Thomas K. Grose

/ Legal Issue 2017

LONDON—There’s growing anger worldwide as evidence piles up that many multinational corporations have successfully used geography—mainly discrepancies within a global patchwork of legal tax laws and loopholes—to essentially game the system to avoid paying their fair share of taxes.

Three years ago, for instance, U.S. Senate hearings revealed that consumer electronics behemoth Apple paid only one percent or less on profits it made on overseas sales by transferring the rights of its intellectual property to subsidiaries set up in Ireland.

Last summer, the European Commission, the European Union’s executive body, using the Senate’s findings as a starting point, ruled that from 2003–2014, a tax arrangement between Apple and Ireland gave Apple an edge over competitors and violated EU state-aid rules. It ordered Apple to pay Ireland as much as $14.2 billion in back taxes, plus interest.

Margrethe Vestager, the EU competition commissioner, said that the “illegal tax benefits” Apple received from Ireland “enabled it to pay substantially less tax than other businesses over many years.”

Both Ireland and Apple say they’ll appeal the ruling to the EU General Court. And the finding has also been criticized as overreach by the U.S. Treasury—a view also voiced by some proponents of efforts to curb abuses of transnational tax law, including one of Vestager’s predecessors, Neelie Kroes.

Regardless of the outcome of the appeals process, which could take three to four years, the Apple case will probably have less of an effect on the international tax system than reform efforts now underway to make the system fairer. But if the ruling’s upheld, there are concerns that it could spark an exodus of globespanning companies from Europe. “The risk of chaos is great,” says Eduardo Baistrocchi, an expert on tax law at the London School of Economics’ Transnational Law Project.

The main vehicle for reform is a model set of tax guidelines known as the Base Erosion and Profit Shifting project, or BEPS, which was published last year by the Organization for Economic Cooperation and Development at the instigation of the G-20 nations, which are the world’s largest economies. These new principles, which are rapidly gaining acceptance around the world, would close loopholes, erase inconsistencies in national laws, and promote greater transparency to make it harder for multinationals to shuffle profits around the world to avoid the taxman.

“The old principles don’t work in today’s world,” says Erika Jupe, a tax partner at London law firm Osborne Clarke. “Now, greater transparency and PR has become important.” She calls BEPS a “good and speedy” response to concerns that the old system was out of date.

And there is indeed a sense that the European Commission’s ruling also has a political component: that it’s a way for the EU to push back against the growing popularity of populist political parties that claim Brussels’ relationships with multinationals have been too cozy. But if the commission is playing to the hoi polloi, it’s also unfairly only targeting U.S. multinationals, not European ones that use the same tax rules, says Elaine Fahey, an expert on EU law and global governance at London’s City Law School. “American companies are a convenient source of attack.”

But Christiana HJI Panayi, a tax law professor at Queen Mary University of London, says that the EC can easily argue politics aren’t involved and that it’s only now dealing with what it sees as an instance of state-aid abuse because it only recently found out about it, thanks to the Senate hearings. If BEPS is successful, she says, “agreements such as Apple’s with Ireland would no longer be hidden.”

"The old principles don’t work in today’s world. Now, greater transparency and PR has become important." Erika Jupe, Partner, Osborne Clark

Jupe also thinks the EC’s ruling is more a coincidence of timing than an outgrowth of the tax reform movement. But she also calls it a radical application of competition law to tax standards that have been legally used for decades.

To be sure, Jupe says, the commission has linked tax agreements to state-aid in the past, but in this case—and in two other smaller, recent rulings involving Luxembourg and Fiat Chrysler Automobiles, and the Netherlands and Starbucks—it’s focused on an aspect of tax law it previously ignored: transfer pricing, or advanced pricing arrangements that cover transactions between subsidiaries of the same company. “That is the novel bit in this ruling,” she says. It’s long been considered an area of set law, based on OECD models. Moreover, Jupe adds, the ruling also questions the right of individual EU member states to set their own tax rules.

Kroes, the former commissioner, in a column in The Guardian last September1, argued against changing “the rules of the game through ad hoc state-aid enforcement” to seek “retroactive recovery for unpaid taxes. Doing so would be fundamentally unfair and would harm competition, growth, and tax income in Europe.”

As Baistrocchi says, Apple had “legitimate expectations” that its agreement with Ireland was legally sound.

“The European Commission has launched an effort to rewrite Apple’s history in Europe, ignore Ireland’s tax laws, and upend the international tax system in the process … Apple follows the law and pays all of the taxes we owe wherever we operate,” Apple said in a statement.

Baistrocchi says it’s possible that the appellate courts “might decide that this EC decision should be applied prospectively rather than retroactively.”

And Jupe thinks that the EC will have a hard time proving in court that the Apple-Ireland agreement was illegal state-aid because it will have to demonstrate that Ireland applied the tax rules selectively to Apple. “Was it a sweetheart deal? That will be difficult to show,” Jupe says. That’s because the pricing arrangements are based on idiosyncratic circumstances within each company and are very flexible—OECD’s models allow for five different methods to calculate them.

Panayi, however, claims that the EC “has a good case, that this is a natural evolution of [state-aid] law.” And, she adds, “it rarely loses appeals.”

If the courts uphold the EC’s ruling, the impact could be more economic than legal, which is what worries Kroes and Baistrocchi. The fear is that companies may avoid locating subsidiaries in Europe—or relocate existing ones—if they think that accepted tax practices can be reexamined at some point in the future. But no matter what the courts decide, legal guidance to multinationals is already changing as greater transparency looms larger, Jupe says.

But it won’t mean an end to advanced pricing arrangements, she insists. Instead, when tax lawyers draw them up, “they’ll make it clear they’re not sweetheart deals that give one company an advantage.”