Has Apple taken the bite out of state aid enforcement?
The European Commission’s (the Commission) main focus has been on individual tax rulings granted by certain Member States to multinationals such as Starbucks, Amazon and Apple, however the UK’s Controlled Foreign Companies (CFC) regime has also been found to be in breach of the state aid rules.
As a result of the Commission’s decisions, Member States have been ordered to recover the “aid” from the companies involved. Given the often eye-watering sums of money involved, many of the companies and Member States have lodged appeals with the European Courts.
Although the Commission was successful in upholding its decision of illegal state aid in the Fiat case, it lost against Starbucks. This has generated even greater interest in the General Court’s judgment of 15 July in which the General Court quashed the Commission’s decision against Apple and Ireland, holding that the Commission had not established to the requisite standard of proof that Apple was in receipt of illegal State aid.
The Commission Decision
In August 2016, the Commission issued a decision requiring Ireland to recover illegal state aid of up to €13bn, the largest single amount of aid ever ordered to be recovered following a state aid investigation. The Commission claimed that aid had been granted to two Irish incorporated, but non-Irish tax resident, subsidiaries of Apple as a result of two tax rulings granted in 1991 and 2007 respectively. The Commission alleged that the tax rulings had enabled the Irish branches of Apple Sales International (ASI) and Apple Operations Europe (AOE) to reduce their taxable profits as compared to other corporate taxpayers, giving rise to illegal state aid.
AOE and AIS manufactured and sold Apple products outside North and South America during the period to which the Commission’s decision applied. Under a cost-sharing agreement with their ultimate parent, Apple Inc, AOE and ASI shared in the economic ownership of Apple’s IP in return for contributions to R&D costs. The Companies were incorporated in Ireland but were centrally managed and controlled in the US. Because of a difference between the corporate residence rules in the US (which focused on place of incorporation) and Ireland (which focused on place of central management and control) both countries treated ASI and AOE as non-resident for tax purposes. This meant the companies’ profits under the cost-sharing agreement were outside the scope of US tax.
From an Irish tax perspective, the taxable profits of AOE and ASI in Ireland were those attributable to their Irish branches. The branches performed manufacturing, procurement, sales and distribution activities. The tax rulings granted by the Irish tax authorities accepted an attribution methodology that taxed a modest margin on the branches’ operating costs, which was substantially less than the IP profits beyond US taxation.
The Commission objected to these rulings and its case was primarily based on the argument that as ASI and AOE lacked the staff and resources to control or manage the Apple Group’s IP licences, they should not have been allocated, in an arm’s length context, the profits derived from the economic ownership and use of those licences. Since ASI and AOE could not have generated these profits, they should instead have been allocated to their Irish branches and taxed accordingly in Ireland. The Commission also argued that even if the Irish tax authority had been correct in allocating the IP assets (and related profits) outside Ireland, the tax rulings still constituted state aid by endorsing a profit allocation method which rested on various errors. Finally, the Commission contended that the tax rulings also gave rise to a selective advantage because they had been issued on an entirely discretionary basis.
The General Court’s key findings
The General Court began by recalling that whilst direct taxation remains a matter for each Member State, that competence must be exercised in a manner which is consistent with EU state aid law. Accordingly, measures which grant certain undertakings a selective advantage through favourable tax treatment can constitute state aid. The Commission was therefore entitled to assess whether Ireland had granted ASI and AOE favourable tax treatment by enabling them to reduce their chargeable profits compared with the chargeable profits of other corporate taxpayers in a comparable factual and legal situation.
Significantly, the Court also held that the “reference framework” used to assess whether ASI and AOE received a selective advantage was correctly identified by the Commission as the ordinary rules of taxation of corporate profits under the Irish corporate tax regime, the objective of which is to tax the chargeable profits of companies carrying on activities in Ireland regardless of whether they are resident, non-resident, vertically integrated or standalone. The Commission was also correct to find that resident and non-resident companies were in a comparable position in the light of the objectives pursued by the Irish corporate tax regime.
In respect of one of the most controversial aspects of the Commission’s case, namely the use of the “arm’s length principle”, the Court rejected the Commission’s argument there is a freestanding obligation under EU state aid law to apply the arm’s length principle in all areas of national tax law, regardless of whether a Member State has incorporated that principle into its national law. The Commission could not simply disregard national rules of taxation but must instead be guided by those rules in determining what constitutes normal taxation. While the Court was not prepared to accept that there is an overriding arm’s length principle under EU state aid law, it agreed with the Commission that under Irish tax law the profits attributed to the trading activity of a branch must correspond to the level of profits that would have been obtained under market conditions. The Commission was therefore entitled to check whether the profits allocated to the branches reflected market conditions. In this specific context the Court accepted that the arm’s length principle is one tool which the Commission could use to assess whether an advantage had been conferred contrary to the state aid rules. The Court also noted that the arm’s length principle was included in certain double taxation treaties between Ireland and other countries (including the US). As such, it was a tool recognised by Ireland, at least in its bilateral relations with those countries and to that extent formed part of the Irish tax regime.
Against this background, the General Court also refused to criticise the Commission for applying the Authorised OECD Approach to assessing an arm’s length transaction, which determines the allocation of profits to permanent establishments (i.e. branches) of non-resident companies. However, the Court concluded that the Commission had failed to apply that test properly to the profit allocation methods endorsed by the Irish Revenue. In particular, the Court held that the mere fact that ASI and AOE had no employees or a physical presence outside their Irish branches to manage the Apple Group’s IP licences did not allow the Commission to jump to the conclusion that it was the Irish branches that managed those licences and therefore should have had the profits generated from their use allocated to them. The Commission could not presume that the management functions related to the Apple Group’s IP licences rested by default with the branches simply because these functions could not be exercised by ASI and AOE. Such an approach was inconsistent with the Irish tax rules and the Authorised OECD Approach to assessing arm’s length transactions.
In order to discharge its burden of proof it was incumbent on the Commission to show that the IP management functions had actually been carried out by the Irish branches. Although there was a cost-sharing agreement involving ASI and AOE head offices and the Irish branches which set out what functions the Irish branches were authorised to perform and the risks they may be expected to assume, the Commission failed to produce any “evidence to show that ASI or AOE, let alone their Irish branches, had actually performed any of those functions”.
Moreover, whilst a key part of the Commission’s reasoning was based on the fact that the ASI head office had no employees, it failed to take into account that ASI’s Irish branch also contained no employees for a considerable part of the period under review. Furthermore, there was no evidence that the branches had actively managed the IP on a day-to-day basis. The branches were mostly carrying out routine and not particularly complex functions and the Court found (contrary to the Commission’s submissions) that strategic decisions were centralised and taken in the US head office, which suggested that the profits generated by the Apple Group’s IP licences should have been allocated to the US (although the Court did not go as far as to say so explicitly).
The Irish branches were responsible for the manufacture and assembly of certain Apple products. However those activities (and the IP generated by such activities) were insufficient to justify allocating all of the Apple Group’s IP licence (and the related profits) to the branches. The Court also concluded that the fact that the minutes of ASI and AOE’s board meetings did not give details of the decisions taken regarding the management of Apple’s IP, or other important business decisions did not mean that the decisions were not taken.
The General Court was equally dismissive of the Commission’s position that the existence of aid could also be inferred from the fact that the profit allocation methods endorsed by the contested tax rulings were vitiated by various errors. Echoing its decision in the 2019 Starbucks case, the Court held that it was not possible to conclude that a tax advantage had been conferred on ASI and AOE simply because there were methodological errors in the approach taken by the Irish authorities. The Commission must prove that the profit allocation in question led to a reduction in the tax burden of the entities compared to the situation if the tax rulings had not been issued. It cannot discharge its burden of proof merely by stating that there have been methodological errors, however regrettable these may be. The Court also emphasised that analysing transfer pricing is not an exact science but requires judgment with the ultimate objective being to find a reasonable estimate of market conditions. In practice, this means that some latitude must be given to the responsible tax authority.
Finally, the General Court was also not prepared to accept that the tax rulings conferred an advantage on Apple because they were issued by the Irish tax authorities on a discretionary basis and were not based on any objective criteria. Even if it could be shown that the tax authorities had such a discretion (which the Court found the Commission had failed to establish), the existence of that discretion did not necessarily mean that it had been used to confer an advantage to the recipient of a tax ruling. Again, it was not open to the Commission to operate on the basis of such a simple presumption in seeking to discharge its burden of proof.
For all these reasons, the Commission had failed to establish to the requisite standard of proof that the tax rulings had resulted in the Irish branches receiving an advantage (i.e. by undervaluing the chargeable profits that should have been allocated to the Irish branches) contrary to the state aid rules.
What now for tax rulings?
The Commission has said that it will carefully study the judgment and reflect on possible steps. It remains to be seen whether the Commission will decide to appeal this judgment to the European Court of Justice, particularly since an appeal only lies on a point of law. It is notable, for example, that the Commission chose not to appeal the 2019 Starbucks case, which reached similar conclusions on the standard of proof that the Commission must meet to establish that a selective advantage (and therefore state aid) has been granted.
The Apple judgment is undoubtedly a blow and a significant PR defeat for the Commission. However, the General Court did not fundamentally challenge the broad analytical framework adopted by the Commission to scrutinise tax rulings. While the Court refused to accept that there is an autonomous “arm’s length principle” under EU law which can be automatically read into the national tax regimes of the Members States, in practice many Member States have incorporated such a principle in their national tax regimes. This is therefore unlikely to be a significant impediment to future investigations.
The greatest impact of the judgment on the future use of state aid principles to tackle perceived unfair tax practices is almost certainly going to be the evidential burden that the Commission must discharge. The Starbucks and Apple cases make clear that the Commission’s ability to rely on legal presumptions is limited and that simply drawing broad assumptions based on departures from established methodologies or the absence of activities in one jurisdiction is not sufficient to establish state aid. The Commission will need to engage in more disciplined, forensic and rigorous investigations in order to discharge its burden of proof. The extent to which the Commission will be willing to invest the significant time and resources that such investigations will inevitably require remains to be seen.
It is also clear that this latest ruling will give encouragement to many of those whose cases are under review by the Commission and where appeals against similar findings are currently pending (e.g. Amazon). Although not directly analogous, it is also likely that those involved in the UK’s CFC case will be heartened by the degree of rigorous scrutiny applied by the General Court to the Commission’s analysis on points of principle as well as by the standard of proof which must be met to establish if, and to what extent, individual companies may, in fact, have benefited from any state aid.
Finally, the Commission has recently stated when publishing its action plan for fair and simple taxation (and before it knew the outcome of the Apple case) that it was prepared to activate all existing policy levers to deliver on the EU’s fair tax agenda, including article 116 TFEU. This provision, which concerns internal market distortions arising from national law or administrative action, authorises the European Parliament and the Council to issue any directives necessary to correct such distortions if these cannot be eliminated through concertation with Member States. Crucially, legislation under Article 116 TFEU requires only a qualified majority of Member States (rather than unanimity) and while Article 116 TFEU is subject to strict conditions and has never been used so far, the Apple judgment could now embolden the Commission to push forward and explore how it can make use of this provision to prevent what it regards as harmful tax competition between EU Member States.