Understanding the European Commission’s Recent Tax Rulings

September 13, 2016

On August 30th the EC announced that two of Apple’s tax agreements with Ireland violated the state aid clause in the Treaty on the Functioning of the European Union (TFEU), a clause guarding against states giving an advantage to a particular business or industry. This ruling set off a firestorm of criticism for recent EC rulings that have used the state aid clause to strike down tax agreements and force collection of back taxes with interest. The affected companies, the U.S. Treasury, and Ministries of Finance from affected member states have issued statements arguing that these tax agreements do not meet the standard for state aid and discriminate against American companies. But EC officials have defended their position with Commissioner Vestager, stating, “This is a decision based on the facts of the case.” Luxemburg and the Netherlands have already submitted appeals for the rulings involving Fiat and Starbucks, respectively. Ireland has announced an appeal for the ruling involving Apple.

Conventionally, there are several criteria to allege state aid under article 107 of the TFEU. The most important of these criteria are Advantage and Selective. Advantage relates to a benefit received by a business from a member state, which gave the business(es) an unfair advantage in the marketplace. Selective relates to structuring the rules such that only specific businesses can access the benefit. Both must be present for state aid rules to apply.

Almost any tax policy can give a benefit to businesses, but only if the policy selectively targets a business can it be considered state aid. Most of the objections to the EC rulings hinge on the Selective criterion. Defenders of the tax agreements argue that any corporation could receive similar advanced pricing agreements if they had applied to the appropriate authorities. This line of reasoning was actually part of an EC judgment for a Spanish company, Autogrill España. The ruling argued that any company could access the tax benefit by purchasing a company outside of Spain, and thus did not meet the Selective criterion.

Two judgments against Belgium show when the Selective criterion is met: Belgium Coordination Centres and Belgium Excess Profit rule. In both of these cases, companies seeking the tax benefit must apply to the Ministry of Finance. The companies had to meet several size, revenue, and industry conditions to receive the reduced tax burden. In addition, most of the companies that received the tax benefits had made substantial investments in Belgium before applying. As such, the EC found that these tax policies violated the state aid clause.

In the earlier ruling of Belgium Coordination Centres, the EC chose not to require the collection of the back taxes, while under the Belgium Excess Profit ruling, the EC strictly enforced the collection of 10 years of back taxes, the maximum amount allowable under the TFEU. Almost all of the 35 companies that receive the benefits of the Excess Profit provision have European headquarters.

In the ruling against Luxemburg and the Netherlands, the EC argues that the member states allowed Fiat and Starbucks to set unreasonable transfer prices, the price one business pays another business for a good or service when both businesses are owned by the same parent company, through advanced pricing agreements. The EC alleges that the advanced pricing agreements allowed Fiat and Starbucks to shift income in such a way as to lower their tax burden.

Luxemburg and the Netherlands have argued that the agreements were meant to reduce uncertainty about future prices, which helps facilitate economic activity. In addition, both states have argued that, although there was an Advantage given by the advanced pricing agreements, the agreements lacked the Selective criterion because any corporation could have applied for a similar agreement.

The appeals filed by Luxemburg and the Netherlands must prove that the advanced pricing agreements were available to any business. If other businesses received advanced pricing agreements with similar deviations from the OECD transfer pricing rules, the appeal could successfully invoke a list of past agreements where the Selective criterion was not met.

Ireland’s appeal faces stronger headwinds. Unlike the rulings against Luxemburg and the Netherlands, Ireland’s state aid was related to a designation given to Apple’s two subsidiaries in Ireland: Apple Sales International and Apple Operations Europe. Ireland granted Apple two rules in 1991 and 2007 that allowed the subsidiaries to create a legal entity within the organization, which acts as the head office. The head offices within the two subsidiaries did not have permanent establishment (PE) within Ireland and were not subject to Irish corporate income taxes as part of the ruling.

Both of the subsidiaries attributed most of their income from direct sales in Europe to their head offices. Some of the income was attributed to the U.S. parent as part of a cost-sharing arrangement for R & D, but the lion’s share was passed to the head office for management services. Only a small portion of total income was declared in the Irish branches.

The EC’s complaint is that the Irish ruling created income that was not taxed by any jurisdiction, which amounts to state aid. Ireland could argue that this is a violation of its right to have advanced pricing agreements, but as the EC argued in the Belgium Excess Profit case, if the rule was meant to correct a transfer price, the rule would have generated taxable income in another jurisdiction. In Ireland’s agreement with Apple, the income was not passed to another tax authority. As such, the ruling cannot be classified as a transfer pricing agreement.

Two more cases of alleged state aid are still under review: Luxemburg’s advanced pricing agreements with Amazon and Luxemburg’s ruling on franchise royalties to McDonald’s. The case of state aid involving Amazon is similar to the case involving Fiat and Starbucks. All of these cases rest on the member states’ right to create advanced transfer pricing agreements with companies. The EC main argument in these cases is that the transfer pricing deviated from the OECD rules, but if this is the case, the EC is not the appropriate venue to challenge the transfer pricing agreements.

The case involving McDonald’s is similar to the case involving Apple and Belgium’s Excess Profit rule. The EC is alleging that Luxemburg’s ruling on McDonald’s franchise royalties left the income untaxed in any jurisdiction. The Luxemburg tax ruling stated that franchise royalties given to McDonald’s European Franchising, a subsidiary of McDonald’s in Luxemburg, were again taxed in the United States and thus could not be taxed in Luxemburg under a double-taxation treaty. At the same time, the United States ruled that McDonald’s European Franchising had no presence in the United States, and its income was not taxable under U.S. law. The two rules created income that was not taxed in any jurisdiction.

From all these cases, two general themes seem to be developed: inappropriate advance transfer pricing and double nontaxation of income. In both cases, corporations with head tax offices in both Europe and the United States are affected by the decisions, but the cases seem to be overly represented by U.S. corporations.

It is unlikely that the double nontaxation cases will find much success in the appeal process, but the cases involving advanced transfer pricing agreements have strong arguments for dismissal. These appeals are likely to chart the course of tax competition in Europe for the next decade.


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