The Apple State-Aid saga reached a surprisingly abrupt conclusion a few weeks ago. While not a huge surprise that the EU’s highest court, the CJEU, took a position closer to the Commission’s original finding of State-Aid – the opinion of the Advocate General indicated this was the direction the court may go - the decisiveness of the court’s ruling was surprising.
Rather than kick the case back to the lower court and give guidance to its deliberations, the EU’s top court issued a “final judgement in the matter”. And this final judgement “confirms the European Commission’s 2016 decision: Ireland granted Apple unlawful aid which Ireland is required to recover“. There is no avenue to appeal this decision.
Here we will pull together a collection of thoughts on the case:
- Three entities and two circles
- The activities of the Irish branch
- The profit generated from procurement, sales and distribution activities
- Would you accept a 12.5 per cent margin on costs?
- All changed, changed utterly
- The residual claimant: the head office
- The tax provisions of Apple Inc. and deferred tax
- The U.S. triggers the payment of the deferred tax
- The ECJ cuts Apple’s U.S. tax bill
- It’s not stateless income, it’s ours
- An instrumentality of the parent
- What if LVMH tried this court-approved profit shifting?
- What next?
1. Three entities and two circles
At its heart, the Apple case involves three entities.
- Apple Inc., the group’s overall parent and two components within Apple Sales International, a subsidiary within the Apple group,
- ASI’s head office, which was located in the United States, and
- ASI’s sole branch, which was in Ireland.
The crux of the case is how these three entities can be covered by two non-overlapping entities. How one draws these circles plays a key role in how their tax outcomes are assessed. Given the hierarchy of the entities there are two possible approaches.
The first is to do it by location. Apple Inc. and ASI’s head office are both in the United States, with ASI’s branch being located in Ireland so we could draw the circles like this:
This was the approach preferred by Ireland through both the Revenue Commissioners and the legal case put forward, the EU’s lower court, and by Apple, at least for Irish tax purposes. These means viewing the activities of the Irish branch on a standalone basis.
The second approach is to do it by distinct legal entity with the two components of ASI viewed jointly.
This is the approach preferred by the Commission and now, decisively, by the EU’s top court. It is also the approach that had approval, at least implicitly, from the U.S. tax authorities.
Where one draws these circles ultimately decides on where one’s position on the case will lie. The circles determine which activities and functions are taken into account when determining the profit of the Irish branch which is key to the case.
2. The activities of the Irish branch
The activities of the Irish branch are not in dispute. As described in the latest judgement this was:
ASI’s Irish branch is responsible for, inter alia, carrying out procurement, sales and distribution activities associated with the sale of Apple-branded products to related entities and third-party customers in the regions covering Europe, the Middle East, India and Africa (EMEIA) and the Asia-Pacific (APAC).
These are important, but relatively mundane functions, for a technology company such as Apple. The relevant provision of the Irish tax code for taxing a branch of a non-resident company is Section 25(2)(a):
25 (2) For the purposes of corporation tax, the chargeable profits of a company not resident in the State but carrying on a trade in the State through a branch or agency shall be—
(a) any trading income arising directly or indirectly through or from the branch or agency, and any income from property or rights used by, or held by or for, the branch or agency, but this paragraph shall not include distributions received from companies resident in the State, and
And this is the crux of the case. How much profit did the Irish branch of ASI make? When Apple came to Ireland first in 1980 this wasn’t an issue as Apple was able to avail of the zero effective tax under Ireland’s Export Profit Tax Relief. The amount of profit didn’t matter as any number multiplied by zero is going to give zero.
3. The profit generated from procurement sales and distribution activities
The amount of profit earned by the Irish branch did matter when Apple was required to move to the 10 per cent Corporate Tax rate for “manufacturing” in 1991. The latest judgment summarises what happened then, noting that the company that became Apple Sales International, ASI, was then known as Apple Computer Accessories Ltd, ACAL:
15 By letter of 2 January 1991, the Apple Group’s tax advisors informed the Irish tax authorities of the existence of ACAL, the Irish branch of which was described as being responsible for sourcing from Irish manufacturers products intended for export.
16 On 16 January 1991, the Apple Group’s representatives sent a letter to the Irish tax authorities summarising the terms of the agreement which had been concluded during a meeting between that group and those authorities on 3 January 1991 as regards the determination of ACAL’s chargeable profit. According to that letter, the calculation of the branch’s profit was to be based on a margin of 12.5% of branch operating costs, excluding material for resale.
17 By letter of 29 January 1991, the Irish tax authorities confirmed the terms of the agreement as expressed in the letter of 16 January 1991.
So, ASI’s Irish branch was to have a profit margin of 12.5 per cent of its operating costs. That might look modest now when viewed through the lens of a global behemoth making over $2 billion of pre-tax profit a week but by the mid-1990s Apple was on the verge of bankruptcy. In both 1996 and 1997, Apple recorded operating losses of over $1 billion. These wouldn’t be cumulatively offset by operating profits until the middle of 2005.
In 2007, the base on which the profit of the Irish branch was amended but the margin remained unchanged. The previous year Apple as a whole had an operating income of $2.4 billion. Paragraph 320 of the ECJ judgement gives us their view of the Irish branches willingness to provide the above described services at a profit margin of 12.5 per cent:
320 In the present case, the Commission did not err when it found, in recital 221 of the decision at issue, that Ireland had renounced tax revenue from ASI and AOE since the contested tax rulings endorse methods for allocating profits which produce an outcome that separate and standalone undertakings operating under normal market conditions would not have accepted. Those tax rulings reduce the chargeable profits of ASI and AOE for the purposes of applying section 25 of the TCA 97 and, therefore, the amount of corporation tax which they are required to pay in Ireland, as compared to other companies taxed in Ireland whose chargeable profits reflect prices determined on the market in line with the arm’s length principle.
The court found that Section 25 of the Taxes Consolidated Act was not applied correctly because, in their view, the outcome that resulted would not have been accepted by independent entities operating under normal market conditions, i.e., the 12.5 per cent profit margin was a violation of the arm’s length principle.
Combining figures from the US Senate Investigation and the Commission’s State-Aid Decision we can get see the outcomes that resulted for the Irish branch:
We can see that the turnover of the branch was around €500 million in each year from 2010 to 2012. It is likely that some of this is excluded from the base used to calculate the profit of the branch but can see that the branch had a profit that averaged €42 million per annum from 2009 to 2012. Irish Corporation Tax was levied on these profits giving the effective rates in the final column.
4. Would you accept a 12.5 per cent margin on costs for supplying these services?
One way to look at this is whether you as an independent operator would enter a contract to provide procurement, sales and distribution services to Apple on a similar basis. Would I accept a 12.5 per cent profit margin on my costs and an average profit of €40 million per annum? Sign me up!
Apparently though, per the Commission and the ECJ, I should be concerned with what the head office of ASI did or did not do - and completely uninterested in what Apple Inc. did or did not do.
When the Commission examined this they concluded that “all profit from sales activities, other than the interest income obtained by ASI and AOE under normal market circumstances, should have been allocated to the Irish branches of ASI and AOE.”
Through a cost-sharing agreement with Apple Inc., ASI had a license to sell Apple products in all markets outside the Americas. In rough terms, these regions accounted for 50 per cent of Apple’s sales over the period covered by the state-aid finding, essentially Apple’s financial years from 2004 to 2014.
In that period Apple had a cumulative operating profits of nearly $240 billion. Half of that is $120 billion. If we convert to euro we would get around €105 billion, which when multiplied by 12.5 per cent gives the €13 billion headline-grabbing tax amount.
OK, so if I was willing to sign up to provide procurement, sales and distribution services for Apple’s sales outside the Americas for a profit of €40 million per annum, would I sign up for 50 per cent of Apple’s global profits? I guess that depends on when you put the offer in front of me. It would not have been so attractive in the 1990s when Apple was recording operating losses in excess of one billion dollars a year – with my share of that being half a billion a year.
Sure, by 2006, Apple had generated annual operating profits of $2.4 billion but as recent as 2003 it had recorded an operating loss, albeit a small one. There was an operating loss of close to $350 million in 2001. Would I take a guaranteed 12.5 per cent margin on my support services provider or take a punt on a full profit-share of a subsidiary in a volatile company in a volatile sector?
This isn’t really as clear cut as the Commission and ECJ might have us think. There are no black and white answers when it comes to such choices, which in turn translates into plenty of grey areas when it comes to applying the arms-length principle.
The cost-plus approach guaranteed that there would always be profit in Ireland. So, when Apple itself was generating annual losses of more than $1 billion in the mid-1990s, the Irish branch was reporting positive profits and paying Irish Corporation Tax. Even by 2006, with operating losses not long in the rear-view mirror, the 12.5 per cent cost-plus margin might well have seemed pretty attractive.
5. All changed, changed utterly
Of course, we all know what happened. On the 9th of January 2007, Steve Jobs revealed the iPhone with the product going on sale in June of that year. European sales began in November 2007.
This utterly changed the landscape. By 2009, Apple was generating an operating profit of $1 billion a month; by 2012 it was $1 billion a week. Here is the performance of Apple Inc. for the period covering the State Aid case: the financial years from 2004 to 2014. Click to enlarge.
Within ASI, the annual profit before tax went from $1 billion in 2006 to $25 billion in 2014.
The Commission, and now the ECJ, have found that if the Irish branch was a “separate and standalone undertakings operating under normal market conditions” it would not have entered into an arrangement to provide procurement, sales and distribution services to Apple unless it was paid the $1 billion of operating profit of ASI in 2006 and pretty much 100 per cent of ASI’s profit thereafter, summing to over €100 billion across the period in question.
The only part of ASI’s profit not attributed to the Irish branch was the relatively minor portion due to interest earned on ASI’s main bank accounts – as the board of directors at the head office had given direction on how these was to be managed.
Though this was pretty much the only actions linked to profits found in the minutes of the board meetings of ASI. Per the US Senate Investigation of May 2013 we learned that “Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in California.”
It was the board of ASI who entered the cost-sharing agreement with Apple Inc. that gave the rights to ASI to see Apple products in all markets outside the Americas. A cost-sharing agreement is a risky undertaking. As part of the agreement, the board of ASI agreed to cover a proportion of Apple Inc.’s research and development costs. The US Senate investigation gave the details of these payments for a number of years:
Paying these amounts to be left with whatever interest might be earned on the company’s bank accounts does not seem like something someone operating under normal market conditions would accept.
6. The residual claimant: the head office
Under the approach envisaged by Apple, the residual claimant of the profits of ASI would accrue to the head office – with the Irish branch remunerated on a fixed basis for the functions it carried out. The head office was located in the United States. As we have noted before, this was commented on by Senator Carl Levin in his opening statement to the May 2013 US Senate Hearing:
“Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in California.
In short, these companies’ decision-makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States.”
The question then arises as to why didn’t the U.S. levy tax on the profits of the U.S.-based head office of ASI. That is slightly the wrong question. The U.S. did tax the profits of ASI – the U.S. had a worldwide tax system that levied U.S. tax on the worldwide profits of U.S. MNCs. The key question is why didn’t the US collect the tax that was due.
This goes back to the old chestnut of deferral and repatriation. Under the old U.S. corporate tax regime, U.S. MNCs could delay the payment of some of their U.S. corporate income taxes until the profits were repatriated back to the U.S. This meant until the profits were transferred to a U.S. registered entity with the MNC group. And ASI, of course, was an Irish-registered company.
7. The tax provisions of Apple Inc. and deferred tax liabilities
Over the period 2004 to 2014, Apple Inc. recorded a cumulative pre-tax profit of $243 billion. Of this $89 billion was described as “domestic income”, that is earned with the U.S. for U.S. tax purposes with the remaining $154 billion described as “foreign income”. We know that the bulk of this foreign income was generated by ASI and is described as “foreign” even though it accrued to the U.S. head office of ASI.
Apple’s tax affairs have generated significant interest, in particular, the very low tax rates reported on its foreign income. Over the same period, Apple made a provision for foreign, i.e. non-U.S., corporate income taxes of $4.9 billion. With that $154 billion of income, that gives an effective foreign tax rate of just 3.2 per cent, with this falling as low as 1.2 per cent in 2010.
What can occasionally get missed, is that Apple’s domestic tax rate is also noteworthy. Again, looking at the same period, Apple’s annual reports show that it had a provision for domestic, i.e. U.S. federal and state, taxes of $58.7 billion. With a domestic income of $89 billion, this gives an effective domestic tax rate of 65.9 per cent, with this reaching as high as 78.2 per cent in 2010.
How could Apple have a domestic tax rate of nearly 80 per cent when the rate of the federal corporation income tax was 35 per cent during this period with state and local taxes adding no more than another three or four per cent?
The reason is because Apple’s provision for U.S. taxes included a provision for tax on the income earned by ASI. This is “foreign” income but U.S. tax is due on it and would be paid if Apple transferred the profits to a U.S. incorporated entity within the company. Of course, Apple had no need to do this but were indicating to shareholders that not all of the profit generated would be available for distribution as dividends.
We can see this if we look at the tax items in the earlier table of Apple Inc.’s performance over the period 2004 to 2014. Cumulatively over the period, Apple had tax provisions of $63.5 billion but made cash tax payments of $43.5 billion. The reason for the difference is set out in the accounts.
The Company’s effective tax rates for all years differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings, a substantial portion of which was generated by subsidiaries organized in Ireland, for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S. As of September 27, 2014, the Company had deferred tax assets arising from deductible temporary differences, tax losses and tax credits of $5.1 billion and deferred tax liabilities of $20.3 billion.
The Company’s consolidated financial statements provide for any related tax liability on undistributed earnings that the Company does not intend to be indefinitely reinvested outside the U.S. Substantially all of the Company’s undistributed international earnings intended to be indefinitely reinvested in operations outside the U.S. were generated by subsidiaries organized in Ireland, which has a statutory tax rate of 12.5%. As of September 27, 2014, U.S. income taxes have not been provided on a cumulative total of $69.7 billion of such earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $23.3 billion.
As stated above, Apple did not provide for U.S. taxes on $70 billion of its foreign income but did so for the remainder. This resulted in a deferred tax liability of $20 billion, which is the U.S. tax due, net of credits for any foreign taxes paid. It was always clear that the profits of ASI were subject to U.S. tax but the U.S. had a very weak system for actually collecting it.
8. The U.S. triggers the payment of the deferred tax liabilities
With the passing of the Tax Cuts and Jobs Act (TCJA), the U.S. set about collecting tax on the accumulated foreign profits of its MNCs. In its case, Apple noted the following in its 2018 annual report:
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (the “Act”), which significantly changed U.S. tax law. The Act lowered the Company’s U.S. statutory federal income tax rate from 35% to 21% effective January 1, 2018, while also imposing a deemed repatriation tax on previously deferred foreign income.
As of September 30, 2017, the Company had a U.S. deferred tax liability of $36.4 billion for deferred foreign income. During 2018, the Company replaced $36.1 billion of its U.S. deferred tax liability with a deemed repatriation tax payable of $37.3 billion , which was based on the Company’s cumulative post-1986 deferred foreign income.
After 2014, Apple increased its deferred tax liability on its “foreign” earnings by around $5 billion a year and this gave the $36.4 billion amount for the end of the 2017 financial year referred to above. The TCJA introduced a deemed repatriation tax where the profit of U.S. MNCs on which the payment of the U.S. tax due was deferred was deemed to be repatriated to a U.S.-registered entity.
In line with the name of the Act this was at a significantly lower rate than if the 35 per cent federal rate had been paid when the profit had been earned, rather than deferred. For Apple, the effective rate of the deemed repatriation tax was around 15 per cent. This means that there was around $21 billion of U.S. tax due on the $154 billion of foreign income earned by Apple in the period from 2004 to 2014. This is a gross liability of around $23 billion minus tax credits for tax paid abroad of around €2 billion.
It was not by design but the amount of the deferred tax liability Apple had in 2017 and the amount due under the deemed repatriation tax was pretty similar. This would not have been the case if Apple had provided for the U.S. due on a lower or higher share of its foreign income.
9. The ECJ cuts Apple’s U.S. tax bill
Related to this is a note Apple released on the date the ECJ’s ruling was delivered. In the note, Apple said:
On September 10, 2024, the ECJ announced that it had set aside the 2020 judgment of the General Court and confirmed the Commission’s 2016 State Aid Decision. As a result, the Company expects to record a one-time income tax charge in its fourth fiscal quarter ending September 28, 2024, of up to approximately $10 billion, which will increase the Company’s effective tax rate for the quarter.
What is interesting here is that Apple indicates that the State Aid finding will add around $10 billion to its tax bill rather than the headline amount which would be around $15 billion. This is because the payment of this tax to Ireland will reduce the amount of tax Apple has to pay to the U.S.
As this tax is due under the deemed repatriation tax, the foreign tax credits that Apple can claim are based on the ratio of the federal corporate income tax rate that applied at the time the profit was earned (35 per cent) and the effective rate of the deemed repatriation tax (15 per cent). In the case of Apple, they will be able to claim a tax credit for around one-third of the foreign tax paid. So, if Apple pays $15 billion of tax to Ireland, they will claim a U.S. tax credit of $5 billion, thereby giving the net $10 billion increase in their taxes.
The EU’s State Aid finding will have reduced U.S. tax revenues by $5 billion.
10. It’s not stateless income, it’s ours
The likelihood of this was discussed shortly after the Commission launched its State Aid investigation. Here is former U.S. Assistant Treasury Secretary Bob Stack during an appearance before the U.S. Senate Finance Committee in 2016:
Mr Warner (D): I wanted to ask as well, I know Senator Wyden raised the question of the European Union state aid cases and the overall impact because of potential targetting of American companies and what that impact is for American taxpayers.
Mr. Stack could you kind of walk through that just of terms if a taxpayer was sitting in front of you, how does it affect me ultimately or how could it potentially affect that taxpayer.
Mr Stack: Sure Senator. When a US company pays a tax in a foreign jurisdiction and then they bring money home they get a credit for the tax paid in a foreign jurisdiction up to a certain limit.
Now, in the normal case that means you are actually doing some business in Germany, let's say, and you had some tax and you brought it home and you got your credit. In this fact pattern, the EU is coming along and they're saying "Oh we think when you cut your deal with Ireland or Luxembourg or the Netherlands that in fact you, the company, should have been paying more tax to those jurisdictions."
Now if we were to determine that those payments are in fact taxes and we were to determine that they are creditable under our rules, now when that money comes home from those companies in addition to the credit they got for the tax they originally paid in those jurisdictions they get an extra credit. And that credit to this taxpayer you asked me about means in effect the US Treasury got less money and in effect made a direct transfer to the European jurisdiction that is getting the ruling from the Commission.
So if these turn out to be creditable taxes it is the US taxpayer that are footing the bill for these EU investigations.
He later added:
Mr Stack: We were faced with a choice as to whether speak up now before multi-billion dollar judgements are rendered against our companies or wait until the decisions have been handed down so we have been raising this issue today.
From my personal observation of these cases and study it appears to me that the Commission is attempting to tax income that really under international standards doesn't belong to any member and, I agree with you, my perception is that they are trying to tax the income that they perceive as untaxed because it has been deferred for US tax and they see it as something that is there for the taking because our system has let it set offshore without being taxed. So that's my perception of the substantive state of those cases. They have ways to go; I could be wrong. But that's the way I see them today.
A similar point was made by another former U.S. Treasury official, Pam Olson, at the 2015 OECD Conference on International Tax:
“The ‘stateless income’ that is so often referred to is in fact the un-repatriated profits of U.S. companies. ... The reality is stateless income isn’t stateless at all — it’s ours, and we have merely delayed taxing it until it’s repatriated. It is nothing for the rest of the world to be obsessed over.
But obsessed over it we are. And now Ireland will collect tax on it. But there have been suggestions that the U.S. should not have left things go this far and should already have collected the tax on these profits. Again, we go back to Sen. Carl Levin at the U.S. Senate hearing.
11. An instrumentality of the parent
Sen. Levin also draws circles and like the Revenue Commissioners in Ireland he does so on a geographic basis. His view is probably best represented by taking the quote in full.
Sen. Levin (D): Apple is exploiting an absurdity, one that we have not seen other companies use. The absurdity need not continue. Although the United States generally looks to where an entity is incorporated to determine its tax residency, it is possible to penetrate an entity’s corporate structure for tax purposes, and collect U.S. taxes on its income, if the entity is controlled by its U.S. parent to such a degree that the shell entity is nothing more than an “instrumentality” of its parent, a sham that should be treated as the parent itself rather than as a separate legal entity. AOI, AOE and ASI all sure seem to fit that description.
Take AOI. AOI has no owner but Apple. AOI has no physical presence at any address. In thirty years of existence, AOI has never had any employees. AOI’s general ledger, its major accounting record, is maintained at Apple’s U.S. shared service center in Austin, Texas. AOI’s finances are managed by Braeburn Capital, an Apple Inc. subsidiary in Nevada. Its assets are held in a bank account in New York.
AOI’s board minutes show that its board of directors consists of two Apple Inc. employees who live in California and one Irish employee of Apple Distribution International, an Irish company that AOI itself owns. Over the last six years, from May 2006 through the end of 2012, AOI held 33 board meetings, 32 of which took place in Cupertino, California. AOI’s lone Irish-resident director participated in just 7 of those meetings, six by telephone, and in none of the 18 board meetings between September 2006 and August 2012.
ASI’s circumstances are similar. Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in Cupertino.
In short, these companies’ decision makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States. Apple’s tax director acknowledged to the Subcommittee staff that it was his opinion that AOI is functionally managed and controlled in the United States. The circumstances with ASI and AOE appear to be similar.
Our legal system has a preference to respect the corporate form. But the facts here present this issue: Are these offshore corporations so totally controlled by Apple Inc. that their identity as separate companies is a sham and a mere instrumentality of the parent, and if so, whether Apple’s claim that AOI and ASI owe no U.S. taxes is a sham as well?
Although, Sen. Levin sets outs this view that the head office of ASI be considered an instrumentality of Apple Inc., there has never been an indication that the U.S. authorities considered exploring this course of action.
12. What if LVMH tried this court-approved profit shifting?
In paragraph 8 of its June 2014 letter to Ireland announcing that there would be a formal State Aid investigation into the tax treatment of Apple in Ireland, the European Commission stated the following about companies shifting profits to low-tax jurisdictions:
(8) Multinational corporations pay taxes in jurisdictions which have different tax rates. The after-tax profit recorded at the corporate group level is the sum of the after-tax profits in each county in which it is subject to taxation. Therefore, rather than maximise the profit declared in each country, multinational corporations have a financial incentive when allocating profit to the different companies of the corporate group to allocate as much profit as possible to low-tax jurisdictions and as little profit as possible to high-tax jurisdictions. This could, for example, be achieved by exaggerating the price of goods sold by a subsidiary established in a low-tax jurisdiction to a subsidiary established in a high-tax jurisdiction. In this manner, the higher-taxed subsidiary would declare higher costs and therefore lower profits when compared to market conditions. This excess profit would be recorded in the lower-tax jurisdiction and taxed at a lower rate than if the transaction had been priced at market conditions.
Ireland is a low-tax jurisdiction for companies and one might expect the accusation to be that companies report too high a share of their profits in Ireland. However, the crux of the State Aid case was the opposite – that Apple had reported insufficient profits in Ireland.
The Commission’s finding, as upheld by the ECJ, that Apple’s profits in Ireland should be over €100 billion higher. In essence, the finding is that this huge amount of profit should be shifted from ASI’s head office in the U.S. to ASI’s branch in Ireland. Let’s consider what a European company trying to do this might look like.
Consider the example of the French luxury goods conglomerate LVMH named after the Louis Vitton, Moët, and Hennessy brands. In recent years LVMH has been generated pre-tax profits of around €20 billion a year.
Let’s say LVMH establishes an Irish-registered subsidiary and creates an arrangement so that the rights to use its brands in markets outside the EU are transferred to this subsidiary (where we assume 60 per cent of LVMH’s sales are made). The subsidiary can get external producers to make products in LVMH’s range and sell them in markets outside the EU. Due to the value of the brand rights held by the subsidiary the goods are sold at a very significant mark-up above cost.
The board of the subsidiary is made up mainly of the executives of LVMH itself. The board meetings are held and all management functions are undertaken at LVMH’s headquarters in Paris with all the key decisions taken by the executives of LVMH. In accordance with Article 8(2) of the Ireland-France tax treaty this company will not be tax resident in Ireland.
A company shall be regarded as a resident of France if it is managed and controlled in France.
The key decisions taken by the LVMH executive include the choice of external producers to use, the promotion and advertising of the brands, the locations to sell from and the prices to charge. These decisions apply across all the markets LVMH serves and are not recorded in the minutes of the board meeting of the Irish subsidiary. All relatively benign so far.
But let’s now add that the subsidiary has a branch in Ireland with the branch tasked with important support functions for the sale of LVMH products outside the EU. The brand rights are not transferred to the Irish branch and remain with the subsidiary’s head office in Paris.
The branch provides procurement, sales and distribution services for LVMH’s non-EU sales. The Irish branch is the only location where the subsidiary has employees and is the only location within the subsidiary where activities linked to the sale of LVMH products are undertaken.
What should be profit of the Irish branch be?
Under the approach previously applied by the Revenue Commissioners the profit of the Irish branch would be established based on the risks, functions and assets of the Irish branch. The Irish branch does hold significant assets. The most valuable asset, the brands’ intellectual property is held by the head office. The Irish branch does not carry significant risk. This is faced by the executives of LVMH and the decisions they have to make. The functions of the Irish branch are important but routine support functions. A profit based on a mark-up of costs would not appear unreasonable with the residual profits accruing to the subsidiary’s head office where the main decisions influencing the profits generated are made.
But that was the old approach. The new approach must be in line with the judgement of the ECJ in the Apple case. The above is not in line with the judgement. We must consider two elements of the judgment.
- That the functions performed by the executives of Apple Inc. have no bearing on the division of profits between the head office and branch of ASI, and
- That in the absence of evidence, such as board minutes, establishing that decisions were taken and implemented by the head offices of ASI, the profits of ASI should be allocated to its Irish branch.
In our LVMH story it means, that while the decisions of the LVMH executives might dictate the activities of the Irish branch, they have no role in determining the profits of the Irish branch and second, if these decisions taken by the LVMH executives are not recorded in the board minutes of its subsidiary, and the subsidiary’s head office in Paris shows no other functional or operational capacity then all of the profits of the subsidiary should be recorded as profits of its Irish branch.
And there we have it. We have shifted 60 per cent of LVMH’s profit from France to Ireland and all in line with the ECJ’s ruling in the Apple case. There was no need to relocate IP. No need for elaborate transfer pricing reports. Just repeat the fact pattern of the Apple case and rely on the CJEU judgment. Hmmm, that does not seem like a direction we would like things to go.
13. What next? Maybe not much under Section 25 but what about 291A?
Section 25
There are potentially significant consequences from the CJEU ruling. The first is how Section 25 of the Taxes Consolidated Act is to be applied. It is now law that the taxation of branches in Ireland of non-resident companies requires the activities of the entire company to be assessed. It was by assessing the entire company that the court ruled that the profits attributed to ASI’s Irish branch were under-reported.
Up to now, the Revenue Commissioners will have applied Section 25 to branches operating in Ireland by assessing only the activities of the Irish branch. This approach is not in line with the court’s interpretation of how Section 25 should be applied and will need to be discontinued.
As this is now the law of the land, the Revenue Commissioners may to apply it retrospectively in instances where they know that following the approach set out by the CJEU would lead to a different outcome. It is not the Revenue Commissioners’ job to make law it is their job to implement it.
Were there other non-resident companies with Irish branches that involve similar fact patterns to those seen in the Apple case? It is almost certainly the case that there were. Probably many.
If the Revenue Commissioners are aware of these, or have reason to believe that the position could be similar, do they need to go back and review the tax outcomes that arose and ensure that they are in line with the CJEU judgement? Yes.
Will this result in significant changes or additional tax liabilities? Probably not. The reason is the four-year statute of limitations on the Revenue Commissioners re-opening tax returns, bar instances of criminality, fraud or tax evasion. Those do not apply as the error the CJEU have ruled on was made by the Revenue Commissioners not the companies.
The passage of time has seen structures similar to that used by Apple, and other structures used by US MNCs such as the “double irish” phased out. Most of the IP at the heart of such structures was relocated in 2019 and 2020 so that the outcomes before that, which would likely fall foul of the CJEU’s ruling, are now mainly outside the four-year statute of limitations imposed on the Revenue Commissioners.
That doesn’t mean some of these cases may not be revisited. Under state-aid law, the Commission can require that any state-aid conferred on a company must be collected from a date ten years before the Commission announces a formal investigation. If the Commission was to announce an investigation now the relevant period would extend back to September 2014, when we know many of these structures were still in place.
There are no indications that the Commission intends to announce such investigations in other companies and, as time goes on, the window for which such investigations will apply becomes smaller and smaller.
Section 291A
We know what Apple did next. In 2015, Apple relocated the IP at the centre of the state aid case from the ASI head office in California to a company that became Irish resident. This company bought the license from ASI for something in the region of €225 billion. This valuation seems plausible given the annual profits been generated at the time.
Under Section 291A of the Taxes Consolidated Act, a company acquiring intangible assets can offset the capital outlay of purchasing the asset against its income using capital allowances. The TCA sets out how the capital allowances can be claimed. Getting a deduction for capital expenditure is a standard feature of all tax regimes and is not at issue here. What may be at issue is sub-section 7 of Section 291A:
(7) This section shall not apply to capital expenditure incurred by a company—
(a) for which any relief or deduction under the Tax Acts may be given or allowed other than by virtue of this section,
(b) to the extent that the expenditure incurred on the provision of a specified intangible asset exceeds the amount which would have been paid or payable for the asset in a transaction between independent persons acting at arm’s length, or
(c) that is not made wholly and exclusively for bona fide commercial reasons and that was incurred as part of a scheme or arrangement of which the main purpose or one of the main purposes is the avoidance of, or reduction in, liability to tax.
This all seems fairly benign. Paragraph (a) sets out that a deduction for the capital expenditure incurred can only be taken once. Paragraph (b) requires that amount of the deduction not exceed the arm’s length value. Paragraph (c) is the one of interest and sets out that there will be no deduction if the transaction was part of a scheme intended to reduce a company’s tax liability.
This may now have to be looked at in light of the CJEU ruling. Under the old approach previously applied by the Revenue Commissioners, the profit linked to the licenses held by the ASI head office was not subject to tax in Ireland. The court have now ruled that these profits should be subject to tax in Ireland. For 2014, this was about €20 billion of profit and €2.5 billion of tax.
With its restructure, Apple formally moved the licenses to Ireland and the company that acquired them claimed a deduction under Section 291A. This meant that in 2015, this company had a tax bill of nil on the profit linked to the licenses.
So, we now have a situation where ASI owes €2.5 billion of tax to Ireland for 2014 on the licenses it held as the CJEU has ruled that the associated profit is to be attributed to the Irish branch of ASI to one where a company that became Irish resident buys the same licenses from ASI and claims a deduction under S291A of the TCA, thereby reducing its tax bill on those same profits to nil in 2015. Isn’t this something that S291A(7)(c) was designed to prohibit?
It is hard to know where this will go, if anywhere. Under the old approach applied by the Revenue Commissioners there is no issue here. The profits were not located here in 2014 and were not subject to tax here. When the company that bought the licenses relocated here in 2015 it was perfectly reasonable that it would be entitled to a deduction on the capital expenditure it had incurred. But that was under an approach taken that has now been deemed by the CJEU not to comply with the law.
If Apple had a tax liability of €2.5 billion on those profits in 2014 there is no way the Revenue would have allowed a deduction reducing that tax liability to nil in 2015. And through the lens of the CJEU ruling that is precisely what has happened. Given the four-year statute of limitations on the Revenue Commissioners it may not be something they have to revisit.
The Commission, however, can look back as far as they want with any state aid to be repaid going back ten years from the time a formal investigation is initiated. Back in 2017, outgoing Competition Commissioner, Margrethe Vestager, indicated that they were interested in Apple’s 2015 restructure:
"I have been asking for an update on the arrangement made by Apple, the recent way they have been organized, in order to get the feeling whether or not this is in accordance with our European rules but that remains to be seen," Vestager told a news briefing at an international tech summit in Lisbon.
"We are looking into this of course without any kind of prejudice, just to get the information," she said.
No formal investigation was initiated and given the resounding vindication of the Commission’s position by the CJEU, the Commission may not want to open up another front targeting possible state aid given by Ireland to Apple. Getting another €25-30 billion of Corporation Tax for Ireland may not be a priority and they may take the win at the CJEU and move on.
What will be interesting to see is if there is any reaction in the U.S. As discussed above, the ruling means a $5 billion reduction in Apple’s U.S. tax payments. Will this prompt a reaction by say, the IRS? This may also be unlikely because, although ASI’s head office was in the U.S., ASI itself was not a U.S. tax resident and the head office was not deemed a permanent establishment in the U.S., and this means that the IRS cannot lean on the U.S/Ireland tax treaty to support any position it might make. And do the IRS really want to be out arguing that an entity was operating in the U.S. but was outside the domestic U.S. tax base?
All told, it may be that the consequences from the CJEU ruling to Apple itself may be limited to the €13 billion. But what it means for the taxation of MNCs and the application of transfer pricing guidelines will certainly reverberate for some time.
