EC letter to Ireland on Apple State-Aid Case

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.

Barking up the wrong Apple tree

There is lots of excitement this morning about a story in the Financial Times about the European Commission state-aid investigation into Apple’s tax arrangements in Ireland. The story first appeared online under the headline “Apple hit by Brussels finding over illegal Irish tax deals”. When put on the front page of today’s print edition the headline was “Apple hit by Brussels findings over Irish backroom tax deals”. The story begins:

Apple will be accused of prospering from illegal tax deals with the Irish government for more than two decades when Brussels this week unveils details of a probe that could leave the iPhone maker with a record fine of as much as several billions of euros.

Preliminary findings from the European Commission’s investigation into Apple’s tax affairs in Ireland, where it has had a rate of less than 2 per cent, claim the Silicon Valley company benefited from illicit state aid after striking backroom deals with Ireland’s authorities, according to people involved in the case.

The headline and story resulted in widespread opprobrium from the usual sources being directed at Ireland. The reality is that the headline is nonsense and the presentation of the story in the text was misleading (at best). Anyone with even a summary understanding of the issue would immediately see that, but there are plenty who love jumping to and jumping on adverse conclusions about Ireland’s corporation tax regime.

The errors include:

  • there are no “fines” in state-aid cases
  • the case does not involve “billions of euros”
  • there are no “preliminary findings”
  • there is no “rate of less than 2 per cent”

And that’s just the first two paragraphs!

At present Apple pays very little corporate income tax on its profit earned on sales made outside the US. These profits will be taxed based on the source-location of the risks, assets and functions from which the profits are derived. The risks, assets and functions that generate Apple’s profits are mainly in the US and under current rules the US is granted the taxing right for the bulk of Apple’s profits. The fact that the US allows Apple to defer the payment of this tax until the profits are transferred to a US-incorporated company is a matter for the US.

Sometimes we tend to use the word “repatriate” when it comes to these profits. But Apple’s non-US profits don’t have to be repatriated to the US; they go there directly and there is no stop-off in Ireland. Yes, Apple’s non-US profits are accumulated in Irish-incorporated companies but almost everything about these companies happens in the US.  Using US rules, Apple was able to create this situation and maintain that these companies did not have a taxable presence in the US.  The EC investigation will examine none of the headline issues about these companies highlighted in the US Senate Report last May.

The EC can only investigate the taxing of activity that happens in Ireland and decisions that are made in Ireland. In its June announcement, the EC said the Irish element of its investigation relates to:

the individual rulings issued by the Irish tax authorities on the calculation of the taxable profit allocated to the Irish branches of Apple Sales International and of Apple Operations Europe;

It is the profit attributed to just the Irish branches of the companies that is in question not the entire profits of these companies. In his opening statement to the US Senate hearing last May, Sen. Carl Levin (D) said:

Continue reading “Barking up the wrong Apple tree”

Geneva Report on the World Economy: “Deleveraging, What Deleveraging?”

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.

McSharry on Trichet

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.

Autumn 2014 Issue of Economic and Social Review

Vol 45, No 3, Autumn (2014)

Table of Contents

Articles

Determinants of Pension Coverage and Retirement Income Replacement Rates – Evidence from TILDA PDF
Sanna Nivakoski 299–328
Income and Wealth in The Irish Longitudinal Study on Ageing PDF
Vincent O’Sullivan, Brian Nolan, Alan Barrett, Cara Dooley 329–348
Informational Efficiency in Distressed Markets: The Case of European Corporate Bonds PDF
Aurelio Fernández Bariviera, M. Belén Guercio, Lisana B. Martinez 349–369
The Socio-economic Gradient of Obesity in Ireland – Corrigendum PDF
David Madden 451–454

Policy Section Articles

The Risks of Intuition: Size, Costs and Economies of Scale in Local Government PDF
Mark Callinan, Ronan Murphy, Aodh Quinlivan 371–403
Winners and Losers on the Roller-Coaster: Ireland, 2003-2011 PDF
David Madden 405–421
The Impact of Training Programme Type and Duration on the Employment Chances of the Unemployed in Ireland PDF
Seamus McGuinness, Philip J. O’Connell, Elish Kelly 425–450