The European Commission’s crackdown on the deal between Irish tax authorities and Apple Inc. (AAPL) marks an expansion in the growing global war on tax avoidance by multinational companies. Governments that enable it are now a target.
Yesterday, the European Commission said the Irish tax authorities failed to conform to international guidelines when they “reverse engineered” an agreement with Apple to determine the company’s bills. The Commission also found problems with Luxembourg’s treatment of Fiat Finance and Trade Ltd, and a Commission review of Starbucks Corp.’s (SBUX) taxable profits in the Netherlands is expected shortly.
Countries like Ireland, Luxembourg and the Netherlands have long enabled corporate tax avoidance by offering low rates and serving as intermediaries to help companies move profits into subsidiaries around the world. Now, their ability to offer such flexible arrangements may be in jeopardy.
“It’s a shot across the bow for many European tax authorities who have to look at what kind of sweetheart agreements they may have in place that would be hard to justify,” said Alex Cobham, a research fellow at the Center for Global Development in London.
The Commission unveiled a new tool to limit governments’ ability to negotiate favorable tax deals. It said that the agreement with Apple constituted “state aid,” violating Europe’s rules prohibiting countries from giving anti-competitive advantages. Those rules are more frequently applied to benefits such as tax holidays, which are offered to entire industries, rather than to negotiated agreements with individual companies, according to two people familiar with the process.
The Commission’s finding is the latest move around the world to rein in tax avoidance techniques.
Last week, the Obama administration announced its long awaited restrictions on “inversions,” in which companies use an overseas address to avoid U.S. taxes. Two weeks ago, the Organization for Economic Cooperation and Development announced its proposals to hinder corporate avoidance. And on Monday, U.K. Chancellor of the Exchequer George Osbornewarned big technology companies against using loopholes to avoid paying tax. He will outline enforcement plans in December.
“I think there is real reform underway,” said Edward Kleinbard, a tax law professor at the University of Southern California. “European jurisdictions in particular have woken up to the fact that multinational firms are systematically underreporting their tax liabilities in the jurisdictions where they actually do business.”
To be sure, some of the steps are narrow. Despite the Obama administration’s plan to make it harder for U.S. companies to invert, Burger King Worldwide Inc. (BKW) has said it is proceeding with its plan to move its address to Canada. The pending inversions of companies such as Medtronic Inc. (MDT) and AbbVie Inc. (ABBV) are also expected to go forward.
The European Commission’s Ireland inquiry so far is limited to how Irish tax authorities determined Apple’s tax obligation within the country’s borders. The Commission did not explore how Apple’s Irish subsidiaries save the company taxes outside Ireland.
Over a four year period, Apple shifted $74 billion in profits to an Irish entity that had no “tax residence” anywhere in the world, and thus owed minimal income taxes to any country, the US Senate Permanent Subcommittee on Investigations found last year.
Cupertino, California-based Apple now has $54.4 billion in profits sitting offshore that have been barely taxed, thanks in part to Irish subsidiaries, according to its annual report. The amount that Apple may eventually owe Ireland based on the Commission’s findings is unclear.
Apple “did not receive selective treatment and was taxed fully in accordance with the law,” according to the Irish Finance Ministry. The European Commission’s review of state aid can take more than a year and decisions can be challenged at the European Court of Justice in Luxembourg. The findings released are preliminary.
Some tax experts expect that the Commission will examine Ireland’s arrangements with other large multinationals that use Irish subsidiaries to cut their bills, such as Google Inc. (GOOG) and Facebook Inc. Al Verney, a spokesman for Google, declined to comment, while Vanessa Chan, a spokeswoman for Facebook didn’t reply to request for comment.
Ireland’s tax friendliness has prompted numerous multinationals to attribute profits to units there, often far in excess of their actual economic activity in the country. From 2000 to 2010, profits attributed by US companies to their Irish units grew more than sevenfold, while actual employment at those subsidiaries barely grew, according to U.S. Commerce Department data.
“It’s clear that the tax bills of many multinationals are going to go up,” said Peter Vale, a tax partner at accounting firm Grant Thornton’s Dublin office. “The question is where will they pay the extra taxes.”
The Commission will likely also soon release findings on an agreement between Dutch tax authorities and a subsidiary of Seattle-based Starbucks. The Netherlands has long been a favored destination for routing profits into tax haven subsidiaries in places like Bermuda -- giving rise to techniques with nicknames like the “Dutch Sandwich.”
Those sorts of transactions could be endangered. In August, the OECD issued a series of proposed guidelines to make it harder for multinational companies to avoid taxes. One of its plans would make it more difficult for companies to take advantage of generous tax treaties in places like the Netherlands by locating units there with few or no employees.
The group’s proposals could also make it harder for companies to move profits into tax haven subsidiaries by assigning valuable patent rights. Another proposal limits deductions taken by companies in one country without reporting commensurate profit in another. And the OECD also called for companies to disclose to regulators detailed geographic breakdowns of sales, profits and taxes paid around the world.
While the OECD can’t require countries to implement its tax recommendations, regulations in its 34 member countries are required to conform to its standards. In many countries, regulators simply adopt OECD tax guidelines as their own.
“We are now in a different phase of the debate of tax avoidance,” said Richard Murphy, director of U.K. based Tax Research LLP. “We are now in a technical phase. We’ve gone from the political rhetoric to ’What are the solutions?’ I think we are moving toward real action, and there is a belief on part of companies and their advisers that that is inevitable.”
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