EC takes on Ireland and Luxembourg over tax avoidance

The European Commission has referred the Irish government to the European Court of Justice (ECJ) over its failure to collect more than €13bn (U.S.$15.3bn) in back taxes from Apple, and has also ordered Luxembourg to claim around €250m (U.S.$294m) in unpaid taxes from Amazon.

The move signifies a greater willingness by the Commission to root out corporate tax avoidance and pours fresh doubts on the written assurances that companies have sought—and received—from EU governments that say that their tax affairs are in order.

Ireland was originally ordered to recover the money from the tech giant—a sum equivalent to the country’s entire healthcare budget, or two-thirds of its annual social welfare bill—in August 2016, when the Commission ruled that the Irish government’s light tax treatment of the company amounted to state aid, which is illegal under EU rules. However, the Irish government—which should have taken steps to receive the funds by 3 January—does not want the money, and Apple (unsurprisingly) does not want to pay it.

The Commission had concluded that two tax rulings that Ireland issued to Apple in 1991 and 2007 helped to “substantially and artificially” lower the company’s tax bills for at least 22 years. In fact, the tax treatment that Apple received in Ireland enabled the technology company to avoid taxation on almost all profits generated by sales of its products throughout the entire European Union.

The rulings allowed Apple to channel all of its profits from EU sales (as well as sales from the Middle East, Africa, and India) to its two Irish incorporated companies (Apple Sales International and Apple Operations Europe). These companies then allocated the vast majority of the profits to a “head office” which the Commission found existed only on paper. These profits were not subject to tax in any country under specific provisions of the Irish tax law that were then in place (but which since 2015 are no longer in force).

Consequently, only a small percentage of Apple Sales International’s profits were taxed in Ireland: in fact, it paid just €50m (U.S.$59m) in tax out of a recorded €16bn (U.S.$18.8bn) worth of profits in 2011. By 2013 this figure had dropped to less than €10m (U.S.$11.8m), equivalent to an effective tax rate of about 0.05 percent on its overall annual profits. This decreased further to only 0.005 percent in 2014. The usual corporate tax rate for every other company in Ireland is 12.5 percent—some 2,500 times more.

Despite the €13bn figure, in some respects, Apple got off lightly: there is no fine against a company for receiving state aid, and the Commission can only order recovery of illegal state aid for a ten-year period preceding its first request for information in 2013. Since Apple had enjoyed the benefits of a tax ruling from 1991, it is not liable for 12 years of unpaid tax between 1991 and 2003.

Tax rulings are perfectly legal. They are comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated, or how special tax provisions can be used. And the Commission does not intend to put an end to such rulings, either, despite the obvious problems they have caused. Instead, it has opted for member states to sign up to an automatic exchange of information on tax rulings, and for EU countries to extend their automatic exchange of information to country-by-country reporting of tax-related financial information of multinationals.

“Tax loopholes, differences in tax rules and regulations, and layers of complexity within tax practices and organisational structures make it very difficult to decide how much a company trading across national boundaries owes in tax, and where that tax liability crystalises.”
Professor Louise Gracia, Accounting Group, Warwick Business School

While Ireland has appealed the Commission’s decision from August 2016, under Article 278 of the Treaty of the Functioning of the European Union (TFEU) it is still obliged to recover the money and can place the funds in an escrow account until the ECJ reaches its decision on the appeal. But fourteen months after the Commission’s decision—and ten months after the deadline—Ireland has so far not recovered even part of the money. As such, under Article 260 of TFEU, the ECJ can impose an “appropriate” penalty payment for non-compliance if it finds in the Commission’s favour. The size of the penalty depends on the duration of the infringement, its seriousness, and the ability of the member state to pay.

The Commission has taken firm action against EU member states in the recent past for their failure—or reluctance—to recover state aid given to companies. In 2012 an ECJ judgment forced Spain to make a lump sum payment of €20m (U.S.$23.5m) and a further daily periodic payment of €50,000 (U.S.$59,000) until the government had recovered all the illegal state aid the Commission said had been granted to Magefesa, a Spanish cookware manufacturer. In 2015 the ECJ imposed a €30m (U.S.$35.3m) lump sum penalty on Italy, as well as a further €12m (U.S.$14.1m) fine for every six-month period that the government failed to recover the illegal state aid, in a case relating to certain tax reliefs that were granted to Venice and the coastal town of Chioggia from social security contributions.

Ireland has never accepted the Commission’s analysis in the Apple state aid decision. In a statement, Ireland’s Department of Finance said that it is “fully committed to ensuring that recovery of the alleged Apple state aid takes place without delay.” Ireland has added that it finds the Commission’s actions disappointed and unnecessary, given the progress Ireland feels it has made on complying with EU law.

On the same day that the European Commission took Ireland to task (4 October), the EU’s executive body also took aim at Luxembourg’s favourable tax treatment of online retailer Amazon. Following an investigation that began in October 2014, the Commission has ruled that, as a result of tax ruling issued in 2003 and prolonged in 2011, Amazon has unfairly benefitted to the tune of €250m because almost three-quarters of its profits have not been taxed.

The Commission’s campaign against corporate tax avoidance

Since June 2013, the Commission has been investigating the circumstances under which member states have issued tax rulings to large corporates. It has found that many of these “sweetheart” tax deals are tantamount to state aid, which is illegal under EU rules.
In October 2015 the Commission concluded that Luxembourg and the Netherlands had granted selective tax advantages to Fiat and Starbucks, respectively, and in January 2016 it found that Belgium had granted illegal selective tax advantages to at least 35 multinationals (most of which were EU companies). In August 2016 the Commission concluded that Ireland had granted undue tax benefits of up to €13bn to Apple.
Two other investigations, involving possible illegal state aid to McDonald’s and GDF Suez (now Engie) in Luxembourg, are ongoing.
The Commission is also pursuing ways to ensure greater tax transparency. In January new rules on automatic exchange of information on tax rulings entered into force, and member states have also agreed to extend their automatic exchange of information to country-by-country reporting of tax-related financial information of multinationals. A proposal is now on the table to make some of this information public.
In May the EU adopted new rules to prevent tax avoidance via non-EU countries, completing the Anti-Tax Avoidance Directive (ATAD), which ensures that binding and robust anti-abuse measures are applied throughout the single market.
Other legislation aimed at preventing tax avoidance is in the works. Last October the Commission relaunched its proposals for a Common Consolidated Corporate Tax Base, and this June it proposed new transparency rules for intermediaries (including tax advisors) that design and promote tax planning schemes for their clients. The Commission hopes that the planned legislation will bring about a much greater degree of transparency, as well as deter the use of tax rulings as an instrument for tax abuse.
More recently, in September the Commission launched a new EU agenda to ensure that the digital economy is taxed in a “fair and growth-friendly way”.
—Neil Hodge

“In other words,” said Commissioner Margrethe Vestager, in charge of competition policy, “Amazon was allowed to pay four times less tax than other local companies subject to the same national tax rules.” Luxembourg has four months in which to recover the money.

Vestager found that the 2003 tax ruling underpinning Amazon’s European business structure permitted it to improperly cut taxable European profits by paying intergroup royalties into a non-taxable partnership. The Commission says that the tax ruling “lowered the tax paid by Amazon in Luxembourg without any valid justification” and “did not reflect economic reality.”

The case against Amazon centred on two subsidiaries incorporated in Luxembourg—Amazon EU and Amazon Europe Holding Technologies—which are controlled by the US parent. Amazon EU runs the internet company’s operations in the region, but the Commission describes Amazon Europe Holding Technologies as “an empty shell” that has no employees or offices, but which has been used to bring down the company’s tax bill. Amazon EU group transferred 90 percent of its operating profits to the holding company, and this money was not taxed. As a result, Amazon paid an effective tax rate in Luxembourg of 7.25 percent, compared with the national rate of 29 percent.

Amazon’s blueprint was Project Goldcrest, a tax scheme that Luxembourg gave its approval to in 2003, when Commission President Jean-Claude Juncker served as the country’s prime minister and finance minister. Amazon changed its tax operations in June 2014, a year after Brussels began investigating tax rulings across the European Union. The Commission launched the Amazon investigation in October 2014, just weeks before Juncker took office in Brussels.

Luxembourg and Amazon, which is required to repay the full €250m plus interest, have long denied any wrongdoing and have indicated that they could appeal the decision.

The ramifications of the Commission’s actions are bound to leave some companies perplexed, especially since the Commission’s decisions are not meant to call into question either country’s general tax system or corporate tax rate.  While companies can take comfort that the European Union is keen to preserve fair competition throughout the single market, many are bound to be scratching their heads as to how a sign-off on their tax arrangements by a EU member state can then be overturned over a decade later by the Commission. It could be legitimate for compliance functions to worry that any tax rulings that the company may have might not be worth the paper they are written on. Businesses like certainty, and the Commission’s decision has dented both countries’ images of being low-tax centres.

Professor Louise Gracia of Warwick Business School’s accounting group says that the lack of harmonisation surrounding taxation across the European Union will make it difficult for companies to properly calculate the tax they owe, and how they report tax issues. “Tax loopholes, differences in tax rules and regulations and layers of complexity within tax practices and organisational structures make it very difficult to decide how much a company trading across national boundaries owes in tax, and where that tax liability crystalises,” says Prof. Garcia.

But she adds that “the apathy displayed by some EU partners, such as Ireland, in addressing these tax failures clearly exacerbates matters. While countries continue to collude with these corporate giants, any headway in levelling the tax playing field surely disappears over the fiscal horizon.”