European Commission finds that Ireland has granted unlawful State aid to Apple

Tax and legal Alert, September 2016, Issue 4

Recently the European Commission (EC) announced in the news the adoption of its final decision in the formal State aid investigation into the profit attribution arrangements and corporate taxation of Apple in Ireland. It has concluded that, in its opinion, Apple benefitted from unlawful State aid granted by Ireland, and it orders full recovery of the aid in an amount of up to €13 billion plus compound interest.

However, the EC has clearly stated that the decision does not call into account Ireland’s general tax system or its corporate tax rate and notes also that no other companies in Ireland are subject to this decision.

Background

The EC’s investigation related to two rulings on the attribution of profits to the Irish branches of two Irish incorporated, non-resident companies ultimately owned by Apple Inc. These rulings were granted in 1991 and 2007.

The EC’s position is that the agreements made between the taxpayer and Ireland do not reflect economic reality as regards the profit attribution. The EC concluded the rulings deviated from the arm’s length principle in a manner which was selective and thus constituted unlawful State aid.

Key aspects

The EC has focused on a number of aspects of the rulings on Apple Operations Europe (AOE) and Apple Sales International (ASI) which it considered to be of key relevance for further analysis and in its final decision, it notes that, in its view:

• the tax rulings issued by Ireland endorsed an artificial internal allocation of profits within ASI and AOE which has no factual or economic justification;
• most sales profits of ASI were allocated to its “head office” when this “head office” had no operating capacity to handle and manage the distribution business;
• the sales profits of ASI and AOE should have been recorded with the Irish branches of ASI and AOE and taxed there;

the only activities that associated with the “head offices” were decisions taken by its directors on the distribution of dividends, administrative arrangements and cash management.

On this basis, the EC concluded that, in its view, the tax rulings issued by Ireland endorsed an artificial allocation of Apple’s sales profits to their “head offices” enabling Apple to pay substantially less tax than other companies which is unlawful under EU State aid rules. The full reasoning of the EC will only be apparent when the detailed non-confidential decision is published. This is likely to take several months.

Next steps

The EC has ordered Ireland to recover the unlawful aid from Apple as outlined above. However, the EC has also stated that the amount of unpaid taxes to be recovered by Ireland could be reduced if other countries were to require Apple to pay more taxes on the profits recorded by each entity. The recovery order is subject to a limitation period of ten years.

The Irish Government has stated publically that it will contest the negative decision. Under EU State aid law, both Apple and the Irish Government can challenge the validity of the decision and ask for its annulment before the EU’s General Court. The judgment of the General Court can in turn be appealed before the EU’s Court of Justice which will ultimately have the final say on the merits of the EC’s decision which could take several years. It should be noted however that an appeal does not suspend recovery procedures and Commissioner Vestager indicated that the amount of the aid could be paid into an escrow account pending the outcome of any appeal.

PwC Takeaway

The EC is clearly focused on the fact that a large proportion of the profits generated from sales across the EU were not subject to tax anywhere.  On this basis, coupled with the limited activity at the head office, the EC appear to be saying that residual profit should be taxed in Ireland rather than allocated to the head office.

It is not clear to what extent this is consistent with, for example, the OECD guidelines on branch profit attribution and how that interacts with the State aid analysis. We will need to wait for the detailed decision to answer this important question.