The European Commission on November 14 published its preliminary opinion that an advance pricing agreement (APA) granted by the Netherlands to a Starbucks subsidiary constitutes illegal state aid.
The inquiry, first announced in June, is one of four state aid investigations recently initiated by the Commission that 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 and to Amazon and Fiat in Luxembourg, as well as tax deals struck by Malta, Belgium, Cyprus, and Gibraltar.
The dispute concerns a 2008 APA issued by the Netherlands to Starbucks Manufacturing BV. The Netherlands subsidiary roasts, packages, and stores coffee beans, and performs related functions, such as acting as an intermediary distribution company for non-coffee items like Starbucks cups and napkins. Starbucks Manufacturing BV obtains its coffee beans from a related Swiss company, which charges a 20 percent mark-up. It also pays a royalty to a related UK limited partnership, Alki LP, to license intellectual property needed to run its operations.
The Netherlands APA is based on a transfer pricing report that uses the transactional net margin method, applying a mark-up of 9-12 percent to determine arm’s length pricing. The APA excludes many costs from the cost base though, including the cost of green coffee beans and associated short term inventory risk, costs incurred by the subsidiary in its role as intermediary distributor, and costs related to consignment manufacturing arrangements and arrangements with third-party logistics/distribution service providers.
The rationale for the exclusions was that Starbucks Manufacturing BV operates as a toll manufacturer; does not bear the risk of inventories, which are put on consignment; is not responsible for setting commercial terms with suppler and client; and does not involve the client directly.
According to the Commission, though, the Dutch authorities were wrong to accept these contentions. Moreover, even if the risks had been effectively transferred, the tax authorities should have questioned the economic rational behind such a transfer, the Commission said.
The Commission noted that if costs of raw materials were added to the cost base, using the applicable mark-up for manufacturers of 7.8 percent, as opposed to applying the higher mark-up used in the APA of 9-12 percent to only operating costs as defined in the APA, Starbucks’s tax liability would increase significantly.
The Commission noted that inventories appear on the subsidiary’s balance sheet and the firm also records losses of inventory value. It also said there is no indication that evidence was ever provided to the Dutch authorities to substantiate the claim that the subsidiary was a toll manufacturer or that its level of risk was limited.
The Commission also said the Dutch authorities should not have accepted Starbucks Manufacturing BV’s calculation of the amount of deductible royalties paid to Ali LP for the manufacturing process. Under the method used, if sales minus cost of raw material minus operating and other costs were higher than 9-12% of operating costs, the excess was paid as a royalty to the Alki LP.
The fact that the royalty is disconnected from the value of the IP is an indication that the pricing method agreed to in the APA may not be the most appropriate method to approximate arm’s length pricing, the Commission said. It also questioned whether an independent economic actor would accept such variable royalty payments – both from the perspective the of holder of the IP and the user of the IP.
In a November 14 letter to the Netherlands House of Representatives, State Secretary for Finance, Eric Wiebes said he disagreed with the EU Commission’s allegations. Starbucks Manufacturing BV’s characterization as a contract manufacturer has been sufficiently substantiated, the approved transfer pricing method complies with the arm’s length principle, and no selective advantage was conferred, Wiebes said.
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