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LIVE FROM MYKONOS, GREECE: the EU/Apple state aid case

Mykonos Little Venice

 

Mykonos Little Venice 2

 

6 September 2016 – I spend four weeks (almost) every summer in Greece. Some years include a digital tech/digital media unconference held in Mykonos that has morphed into a “Big Think” event if you have ever participated in one of those. It has been running for a few years now … not every year … and was started quite by accident by a group of digital media sensei who I have met at the Mobile World Conference and Cannes Lions who happen to be in or near Mykonos almost every summer. We had one over the past weekend while the Yanks officially ended their summer.

The term “unconference” has been applied (or self-applied) to a wide range of gatherings that try to avoid one or more aspects of a conventional conference (such as high fees, sponsored presentations, and top-down organization). It is participant driven. Anyone who wants to initiate a discussion on a topic can claim a time and a space. Our event is pretty open discussion rather than having a single speaker at the front of the room giving a talk. Everybody chips in for costs, and there are multiple venues.

It also follows the advice given to me long ago by Dominique Senequier (she now heads Axa Private Equity in France) who told me the trick to happiness and personal success is to be committed to all aspects of your life and disengage from the daily noise and make time for them. Engage in efforts to obtain broad perspectives. Otherwise you are like fish who do not know they swim in water; we are not aware of the atmosphere of the times through which we move.

The Mykonos event draws an eclectic crowd, here for the summer or for part of it. It draws attorneys, CEOs, managers, developers, executives, tech/tool providers, investors, etc. from a very wide range of companies and institutions, most of them connected to TMT industries, but lately a large percentage of scientists and all-around bright thinkers (yes, they eschew the moniker “thought leader”). No one participates in every event, nor stays for all the days which varies depending on mood (or how late we stayed at the Skandinavian Bar or Katerina’s).

katerina mykonos 1

Bert Deaver, engaging in his own “Big Think”

katerina mykonos 2

Lunch at Katerina’s

NOTE: Katerina Xidaki was the first Greek female boat captain, earning her position waaaay back in the 1950s in a very machismo culture. We are long-time friends. She turned her house into a bar/restaurant in 1991. Her son runs both now but Katerina often makes an appearance. I am producing a video on her life. 

As examples this year we had folks buzz in and out from Amazon, Disney, Deutsch Telekom, Google, IBM, LinkedIn, McClatchy, Microsoft, NY Times, Orange, Telefonica, United Airlines, Universal Music, Viacom, and Warner Music. Plus we had folks from MIT Media Labs and the Swiss Federal Institute of Technology. Plus a U.S. Congressional staff attorney.

For the most part these are unique learning/networking events and conversations and stay off-the-record so I never post names or extensive details. Nobody is here wearing their employer hat, representing their company. If you have ever been to an edge.org dinner or the myriad “Master Class” events put on by high level event organizers – think Chris LaCour and his e-discovery/information governance retreats, or the exclusive DRI corporate counsel events in Zurich – and you know what I mean.

One area we discussed is the damage that the gadget-filled, pharmaceutically-enhanced 21st century is doing to our brains, making us sleepwalk towards a future in which neuro-chip technology could blur the line between living and non-living machines, and between our bodies and the outside world.  It actually took up an entire semester of my neuroscience program at Cambridge and all we could do in Myknonos is skirt about the edges of the issues. But some trenchant comments to come in a subsequent post.

This year I presented two sessions:

  1. A primer on the EU/Apple state aid case, benefiting from last week’s EU Commission decision (full disclosure: I was Principal Researcher on the case for a party-of-interest)
  2. A chat about “enterprise search/e-discovery search” versus “social and contextual discovery” and why the ease-of-use, efficiency and advanced developments of the latter frustrates the users who need the former.

The “search” presentation noted in #2 I will publish next week as part of my artificial series.  For this post, a few comments on state aid.

Apple, tax and state aid

A summary:

  • The European Commission has concluded that Ireland granted undue tax benefits of up to €13 billion to Apple. This is illegal under EU state aid rules, because it allowed Apple to pay substantially less tax than other businesses. Ireland must now recover the illegal aid
  • Commissioner Margrethe Vestager, in charge of competition policy, said:

‘Member States cannot give tax benefits to selected companies – this is illegal under EU state aid rules. The Commission’s investigation concluded that Ireland granted illegal tax benefits to Apple, which enabled it to pay substantially less tax than other businesses over many years. In fact, this selective treatment allowed Apple to pay an effective corporate tax rate of 1 per cent on its European profits in 2003 down to 0.005 per cent in 2014.’

  • Following an in-depth state aid investigation launched in June 2014, the European Commission has concluded that two tax rulings issued by Ireland to Apple have substantially and artificially lowered the tax paid by Apple in Ireland since 1991.
  • The rulings 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: 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. These profits allocated to the ‘head offices’ were not subject to tax in any country under specific provisions of the Irish tax law, which are no longer in force. As a result of the allocation method endorsed in the tax rulings, Apple paid an effective corporate tax rate that declined from 1% in 2003 to 0.005% in 2014 on the profits of Apple Sales International.
  • This 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. Ireland must now recover the unpaid taxes in Ireland from Apple for the years 2003 to 2014 of up to €13 billion, plus interest.
  • In fact, the tax treatment in Ireland enabled Apple to avoid taxation on almost all profits generated by sales of Apple products in the entire EU Single Market. This is due to Apple’s decision to record all sales in Ireland rather than in the countries where the products were sold. This structure is however outside the remit of EU state aid control. If other countries were to require Apple to pay more tax on profits of the two companies over the same period under their national taxation rules, this would reduce the amount to be recovered by Ireland.

 

Some thoughts: first, the points for the Commisson … 

Note: to help understand the following points, please refer to my short primer on Apple’s EU tax structure click here.

  • Tax rulings as such 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 on the use of special tax provisions.
  • But the role of EU state aid control is to ensure Member States do not give selected companies a better tax treatment than others, via tax rulings or otherwise. More specifically, profits must be allocated between companies in a corporate group, and between different parts of the same company, in a way that reflects economic reality.
  • In particular, the Commission’s state aid investigation concerned two consecutive tax rulings issued by Ireland, which endorsed a method to internally allocate profits within Apple Sales International and Apple Operations Europe, two Irish incorporated companies. It assessed whether this endorsed method to calculate the taxable profits of each company in Ireland gave Apple an undue advantage that is illegal under EU state aid rules.
  • So …. the Commission’s investigation has shown that the tax rulings issued by Ireland endorsed an artificial internal allocation of profits within Apple Sales International and Apple Operations Europe, which has no factual or economic justification. As a result of the tax rulings, most sales profits of Apple Sales International were allocated to its ‘head office’ when this ‘head office’ had no operating capacity to handle and manage the distribution business, or any other substantive business for that matter. NOTE: by Apple’s own admission the ‘head office’ did not have any employees or own premises. The only activities that can be associated with the ‘head offices’ are limited decisions taken by its directors (many of which were at the same time working full-time as executives for Apple Inc.).
  • On this basis, the Commission concluded that the tax rulings issued by Ireland endorsed an artificial allocation of Apple Sales International and Apple Operations Europe’s sales profits to their ‘head offices’, where they were not taxed. As a result, the tax rulings enabled Apple to pay substantially less tax than other companies, which is illegal under EU state aid rules.
  • NOTE:  this decision does not call into question Ireland’s general tax system or its corporate tax rate. Furthermore, Apple’s tax structure in Europe as such, and whether profits could have been recorded in the countries where the sales effectively took place, are not issues covered by EU state aid rules. 

Some thoughts: second, the politics …  

When Apple first went to Ireland and hooked a good tax deal, I don’t suppose anyone had any idea Apple would grow to its present size. Now the boot is on the other foot and Apple is a major employer and its economic activity (untaxed, but there) is a large part of Ireland’s GDP.
And the other gorilla in the room is the fact that the Irish Government knowingly allowed Apple to avoid paying the other 27 EU Member States their fair share of the taxes Apple should have paid on the Apple products sold throughout the EU. EU Members have long memories. When Ireland’s Banks collapsed, the UK lent money to the Irish Government to help support their economy. At the same time Ireland was enabling Apple to avoid paying tax in the UK.

 

So the problem is not the comparatively low Irish tax rate, but the fact that the Irish authorities allowed profits generated in Europe to be shifted to offshore jurisdictions where they would not be taxed at all (unless repatriated to the US subject to 35% tax). The issue is that Apple generates large profits in Europe, and colluded with the Irish tax authorities to escape taxation of those profits.

 

Very aggressive tax planning from a consumer product company that makes more money than the state budgets of some small countries already.

 

And the tax/political games are all over:
  • Uber bills all its European clients through Holland and that is where your credit cards are charged.
  • Amazon for many years billed all its European sales through Luxembourg.  If I bought a product from Amazon which was made in the UK and delivered from a UK supplier to myself in London, my credit card was billed in Luxembourg, and Amazon claimed that all their warehouses were not trading businesses, but “fulfilment centres” and therefore not taxable.  What tax Amazon did pay was a cosy deal with Mr Juncker (then Prime Minister of Luxembourg and now President of the EU Commission) to pay some tax in Luxembourg, but tax free for all other EU countries.
  • Google bills all its EU sales through Ireland and claims its offices in London are administrative centres, not sales and commercial centres.

 

And let’s be very clear about one thing: U.S. Federal tax rates have no equivalent in EU. For example, Mercedes has an auto plant in Alabama. The U.S. Federal government taxes a portion of Mercedes profits (Germany also gets some) and in return provides defense, social security and medicare for Alabama employees.

 

There’s no similar logic for the EU, France or any other EU state to tax Irish operations. Ireland taxes and provides for its own people’s defense and social safety net.

 

And what the EU Commission is calling “the need for a level playing field” would be considered stifling of competition in the US.  It would be like a high-tax state such as New York objecting to the tax deal that low-tax Alabama gave Mercedes. Because the U.S. tax structure allows state tax competition but without corporations being able to get away with not paying any tax at all.

 

And the ultimate game: being resident “nowhere”. The U.S. treats companies as tax resident based on place of incorporation – hence Apple Operations, incorporated in Ireland was not US tax resident. The Irish apply a “centre of gravity test” (like the UK) which looks at activities like sales, board meetings, directors residence, bank accounts, and as only a factor place of incorporation.  By keeping the Irish activities to a minimum Apple Operations could avoid being tax resident in Ireland too.  So it was tax resident “no-where”.

 

NOTE: how Apple uses billions of dollars in its bonds issues to avoid a potential tax bill of up to $9bn by bringing back cash from abroad is beyond the remit of this post.  According to Moody’s credit agency, Apple avoided paying $6.3 billion in taxes in 2012 alone using this strategy.

 

Can the EU recover €13 billion?  
The Irish government formally decided to appeal the European Commission’s back-tax demand on Friday. In its statement it said:

 

“There are some very important principles at stake in this case. A robust legal challenge before the courts is essential to defend Ireland’s interests. The full amount of tax was paid in this case and no state aid was provided. Ireland did not give favorable tax treatment to Apple.”

 

One of the more amusing phrases used by the media in describing the Irish decision to appeal was Ireland’s need to fight the “claw back of the Apple tax”. I’m sorry, but “claw back” ALWAYS works in direction of the tax-payer, never the tax-extractor even if Big State defenders would like this to be acceptable Newspeak.

 

So, a long and expensive legal and political fight looms. An appeal could take up to five years, with the potential to sour relations between Dublin and Brussels for years to come.

 

Some of the legal points:
  • As a matter of principle, EU state aid rules require that incompatible state aid is recovered in order to remove the distortion of competition created by the aid. There are no fines under EU State aid rules and recovery does not penalie the company in question. It simply restores equal treatment with other companies.
  • The Commission has set out in its decision the methodology to calculate the value of the undue competitive advantage enjoyed by Apple.
  • The Commission can only order recovery of illegal state aid for a ten-year period preceding the Commission’s first request for information in this matter, which dates back to 2013. Ireland must therefore recover from Apple the unpaid tax for the period since 2003, which amounts to up to €13 billion, plus interest.
  • NOTE: the amount of unpaid taxes to be recovered by the Irish authorities would be reduced if other countries were to require Apple to pay more taxes on the profits recorded by Apple Sales International and Apple Operations Europe for this period. This could be the case if they consider, in view of the information revealed through the Commission’s investigation, that Apple’s commercial risks, sales and other activities should have been recorded in their jurisdictions.
  • And … the amount of unpaid taxes to be recovered by the Irish authorities would also be reduced if the US authorities were to require Apple to pay larger amounts of money to their US parent company for this period to finance research and development efforts. These are conducted by Apple in the US on behalf of Apple Sales International and Apple Operations Europe, for which the two companies already make annual payments.
  • Finally, all Commission decisions are subject to scrutiny by EU courts. If a Member State decides to appeal a Commission decision, it must still recover the illegal state aid but could, for example, place the recovered amount in an escrow account pending the outcome of the EU court procedures.

 

The bigger issues
There is more at stake, however, than Ireland’s reputation with its EU allies and its US investor base. The commission finding calls into question the sustainability of the country’s economic development model. Although it dates back nearly 60 years, the system has focused since the early 1990s almost exclusively on attracting foreign direct investment. Companies setting up operations in Ireland get a flexible labor force, the English language and English law, access to the EU single market – and a corporate tax rate of 12.5 per cent, one of the lowest in the world.

 

The result has been a flood of FDI, particularly from Silicon Valley tech groups and US pharmaceutical and healthcare companies. In addition to Apple, multinationals such as Intel, Microsoft and Pfizer have substantial Irish operations. Google and Facebook have their international headquarters in Dublin. The roughly 700 US companies operating in Ireland employ 140,000 people, often in high-paying jobs in research and development, sales, marketing, finance and design. Ireland is much more FDI-intensive than almost anywhere else and it is the reason Ireland is not a low-wage economy.

 

NOTE: according to OECD numbers, only Singapore competes with Ireland as the world’s hottest destination, relative to its size, for FDI. Ninety per cent of exports from Ireland are by foreign companies; one result of that is a consistently high current account surplus. The presence of these big global companies is spurring the development of new domestic industries – especially Irish-owned tech start-ups.

 

But there are downsides. According to the OECD, Ireland has become highly dependent on foreign companies for corporate tax. According to a study of corporation tax receipts by Ireland’s National Treasury Management Agency, the 10 biggest companies paid 40 per cent of the total last year, up from an average of 23 per cent between 2008 and 2012. And the activities of some of these companies distort Irish economic data. Official figures in July showed the economy grew by nearly 30 per cent last year as multinationals moved intellectual property, patents and other assets to Ireland, often for tax-planning reasons.
 
One wonders what Steve Jobs would think of all this.

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