Apple case turns spotlight on Ireland’s tax affairs

Vesna Tomljenovic, the judge tasked with drafting a ruling by the European Union's second-highest court on Apple's alleged €13 billion Irish sweetheart tax deal, at least started out with a good idea of what company actually does.

"Even my seven-year-old grandson is well versed on Apple, " said the Croatian native, as the EU General Court heard arguments this week from the Government and Apple as they appealed the European Commission decision that the tax arrangement amounted to illegal state aid.

“No disrespect, but I doubt he is very well versed on tax matters,” quipped Paul-John Loewenthal, a lawyer for the commission.

Having retreated to the bowels of the court complex to consider the legality of the world’s biggest-ever anti-trust decision, Tomljenovic and others on the five-judge panel must weigh allegations from the commission that Ireland traded tax incentives for jobs as far back as 1991 against claims from the Government and Apple that Brussels has stepped beyond its mandate and is seeking to rewrite Irish law.

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The public airing of the dispute over two days in court this week has turned the spotlight on Ireland's tax affairs at a time when Taoiseach Leo Varadkar is seeking to shore up support across the EU for its position on Brexit – and may need extra help if the UK crashes out of the bloc at the end of next month without an exit deal.

"It was not in the public interest for Ireland to appeal the Apple tax case, irrespective of the merits of the case. It gives the impression that Ireland is not a neutral bystander in dealing with tax-avoidance cases," says Jim Stewart, an associate professor of finance at Trinity College Dublin.

“How can Ireland expect full backing both politically and financially in the case of an emergency – for example, a 30 per cent devaluation of sterling following Brexit – and at the same time be seen to facilitate the erosion of the EU corporate tax base?”

Tax incentive arrangement

The entire case stems from three words Apple chief executive Tim Cook said at a US Senate hearing six years ago.

"Our investigation into the Irish tax rulings began in 2013, after Apple told a US Senate hearing about what it called a 'tax incentive arrangement' with Ireland," EU competition commissioner Margrethe Vestager would tell the Oireachtas finance committee in February 2017.

It also prompted the commission to ask EU members for details of about 1,000 other tax "rulings" by domestic authorities, which would drag companies such as Starbucks and Amazon into the quagmire.

Cook told the US Senate subcommittee that Apple had been paying a top tax rate of 2 per cent on the income of two Irish-based subsidiaries, Apple Sales International (ASI) and Apple Operations Europe (AOE), over the previous three years.

It prompted immediate denials from the Government that Apple had cut special deals with Revenue. Within a week, Cook had also backtracked, saying the company did not use “tax gimmicks”. But Vestager, a Dane who is said to have been as an inspiration for the main character in hit Scandi political drama Borgen, was already on the hunt.

The investigation turned formal in June 2014, when the commission made an initial ruling that Apple’s Irish tax arrangements were improperly designed to give the world’s biggest publicly-listed company – now valued at $1 trillion (€910 billion), more than twice the size of Ireland’s economy – a financial boost in exchange for jobs.

The final ruling, in August 2016, put the tax Apple owed Ireland at €13 billion, plus interest, bringing the total to about €14.3 billion.

The commission’s case is mainly two-fold and centres on two tax opinions – or “rulings” as they are referred to – handed out by Revenue, in 1991 and 2007, the year the first iPhone was unveiled and Apple’s profits started to balloon. The rulings gave the US technology giant an unfair and select advantage over other corporate taxpayers, it says.

The primary argument is that the rulings allowed Apple to channel most of its European sales through employee-less “head office” parts of ASI and AOE in Cork, which were non-resident for tax purposes. Only the activities of Irish “branches” within the same units were subject to tax in the State.

ASI, by far the more profitable of the two units, is responsible for the sales and distribution of iPhones and other products outside of the US, and AOE is a manufacturing and assembly operation. The ruling was based on the premise that the valuable intellectual property (IP) behind Apple products lay outside the Irish branches and was controlled in group headquarters, in Cupertino, California.

The second strand to the commission’s case is that even if it was possible to distinguish between the Irish branches and the head offices within ASI and AOE – and that the Irish branches did not hold the IP – Revenue did not apply a proper arm’s-length principle of transfer pricing when it came to working out what profits could be taxed in the Republic.

Former attorney general Paul Gallagher, leading the Government's legal team at the hearings, came out swinging in opening arguments on Tuesday, claiming the commission's case was "fundamentally flawed", "confused and inconsistent" and had evolved dramatically over time.

“Ireland has been the subject of entirely unjustified criticism,” he said, adding that Brussels had sought to override national law with its findings. “The commission did not identify a single instance where a taxpayer was treated less favourably than Apple.”

“The commission’s conclusion is astonishing,” said Mr Gallagher, adding that “only routine activities” were carried out in Cork and that the Irish offices carried out no research and development activities and held no IP.

However, Loewenthal, for the commission, questioned how Ireland “blindingly accepted” that the IP and licences held by ASI and AOE lay outside the Irish branches, when the head offices had no employees or other distinct structures.

‘Phantom’ companies

The judges were also puzzled. “For me, it is a little bit difficult to accept that they decide for the benefit of [head offices of] ASI and AOE, which, in fact is an empty shell,” said Tomljenovic, while the court’s vice-president, Marc van der Woude, also chipped that they looked like “phantom” companies.

Apple lawyer Daniel Beard – in sight of the tech giant's chief financial officer, Luca Maestri, who had ditched his normal Silicon Valley casual attire for a suited-and-booted look for the hearings – insisted otherwise.

“They are not empty shells because they are taking responsibility for development, manufacture, marketing and sales for Apple products throughout the world,” he said.

Both Apple and Ireland contend that the very fact that ASI and AOE qualified to be registered in Ireland but categorised as non-resident for tax purposes was based on the fact that they are managed and controlled from overseas – in Cupertino. The tax was ultimately owed in the US, they said.

Beard said Apple had made $20 billion of provisions to cover these liabilities before the commission decision, and that it had moved, following US tax law changes in late 2017, to start paying that tax as it repatriated earnings stored in Ireland.

The commission’s second line of argument – that Ireland didn’t use the arm’s-length principle in assessing the taxable profits of the Irish branches – took up most of the time during the two days of acronym-laden hearings. The principle basically means that if two arms of the same group are carrying out a transaction, they should price the deal at open-market rates, as if they were not related.

The Government’s line is that arm’s-length transfer pricing principles did not exist in Ireland at the times of the 1991 and 2007 Apple tax rulings. It has repeatedly claimed that that the commission sought to retrofit guidelines issued in 2010 by the Organisation for Economic Co-operation and Development (OECD) on the matter.

Loewenthal argued, however, that the principle was enshrined in the Treaty of the Functioning of the EU – in article 107, in fact – and backed up by case law. This was rejected by Ireland and a lawyer for Luxemburg, a country also caught in the crosshairs of the commission and which is supporting the Government’s position.

Luxembourg's lawyer, Denis Waelbroeck, said article 107 had become something of a "miraculous" clause to which many things were attributed but not stated. This is all part of an EU effort, according to the grand duchy, to use state-aid rules to drive tax harmonisation.

Either way, the Government has argued, citing independent expert reports, that the transfer-pricing methods used in 1991 and 2007 to work out what Apple profits were taxable by the State, while not to the commission’s liking, achieved the same outcome as what the OECD arm’s-length guidelines would have led to.

For Brussels, the purpose of the alleged sweetheart deal was simple: jobs, and lots of them. The commission’s August 2016 decision said the original 1991 tax ruling “appears to have been arrived at through negotiation and to have been dependent on employment considerations”.

However, Beard characterised this as a “fairytale” and said Apple’s employment in Ireland actually dropped following he 1991 ruling.

While the General Court is expected to take months to deliver its verdict, followers of the case are eyeing another ruling that may shed some light on where things are headed.

The court is due next week to decide on the legality of a commission decision in October 2015 that Luxembourg and the Netherlands had granted selective tax advantages to carmaker Fiat Chrysler and US coffee chain Starbucks, respectively, that amounted to a combined €49 million.

The commission's conclusion in October 2017 that Luxembourg granted €283 million of undue tax benefits to internet retailing giant Amazon, and its finding eight months later that the country gave French electricity group Engie €123 million of illegal tax aid, are also under appeal.

Vestager – who is keeping her post under in the new commission line-up – has also slapped hefty fines in recent years on internet search behemoth Google for alleged unfair commercial practices. And she has taken aim at Facebook for combining personal data of its social network site's users with the group's WhatApp messaging service.

For US president Donald Trump, whose administration had sought, unsuccessfully, to intervene in the Apple case to support the technology group, it's personal.

“She hates the United States perhaps worse than any person I’ve ever met,” he told Fox News in June.

The Apple case is unlikely to stop at the General Court. It's widely expected that the outcome will ultimately end up under appeal before the Court of Justice of the European Union, the EU's highest court. The €14.3 billion, collected by the Government last year following directions from the commission, will remain in an escrow account until the a final verdict is delivered.

"The case hinges on the issue of 'selectivity' – one of the most debated and complex issues in state-aid law," said Philip Andrews, a partner at Dublin-based law firm McCann FitzGerald, which is not involved in the case.

But even if the commission’s case is shot down by the General Court, Ireland is not off the hook, according to Andrews.

“Expect renewed focus on a pan-European digital tax,” he said.

While Minister for Finance Paschal Donohoe has resisted efforts by some of his peers to establish a pan-EU digital tax regime based on revenues of tech companies in individual countries, he has committed to engaging fully with the OECD as it looks to lay the foundations for such a regime to apply internationally.

While the Government has long argued that Ireland is being unfairly targeted in the commission’s case for mismatches between the Irish tax code and elsewhere, it has moved in the wake of reputational damage caused by the investigation to phase out loopholes such as the “double Irish” tax-avoidance strategy and the notion that an Irish-registered company can be stateless for tax purposes.

Foreign direct investment

The case has failed to put a dampener on foreign direct investment into the Republic in recent years, as the OECD’s base-erosion and profit-shifting (Beps) initiative to make it difficult for large companies to shift profits offshore to zero-tax jurisdictions has resulted in a massive movement of IP to the State.

"We know that Beps has been extremely positive to Ireland," Pascal Saint-Amans, tax director of the OECD, said at the Irish Times/PwC Tax Summit on Tuesday, noting that the exchequer's corporate tax receipts have more than doubled to €10 billion in the past five years.

An international digital tax regime, however, poses big risks for Ireland’s corporate tax base.

For now, however, Brexit is more of an immediate worry for the Government. It continues to enjoy strong public support from the commission and EU member states for insisting the Border backstop remain in place under a UK agreement to withdraw from the EU, even as British prime minister Boris Johnson is looking for it to be scrapped.

“There is no sign at all that fellow EU members would link that support on Brexit-related issues with Ireland’s position on corporation tax,” said Dermot O’Leary, an economist with Goodbody Stockbrokers.

“However, the support thus far has only been in the form of words. It is possible that if financial support is required in the event of a hard Brexit that some will use it as leverage in the future.”