knowledge | 16 July 2020 |
EU General Court Annuls Apple State Aid Decision
On 15 July 2020, the General Court of the European Union (the “General Court”) annulled the European Commission’s 2016 decision that Ireland had granted approx. €13 billion in unlawful State aid to Apple through two tax rulings in 1991 and 2007.
The ruling1 is a hammer blow for the Commission’s State aid enforcement record against tax rulings, but does include some positives that may assist the Commission in future cases.
While the General Court confirmed the Commission’s competence to review tax rulings for compliance with State aid rules and confirmed the Commission’s application of an “arm’s-length principle” when doing so, the Court found that the Commission’s decision (which runs to 452 paragraphs and followed a 2-year investigation) did not sufficiently prove that the tax rulings in question resulted in an economic advantage to Apple that it would not have obtained under normal conditions.
For background, including links to our earlier briefings concerning the Commission’s decision and discussion of relevant other recent fiscal aid judgments, please see the section on background below.
What did the Court decide?
The key conclusions of the General Court’s judgment are as follows:
- The Commission has Competence under State Aid Law to Bring Cases Involving Tax Rulings
The Court began by confirming the now well established principle that the Commission is competent, in the exercise of its State aid control function, to examine whether tax rulings amount to unlawful State aid, thereby rejecting Ireland’s argument that the decision encroached on its competence in the area of taxation.
- The Commission Identified the Correct Reference System Against which to Compare Apple’s Tax Arrangements
The determination of a “reference framework” of companies in the same factual and legal situation as an alleged aid beneficiary is a key issue in State aid taxation cases, as it determines the category of entities against which the aid beneficiary is compared, for the purposes of the “selectivity” criterion.
In this regard, Apple and Ireland had argued that the Commission had wrongly sought to compare the situation of Apple Sales Ireland (“ASI”) and Apple Operations Europe (“AOE”) with ordinary Irish tax-resident companies. Though incorporated in Ireland, ASI and AOE were not Irish tax resident, and their taxation was subject to specific rules set out in section 25 of the Taxes Consolidation Act 1997 (as amended), which required that they pay tax only on profits arising “directly or indirectly from or through the branch or agency …”.
The Court held that while section 25 lays down specific rules for the determination of the chargeable profits of non-resident Irish entities, it does not mean that they are not in a comparable situation to resident companies: the objective of the Irish tax system is to ensure that all entities (both resident and non-resident) pay the same rate of tax on their chargeable profits. As such, the Court held that the Commission had correctly established the “reference system” as the ordinary rules governing the taxation of corporate profit.
- The Commission was Correct to Apply the So-Called “Arm’s-Length Principle”
According to the Commission, to assess whether a profit allocation method (allocating profit between companies or, here, between branches of Apple companies) endorsed by a tax ruling confers an advantage, the question is whether the tax ruling generates a chargeable profit that is a reliable approximation of a market-based outcome (i.e., the outcome, if the two branches had been independent actors negotiating at arms’ length). This is the arm’s length principle.
Ireland had argued that the principle is not part of Irish tax law, and that there is no obligation to apply it under the State aid provision, Article 107(1) TFEU.
Broadly following its reasoning in Starbucks, the Court found that in order for the arm’s-length principle to be applied “it must be clear from national tax law that the profits derived from the activities of the branches of non-resident undertakings should be taxed as if they resulted from the economic activities of stand-alone undertakings operating under market conditions”.2
Since, as noted above, the Court had concluded that the Irish tax system pursued the same objective of taxation of chargeable profits in relation to both resident and non-resident companies, then the arm’s-length principle could be used to verify that the profits of ASI and AOE had been appropriately allocated. The Court noted in this regard that Ireland had explicitly confirmed that non-resident companies were to be taxed on the basis of “the activities actually carried out by the branches” (in the Court’s view, on the basis of profit arising under “normal market conditions”).
- The Commission Failed to Prove that the Allocation of Profits was Incompatible with the “Arm’s-Length Principle”
Having determined that the arm’s-length principle could be used, the central issue became whether the Commission had shown that ASI and AOE’s tax treatment was incompatible with the principle.
The Commission argued that Apple Group IP licences held by ASI and AOE should have been allocated (in their entirety) to Irish branches of ASI and AOE, which would have meant that all of the profit arising from those IP licences would be taxable in Ireland.
The Commission argued that the only part of the companies that had a physical presence and that had employees who were capable of managing the licences were in the Irish branches.
But the General Court disagreed with the Commission’s assessment of the Irish tax rules applicable to the taxation of profits of non-resident companies with Irish branches and agreed that the relevant Irish tax laws only required the profits arising from the licences to be allocated to ASI and AOE where it could be shown that the licences were controlled by the Irish branches.
Crucially, whereas the Commission placed the Cork branches at the centre of strategic decisions and functions, the Court placed these Irish branches in a supporting role, with the strategic function sitting with the head offices, in Cupertino. As such, Irish tax law did not require that the income generated from the IP licenses be taxed in Ireland.
On that basis, the Commission had not proven that the tax rulings, which accepted the transfer of the IP to the head office outside Ireland, provided an advantage to Apple. In other words, it was not proven that the allocation of the IP to the head office was a deviation from Irish law or that it was contrary to the outcome that would have been arrived at under market conditions.
- The Commission May Appeal to Europe’s Highest Court
The General Court’s judgment may be appealed to the CJEU on a point of law only. It is not yet clear that the Commission will appeal the judgment – it has said that it will “carefully study the judgment and reflect on possible next steps.” If the Commission does appeal, the €13 billion (plus interest) paid by Apple to Ireland will remain in an escrow account pending the outcome of the appeal (which may take a further 2-3 years to be decided). If the Commission does not appeal, the funds will be returned to Apple.
- The Decision Confirms the Legal Test for Future Tax State Aid Cases and Sets a High Standard of Proof for the European Commission
The judgment will be of crucial significance for ongoing and high-profile State aid investigations in relation to the tax treatment of, for example, Nike and IKEA in the Netherlands. The key learning for the Commission from the Apple judgment will be the high standard of proof required in order to demonstrate the existence of an economic advantage. Failures or defects in the Member State’s determination of an operator’s tax liability, however serious (in this case the Court described the Irish tax rulings as "incomplete" and "inconsistent", will not relieve the Commission of its evidential burden to prove that an economic advantage has, in fact, accrued to the beneficiary.
That being said, the Decision is not all bad news for the Commission. The confirmation that the Commission was entitled to apply the arm’s-length principle in determining the existence of an economic advantage is significant, and this point was hotly contested by Apple and Ireland. While the Court did not agree that the principle is inherent in Article 107(1) TFEU, its conclusion seems to be that the principle may be used to verify tax treatment where the tax system in question provides that entities shall be taxed as if they were trading under normal market conditions. On this basis, the Commission is highly likely to rely on the principle in future tax-related State aid cases.
In addition, the Court confirmed that the Commission had correctly defined the reference system as the rules governing the taxation of corporate profit, in spite of the existence of specific legislative rules governing the tax liability of non-resident entities. The endorsement of this broad reference framework is a positive for the Commission as it may allow it to more easily prove the “selectivity” criterion in future cases: the more broadly the reference framework is defined, the easier it becomes to show that the tax treatment of a certain entity deviated from this framework.
More broadly, the judgment is certain to reignite discussions surrounding the lack of tax harmonisation at EU level, where Ireland’s low corporation tax rate has been a bone of contention for some in recent years. Commenting on the judgment, Commission Competition chief Margrethe Vestager noted that “State aid enforcement needs to go hand in hand with a change in corporate philosophies and the right legislation to address loopholes and ensure transparency.” However it is important to remember that the Commission had previously explicitly stated that the case against Apple “does not call into question Ireland’s general tax system or its corporation tax rate.”
The Commission’s 2016 decision (the “Decision”)3 found that Ireland had granted unlawful State aid to Apple through two tax rulings relating to Apple’s Irish subsidiaries ASI and AOE (read our earlier briefings The Apple Case (31 August 2016) and Apple Case Update (23 December 2016)).
The approach set out in the tax rulings reflected Irish rules applicable to the taxation of profits of non-resident companies and confirmed that ASI and AOE, as Irish incorporated but non-tax resident companies, would be taxed on the basis of the income generated by their Irish branches only. According to the Commission, the tax rulings allowed Apple to allocate profits to head office entities outside Ireland in contravention of the “arm’s-length principle”, and meant that these entities benefitted from a reduction in their tax burden that was not available to other Irish companies. In support of their appeal against the Decision, Ireland and Apple raised 9 and 14 pleas in law respectively.
The Commission’s case against Apple is one a range of cases in which the Commission is targeting “sweetheart” tax deals between Member States and multi-national companies. Last year, the General Court handed down landmark rulings in two of these cases, Starbucks4 and Fiat5, which involved “transfer pricing” arrangements between subsidiaries which, the Commission said, “did not reflect economic reality” and allowed Fiat and Starbucks to artificially reduce their tax burdens in Luxembourg and the Netherlands respectively.
The judgments in Starbucks and Fiat provided crucial insight into the Court’s approach to State aid cases based on tax rulings. In both cases, the General Court endorsed the Commission’s ability to review tax rulings for compliance with State aid rules. Significantly, the judgments also endorse the Commission’s use of the so-called “arm’s-length principle”, which was used in these cases to verify that the amounts paid between group subsidiaries for assets or IP corresponded to comparable market transactions “at arm’s length”. The Commission had argued that the arm’s-length principle is in inherent in Article 107(1) TFEU, and therefore requires Member States to employ the principle when determining tax liability. However, the Court found that it is merely a “useful tool that can be used to verify that intra-group transactions are remunerated as if they had been negotiated between stand-alone undertakings”. The Court also ruled that the relevance of the arm’s-length principle depended on whether the tax system in question treated standalone and integrated companies equally from a tax perspective. Both the Dutch and the Luxembourg systems did so.
While the Commission’s decision in Fiat was upheld, the Court found that the Commission had not proven the existence of an economic advantage in Starbucks. Specifically, the Court held that it was not enough for the Commission to show that the Netherlands has made methodological errors in determining the tax liability of Starbucks, or had used a methodology for the application of the arm’s-length principle that did not accord with the Commission’s preference. Rather, the Commission was required to show that the method used leads to a reduction in the taxable profit compared with the tax burden arising from the normal tax rules. As such, the Court emphasised the high evidential burden borne by the Commission in proving that a tax ruling results in an economic advantage.
The Legal Test for State Aid:
It is useful to recall the legal test the Commission must satisfy in order to prove the existence of an unlawful State aid. The Commission must prove:
- that the aid was granted by a Member State or through State resources (usually clear in tax cases);
- that it gives an advantage to the beneficiary (something that would not normally accrue);
- that the advantage is selective (i.e., that is not available to companies in a comparable situation); and
- that it distorts or threatens to distort competition and affects trade between Member States.
The issues of (ii) advantage and (iii) selectivity have proven the most difficult to apply in tax cases.
Also contributed by Ciarán Donohue.
- Cases T‑778/16 and T‑892/16, Ireland v Commission, EU:T:2020:338.
- Cases T‑778/16 and T‑892/16, Ireland v Commission, EU:T:2020:338, paragraph 207.
- Commission Decision (EU) 2017/1283 of 30 August 2016 on State aid SA.38373 (2014/C) (ex 2014/NN) (ex 2014/CP) implemented by Ireland to Apple.
- Cases T-760/15 and T-636/16, Netherlands v Commission, EU:T:2019:669.
- Cases T-755/15 and T-759/15, Luxembourg v Commission, EU:T:2019:670.
This briefing is for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.