Thursday, September 1, 2016

Why tax campaigners should be aghast at the Apple ruling

The European Commission ruling that Apple should pay €13 billion of Corporation Tax to Ireland has been met with approval in some quarters.  But one problem is that many of those who are approving have a completely different view of how companies should be taxed when compared to the broad logic used by the Commission to reach the €13 billion figure.  It is as if the ruling should be welcomed for the simple reason that it involves more tax (or at least appears to involve more tax).

Would other companies like to replicate the outcome that the ruling reflects?  Absolutely. And particularly for non-US companies as US companies are subject to US tax on their worldwide earnings.  But what about a company in France or Germany?  Would they like to have 60 per cent of their profits taxed at 12.5 per cent in Ireland. You bet they would.

So how can they achieve that?  If we follow the logic of the EC ruling it would be relatively straightforward.

Let’s take a company in France as an example.  The company should aim to have as much of its profits accumulated in a single subsidiary as possible using transfer pricing to maximise the difference between the prices it pays and receives.  There will tax due on the profits on other subsidiaries but the company should be looking for a central ‘hoover’ type subsidiary where as much of the profit as possible is located. 

It could be a company that buys off manufacturing units and then sells on to distribution or retail units or even final customers.  It doesn’t really matter just as long as it captures the maximum amount of profit possible.

This subsidiary can be in France, it can hold intellectual property (which may be how the profit is allocated to it), it can record sales on its accounts, its board of directors can stay in France, its accounts can be maintained in France and its financial assets can be kept in France.  It is crucial though that the company has no employees or physical assets in France.  The company must exist in France “on paper only” (leaving aside the fact that this is  is actually how companies exist).

This subsidiary should then set up a branch in Ireland where the only employees of the subsidiary are located.  The Irish employees implement the decisions of the board of directors.  They can deal with production units within the company and external suppliers.  The can do inventory management on the output to be produced.  They can oversee the logistics of the transport and delivery of the product.  And they can manage the invoicing and payments with customers.

How much profit should be attributed to the Irish branch that undertakes these functions?  Here is the Commission outlining position in the case of the Apple subsidiaries which had their head office in the US and a branches in Ireland with their only employees:

The Commission's investigation has shown that the tax rulings issued by Ireland endorsed an artificial internal allocation of profits within Apple Sales International and Apple Operations Europe, which has no factual or economic justification. As a result of the tax rulings, most sales profits of Apple Sales International were allocated to its "head office" when this "head office" had no operating capacity to handle and manage the distribution business, or any other substantive business for that matter. Only the Irish branch of Apple Sales International had the capacity to generate any income from trading, i.e. from the distribution of Apple products. Therefore, the sales profits of Apple Sales International should have been recorded with the Irish branch and taxed there.

The "head office" did not have any employees or own premises. The only activities that can be associated with the "head offices" are limited decisions taken by its directors (many of which were at the same time working full-time as executives for Apple Inc.) on the distribution of dividends, administrative arrangements and cash management. These activities generated profits in terms of interest that, based on the Commission's assessment, are the only profits which can be attributed to the "head offices".

Per the EC ruling ALL of the profits of this subsidiary should be “recorded with the Irish branch and taxed there”.  The tax to be allocated to France is nil – except for the interest earned on French bank accounts.

If the company can set up this structure they can get a good chunk of their profits taxed at Ireland’s 12.5 per cent and may not have to pay any more corporate income tax on those profits.

How big a chunk depends on the structure of the company and what it does.  Apple is an unusual case in that so much of its profit is derived from IP – design, brand, reputation, innovation etc.  Its central hoover subsidiary had about 60 per cent of the companies profit accumulating in it.  And per the Commission ruling this 60 per cent of Apple’s profits will be subject to Ireland’s 12.5 per cent rate of Corporation Tax. 

This isn’t much of a gain for Apple as US companies are liable for the US 35 per cent federal corporate income tax on their worldwide earnings (though obviously they can defer this).  But France operates a territorial system.  In theory, at least, this means that French companies are only taxed on their profits earned in France.  Profits earned abroad are not subject to French tax.

So our example company could set itself up with a French subsidiary that has a branch in Ireland and have all the profit of that subsidiary taxed in Ireland as long as the only employees of that company are in Ireland.  And it doesn’t matter how many employees. Just a few will do. 

Now we really have Ireland acting as a tax haven.  Think of the possibilities.  Companies all over the world can set up this central subsidiary that hoovers up as much of their profit as possible (within the confines of transfer pricing regulations).  This subsidiary maintains its board of directors in the home country but sets up a branch in Ireland that has the subsidiary’s only employees.  As long as this is the only “operating capacity” of the subsidiary then ALL of the profits will be allocated to the Irish branch and taxed in Ireland.

This would lead to huge profit shifting and significant exploitation of Ireland’s 12.5 per cent Corporation Tax rate.  Countries with territorial system would see large parts of their tax bases shifting to Ireland.  There is no other country in the world where this would be possible but the application of the EC ruling means that this is what Ireland should do. 

Any time the Revenue are faced with a non-resident company with an Irish branch then 100 per cent of profits of that company should be taxable in Ireland if Ireland is the only country that company has employees in.  This is being a tax haven on a grand scale.

How would the authorities in France react if one of its companies tried to pull this stunt?  They would be up in arms.  And rightly so.  There is no way they would accept Ireland taxing 100 per cent of the profits of that subsidiary just because Ireland was the only country it had employees in. 

They would say to Ireland to look at the branch operating there and collect tax based on the risks, functions and assets in the branch and leave the residual profit with the “head office” for the French to tax.  France will only allow Ireland to collect tax based on what happens in the Irish branch.

But this would put Ireland in contradiction to the EC ruling.  The two paragraphs quoted above clearly state that if the subsidiary only has employees in an Irish branch ALL of the profits are taxable in Ireland.  The Revenue Commissioners are between a rock and a hard place.  To avoid falling foul of further state-aid inquires all branches should be treated as the EC ruling requires but France will only allow Ireland to levy tax on the functions that the Irish branch actually undertakes.

This is why there have been many people saying that the EC ruling “flies in the face of international tax practice”.  But not only does it do that it opens the possibility of Ireland becoming a tax haven of grand proportions.  Maybe we should scrap the IDA and set up an agency with the tagline “set up a branch in Ireland, pay all your tax here”.  For companies in countries that have territorial tax systems it would be hugely attractive.  There could be tens of billions in revenue in it for us (if it was possible, which it is not!).

This is all a bit whimsical.  And although what the Commission have done in the case of Apple goes against all principles of taxation what is here is not enough to say they are wrong on the particulars of that case.  We will come back to that.  But it does highlight the inconsistency of some of the reaction to the ruling. 

If other companies set up structures to try and avail of what the ruling offers they would be accused of tax avoidance by many of those welcoming the ruling.  And they would be right. So, rather than welcoming this ruling, if anything, campaigners should be aghast at what this ruling means.  Do they really want the tax system to function as implied by the two paragraphs quoted above?    

1 comment:

  1. I think this rather misses the point that the Commission has found that the head office of ASI does not actually carry out the management and control functions attributed to it, and on which the attribution of profits to the Irish company is based. It did not make decisions about Apple's global sales, but only about where to route the money.

    In your French example, if the decisions about the company's operations are actually being made in France, that is where tax is applied. The problem is that in ASI's case, according to the Commission, they're not being made where Apple claims they're being made.

    If they're not being made at ASI's head office, then either they're being made at Apple Inc - in which case that's where profits should be attributed, not in ASI - or they're being made in ASI's Irish branch.

    The Commission seems essentially to be forcing Apple to choose between those options. Neither of them, though, open the door to the wholesale tax haven setups you suggest.