On Tuesday, August 30, the European Commission ruled that Apple Inc. ("Apple") has received illegal state aid through its advanced pricing agreements with Ireland. However, Apple and Ireland believe the advanced pricing agreements are in line with both Irish and European Union law, and thus Irish Ministers have agreed to appeal the ruling. Nonetheless, the EU's ruling seems to demonstrate once again the EU's initiative to curb tax deals that smaller EU states offer multinational companies in order to lure economic investment.

I. Background

a. EU Commission Investigating the Tax Rulings of Member States

Since June 2013, the EU Commission has been investigating the tax ruling practices of Member States. It extended this information inquiry to all Member States in December 2014. In October 2015, the Commission concluded that Luxembourg and the Netherlands had granted selective tax advantages to Fiat and Starbucks, respectively. In January 2016, the Commission concluded that selective tax advantages granted by Belgium to 35 multinationals, mainly from the EU, under its "excess profit" tax scheme, are illegal under EU state aid rules.

In June 2014, the EU Commission launched an investigation into whether the tax arrangement between Apple and Ireland constituted illegal state aid. At the center of the EU's investigation were two advanced pricing agreements ("APAs") between Apple and Ireland.

b. Advanced Pricing Agreements

An APA is an agreement between a taxpayer and a taxing authority regarding what amounts should be charged for goods and services provided between related parties/companies, generally referred to as "transfer pricing." A multinational corporation's transfer pricing is important because it determines how much income will be sourced to a particular country, and thus transfer pricing ultimately affects a multinational's taxable income in a particular country as well.

There are many motivations that drive taxing jurisdictions and multinationals to enter into APAs. The first is predictability: by entering into an APA, a multinational corporation can benefit from a level of certainty and predictability with regard to its transfer pricing. That is, it can be sure that its sourcing of income will be respected by a particularly jurisdiction, and not challenged through administrative or court proceedings. From a tax authority's perspective, APAs can also present an opportunity to grant multinational corporations so called "sweetheart tax deals," whereby the taxing authority agrees to taxpayer friendly transfer pricing, thus reducing the multinational's tax exposure in the jurisdiction. The benefit provided to the taxing authority is that the multinational will likely invest large amounts of capital into the taxing authority's jurisdiction, thus boosting the jurisdiction's economy.

c. The EU Commission's Crackdown on Abusive APAs

The EU Commission's investigations of the taxing arrangements of Member States is motivated by a belief that some multinational corporations do not pay their fair share of tax. In terms of APAs and other transfer pricing arrangements, the EU Commission is concerned about multinationals' ability to syphon profits away from high tax jurisdictions, and into jurisdictions where the multinationals have entered into a favorable APA, the net effect of which is that some multinational corporate profits are taxed at very low rates, if taxed at all.

II. The Commission's Tax Ruling against Ireland and Apple

In its ruling, the EU Commission has concluded that two APAs issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991.

It is the Commission's belief that the APAs between Ireland and Apple endorsed a way to establish the taxable profits for two Irish incorporated companies of the Apple group (Apple Sales International and Apple Operations Europe), which did not correspond to economic reality because almost all sales profits recorded by the two companies were internally attributed to a "head office". The Commission's assessment showed that these "head offices" existed only on paper and could not have generated such profits. That is, the profit attribution to the "head offices" did not reflect economic reality and thus lacks justification. Further, the profits allocated to the "head offices" were not subject to tax in any country under specific provisions of the Irish tax law. As a result of the allocation method endorsed in the tax rulings, Apple only paid an effective corporate tax rate that declined from 1% in 2003 to 0.005% in 2014 on the profits of Apple Sales International.

According to the Commission's ruling, the selective tax treatment of Apple in Ireland is illegal under EU state aid rules because it gives Apple a significant advantage over other businesses that are subject to the same national taxation rules. The Commission can order recovery of illegal state aid for a ten-year period preceding the Commission's first request for information in 2013. Consequently, the ruling requires Ireland to recover the unpaid taxes in Ireland from Apple for the years 2003 to 2014 of up to $14 billion, plus interest.

III. Despite Ireland's Appeal, Here are Some Likely International Tax Consequences

First, the Commission's ruling certainly represents, once again, the EU's crackdown on abusive tax regimes which favor multinational corporations. Indeed, there is no reason to believe that the Apple ruling will be the last high profile tax ruling issued by the EU Commission; multinationals should continue to expect EU scrutiny of preferential tax arrangements. Furthermore, the Commission's ruling could potentially trigger closer scrutiny of corporate structures in other countries, because the Commission in its ruling has specifically invited Member States to apply a higher level of scrutiny to corporate structures.

Second, the Apple ruling is also an example of the global trend to emphasize substance. In the October 2015 issued OECD BEPS Final Reports, Action 5 recommends that taxing jurisdictions limit preferential intellectual property regimes to companies that can demonstrate a certain level of substance in the jurisdiction. Similarly, the Commission's ruling against Ireland and Apple focuses on the lack of substance with regard to the "head office" allocation of profits.

Third, the US Department of the Treasury, in its White Paper dated August 24, 2016, expressed its concerns relating to the EU Commission's investigation of state aid and transfer pricing rulings. In its White Paper, Treasury focuses on the following problematic concerns: (i) the Commission's approach is new and departs from prior EU case law and commission decisions; (ii) the Commission should not seek retroactive recoveries under its new approach; (iii) the Commission's new approach is inconsistent with international norms and undermines the international tax system. In light of these concerns, Treasury believes that the "Commission's path runs the risk of the EU being perceived as having used its unique structure to undermine and reverse international progress." In particular, Treasury expresses apprehension that the EU's actions may undermine the progress made by the BEPS initiatives.

Last, the Commission's ruling may prompt non-EU jurisdictions to change their taxing regime in order to lure companies like Apple and others. For example, some commentators speculate that the UK could cut corporate tax rates, and make other tax changes, in order to attract major multinational companies. If this or other options materialize, this would validate Treasury's concerns as various jurisdictions may abandon BEPS and other reform initiatives in favor of luring multinationals with attractive tax regimes.

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