Defects, incompleteness and inconsistencies in tax rulings are not sufficient to prove the existence of an advantage in the meaning of Article 107(1) TFEU.
Update on Temporary Framework:
Number of approved and published covid-19 measures, as of 17 July 2020: 213*
Legal basis: Article 107(2)(b): 21; Article 107(3)(b): 179; Article 107(3)(c): 18
Five Member States have implemented 13 or more covid-19 measures each: Belgium, Denmark, France, Italy & Poland.
– Average number of measures per Member State: 7.6
– Median number of measures per Member State: 9
– Mode number of measures per Member State: 5
* Excludes amendments to previously notified measures
Introduction
With the exception of the judgment of the German federal constitutional court on the ECB’s public bond purchases at the beginning of May 2020, no other case in recent memory has generated more press commentary than the ruling of the General Court of 15 July 2020 on the appeal brought by Ireland and Apple against the Commission [joined cases T‑778/16 and T‑892/16, Ireland & Apple v European Commission].[1]
Ireland and Apple applied for annulment of Commission decision 2017/1283 concerning two advance tax rulings by Ireland on the prospective tax liability of Apple Operations Europe [AOE] and Apple Sales International [ASI]. The gist of the dispute was whether the tax rulings had determined correctly the amount of profit that could be attributed to the Irish branches of ASI and AOE.
The Commission found that the tax rulings conferred an advantage and therefore constituted State aid. To prove the existence of State aid, the Commission developed a primary, a subsidiary and an alternative line of reasoning. The General Court faulted all three lines of reasoning. In effect, the General Court raised the standard of proof very high. Perhaps it was too harsh on the Commission which, according to the Court, may not presume that mistakes by Member States in calculating tax liability necessarily indicate that companies obtain an undue advantage.
The judgment is very long and complex and runs to more than 500 paragraphs or about 100 pages. For this reason, the main points of the judgment are summarised below in the form of bullet points for the benefit of the reader.
Autonomy of Member States and competence of the Commission
- Member States must exercise their autonomy in matters of direct taxation in compliance with State aid rules.
- Therefore, the Commission is competent to determine whether tax rulings can constitute State aid by conferring an advantage in comparison to the tax liability that would have arisen from the application of the normal system of taxation.
- However, the Commission does not have the power independently to determine what constitutes normal taxation.
- Member States are free to designate tax bases and to spread the tax burden across the different factors of production and economic sectors.
The reference or normal or ordinary framework of taxation
- The determination of the reference framework is relevant for examining both the advantage criterion and the selectivity criterion.
- The reference framework is made up of the rules of taxation that apply to the recipient of the measure that is regarded as constituting State aid.
- Companies which are in a comparable factual and legal situation have to be taxed in the same way.
- Comparable companies are identified according to the intrinsic objectives of the reference framework.
- The system of advance tax rulings cannot be regarded as the reference framework if the objective of the corporate tax system is to tax the profits of all entities.
- A tax measure is selective if it derogates from the normal or ordinary tax system by benefiting certain operators and not others which are in an objectively comparable situation.
- However, derogation is not always necessary for a measure to be selective if it treats differently comparable companies.
Selective advantage
- The concepts of advantage and selectivity are distinct and their existence must be proven separately.
- However, in the area of taxation, they may be examined together where a tax measure confers an economic advantage that is not enjoyed by other, comparable undertakings.
Arm’s length principle
- In the case of tax measures, the very existence of an advantage may be established only when compared with normal taxation.
- The Commission may use the arm’s length principle to check whether a tax measure confers an advantage.
- In order for an advance tax ruling to determine the profits that have to be allocated to a branch, it must estimate the profits that that branch can earn at an arm’s length if it were a separate and independent enterprise, taking into account the operations performed and the risks borne by the branch.
- Attributed profits must relate and be proportional to the activities actually carried out by the branch.
- The Commission must show that the activities which are subject to taxation are actually carried out. It may not simply assume their presence.
Profit allocation methodology
- The Commission may use the OECD methodologies.
- The Commission may not assume that faulty profit-allocation methods used by Member States confer an advantage. It must prove that they actually result in lower taxable profits.
Cost-plus as a profit indicator
- The choice of the profit indicator must be justified and must reflect the nature of the activities of a branch and the risks inherent in its operations.
- Errors by Member States in the choice of the profit indicator do not prove the existence of an advantage. The Commission must show that the profit indicator has actually resulted in lower profits than those of a comparable independent company subject to normal taxation.
Background
ASI and AOE are both companies incorporated in Ireland, but are not tax resident in Ireland. ASI is a wholly-owned subsidiary of AOE which itself is a wholly-owned subsidiary of Apple Operations International which in turn is fully owned by Apple Inc.
Apple Inc., ASI and AOE were bound by an agreement to share the R&D costs and risks of technology that was incorporated in Apple products. They also agreed that Apple Inc. remained the legal owner of the related intellectual property rights. In return, Apple Inc. granted ASI and AOE free licences enabling them to manufacture and sell the products concerned in the countries that were within the area of their operations.
In 2008, ASI concluded a marketing services agreement with Apple Inc. which undertook to help ASI to develop marketing strategies, programmes and advertising campaigns. ASI agreed to remunerate Apple Inc. for those services with a fee that was a percentage of the “reasonable costs incurred” by Apple Inc., plus a mark-up.
ASI’s Irish branch is responsible for the sale of Apple-branded products. AOE’s Irish branch is responsible for the manufacture and assembly of a specialised range of computer products in Ireland [e.g. iMac, MacBook].
In 1991 and 2007, the Irish tax authorities granted advance tax rulings to ASI and AOE in accordance with the proposals made by Apple concerning the chargeable profits of ASI and AOE in Ireland.
When the Commission examined the two tax rulings, it concluded that they did not conform with the arm’s length principle because the chargeable profits allocated to the Irish branches of ASI and AOE were much lower than what would have been earned by a company that sold its products to independent third parties. In effect the rulings reduced the tax base and therefore the tax liability of ASI and AOE.
The competence of the Commission
The General Court began its analysis by assessing the pleas challenging the Commission’s competence to adopt the contested decision.
The applicants argued that the Commission exceeded its competences and encroached on the competences of the Member States in breach of the principle of fiscal autonomy. The General Court rejected this argument, as it rejected it a year ago in the appeal by Belgium against the Commission decision on the taxation of excess profits of multinational companies [case T‑131/16, Belgium v European Commission].
The General Court recalled that “105 while direct taxation, as EU law currently stands, falls within the competence of the Member States, they must nonetheless exercise that competence consistently with EU law […]. Thus, instances of intervention by the Member States in the field of direct taxation, even if they concern issues that have not been harmonised in the European Union, are not excluded from the scope of the rules on State aid control.”
“(106) The Member States must exercise their competence in the field of taxation consistently with EU law […]. Consequently, they must refrain from taking, in that context, any measure liable to constitute State aid incompatible with the internal market.”
“(109) It follows from the foregoing that, as the Commission is competent to ensure that Article 107 TFEU is complied with, it cannot be said to have exceeded its competences when assessing whether, in issuing the contested tax rulings, the Irish tax authorities had granted ASI and AOE favourable tax treatment by enabling them to reduce their chargeable profit as compared with the chargeable profit of other corporate taxpayers in a comparable situation.”
“(110) In the case of tax measures, the very existence of an advantage may be established only when compared with ‘normal’ taxation”.
“(111) Consequently, in order to determine whether there is a tax advantage, it is necessary to compare the recipient’s situation resulting from the application of the measure in question with its situation had the measure in question not been adopted […] and had the normal rules of taxation been applied.”
Normal taxation in the Irish system
The applicants also argued that the Commission exceeded its competences inasmuch as it relied on a unilateral and incorrect interpretation of Irish tax law for the purpose of harmonising taxes across the EU. The Court had to assess what was the normal taxation in this case. “(113) Pursuant to section 25 of the TCA 97 [i.e. the relevant Irish tax code], non-resident companies carrying on their trade in Ireland through a branch are taxed, with regard to their trading income, only on the profits resulting from trade directly or indirectly attributable to that Irish branch. It should also be noted […] that that provision does not lay down any specific method for determining the profits attributable to the Irish branches of non-resident companies.”
“(114) For the purpose of applying section 25 of the TCA 97, account must be taken of the factual background and the situation of the branch in Ireland, in particular the functions performed, the assets used and the risks assumed by that branch.”
“(115) In order to determine whether there was an advantage in the present instance, the Commission had to be able to analyse ASI and AOE’s tax treatment resulting from the application of the contested tax rulings against the tax treatment which those two companies would have received under the normal rules of taxation applicable in Ireland if the rulings in question had not been issued.”
“(116) Therefore, it cannot be argued that the Commission unilaterally applied the substantive tax rules and carried out a de facto tax harmonisation when analysing whether the chargeable profits of ASI and AOE, calculated under the contested tax rulings, corresponded to profits made by their Irish branches, taking into account the functions performed, the assets used and the risks assumed by those branches, which would have been taxable under section 25 of the TCA 97.”
This is an important finding in favour of the Commission. Companies request advance tax rulings because the tax law itself is not precise enough. For this reason, tax rulings involve considerable subjectivity. The General Court recognised the right of the Commission to challenge the degree of subjectivity of tax rulings. We will see later on that the Commission fail to fully justify its calculation of attributed profits. Last September and largely for similar reasons, the General Court annulled the Commission decision on Starbucks [case T-760/15, Netherlands v European Commission]. But eventually the Commission will learn to calculate correctly and justify sufficiently its calculations.
The Court went on to dismiss the pleas that the Commission had exceeded its competences and that it encroached on the competences of the Member States.
The concepts of advantage and selectivity
The applicants argued that the Commission conflated the conditions of advantage and selectivity.
According to the Commission’s primary line of reasoning “(125) in so far as the head offices of ASI and AOE were unable to control or manage the Apple Group’s IP licences, those head offices should not have been allocated, in an arm’s length context, the profits derived from the use of those licences. Accordingly, those profits should have been allocated to ASI and AOE’s branches, which alone would have been in a position effectively to perform the functions related to the Apple Group’s IP that were crucial to ASI and AOE’s trading activity.”
The General Court recalled that “(134) selectivity and advantage are two separate conditions. In respect of advantage, the Commission must show that the measure improves the financial situation of the recipient […]. In respect of selectivity, the Commission must show that the advantage is not enjoyed by other undertakings in a legal and factual situation comparable to that of the recipient in the light of the objective of the reference framework”.
“(135) However, it is not inconceivable that those conditions may be examined together where it is apparent from the examination carried out by the Commission, first, that the measure in question confers an economic advantage on its recipient and, second, that that advantage is not enjoyed by undertakings in a comparable legal and factual situation.”
“(137) It is apparent from the contested decision that, in its analysis of whether there was a selective advantage […], the Commission examined to what extent the contested tax rulings had led to a reduction in the amount payable by ASI and AOE in the form of corporation tax in Ireland in order to show that those rulings had given those companies an economic advantage. In addition, the Commission defined the reference framework as being the ordinary rules of taxation of corporate profit in Ireland […]. Moreover, in connection with its primary, subsidiary and alternative lines of reasoning […], the Commission examined whether, by reducing those undertakings’ annual chargeable profits, the contested tax rulings had derogated from that reference framework, in order to establish that those rulings were selective in nature.”
“(138) In so far as the Commission did in fact examine both the advantage condition and the selectivity condition, it is irrelevant that that examination covered both conditions simultaneously. It cannot therefore be held that the Commission erred in law simply because it examined them together.” “(139) The complaint raised by Ireland relating to the fact that the conditions of advantage and selectivity were examined together must therefore be rejected as unfounded.
Identification of the reference framework
The reference framework is the normal or ordinary system of taxation against which the existence of a selective advantage is to be determined.
The General Court noted that “(141) the Commission considered that [the] reference framework included both non-integrated and integrated companies because Irish corporation tax does not distinguish between those companies.”
“(142) In addition, the Commission considered that even though resident and non-resident companies were taxed on different sources of income, in the light of the intrinsic objective of those rules, namely the taxation of profit of all companies subject to tax in Ireland, both types of company were in a comparable factual and legal situation. Consequently, those rules included section 25 of the TCA 97, which therefore could not be considered to constitute a separate reference framework in itself.”
“(144) It should be noted that, when analysing tax measures in the context of Article 107(1) TFEU, the determination of the reference framework is relevant for examining both the advantage condition and the selectivity condition.”
“(146) In addition, in order to classify a domestic tax measure as selective, it is necessary to begin by identifying and examining the ordinary or normal tax regime applicable in the Member State concerned”.
“(147) Moreover, the Court of Justice has confirmed its case-law according to which it is sufficient, in order to establish the selectivity of a measure that derogates from an ordinary tax system, to demonstrate that that measure benefits certain operators and not others, although all those operators are in an objectively comparable situation in the light of the objective pursued by the ordinary tax system”.
“(148) Indeed, while it is not always necessary, in order for it to be established that a tax measure is selective, that it should derogate from an ordinary tax system, the fact that it can be so characterised is highly relevant in that regard where the effect of that measure is that two categories of operators are distinguished and are subject, a priori, to different treatment, namely those who fall within the scope of the derogating measure and those who continue to fall within the scope of the ordinary tax system, although those two categories are in a comparable situation in the light of the objective pursued by that system”.
“(150) It is apparent from case-law that it is the rules of taxation to which the recipient of the measure that is regarded as constituting State aid is subject that form the reference framework. It is also apparent from case-law that the substantive scope of the reference framework can be defined only in relation to the measure that is regarded as constituting State aid. Therefore, the purpose of the measures at issue and the legal framework of which they form part must be taken into consideration when determining the reference framework.”
“(151) Moreover, the Commission explained its interpretation of the concept of reference framework in the notice on the notion of State aid as referred to in Article 107(1) TFEU. Although that notice cannot bind the Court, it may nevertheless serve as a useful source of guidance”. “(152) Paragraph 133 of the notice referred to in paragraph 151 above states, inter alia, that the reference system is composed of a consistent set of rules that generally apply – on the basis of objective criteria – to all undertakings falling within its scope as defined by its objective. Typically, those rules define not only the scope of the system, but also the conditions under which the system applies, the rights and obligations of undertakings that are subject to it and the technicalities of the way in which it functions.”
“(154) In the present instance, upon reading the contested tax rulings, […] it is clear that they were issued in order to allow ASI and AOE to determine their chargeable profits in Ireland for the purposes of corporation tax in that Member State.”
“(155) Accordingly, the contested tax rulings form part of the general Irish corporation tax regime, the objective of which is to tax the chargeable profits of companies carrying on activities in Ireland, be they resident or non-resident, integrated or stand-alone.”
Then in paragraphs 156-160, the General Court examined how the Irish tax law would apply to this case and established that the profits of Irish branches of non-resident companies would be subject to the normal corporation tax of 12.5% because “(161) resident and non-resident companies carrying on a trade in Ireland through a branch are in a comparable situation in the light of the objective pursued by that regime, namely the taxation of chargeable profits.”
“(163) The Commission did not err when it concluded that the reference framework in the present instance was the ordinary rules of taxation of corporate profit in Ireland, the intrinsic objective of which was the taxation of profit of all companies subject to tax in that Member State”.
Consequently, the Court rejected the complaints of Ireland and ASI and AOE concerning the reference framework.
This is also an important finding in favour of the Commission. Multinational companies have argued that the reference system should be the narrower framework of advance tax rulings. In this context, even if a tax ruling is selective it is difficult to conclude that by itself it confers an advantage since in the absence of the ruling, the reported income may be much lower resulting in a smaller tax base. But the Court has supported the position of the Commission that the relevant benchmark must be the normal tax system. This requires an assessment of how much tax a branch or subsidiary would have to pay under the normal system. As we will see below, in order to estimate the company’s tax liability under the normal system, it becomes necessary to determine what the company in question should have charged had it transacted at an arm’s length.
The Commission’s primary line of reasoning
The application of the normal taxation of profits under Irish tax law to branches
The General Court first recalled that “(166) the Commission maintained that the fact that the Irish branches of ASI and AOE were not allocated the profits derived from the Apple Group IP licences held by ASI and AOE meant that the determination of the annual chargeable profits of ASI and AOE in Ireland departed from a reliable approximation of a market-based outcome in line with the arm’s length principle, with the result that the amount that would otherwise have been payable by ASI and AOE as corporation tax in Ireland was reduced.”
“(167) The Commission’s analysis in this regard is based on the consideration that […] for the purpose of allocating profits to a branch required the application of a profit allocation method which, under Article 107(1) TFEU, had to be based on the arm’s length principle. […] the profits to be allocated to a branch were the profits that that branch would have earned at arm’s length if it had been a separate and independent enterprise engaged in identical or similar activities under identical or similar conditions, taking into account the functions performed, the assets used, and the risks assumed by the company through its branch.”
“(174) Therefore, it is necessary to analyse whether the Commission was entitled to consider that, under section 25 of the TCA 97, when determining ASI and AOE’s profits in Ireland, the Irish tax authorities should have allocated the Apple Group’s IP licences to the Irish branches of those two companies.”
“(176) It is true, […] that section 25 of the TCA 97 does not lay down any specific method enabling it to be established which profits are directly or indirectly attributable to the Irish branches of non-resident companies and makes no reference to the arm’s length principle for the purposes of that attribution.”
“(177) Nevertheless, it is clear that section 25 of the TCA 97 relates only to the profits derived from trade that the Irish branches have carried on themselves and excludes profits derived from trade carried on by other parts of the non-resident company in question.”
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Control of intellectual property
“(182) Therefore, […] the question that is relevant when determining the profits of the branch is whether the Irish branch has control of that [intellectual] property.”
“(184) When determining which profits are attributable to the Irish branch of a company that is not tax resident for the purposes of section 25 of the TCA 97, the property held by that company cannot be allocated to the Irish branch if it has not been established that that property is actually controlled by that branch.”
“(185) If the Apple Group IP licences held by ASI and AOE were not controlled by the Irish branches, it would be wrong to allocate all of the income generated by the companies arising from those licences to those branches under section 25 of the TCA 97. Only the profit derived from the trading activity of the Irish branches, including that carried on the basis of the Apple Group IP licences held by ASI and AOE, should be regarded as relating to the activities of those branches.”
“(186) In its primary line of reasoning, the Commission did not attempt to show that the Irish branches of ASI and AOE had in fact controlled the Apple Group’s IP licences when it concluded that the Irish tax authorities should have allocated the Apple Group’s IP licences to those branches and that, consequently, under section 25 of the TCA 97, all of ASI and AOE’s trading income should have been regarded as arising from the activities of those branches.”
The General Court concluded that the Commission erred, in its primary line of reasoning, in attributing the income of Apple’s IPRs to ASI and AOE.
The Court considered that it was, nonetheless, necessary to go on to examine the arguments raised by Ireland and ASI and AOE against the other inherent aspects of the Commission’s assessment of the normal taxation of profits.
The arm’s length principle
Ireland and ASI and AOE contended that the arm’s length principle was not part of Irish tax law and that no freestanding obligation to apply that principle emerges from Article 107 TFEU, any other provision of EU law, or the landmark judgment in case C‑217/03, Forum 187 v Commission. This is the judgment that provided the intellectual foundation of the Commission’s position that integrated companies should not pay less tax than independent companies.
The General Court examined, first, whether the Commission was entitled to rely on the arm’s length principle in order to determine whether there was a selective advantage.
The Court recalled the Commission’s view. “(193) The Commission stated that, according to the judgment of 22 June 2006, Belgium and Forum 187 v Commission (C‑182/03 and C‑217/03, EU:C:2006:416), a reduction in the taxable base that resulted from a tax measure that enabled a taxpayer to employ transfer prices in intra-group transactions that did not resemble prices which would have been charged in conditions of free competition between independent undertakings negotiating under comparable circumstances at arm’s length conferred a selective advantage on that taxpayer for the purposes of Article 107(1) TFEU.”
Then the Court reiterated the procedure for determining whether a tax measure confers an advantage. “(202) In the case of tax measures, the very existence of an advantage may be established only when compared with ‘normal’ taxation”. “(203) Accordingly, in order to determine whether there is a tax advantage, it is necessary to compare the recipient’s situation resulting from the application of the measure in question with its situation had the measure in question not been adopted […] and had the normal rules of taxation been applied.”
“(204) The issue therefore lies in determining what profits must be allocated to those branches for corporation tax purposes as part of ‘normal’ taxation, taking into account the normal rules of taxation applicable in the present instance”.
Because the crux of the issue here is the allocation of profits from IPRs, the Court clarified that “(205) the question that is relevant in the present instance is not linked to the prices of intra-group transactions within a group of undertakings, as was the situation in the case that gave rise to the judgment of 24 September 2019, Netherlands and Others v Commission (T‑760/15 and T‑636/16, EU:T:2019:669).”
“(206) It is true that the allocation of profits to a branch of a company may lend itself to the application by analogy of the principles applicable to the prices of intra-group transactions within a group of undertakings. In the same way as the prices of intra-group transactions between companies integrated in a single group of undertakings are not determined under market conditions, the allocation of profits to a branch of a single company is not carried out under market conditions.”
“(207) However, in order for those principles to be applied by analogy, 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.”
“(208) In that regard, […] it should be borne in mind that, […] under section 25 of the TCA 97, both resident companies, on the one hand, and non-resident companies carrying on a trade in Ireland through a branch, on the other, are in a comparable situation in the light of the objective pursued by that regime, namely taxing the chargeable profits of those companies, be they resident or non-resident.”
Then, after analysing the Irish tax law, the Court found that “(211) under Irish tax law, the profit resulting from the trading activity of such a branch is to be taxed as if it were determined under market conditions.”
“(212) In those circumstances, when the Commission examines, in connection with the power conferred on it by Article 107(1) TFEU, a tax measure concerning the chargeable profits of a non-resident company carrying on a trade in Ireland through a branch, it may compare the tax burden of such a non-resident company resulting from the application of that tax measure with the tax burden resulting from the application of the normal rules of taxation under national law to a resident company, placed in a comparable factual situation, carrying on its activities under market conditions.”
“(213) Those findings are borne out, mutatis mutandis, by the judgment of 22 June 2006, Belgium and Forum 187 v Commission (C‑182/03 and C‑217/03, EU:C:2006:416), as the Commission correctly pointed out in the contested decision. The case that gave rise to that judgment concerned Belgian tax law, which provided for integrated companies and stand-alone companies to be treated on equal terms. The Court of Justice recognised in paragraph 95 of that judgment the need to compare a regime of derogating aid with the ordinary rules ‘based on the difference between profits and outgoings of an undertaking carrying on its activities in conditions of free competition’.”
“(214) Thus, although, through the tax measure concerning the chargeable profits of a non-resident company carrying on a trade in Ireland through a branch, national authorities have accepted a certain level of profit attributable to that branch, Article 107(1) TFEU allows the Commission to check whether that level of profit corresponds to the level that would have been obtained through carrying on that trade under market conditions, in order to determine whether there is, as a result, any mitigation of the burdens normally included in the budget of the undertaking concerned, thus conferring on that undertaking an advantage for the purposes of that provision. The arm’s length principle, as described by the Commission in the contested decision, is thus a tool enabling the Commission to make that determination in the exercise of its powers under Article 107(1) TFEU.”
In other words, the arm’s length principle is a tool or benchmark for comparing the tax treatment of different classes of companies which, however, are in the same legal position in relation to the reference tax system.
The Court went on to examine whether it could be applied in the Irish context. It first warned that “(221) the Commission cannot, however, contend that there is a freestanding obligation to apply the arm’s length principle arising from Article 107 TFEU obliging Member States to apply that principle horizontally and in all areas of their national tax law.”
“(222) In the absence of EU rules governing the matter, it falls within the competence of the Member States to designate bases of assessment and to spread the tax burden across the different factors of production and economic sectors”.
“(223) The fact remains that, at the current stage of development of EU law, the Commission does not have the power independently to determine what constitutes the ‘normal’ taxation of an integrated undertaking while disregarding the national rules of taxation.”
“(224) Nevertheless, although so-called ‘normal’ taxation is to be determined according to the national tax rules and in spite of the fact that those rules must be used as a reference point when establishing the very existence of an advantage, the fact remains that, if those national rules provide that the branches of non-resident companies, as concerns the profits derived from those branches’ trading activity in Ireland, and resident companies are to be subject to the same conditions of taxation, Article 107(1) TFEU gives the Commission the right to check whether the level of profit allocated to the branches that has been accepted by the national authorities for the purpose of determining the chargeable profits of those non-resident companies corresponds to the level of profit that would have been obtained if that activity had been carried on under market conditions.”
The actual economic activities of branches
Then the General Court examined whether the Commission applied correctly the arm’s length principle in its primary line of reasoning to determine the market value of the activities that were actually carried out by the branches themselves.
“(228) In its primary line of reasoning, the Commission concluded that the Apple Group IP licences held by ASI and AOE should have been allocated to the Irish branches due to the lack of staff and physical presence of those two companies, without attempting to show that that allocation followed from the activities actually carried on by those Irish branches. In addition, the Commission inferred from that conclusion that all of the trading income of ASI and AOE should have been regarded as arising from the activities of the Irish branches without attempting to show that that income was representative of the value of the activities actually carried out by the branches themselves.”
The Commission had considered that, because ASI and AOE did not have staff to manage the IPRs or to carry out trading activities, the income from IPRs and trading should have been attributed to the branches. But the General Court concluded that the Commission’s use of the arm’s length principle in this context was incorrect. A few paragraphs later on [paragraphs 241-245], the General Court also found that the Commission had applied wrongly the OECD methodology for determining attributed income because it did not show that the branches had actually carried out any management functions.
I think there may be a logical weakness in the reasoning of the General Court at this point. If, for example, AOE is just a brass-plate company, then it logically follows that any income generated by its activities must necessarily be the result of the efforts of its Irish branch. If no other company can generate that income for AOE, then, assuming that IPRs require management, the Commission does not have to show that the attribution to the branch is proportional to its activities. However, if that income can also be generated by other companies or branches controlled by AOE or if the IPRs do not require management, then the Commission must prove the proportionality of the attributed income to the Irish branch. The General Court did not consider this possibility.
The General Court conveniently summarised, in paragraphs 246-249, its findings concerning the reference framework and the application of the normal system of Irish tax law:
- The Commission did not err when it identified the reference framework to be composed of the ordinary rules of taxation of corporate profit. [paragraph 246]
- The Commission did not err when it used the arm’s length principle as a tool in order to verify that the profit allocated to the branches corresponded to the profit that could be earned under market conditions. [paragraph 247]
- The Commission did not err when it used the OECD methodology. [paragraph 248]
- The Commission erred in its allocation of profit to the branches without verifying that they had control over the IPRs or that they managed those IPRs or that the attributed profit corresponded to their trading activities. [paragraph 249]
Then the General Court, in paragraphs 250-310, examined in detail whether the income from the IPRs of the Apple Group should have been allocated to the Irish branches of AOE and ASI. The analysis and the weighing of the evidence and various arguments from each side in fact demonstrate how difficult it is for the Commission to determine to whom the value of ideas should be attributed.
In the end, the General Court found that “310 the Commission has not succeeded in showing that, in the light, first, of the activities and functions actually performed by the Irish branches of ASI and AOE and, second, of the strategic decisions taken and implemented outside of those branches, the Apple Group’s IP licences should have been allocated to those Irish branches when determining the annual chargeable profits of ASI and AOE in Ireland.”
Consequently, it concluded that “(312) in the light of the findings in paragraph 249 above regarding the Commission’s erroneous assessments of normal taxation under the Irish tax law applicable in the present instance and the findings in paragraph 310 above regarding the Commission’s erroneous assessments of the activities within the Apple Group, it is necessary to uphold the pleas in law alleging that, in its primary line of reasoning, the Commission did not succeed in showing that, by issuing the contested tax rulings, the Irish tax authorities granted ASI and AOE an advantage for the purposes of Article 107(1) TFEU.”
The Commission’s subsidiary line of reasoning
Profit allocation methodology
Having faulted the Commission’s primary line of reasoning, the General Court turned its attention to the Commission’s subsidiary and alternative lines of reasoning.
In its subsidiary line of reasoning, the Commission contended that, “(315) even if the Irish tax authorities had been fully entitled to accept that the Apple Group IP licences held by ASI and AOE should not have been allocated to their Irish branches, the profit allocation methods endorsed in the contested tax rulings had nonetheless led to a result departing from a reliable approximation of a market-based outcome in line with the arm’s length principle, because those methods undervalued the annual chargeable profits of ASI and AOE in Ireland.”
According to the Commission, those profit allocation methods, which resembled the transaction net margin method [TNMM] in the OECD’s Transfer Pricing Guidelines, were applied incorrectly.
The General Court first noted that “(319) the mere non-observance of methodological requirements, in particular in connection with the OECD Transfer Pricing Guidelines, is not a sufficient ground for concluding that the calculated profit is not a reliable approximation of a market-based outcome, let alone that the calculated profit is lower than the profit that should have been obtained if the method for determining transfer pricing had been correctly applied. Thus, merely stating that there has been a methodological error is not sufficient, in itself, to demonstrate that the tax measures at issue have conferred an advantage on the recipients of those measures. Indeed, the Commission must also demonstrate that the methodological errors that have been identified have led to a reduction in the chargeable profit and thus in the tax burden borne by those recipients, in the light of the tax burden which they would have borne pursuant to the normal rules of taxation under national law had the tax measures in question not been adopted.”
At any rate, the General Court accepted that the Commission could use the TNMM and went on to assess whether the Commission had applied it correctly in this case.
In this connection, the Court first explained the logic of the TNMM. “(329) The TNMM constitutes a one-sided method of determining transfer pricing. It consists in determining, relative to an appropriate base, the net profit obtained by a taxpayer, namely the ‘tested party’, from a controlled transaction or from controlled transactions which are closely linked or continuous. In order to determine the appropriate base, it is necessary to choose a profit level indicator, such as costs, sales or assets. The net profit indicator obtained by the taxpayer from a controlled transaction must be determined by reference to the net profit indicator that the same taxpayer or an independent undertaking obtains from comparable transactions on the free market. The TNMM therefore requires the identification of a party to the transaction in respect of which an indicator is tested. This is the ‘tested party’.”
“(330) As a general rule, the tested party is the party to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be identified. This will most often be the party that has the least complex functional analysis.”
The General Court observed that “(333) the mere statement by the Commission that there is a methodological error resulting from the choice of tested party in connection with the profit allocation methods used in respect of the Irish branches of ASI and AOE approved by the contested tax rulings, even assuming that error is established, is not sufficient, per se, to demonstrate that those tax rulings conferred an advantage on ASI and AOE.”
“(337) It should be borne in mind that the Commission based its subsidiary line of reasoning on the premiss that the Apple Group’s IP licences were correctly allocated to the head offices of ASI and AOE.” “(338) As is correctly emphasised by Ireland and ASI and AOE, it should be noted that IP constitutes the key asset for an undertaking, such as the Apple Group, whose business model is essentially based on technological innovations. That IP may therefore be regarded, in the present instance, as a unique asset for the purposes of the OECD Transfer Pricing Guidelines.”
“(340) It follows that the Commission cannot claim, in its subsidiary line of reasoning, that the Apple Group’s IP was correctly allocated to the head offices of ASI and AOE and, at the same time, that it is the Irish branches of those two companies which performed the most complex functions in relation to that IP, without providing any evidence as to the actual performance of such complex functions by those branches.”
The General Court noted that “(344) the contested tax rulings were issued after the Apple Group’s tax advisors sent the Irish tax authorities some short letters in which they briefly described the activities of ASI and AOE’s branches and proposed a methodology for calculating the chargeable profits of those two companies in Ireland. The content of those exchanges is fairly vague and […] without there being any documented objective and detailed analysis regarding the functions of the branches and the assessment of those functions.” “(345) No profit allocation report or any additional information was provided to the Irish tax authorities prior to the issuing of the contested tax rulings.”
“(347) That lack of evidence submitted to the Irish tax authorities concerning the functions actually performed by the Irish branches and the assessment of those functions for the purpose of determining the profit to be allocated to those branches may be regarded as a methodological defect in the application of section 25 of the TCA 97”.
“(348) However, as regrettable as that methodological defect is, the Commission, in carrying out its State aid control under Article 107 TFEU, cannot, for its part, confine itself to stating that the choice of ASI and AOE’s Irish branches as the tested parties when applying the profit allocation method was incorrect, without proving that the functions actually performed by those branches constituted particularly complex or unique functions, or functions that were difficult to identify, so that the comparables for such a one-sided profit allocation method would not have been identifiable or reliable and, consequently, the resulting allocation would necessarily have been incorrect.”
“(350) The Commission has not submitted any evidence in connection with its subsidiary line of reasoning to demonstrate that such a methodological defect, resulting from the lack of information submitted to the Irish tax authorities, led to a reduction in the tax base of ASI and AOE as a result of the application of the contested tax rulings.”
In other words, the General Court seems to be saying that it appears the Irish authorities did not have enough information to calculate the attributed profit correctly, but their tax rulings may have hit the right level by luck. The burden of proof was on the Commission.
For the reasons explained above, the General Court upheld the complaints raised by Ireland and by ASI and AOE that the branches should not have been identified as the tested parties.
The appropriate profit level indicator
Since the attribution of profits was incorrect, the next issue was what could be the right indicator of the profits that the branches could have earned had they been independent companies.
Operating costs
The Court assessed the choice of the operating costs as the profit level indicator. In this case, the chargeable profits of the Irish branches were calculated as a margin of the operating costs. The General Court examined first the data and situation of ASI and then those of AOE.
The Commission contended that the choice of the operating costs of those branches as the profit level indicator was wrong.
“(355) Regarding, specifically, the Irish branch of ASI […], the Commission considered that it was inappropriate to rely on the operating costs, which would be ‘generally’ recommended for analysing the profits of low-risk distributors. It contended that the Irish branch of ASI was not such a distributor, in so far as that branch had assumed risks connected with turnover, warranties, and third-party contractors.”
“(356) It should be noted at the outset that the Commission did not specifically state the source on which it was relying in order to make such an assertion. In addition, the use of the term ‘generally’ indicates that it was not ruling out the use of operating costs as a profit level indicator in certain situations.”
“(357) Besides the fact that the argument presented by the Commission is imprecise, it should be noted that such an argument is not in line with the OECD Transfer Pricing Guidelines, on which the Commission relied in connection with its subsidiary line of reasoning, as is correctly argued by Ireland and ASI and AOE.”
“(359) The Commission contended that the choice of the operating costs as the profit level indicator was not appropriate, inasmuch as that choice did not properly reflect the risks assumed and the activities carried out by the Irish branch of ASI, and that sales would have been a more appropriate indicator.”
“(365) The Commission, by stating, […] that the use of the operating costs as the profit level indicator does not reflect the risks connected with turnover, warranties, and products handled by third-party contractors and that the sales figure would be more appropriate as a profit level indicator, does not answer the question whether the operating costs suitably reflect the value contributed by the Irish branch of ASI in view of the functions, assets and risks assumed by that branch. Indeed, the Commission merely states that ASI’s sales would have been an appropriate profit level indicator without demonstrating why, in the present instance, the operating costs of its branch were not capable of reflecting the value which that branch had contributed to the company’s operations through the functions, risks and assets for which it had actually been responsible within that company.”
“(373) Having regard to the foregoing considerations, it must be held that the Commission did not succeed in demonstrating that the choice of the operating costs was not appropriate as a profit level indicator for ASI’s Irish branch.”
“(374) In any event, even assuming that it can be argued, […] that operating costs cannot serve as a profit level indicator except for ‘low-risk’ distributors, it is necessary to assess whether the Irish tax authorities were entitled to consider that the Irish branch of ASI had not assumed the risks that, according to the Commission, should have been allocated to that branch.”
The risk connected with turnover
“(375) The Commission noted that ASI had assumed the risk connected with turnover and that, in so far as its head office had no staff to manage those risks, ‘it [had to] be assumed’ that the Irish branch had assumed those risks. It added that the choice of the operating costs did not reflect that risk, which was borne out by the fact that the operating costs had remained relatively stable during the reference period whereas the turnover had increased exponentially.”
“(376) First of all, it must be pointed out that the Commission’s argument is based, according to the very wording of the contested decision, on an assumption.”
The same comment as made earlier concerning allocation of profits applies here too. Perhaps the Commission’s conclusion was not just an assumption, but the only logical possibility.
“(377) Next, it should be noted that the Commission was not in a position to explain in the contested decision exactly what the risk connected with turnover was.”
By contrast, the Court accepted much more detailed evidence submitted by ASI and AOE that the risk connected with turnover was borne by other parts of the Apple Group.
The General Court carried out the same assessment with respect to the choice of the operating costs as the profit level indicator for the Irish branch of AOE and the risks assumed by that branch.
The overall conclusion of the General was that “(413) the Commission did not succeed in demonstrating, […] that the choice of the operating costs of the Irish branches of ASI and AOE as the profit level indicator when applying a one-sided profit allocation method was inappropriate.” “(414) In addition and in any event, the Commission also did not submit evidence demonstrating that such a choice, as such, necessarily had to lead to the conclusion that the contested tax rulings had reduced ASI and AOE’s tax liability in Ireland.”
“(416) Even where there are inconsistencies which show defects in the methodology used to calculate the chargeable profits in the contested tax rulings, it is necessary to recall the considerations set out in paragraph 348 above, from which it follows that the Commission cannot confine itself to invoking a methodological error but must prove that an advantage has actually been granted, inasmuch as such an error has actually led to a reduction in the tax burden of the companies in question as compared to the burden which they would have borne had the normal rules of taxation been applied.”
Consequently, the General Court upheld the pleas of the applicants.
The levels of return accepted in the tax rulings
The Commission had considered that the levels of return of ASI and AOE’s Irish branches accepted by the tax rulings were too low in relation to those of independent companies.
After examining available evidence with respect to the 1991 tax ruling, the General Court noted that “(433) neither the exchanges [between Apple and the Irish authorities] preceding the issuing of the contested tax rulings nor Ireland and ASI and AOE when questioned on that point in the context of the present proceedings were able to provide a sufficient explanation of the exact reason for the indicators and figures used to calculate the chargeable profits of ASI and AOE. Thus, there is no concrete and contemporary piece of evidence explaining the reasons for the level of the percentages of the operating costs accepted in the contested tax rulings, let alone for the changes in those percentages over time.”
“(434) However, it must be pointed out that, apart from raising the issue of the lack of profit allocation reports, the Commission did not conduct its analysis in such a way as to demonstrate that, as a result of that calculation, the tax actually paid by ASI and AOE on the basis of the contested tax rulings was less than that which should have been paid under the normal rules of taxation, had the contested tax rulings not been issued.”
“(435) Thus, for the same reasons as those set out in paragraph 332 above, the mere finding of an error as regards the methodology leading to the calculation of the profits to be allocated to the branches is not sufficient to demonstrate that the contested tax rulings conferred an advantage on ASI and AOE.”
The Commission had argued in its decision that the Irish authorities had taken into account criteria unrelated to the tax system such as such as employment considerations.
The response of the General Court was that “(439) while it is true that it has been held that, if the competent authorities have a broad discretion to determine, inter alia, the conditions under which the financial assistance is provided on the basis of criteria unrelated to the tax system, such as maintaining employment, the exercise of that discretion may be regarded as giving rise to a selective measure […] the fact remains that, in order to determine whether State measures may constitute State aid, regard must primarily be had to the effects of those measures on the undertakings favoured”. “(440) In any event, the mere allusion, during the exchanges between the Irish tax authorities and the Apple Group preceding the 1991 tax ruling, to the fact that the Apple Group was one of the largest employers in the region where the Irish branches of ASI and AOE were established does not prove that ASI and AOE’s chargeable profits were determined on the basis of employment-related issues.” “(441) Thus, in the absence of other evidence, the Commission cannot argue that the tax ruling in question was issued as consideration for the potential creation of jobs in the region.”
“(445) Even if the Commission’s argument were to be understood as meaning that the levels of return accepted by the Irish tax authorities were too low for the functions performed by the branches, in view of the assets and risks relating to those functions, that argument cannot succeed without other evidence.”
“(446) The Commission’s subsidiary line of reasoning is based on the premiss that the Irish tax authorities could have correctly allocated the Apple Group’s IP licences to the head offices, which, according to the OECD Transfer Pricing Guidelines, implies the performance of complex or unique functions. However, as can be seen from the conclusions expressed in paragraph 348 above, the Commission did not succeed in demonstrating that the Irish branches of ASI and AOE had performed the most complex functions.”
Then the General Court performed the same analysis with respect to the 2007 tax ruling. In this connection, the applicants had submitted to the Commission a report comparing the profitability of the Irish branches with a sample of similar companies. The Commission contested the correctness of the report, but the General Court rejected the Commission’s arguments. In fact, the Commission carried out its own comparability analysis in order to determine whether the remuneration for the Irish branches of ASI and AOE as endorsed by the contested tax rulings fell within arm’s length ranges.
The General Court noted “(468) that it is true that the Commission’s approach, consisting in comparing the results of its own analysis, on the one hand, and ASI’s chargeable profits under the contested tax rulings, on the other, could have enabled it, in principle, to demonstrate the existence of a selective advantage.”
“(469) However, the conclusions of the corrected comparability analysis conducted by the Commission cannot invalidate the conclusions of the ad hoc reports submitted by Ireland and Apple Inc., according to which the profits of the Irish branches of ASI and AOE, determined pursuant to the contested tax rulings, fell within arm’s length ranges.”
“(470) First of all, it must be pointed out that the Commission’s corrected comparability analysis relies on sales as a profit level indicator for the purpose of applying the TNMM. However, as is apparent from the considerations expressed in paragraphs 402 and 412 above, it has not been demonstrated that the use of the operating costs as the profit level indicator was inappropriate in the present instance. In addition, it has not been demonstrated that the use of sales would have been more appropriate.”
“(475) The conclusions of the corrected comparability analysis conducted by the Commission concerning the remuneration of ASI’s Irish branch, an analysis which used sales as a profit level indicator, cannot invalidate the conclusions of the ad hoc reports submitted by Ireland and Apple Inc., which used the operating costs as the profit level indicator.”
“(476) Concerning AOE’s remuneration, […] the results of the comparability analysis used by the Commission, […] show that the profits allocated to the Irish branch of AOE in Ireland under the contested tax rulings fell within ranges which could be regarded as being arm’s length ranges.”
On the basis of the above considerations, the General Court also rejected the analysis of the Commission in connection with its subsidiary line of reasoning.
“(479) The findings made above concerning the defects in the methods for calculating the chargeable profits of ASI and AOE demonstrate the incomplete and occasionally inconsistent nature of the contested tax rulings. However, in themselves, those circumstances are not sufficient to prove the existence of an advantage for the purposes of Article 107(1) TFEU.”
“(480) Indeed, the Commission did not succeed in demonstrating that the methodological errors to which it had referred with regard to the profit allocation methods endorsed by the contested tax rulings, consisting in the choice of the Irish branches as tested parties (paragraph 351 above), the choice of the operating costs as the profit level indicator (paragraph 417 above), and the levels of return accepted by the contested tax rulings (paragraph 478 above) had led to a reduction in ASI and AOE’s chargeable profits in Ireland. Accordingly, it did not succeed in demonstrating that those rulings had granted those companies an advantage.”
The Commission’s alternative line of reasoning
The Commission had also developed in its decision an alternative line of reasoning that was made up of two parts. Firstly, the arm’s length principle was inherent in the application of section 25 of the TCA 97 and that, in so far as the contested tax rulings derogated from that principle, they conferred a selective advantage on ASI and AOE in the form of a reduction of their taxable base. Secondly, even assuming that the application of section 25 of the TCA 97 was not governed by the arm’s length principle, the contested tax rulings still had to be regarded as granting ASI and AOE a selective advantage in so far as those rulings were the result of the discretion exercised by the Irish tax authorities.
In developing its alternative line of reasoning, the Commission referred to its subsidiary line of reasoning, in which it considered that the contested tax rulings did not allow a reliable approximation of a market-based outcome in line with the arm’s length principle to be calculated and, therefore, concluded that those rulings had granted ASI and AOE a selective advantage.
The General Court noted in that regard “(487) that, in so far as the first part of the Commission’s alternative line of reasoning is based on statements that it made in its subsidiary line of reasoning and that, as has been found in paragraph 481 above, the Commission cannot rely on that reasoning in order to conclude that there was an advantage in the present instance, it must be held that the Commission is equally unable to rely on the first part of its alternative line of reasoning in order to conclude that there was a selective advantage in the present instance.”
Administrative discretion
In the second part of its alternative line of reasoning, the Commission contended that the contested tax rulings still conferred a selective advantage on ASI and AOE in so far as those rulings were issued by the Irish tax authorities on a discretionary basis.
The General Court dismissed this line of reasoning too. “(493) In so far as the Commission did not succeed in showing that there was an advantage through its primary and subsidiary lines of reasoning, it cannot, solely through its alternative line of reasoning as described above, show that there is a selective advantage in the present instance. Even assuming that it were established that the tax authorities had discretion, the existence of such discretion does not necessarily mean that it was used to reduce the tax liability of the recipient of the tax ruling as compared with the liability to which that recipient would normally have been subject.”
But the Court also found that “(495) the Commission did not succeed in showing that the Irish tax authorities had exercised a broad discretion in the present instance.”
“(496) It is necessary to recall the case-law stating that, in order to establish the selective nature of a tax advantage, it is not necessary for the competent national authorities to have the discretionary power to grant the benefit of that measure. However, the existence of such discretion may be such as to enable those authorities to favour certain undertakings or the production of certain goods to the detriment of others, in particular where the competent authorities have the discretionary power to determine the beneficiaries and the conditions of the measure granted on the basis of criteria unrelated to the tax system” [The Court cited at this point case C-128/16, Commission v Spain, paragraph 55]
“(497) It is clear that […] the Commission limited itself to stating that Ireland had not identified any objective standard for allocating the profits of a non-resident company for the purpose of applying section 25 of the TCA 97. […] It concluded directly from the above that ‘this would mean that [the Irish tax authorities’] discretion in applying that provision [was] not based on objective criteria related to the tax system, which [gave] rise to a presumption of a selective advantage’.”
“(498) As has been pointed out in paragraphs 238 and 239 above, in order to apply section 25 of the TCA 97, it is necessary to carry out an objective analysis of the facts that includes, first, identifying the activities performed by the branch, the assets it uses for its functions and the related risks that it assumes and, second, determining the value of that type of activity on the market. Such an analysis corresponds, in essence, to the analysis proposed by the Authorised OECD Approach.”
“(499) Consequently, the Commission cannot argue that the Irish tax authorities’ application of section 25 of the TCA 97 did not involve the use of any consistent criterion in order to determine the profits to be allocated to the Irish branches of non-resident companies.”
Since the General Court rejected the primary, subsidiary and alternative lines of reasoning of the Commission, it proceeded to annul decision 2017/1283 in its entirety.
Conclusion
What shall we infer from this rich judgment? The Commission has lost the battle but not the war. It will be more careful to prove rather than assume the existence of advantage. But tax advisors will have to be more careful too. Their calculations of attributed profit must be credible.
[1] The full text of the judgment can be accessed at:
