By Edmund Honohan
MEDIA ANALYSIS of the EU Commission’s 2016 Apple judgment that Ireland gave the company €13bn in illegal tax aid is half-baked, and the Irish government’s defence even worse. The implications of the judgment are much further-reaching than many realise. The Commission has argued that Apple’s two subsidiary companies in Ireland – ASI and AOE – should have paid Corporation tax here at the full Irish rate of 12.5% on the profits of their businesses between 1991 and 2015. There’s no suggestion from either side in this case that profits on sales of merchandise abroad should be booked abroad and taxed there. In other words, if the EU is right, the entire balance must be paid here and not be subject to some international shareout.
The EU Commission’s judgment refers to a 1991 ruling by Ireland’s Revenue Commissioners which fixed AOE’s net profit at 65% of branch operating costs (sic) up to US $50-60m and 20% above that, and ASI’s at 12.5% of branch operating costs. The basis of capital allowances was fixed in the ruling, but not explained. In 2007, for example, ASI’s bill under the 12.5% liability came to $230m; but, in what was described in the accounts as “an adjustment for income taxed at lower rates”, this was then lowered to $8.9m. Ireland doesn’t want any of that money back, but the EU says the adjustments were State Aid to ASI and AOE and, as such, in breach of Article 107 of the Treaty on the Functioning of the European Union, one of the two main Treaties that underpin EU law.
To be exact, the EU’s argument is that the accepted accountancy approach to the allocation of profits among companies in a group company architecture was neither followed in 1991 nor in the Revenue ruling in 2007, when Apple sought and obtained assurances from the Revenue Commissioners in Dublin as to the basis on which ASI and AOE would be taxed.
The Commission says that all of Apple’s retail business outside of the Americas and Singapore was handled in Ireland, and that the respective head offices of ASI and AOE in the USA were brass-plate addresses with no employees. It adds that any functions performed, or “fictitious remuneration for services provided for free” by Apple Inc employees for ASI and AOE would be outside the scope of the assessment of profit allocation as between ASI, AOE and their respective head offices.
In its 300,000-word decision issued in late 2016, the Commission was deeply critical of instances of poor professional quality in the Irish submissions. In paragraph 353, it notes: “at least three of the 52 companies chosen by PwC as comparables are in liquidation”. But it is even more critical of the actions of Revenue, who issued the rulings, stating that “none of the documents provided in support of the contested tax rulings contain either a contemporaneous profit allocation study or a transfer pricing report”. It later says that Revenue “should have at the very least analysed how that branch’s access to the Apple IP (intellectual property), which it needed to perform its functions, was ensured and set up within the company. There is no evidence that such an analysis was ever conducted”.
The Commission says that in regard to allocation of profits to Irish branches of non-resident companies for the purposes of applying Section 25 of the 1997 Taxes Consolidation Act, “the profit allocation ruling practice of Irish Revenue demonstrates that no consistent criteria are applied”. But the Commission also cites cases of Revenue applying the arm’s length principle, with a Revenue tax advisor in one case confirming the OECD model as “little more than a restatement of the position under domestic law”.
There’s no suggestion here that if a Pear or an Apricot were to come knocking, Ireland could still legitimately offer it the same deal it gave Apple in 1991. Nor does Ireland attempt to approach the case on a collaborative basis, to reconcile differing perspectives. Ireland hasn’t even offered a draft formula for a judgment in its favour, except to say that what we know now about fiscal State Aid was not known then, even by the Commission.
The Commission was not happy with an after-the-event attempt to represent the profit allocation as a bona fide group company accounting exercise, with justifiable transfer pricing, holding that “the fact that the costs of the CSA (cost sharing agreement) were allocated to AOE’s Irish branch by Apple itself should have made Irish Revenue question the unsubstantiated assumption underlying the profit allocation methods ultimately endorsed by it”.
The Commission goes on dramatically: “Even if Irish Revenue had been right to have accepted the unsubstantiated assumption that the Apple IP licences held by ASI and AOE should be allocated outside of Ireland, which the Commission contests, the inappropriate choice of operating expense and the inappropriately low levels of return accepted by Irish Revenue in the application of the one-sided profit allocation methods endorsed by the
contested tax rulings result in an annual taxable profit for ASI and AOE in Ireland that, in any event, departs from a reliable approximation of a market based outcome for their respective Irish branches”.
And in relation to a possible derogation if justified by the nature or general scheme of the tax system: “Ireland has not put forward any justification at all for the selective treatment”, and ”the argument (is) put forward by Apple that ‘the( tax rulings) derive from the intrinsic principles of Section 25 TCA 97’, without further explaining how this is to be understood or how this could justify the selective treatment in this case”.
While it’s an arguable defence that the Commission’s pursuit of fiscal State Aid is in conflict with Member States’ general autonomy in taxation, the last time Ireland intervened in Court to make that point – in a case against Belgium – the Court gave it short shrift. Ireland has also pleaded that even if the accounting was a back-of-an-envelope exercise at the outset, the recalculated, arm’s length, open-books, tax liability for the two companies would have been about the same. The Commission believes otherwise. Applying OECD thinking, it demonstrates shortcomings in the treatment of IP and risk in the proposed counterfactual. In response, Ireland ironically disputes the Commission’s citation of the OECD arm’s length approach as not having yet been formally adopted by the EU.
In an article in a legal journal in 2015, a Commission legal expert, Richard Lyal, wrote that: “There is nothing novel or unconventional in deployment of State Aid control in the manner adopted by the Commission in these decisions, irrespective of the particular background. What the Commission can and must do is check that transfer pricing methods which depart from the norm – where national legislation permits taxpayers to propose alternative methods – nevertheless arrive at a result which is a good or at least a defendable approximation of a market price”.
Now note the damning subtlety of the Commission’s next argument: “It is the endorsement by the Irish Revenue of the profit allocation method pro- posed by Apple to determine the taxable profit of ASI and AOE in Ireland that gives rise to a selective advantage, not the exercise of discretion as such in endorsing these methods”.
There is no doubt but that the Apple deal was a coup for the IDA, and a celebrated one. Perhaps Revenue endorsed Apple’s offer thinking its statutory discretion was unfettered. It certainly looks like that, because the ex post facto rationalisation is so technically weak.
Ireland’s weak argument is reflected where the Commission notes that “Ireland points out that the so-called ‘Double Irish’ tax structure is not, and was never, part of the Irish tax regime, but rather an international tax planning arrangement designed and developed by tax and legal advisors”.
Will this be the Irish defence when the Commission comes to look at the mutant vulture fund strain of the Section 110 tax avoidance, which allows special-purpose vehicles to facilitate more profit-shifting through non-arm’s length financing, and which was developed by the same tax and legal advisers for vulture funds after the crash? And will it be their defence for the Qualified Investor Alternative Investment Fund tax avoidance industry, the recent concern of tech-summit guru Paddy Cosgrave, who warned that the QIAIF, in its various guises, has the potential to hollow out the corpo- rate tax base altogether? Effectively, self-assessment with no questions asked.
With QIAIFs, the Revenue’s tax-ruling “discretion”, so obviously the elephant in the room in the Apple case, returns with what somebody must think is a perfect smoke screen: this time, the discretion will be not Revenue’s but the Central Bank’s, outside the purview of freedom of information scrutiny.
The Minister for Finance now has a new concern about what he calls “aggressive” tax avoidance. We used to call that tax evasion. Blaming those who exploit Irish law, and not the law itself, seems a tenuous defence.
Edmund Honohan is Master of the High Court. He is writing in a personal capacity.
Image by Faye Larkin.