Tax rulings and State aid: The Apple case or the Commission’s lost challenge?

By cancelling on 15 July 2020[1], the decision adopted by the European Commission on 30 August 2016, which had found that Ireland's tax treatment of Apple constituted State aid, the European General Court ("EGC") has inflicted a serious setback on the Commission in relation to the rulings.

The manufacturing and sales structure for products sold by Apple outside the Americas - which has since been modified - has proven to be particularly advantageous from a tax point of view with the combined application of US tax laws, allowing the income from intangible assets allocated to foreign sales to be tax-free, and Irish tax laws, offering very low taxation of manufacturing and sales revenues generated in Europe.

However, the total absence of taxation does not necessarily lead to State aid. The existence of a “selective advantage” granted at the national level must be demonstrated and does not necessarily result from an optimisation that is essentially multinational. The United States has nevertheless been able to preserve its ability to levy 15.5% tax on these profits now considered to be repatriated.

I. The European Commission's decision ordering Ireland to recover more than €13 billion of “evaded” tax from Apple is no longer applicable

It is recalled that, as early as 2014, the European Commission was already investigating the practices of certain Member States with regard to tax rulings validating supposedly derogating transfer pricing policies. For the European Commission, any ruling granted to a company validating transfer prices allowing an allocation of intra-group profits that deviates from the “arm’s length” principle, as set out in the OECD guidelines, constitutes a “selective advantage” amounting to State aid for the benefit of its beneficiary.

It is on the basis of this reasoning that the Commission opened around ten procedures targeting APAs granted by Luxembourg, Ireland and the Netherlands to multinationals established on their territory. With the exception of Mc Donald, for which the Commission considered that no state aid could be identified since the tax advantage enjoyed by Mc Donald did not result directly from the ruling granted by Luxembourg but from the tax treaty concluded by that Member State with the United States[2], all these procedures resulted in decisions qualifying these rulings as State aid and requiring the States concerned to recover the benefit granted, that is to say the tax “evaded”, with interest for late payment[3].

The decision taken against Apple was the most emblematic since it concerned a situation in which two rulings granted by Ireland to Apple (Apple Sales International “ASI” and Apple Operations Europe “AOE”) had led in fine to a situation of almost total non-taxation of profits made by Apple outside the American continent and that the estimated sums to be recovered by Ireland amounted to nearly € 13 billion.

This decision was based on the premise that, although Member States such as Ireland did not expressly enshrine the arm's length principle in their internal tax law, it followed directly from Article 107 of the Treaty on the Functioning of the European Union (TFEU) which defines the concept of State aid. Due to the principle of the primacy of European Union law, it was therefore directly applicable to rulings issued by member states and any rulings deviating from it should therefore be considered as a "selective advantage" constituting State aid. In this particular case, the Commission took the view that Ireland had departed from the OECD principles by validating the method for determining the taxable profits in Ireland of ASI and AOE, which allowed almost all the profits made by the branches of ASI and AOE in Ireland to be allocated to a "registered office" not subject to the tax jurisdiction of any State.

In the alternative, the Commission considered that the analysis of a sample of rulings granted to other multinationals led to the conclusion of selective and discretionary favourable treatment reserved by Ireland for Apple.

II. The censure by the Court is based not on a question of principle but on the lack of sufficient justification for the alleged advantageous and derogating treatment reserved for Apple

The EGC applied the principle, already validated in the Starbucks case, according to which the arm's length principle derives directly from the TFEU and not from its existence in the internal tax law of the Member State concerned. The application of the arm's length principle thus makes it possible to verify that a company which is part of a group is not allocated a lower level of profit than a company which may contract with an independent company. The Court points out that it is for the Commission to prove, in the light of that principle, the existence of a selective advantage under the supervision of the court, which takes into account “its approximate nature'' for the determination of transfer prices.[4]

After having validated that the arm’s length principle could be used as benchmark to determine whether the Apple’s branches in Ireland had been attributed the right level of profits, the EGC also confirmed that the Commission should rely on OCDE guidance. According to the Commission, profits should be attributed to the branches since they had substances whereas head offices had not. The debate on the application of the OECD principles to the distribution of profits and expenses between the management offices of ASI and AOE and their permanent establishments proves to be more complex than between two separate companies as was the case in the Fiat and Starbucks cases. In these cases, the exercise was also facilitated by a deviation committed by the States themselves in relation to the arm’s length principle even though this principle is in force in their legislation. In the case of Apple, since Ireland had not introduced such a principle into its domestic law, the Commission's task here was more difficult. According to the OECD, one of the keys to the allocation of assets or contracts derives mainly from the distribution of risks and functions between the two units. The EGC Court carried out an in-depth review by analysing whether the Commission could rightly consider that the intellectual property licenses held by ASI and AOE, and therefore all the commercial income, should have been allocated to the Irish branches of ASI and AOE. In doing so, the EGC referred to Irish case law on branch allocation rule as being comparable to OECD guidelines. It departed from a sui generis or autonomous assessment of the arm's length principle that was promoted by the commission in automatically attaching intangible assets and contracts to the registered office. Under Irish case law, the recognition of an asset in Ireland required its control by the local permanent establishment even if it may be impossible to demonstrate that the (foreign) registered office controlled it (S. Murphy (Inspector of Taxes) v. Dataproducts (Dub.) Ltd, [1988] I.R. 10). The EGC finally decided that the Commission failed to demonstrate the improper allocation of income to the branches under the OECD guidance and Irish law.

The EU Commission “respectfully considers that in its judgment the General Court has made a number of errors of law. For this reason, the Commission is bringing this matter before the European Court of Justice," Executive Vice President Margrethe Vestager said.

The Commission may intend to challenge the application of the OCDE guidance for the application of its sui generis arm’s length standard rather than fighting back on the manner it was applied.

Many preventive measures have since been adopted, whether unilaterally by States, within the European Union or multilaterally through the work of the OECD. But, for the States it is also a question of preserving their tax base with regard to… the other States. Tax competition between states should therefore intensify. It is desirable for the Commission to clarify the objectives of its actions in the field of State aid in order to preserve the legal certainty that it is in the interest of all those involved to preserve the functioning of the single market.

[1] EGC, 15 July 2020, Ireland and others v/Commission, cases T-778/16 and T-892/16.

[2] See decision SA.38945 of 20 June 2018.

[3] See EGC, 24 September 2019, Kingdom of the Netherlands and Others v Commission, Cases T6760/15 and T-636/16.