not be clarified until the European Court of Justice rules on the matter. The statute does not contain any explicit provisions conferring such an important power.
McSharry’s report of his conversation with Lenihan is further support for the view, which I have expressed many times, that Ireland should take a case against the ECB as provided for in the ECB statute. This is important for the credibility of the ECB as an independent central bank. Win or lose, referral of the matter to the ECJ would clarify whether the ECB possesses the powers it appeared to believe it had back in 2010. If the ECB can impose costs of policies aimed at stabilising markets across the common currency area on an individual member state it is time the member states knew about it.