State Aid and Taxation update: Commission suffers defeat in the Apple case
On 15 July 2020, the General Court (Court) quashed the landmark decision taken by the European Commission (Commission) in 2016 ordering repayment of about €14.3bn (c. €13.1 billion plus interest of c. €1.2 billion) of unlawful State aid granted by Ireland to Apple in the form of tax rulings which sought to establish Apple’s taxable profits in Ireland (the Court’s judgment is available here). While the ruling of the judges in Luxembourg reaffirms the Commission’s powers to review tax rulings under EU State aid rules, it underlines that the Commission may only do so insofar as it proves that all the conditions for classifying the measure as aid are satisfied. This is a case where the Commission failed to gather and adduce sufficient evidence to prove that there had indeed been State aid. According to the Court, the Commission did not succeed in in showing “to the requisite legal standard” that the tax ruling triggered a “selective advantage”.
The Commission’s 2016 decision involved two Apple subsidiaries - ASI and AOE - that were incorporated but not tax resident in Ireland. Nor were they tax resident in the US or in any other jurisdiction. Both companies had however set up Irish branches. ASI’s Irish branch was responsible for procuring and distributing Apple products in the EMEA, India and Africa (EMEIA) and Asia-Pacific regions, while AOE’s Irish branch was in charge of manufacturing and assembling Apple computer products in Ireland to be sold in the EMEIA region. Under Irish tax law as it applied at the time, non-resident companies such as ASI and AOE that carry on a trade in Ireland through a branch pay corporate income tax on (i) profits derived from the trade attributable to the branch and (ii) all income from property or rights controlled by such a branch.
In 1991 and 2007, the Irish tax authorities had granted tax rulings setting out the methodologies for how to establish the taxable profits of ASI and AOE in Ireland. The endorsed profit allocation between the non-resident head offices of ASI, AOE and their Irish branches resulted in the majority of profits being allocated to the non-resident head offices of ASI and AOE. Such profits were therefore not subject to Irish tax. The Commission’s decision criticised these rulings and considered that the profit allocation departed from the normal corporate income tax regime in Ireland as well as from established OECD transfer pricing guidelines and, as a result, triggered unlawful State aid to Apple (see here). At the core of the Commission’s misgivings lay the fact that ASI and AOE had no physical presence or employees outside Ireland. Under such circumstances, the Commission reasoned, how could the Irish tax authorities agree with the allocation of profits to anything other than the Irish branches? Wasn’t it in fact these branches that generated ASI and AOE’s profits?
The Court’s findings
In its judgment, the Court endorsed a series of key principles that are fundamental to the Commission’s powers to review tax rulings using EU State aid rules.
- First, the Court dismissed the claim that the Commission’s decision impinged on Ireland’s fiscal sovereignty. Some have commented that the Commission may be using State aid to harmonise taxation as between Member States through the back door. But the Court confirms that the Commission’s State aid remit allows it to scrutinise tax measures adopted by Member States.
- Second, the Court also accepted the view that the relevant benchmark to determine the existence of State aid was the general corporate income tax regime in Ireland and the use of the tools developed by the OECD, such as its transfer pricing guidelines and the arm’s length principle, to verify whether a tax ruling gives rise to State aid. In this sense, the judgment is fully aligned with the Court’s previous rulings in the Fiat and Starbucks cases (see here).
However, the devil is in the detail, and the Court was less than impressed by the manner in which the Commission applied these principles and by the factual evidence it had put forward.
One of the rather unusual aspects of the decision was the Commission’s confusing use of primary, subsidiary and alternative lines of argumentation. This approach - labelled by judge van der Woude at the September 2019 hearing as “two decisions for the price of one” - enabled the Commission to use a menu of justifications, and led, as was mentioned during the hearing, to entirely different results in terms of the quantification of the alleged aid to be recovered from Apple.
- The primary line - The Commission’s primary line of reasoning was based on the notion that all profits derived from the IP-rights used by ASI and AOE ought to be taxable in Ireland. Under Irish tax law, this would only be the case if the Irish branches actually controlled these rights. The Commission’s main piece of evidence of such control was, as mentioned, the fact that ASI and AOE had no physical presence or employees outside Ireland. However, the Court found this reasoning was far from satisfactory and concluded that the Commission had not even attempted to show that this allocation followed from the activities actually carried on by the Irish branches. Nor had the Commission attempted to show that the profit was representative of the value of the activities actually carried out by the branches themselves.
Moreover, when the Court assessed ASI and AOE’s main functions and the distribution of responsibilities within the Apple Group, it found that the evidence lent little support to the Commission’s claims. Indeed, strategic decisions were taken at the Cupertino HQ in the US and the role of overseas subsidiaries like ASI and AOE was largely limited to implementing such decisions. On this basis, the Commission’s primary line of reasoning failed.
- The subsidiary line - The Commission’s subsidiary line of reasoning hinged on the correct application of the OECD transfer pricing guidelines and the risks assumed by the Irish branches of ASI and AOE. The Commission argued that the profits allocated to the Irish branches under the 1991 and 2007 tax rulings were too low, even if the IP-rights were not taken into account. As noted above, the Court upheld the Commission’s approach, as a matter of principle, but like in the previous Starbucks case, the Court picked the Commission’s factual assessment apart and was not persuaded by what it found. The functions of the Irish branches of ASI and AOE did not seem as complex and fraught with risk as the Commission had suggested in its 2016 decision. Mere methodological errors in the tax rulings and in the underlying reports prepared by Apple, criticised by the Commission in its decision, did not suffice to prove the existence of an advantage for State aid purposes.
- The alternative line - The Commission had offered yet another line of reasoning. It applied to the extent that the benchmark for determining the existence of a selective advantage, contrary the Commission’s principal claim, was deemed to be limited to the rules applicable to non-resident companies. This was based on the fact that the relevant provisions under Irish law did not have objective criteria for the allocation of profits and therefore the Irish tax authorities enjoyed discretion in applying those provisions. Since the Court found that the benchmark was the corporate tax regime in Ireland as a whole, it could have avoided considering this point. Nevertheless, it proceeded to analyse the Commission’s claim and Ireland and Apple’s counterarguments, and found, in a final blow to the Commission decision, that it had also failed to prove the existence of a selective advantage in this scenario by presuming that such discretion led to a selective advantage.
The Court’s ruling in the Apple case is a timely reminder that there are limits to the ability to fill the perceived gaps in EU tax law by resorting to EU State aid rules. The Commission may disapprove of tax rulings attributing profits to the head offices of non-resident companies, resulting in double non-taxation, but that was an inherent feature of the general structure of corporate income taxation in Ireland. And the Commission was unable to prove, to the “requisite legal standard”, that Apple had been treated more leniently than other companies in a comparable situation.
Indeed, the Court’s conclusions are largely based on the insufficient evidence put forward by the Commission. As such, the Court did not dispute the legality of the Commission’s campaign against alleged tax “sweeteners”. The Commission’s powers to review tax rulings and to apply the arm’s length principle and transfer pricing guidelines, as developed by the OECD, remain intact. Instead, the Commission came unstuck over its application of those principles.
This means that the Commission, despite headlines suggesting otherwise, may end up deciding not to appeal the ruling (appeals to the Court of Justice are limited to points of law only) which would mean that the €14.3 billion recovered from Apple might soon be released from the escrow account into which it was paid. The Commission did not appeal the Starbucks judgment from last year, even though its decision in that case was also annulled by the Court, for similar reasons. Moreover, the judgment in the Apple case has already revitalised the debate about the need for enhanced co-operation on business taxation within the EU. As a result, there may be a silver lining for the Commission, as such co-operation is arguably more important for it in the long term.