On 15 July 2020, the lower-tier EU court annulled the Commission’s decision of 30 August 2016 finding that Ireland had granted illegal State aid to two Irish-incorporated Apple group companies. Apple had to repay a record amount in excess of EUR 13 billion. The Commission may appeal the judgment before the Court of Justice. The judgment analyses transfer pricing arguments in depth and will therefore likely impact the interpretation of transfer pricing rules in the EU.
The tax rulings of 1991 and 2007 issued by the Irish tax authorities confirmed that nearly all sales profits recorded by two Apple group companies incorporated but not tax resident in Ireland were attributable to head offices outside Ireland, rather than to their Irish trading branches. Ireland only taxed the profits of the branches.
The Commission’s decision argued that the allocation of profit to the foreign head offices was not at arm’s length based on three lines of reasoning:
- The primary line of reasoning relied on the fact that the foreign head offices had no employee and substance and therefore could not perform the functions and bear the risks related to certain IP assets that are key value-generating assets. The Commission argued that the functions and risks were therefore necessarily to be allocated to the Irish branches which, in its view, performed much more than low value-adding routine functions.
- The subsidiary line of reasoning accepted the allocation of the IP assets (and related share of profits) outside of Ireland but claimed there were several mistakes in the application of the transfer pricing method known as ‘TNMM’ (transactional net margin method).
- The alternative line of reasoning in part relied on the subsidiary line and in part argued that the discretion of the Irish tax authorities in granting the rulings was excessively broad, thereby resulting in a selective advantage granted to the two Apple group companies.
Motives for the annulment
In the judgment, the General Court first confirmed its earlier stance in the Fiat and Starbucks judgments (see our tax flash of 24 September 2019) that the Commission can check the compatibility of tax rulings with EU State aid rules. It also confirmed that the tax treatment of the beneficiaries of the rulings should be assessed against the general tax system in force in Ireland.
It then dismisses the three lines of the Commission:
- On the primary line, the General Court accepted that the Commission can use the arm’s length principle as a tool to check whether the profit allocation reflects market values. It also accepted the use of the authorised OECD approach to assess the split of profits allocable to the head office and to a branch under transfer pricing rules. However, it found that the Commission did not properly apply the rules by presuming, rather than showing, that the functions and risks related to the value-generating IP were in Ireland. The General Court accepted Ireland’s and Apple’s arguments that the key functions were performed outside of Ireland (essentially in the United States).
- On the subsidiary line, the General Court pointed to a contradiction between the acceptance to allocate the complex, value-generating IP to the head offices and the claim that the Irish branches would have a more complex functional profile than the head offices. The lack of transfer pricing documentation when the rulings were granted was “regrettable” but cannot lead to a presumption of aid. Also, the Commission failed to demonstrate that the choice of profit level indicator (operating costs) was inappropriate; the Commission had furthermore wrongly allocated certain risks to the Irish branches. Finally, the Commission did not establish that the level of return on costs was too low and did not demonstrate that the transfer pricing studies submitted by Apple were unreliable.
- As regards the alternative line of reasoning, to the extent it relied on the subsidiary line, it was necessarily annulled as well. On the second part, the General Court found that the Commission failed to show that the Irish tax authorities had exercised a (too) broad discretion in this case.
Taxpayers engaged in intragroup transactions in the EU should review the General Court’s positions, as the reasoning may affect transfer pricing analyses and audits going forward. The judgment should also be considered in the context of State aid risk assessments (e.g., as part of FIN48 analyses).
The Commission may appeal the judgment on matters of law before the Court of Justice. As the General Court dismissed the factual findings of the Commission, it is quite uncertain whether an appeal would be successful.
Status of other State aid cases
An appeal of the Commission in the Belgian Excess profit ruling case and of Fiat in the Fiat case are already pending with the Court of Justice. The Amazon and ENGIE cases are still pending before the General Court. The Commission also still has formal investigations pending into the tax treatment of Nike and Inter IKEA in the Netherlands, Huhtamäki in Luxembourg and 39 Belgian companies which benefited from an Excess profit ruling. It is rumoured that more investigations will be opened shortly.
The Commission’s decision to extend the scope of its formal investigation into tax rulings granted to Inter IKEA in the Netherlands was recently published. It takes into account changes of facts compared to those described in the tax ruling, but the challenge remains essentially the same: the Commission considers that a Dutch entity purchased IP rights for an excessively high price, which was left outstanding and converted into a loan. As a result, the Dutch company was allegedly wrongly entitled to deduct an excessive amount of interest (because the principal amount is too high), part of which should be requalified into a hidden profit distribution. For the same reason (excessively high purchase price), the Commission considers that the amortization expenses are excessive and should partly not be deductible.
We will keep you informed about further developments. Should you have any question, please contact a member of our EU State aid team or your trusted Loyens & Loeff adviser.