What US Businesses Should Know About Brussels' Apple Ruling

Tom Lickess, Line of Service Lead, Tax Advisory, Radius

The European Commission ruled last week that Apple must repay €13 billion plus interest to Irish tax authorities for unpaid taxes for the years 2003 to 2014. The Commission — which is the Brussels-based executive body of the European Union — explained in a press release that EU member states are prohibited under EU state aid rules from giving tax breaks to selected companies.

After a two-year investigation, the Commission “concluded that Ireland granted illegal tax benefits to Apple, which enabled it to pay substantially less tax than other businesses over many years. … [T]his selective treatment allowed Apple to pay an effective corporate tax rate of 1 per cent on its European profits in 2003 down to 0.005 per cent in 2014.”

The Commission’s findings relate to two tax rulings issued by Ireland to Apple in 1991 and 2007. Broadly speaking, those former Irish rulings allowed Apple’s Irish subsidiaries the right to use the intellectual property of Apple US to sell and manufacture Apple products outside the US. Payments from the Irish subsidiaries to Apple US to fund research were tax deductible in Ireland, and most of Apple’s non-US sales were recorded in Ireland, with profits attributed to a “head office” of the Irish subsidiaries. The Commission asserts in its press release that the head office “existed only on paper and could not have generated such profits.”

In a statement released the day of the ruling, Apple said the Commission’s “claim has no basis in fact or in law.” Apple will appeal the decision and Ireland may follow suit.

Background: A Changing Global Corporate Tax Landscape

The European Commission’s Apple ruling is a high-profile example of ongoing changes in the global corporate tax landscape. Late last year, for example, the Organization for Economic Cooperation and Development presented its final package of measures under the Base Erosion and Profit Shifting project, or BEPS. As another Radius blog post explains, “BEPS seeks to protect the tax bases of all countries by creating a model that taxes a multinational’s profits based on where the economic value is created, rather than on the location of corporate headquarters after allowing for inter-group transfer pricing.”

There have been other high-profile cases involving US companies and accusations of profit shifting by EU authorities. For example, in October 2015, the European Commission ordered Starbucks to pay more than €20 million in back taxes to Netherlands tax authorities in a decision that was similar to the recent Apple decision. As the Commission’s October 2015 press release summarizes, “Dutch authorities in 2008 gave a selective advantage to Starbucks Manufacturing, which has unduly reduced Starbucks Manufacturing's tax burden.”

Why Ireland May Appeal the Commission’s Ruling

It may seem counterintuitive that in the immediate aftermath of the Commission’s decision, Ireland’s Finance Minister Michael Noonan announced his government would contest the decision. Dublin would, after all, stand to gain more than €13 billion from the ruling, and treasuries aren’t in the habit of turning down billions in free money. It’s also worth remembering that Ireland is only six years removed from accepting a €100 billion bailout from the EU and the IMF due to the global financial crisis.

As it happens, just a day after Noonan’s comments indicating that Ireland would appeal the Commission’s ruling, Irish cabinet members reached an impasse over whether or not to follow through. As a Reuters article explains: “Some Irish voters are astounded that the government might turn down a tax windfall that would be enough to fund the country's health service for a year, and this appears to be complicating the cabinet decision whether to fight the ruling.”

The dilemma lies in the fact that Ireland has long positioned itself as a low-tax, tech-friendly destination for multinationals. Its campaign in this area has been successful. For more than two decades, Ireland’s economy has benefitted from inward investment by US tech companies in particular. Apple alone employs 6,000 people in Ireland. Partly as a result of this, Irish unemployment is low by European standards (8.3% in August 2016), which has in turn kept social security bills down and income tax receipts up. Ireland has been content to let big companies pay a low rate of corporate income tax if they support inward investment and jobs.

It’s also worth noting that Ireland, as a BBC.com puts it, “has been criticized, particularly in the US, for almost being a tax haven similar to the Cayman Islands, something it strongly denies.” If Ireland does not appeal the Commission’s recent decision, the inaction would almost amount to an admission that such claims are in fact accurate.

The Effects of the Apple Decision on Ireland (and Beyond)

It is highly unlikely that the Commission’s finding on Apple will induce companies to leave Ireland or deter companies that are interested in expanding into the country. As mentioned, Ireland has built itself into one of Europe’s leading tech locations. Moreover, the finding does not change the fact that Ireland still has one of the lowest corporate income tax rates in the EU, at 12.5%.

If Irish leaders ultimately decide to contest the decision, the appeal process may go on for years. In the meantime, Irish authorities — appeal or no appeal — will still collect the cash from Apple. (Paying the tax and any interest should not be a problem for Apple, which is reported to hold over $200 billion in cash stockpiles outside the US).

Other forces beyond the European Commission, the Irish government and Apple, however, may come into play. The determination has laid bare Apple’s tax practices in Europe. In particular, all its European profits are recognized in Ireland, and other European countries where Apple’s customers are based could well demand a share. This kind of equitable distribution of taxes based on where economic value is created is, after all, at the very heart of the BEPS project and similar initiatives.

The US Position

US Regulators have poured cold water on the verdict, questioning its validity. This reaction was expected. Just six days before the August 30 decision, the US Treasury released a 25-page white paper on the Commission’s state aid investigations warning in part that a policy of retroactive adjustments leads to uncertainty and is contrary to business stability.

In a related blog post on the subject, Robert Stack, deputy assistant secretary for international tax affairs at the US Treasury, explains the US’s misgivings. While Stack reaffirms the Treasury’s commitment to the OECD’s BEPS project, the European Commission’s state aid investigations “threaten to undermine progress in this area.” He indicates that the investigations would unfairly affect US companies. “Furthermore,” Stack continues, “it is possible that the settlement payments ultimately could be determined to give rise to creditable foreign taxes. If so, US taxpayers could wind up eventually footing the bill for these state aid recoveries in the form of foreign tax credits that would offset the US tax bills of these companies.”

What US Businesses Should Consider in the Wake of the Apple Decision

The European Commission’s ruling and the eye-popping sum Apple must pay in back taxes have caused shockwaves on both sides of the Atlantic. And though the ruling is unlikely to cause an exodus of high tech companies from Ireland, it has introduced a measure of uncertainty into the corporate tax climate there, similar to the uncertainty caused by the Brexit referendum.

The Apple ruling also stands as a timely reminder to corporate taxpayers of the need to revisit historic tax positions, operational practices and perhaps most importantly tax structures. As Apple has painfully discovered, there are major risks associated with cross-border tax (even relying on revenue-authority rulings) in a time of increased tax-authority scrutiny, public pressure for corporations to pay their perceived “fair share” of taxes and global initiatives like BEPS that target tax base erosion and profit shifting.

Apple’s gripe is that the rules seem to have shifted without warning, and they are being penalized for regulations they weren’t operating under just a couple of weeks ago. As Apple CEO Tim Cook said in his August 30 statement, “every company in Ireland and across Europe is suddenly at risk of being subjected to taxes under laws that never existed.” And that aspect of the ruling surely has corporate taxpayers everywhere seriously concerned.