by Julie Martin
The EU Commission, on December 19, released the public version of its decision, announced last August, determining that Ireland granted illegal State aid to Apple by issuing Apple subsidiaries overly-generous private tax rulings. A lot is at stake, including a potential tax recovery to Ireland which could top €19 billion after interest is taken into account.
Tax specialists will be pouring over the 130-page decision in the coming weeks; however, two international tax experts have already reached the same conclusion: the Commission appears to have a pretty good case, though the outcome is by no means certain.
The EU Commission’s arguments are stronger than expected and have a good chance of being upheld in court, concludes Mary Cosgrove, a tax lecturer at J. E. Cairnes School of Business & Economics at the National University of Ireland, Galway.
Cosgrove said while she does not fully agree with all the Commission’s analysis, the decision does appear to address the technical arguments raised by both Ireland and Apple.
“Ireland’s side is weakened by the lack of scientific rigor on the part of the Revenue Commissioners when entering into tax rulings with branches – while there may not have been an intention to give a benefit to certain types of businesses, that seems to have been the result,” Cosgrove said.
Similarly, Aisling Donohue, a tax partner with mgpartners in Dublin, said that after analyzing the decision, Ireland’s appeal “looks weaker than might have been expected.”
Donohue said that in its October 2014 discussion of the case, the Commission made bald assertions as to how international tax law applied in Ireland. “It looked like a soft win for Ireland because the Commission didn’t deal with Irish domestic tax law,” Donohue said.
In contrast, the decision states that the Commission considers the international tax law in question as merely codifying international norms and forming part of the State aid rules of the EU, Donohue observed.
“Here, they demanded Ireland tell them why Irish domestic tax law differed from international norms,” Donohue said, adding that this effectively put the burden of proof on Ireland.
“When Ireland was challenged as to how it departs from Irish tax law, Ireland provided no convincing answers,” Donohue said.
Ireland’s Department of Finance offered a different view. In a statement released yesterday, the government said Ireland properly taxed profits in accordance with the territoriality principle. The Commission misunderstood both the facts and Irish law, the Irish government asserted.
US Treasury also weighed-in, expressing disagreement with decision, as expected.
“We continue to believe the Commission is retroactively applying a sweeping new State aid theory that is contrary to well-established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe. Moreover, it threatens to erode America’s corporate tax base,” a Treasury spokesperson said.
Stateless ‘head offices’
The decision involves the taxation of the profits of two Apple subsidiaries: Apple Sales International (ASI) and Apple Operations Europe (AOE) from 2003–2014. Both subsidiaries were Irish-incorporated nonresident companies that operated through branches in Ireland.
ASI and AEO were engaged in sales, manufacturing, and distribution of Apple products sold outside the Americas. Significant profits were derived by the companies from Apple IP, which ASI and AOE had the right to use or exploit outside of the Americas under a cost sharing agreement with Apple Inc.
The private rulings at issue, granted by Ireland to the companies in 1991 and 2007, endorsed a method for determining the profit allocated to the companies’ Irish branches based on a percentage of the branches’ operating expenses.
The balance of the profits were then attributed to the non-resident ‘head offices’ of ASI and AOE, which existed only on paper, having no employees or physical presence. These head offices paid tax nowhere because, under a tax loophole existing at the time, the US viewed the head offices as Irish tax residents while Ireland viewed them as US tax residents.
In its decision, the Commission concluded that Irish Revenue inappropriately sanctioned profit allocation methods in the tax rulings that resulted in too little tax paid to the Irish branches.
While the Commission offered many reasons in support of its view, the crux of its argument appeared to be that Irish Revenue should not have accepted Apple’s assertion that the Apple IP was held in the ASI and AOE head offices outside of Ireland.
The Commission noted that the head offices had no employees and their directors were unpaid. Without any resources to manage the IP, the revenue from the IP could not reasonably be allocated to head office, but instead should be allocated to the branch, the Commission said.
The Commission also offered alternate arguments if the IP was not deemed attributable to the branches. The Commission said Irish Revenue should have not accepted operating expense as profit level indicator, but should have used sales for ASI’s Irish branch and total costs for AOE’s Irish branch. The levels of return accepted were also too low, the Commission said.
The Commission concluded that, by endorsing methods for allocating profit to ASI’s and AOE’s Irish branches that depart from a market-based outcome, Apple received favorable treatment as compared to “non-integrated” companies or, alternatively, as compared to other non-resident companies operating through a branch in Ireland, and, as such, a selective advantage was conferred on Apple.
According to the Irish government, though, the Commission’s arguments are misplaced. Ireland was following Irish law, applying the territoriality principle to tax only the profits attributable to the branch, the Department of Finance maintained.
“These branches carried out routine functions, but all important decisions within ASI and AOE were made in the USA, and the profits deriving from these decisions were not properly attributable to the Irish branches of ASI and AOE,” the Department of Finance said.
Further, the Commission’s attribution of Apple’s intellectual property licenses to the Irish branches of AOE and ASI is not consistent with Irish law and fails to take into account the activities of Apple Inc, the Irish Department of Finance asserted.
Cosgrove said that, by focusing on the attribution of the IP to the Irish branch, there is “subtle but key difference between the argument made in the decision and the Irish government’s claim that the [Commission] is trying to expand territoriality rules and retrospectively change tax rules.”
She added, though, that while decision clearly explains why the IP income should be attributed to the Irish branches under Irish tax law, the dismissal of the contribution of ASI and AOE director, Tim Cook, is “troubling.”
“Just because a director is not paid by that company does not mean they are not carrying out services for a company. Mr Cook was a director of ASI for all but three months of the period under dispute and a director of AOE until December 2009,” Cosgrove said .
Donohue said it was problematic that two companies’ boards rarely met, and that when it did meet, they didn’t consider the IP.
“Apple implemented the structure really badly. So their facts are awful if this goes to court,” Donohue said.
“They’re saying that the pot of gold doesn’t belong to Ireland, but they have put in place a structure which prevents them identifying where the pot of gold is, apart from California,” she said.
Donohue added that other, similarly situated, taxpayers could have better facts.
‘Road map’ for US tax
Donohue said the decision also seems to offer a “road map” for the IRS to challenge the structure, both on the basis that the cost sharing arrangement with the US entities underpriced the value being added in the US, and on the theory that the US entities should have been remunerated for the services they provided to the structure, which couldn’t be explained on the basis of the information provided to Irish Revenue or the Commission.
Insofar as the US claims that the parent company was under-remunerated for the services which it provided, any tax exposure in Ireland will be correspondingly reduced, which would address the European Commission’s concerns about competitive advantage granted to Apple and would also suit Ireland, which can claim it did nothing wrong, she said.
She added that this would also make it politically difficult for the US to allege that the EU Commission is targeting US companies.
“The only party it would appear not to suit is Apple,” Donohue said.
Cosgrove added that the decision also suggests that the activities of the US based directors could create a permanent establishment for the companies in the US.
Further, the decision refers to the additional taxes assessed and collected by Italy and another jurisdiction (which is redacted) on the basis that the Irish companies had permanent establishments in those countries and suggests that there may be more such cases, Cosgrove noted.
In the absence of greater details on the successful PE cases, it is difficult to predict whether similar cases will be brought, she said.
Ireland tax ruling practices
Cosgrove also noted that other Irish company tax rulings discussed in the decision reflect a wide variety of practices, from profit splits, to operating cost plus margins of between 10% and 100%, to cost plus arrangements based on total costs.
“The lack of any method in agreeing the taxable profits of branches reflects poorly on the Revenue Commissioners, but could be used in support of either side – Ireland could argue that the Apple ruling was not out of line with other branch rulings while the [Commission] could argue that branches seemed to be able to pick their own tax base,” she said.
On the issue of selectivity, Cosgrove pointed out while it could be argued that the branch structure was open to all businesses, Irish residence rules did not allow non-listed groups that were ultimately controlled in Ireland to establish a non-resident Irish incorporated company.
“Limiting this structure to smaller (non-listed) and foreign controlled groups is unlikely to help Ireland’s case,” she said.
Cosgrove added that there is no suggestion in the decision that other companies who sought rulings on the attribution of branch profits were subject to scrutiny on the location of the IP.
However, this does not conflict with Commission’s assertion that that Apple received favorable treatment compared to “non-integrated” companies, she said.