An advance pricing agreement (APA) issued to Amazon by the Luxembourg tax authorities setting the price of intra-group royalties seems to be designed to ensure a predictable level of profit to Amazon’s Luxembourg operations rather than to achieve an arm’s length result, and thus appears likely to be state aid, the European Commission concluded in a document released January 16.
The document follows up on the Commission’s October 7 announcement that it is investigating whether Luxembourg violated EU state aid rules by issuing an APA to Amazon in 2003. The APA, which is still in force today, sets the amount of tax deductible royalties paid by Amazon’s Luxembourg-based European headquarters company, Amazon EU Sàrl, to a related Luxembourg partnership, Amazon Europe Technologies Holding SCS (“Lux SCS”), for the use of intellectual property. Amazon EU Sàrl reports most of Amazon’s European profits, and had turnover in 2013 of 13.6 billion euros ($15.8 billion).
The APA establishes the license fee paid to Lux SCS as an amount equal to European operating profit minus the profit attributed to functions performed by Amazon EU Sàrl. It further sets Amazon EU Sarl’s profits as 4–6 percent of EU operating expenses, subject to a cap and a floor. The floor is set at .45 percent of European sales and the cap is .55 percent of European sales.
The Commission said that the APA’s method of setting royalty payments does not correspond to any method listed in the OECD guidelines. Contrary to OECD rules, the APA computes the value of the license fee as a residual, rather than basing it on the license user’s output, sales, or profits, the Commission said.
Moreover, the remuneration assigned to Amazon EU Sàrl, set at 4–6 percent of operating expense, is not based on any comparability analysis and seems too low. Further, the floor and a cap on the remuneration “effectively override the pricing method based on operating expenses [without any] explanation.”
Rather than being based on arm’s length reasoning, the APA appears to be designed more to ensure a predictable level of profit to Amazon’s Luxembourg operations, the Commission said, concluding that the ruling appears to confer a selective advantage on Amazon, constituting state aid. “That advantage is obtained every year and on-going, when the annual tax liability is agreed upon by the tax authorities in view of that ruling,” the Commission said.
The Commission added that Amazon has a “financial incentive to exaggerate” the amount of royalty paid by Amazon EU Sàrl to Lux SCS. The royalty is deductible from Amazon EU Sàrl’s income and, since Lux SCS is a transparent entity, that income is not taxed in Luxembourg. Moreover, because the Lux SCS is US owned, Amazon can take advantage of US check-the-box rules to defer US income from Amazon’s European operations indefinitely, as long as none of the profit is repatriated, the Commission noted.
Luxembourg’s Ministry of Finance said in a statement that the allegations of state aid are unsubstantiated and that no selective advantage was granted. The government said it was confident it would be able to convince the Commission of the legitimacy of the tax ruling.
The inquiry, first announced in October, is one of four in-depth state aid investigations initiated by the Commission to clamp down on EU states that grant sweetheart deals to multinationals to attract investment. Also under scrutiny are private rulings granted to Apple in Ireland, Starbucks in the Netherlands, and Fiat in Luxembourg. The Commission in December said it intends to investigate the private rulings practices of all member states.
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