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Background
In 2014 the European Commission launched in-depth investigations into tax incentives given to Apple in Ireland, Starbucks in the Netherlands and Fiat Finance and Trade and Amazon in Luxembourg.
In August 2016 the Commission found that Apple’s arrangements in Ireland breached State aid rules. The Commission said that rulings given by Ireland allowed Apple to establish the taxable profits for two Irish incorporated companies of the Apple group in a way "that did not correspond to economic reality". Almost all of the profits of these companies, which derived from Apple’s operations outside the US, were attributed to a head office which did not pay tax anywhere.
In 2015 it published its decisions in relation to Starbucks and Fiat, finding that State aid rules were breached – although both decisions are being appealed. A decision from the Commission in relation to Amazon is expected soon.
Shortly after these investigations were opened over 340 multinational companies were exposed for securing secret deals from Luxembourg in order to save billions of dollars in taxes. Hundreds of documents were leaked that showed some companies paying an effective 1% rate of tax on profits moved from higher tax jurisdictions to Luxembourg through the use of private tax rulings – also known as ‘comfort letters’ or advance pricing arrangements (APAs).
The aptly named ‘Lux Leaks’ disclosures have been the biggest tax scandal to hit the EU, especially significant as the European Commission has been actively seeking to eliminate ‘harmful tax practices’ within the EU.
In December 2015 the Commission announced it was investigating tax rulings granted by Luxembourg to McDonald’s. The rulings enabled McDonald’s to pay no corporate tax in Luxembourg on the grounds that the profits were subject to US tax under the Luxembourg-US double taxation treaty. However, as the company had no taxable presence in the US under US law, the profits were not in fact subject to US tax.
In January 2016, the European Commission found that Belgium's 'excess profit' ruling system breached State aid rules. This is a Belgian tax provision that allowed companies to obtain a ruling to reduce their tax liability on the basis of the 'excess profits' that were said to result from being part of a multinational group. The scheme was used mainly by European headquartered companies. The Commission said that the scheme constituted State aid as it only benefited multinational groups, whilst companies that were not part of a group and were active only in Belgium could not claim similar benefits. The Commission estimates that in total around €700 million should be recovered from the companies concerned.
Why is the European Commission investigating these deals?
Although the European Commission does not have direct authority over national direct tax systems of EU Member States, it can investigate whether tax incentives breach EU ‘State aid’ law.
State aid can occur whenever state resources are used to provide assistance that gives organisations an advantage over others. It can distort competition which is harmful to consumers and companies in the EU and is effectively a breach of EU law. A tax ruling can be seen to constitute an advantage as it effectively means a tax authority is waiving a right to collect taxes otherwise due.
What are the implications of the investigation?
It will not be a defence to a State aid enquiry that rulings have been a common arrangement, even though almost every major group will have used a Luxembourg (or other low tax jurisdiction) finance ruling as part of its overall structure. The consequences are that companies may have to repay up to 10 years’ worth of tax benefits.
A particularly worrying aspect of the Starbucks case is that the company appeared to have undertaken a full transfer pricing review and to have complied with the Netherlands’ long-established and internationally well-respected rulings process.
The European Commission has undertaken to scrutinise the papers published as part of the ‘Lux Leaks’ disclosures meaning that hundreds of companies risk joining Apple, Starbucks, Fiat and Amazon under the microscope of a formal State aid investigation.
There could also be serious adverse publicity if a group becomes the subject of a formal investigation by the Commission. Such an investigation would result in the tax affairs and planning of the group being made public and could mean that company officials are named.
The European Commission has extended its tax ruling probe to all 28 EU member states. The European Parliament has set up a special committee to look at tax ruling practices in EU member states, going back to 1 January 1991.
What could have to be repaid?
If a ruling is found to constitute unlawful State aid, the recipient could have to repay to the State in question the difference between the tax charged and the tax it would have paid without the ruling. Interest is also charged.
The amounts to be repaid could be very substantial. For example in Apple’s case, the figure is estimated to be €13 billion.
In repaying the aid no account is taken of the expenses a group has incurred in setting up in a particular state or region. A group can therefore be left seriously out of pocket as a result of a requirement to repay State aid.
What does the future hold?
Undoubtedly the days of being able to get very favourable rulings in EU States desperate to attract foreign investment are gone. All future investment in the EU needs to be checked to ensure it is State aid compliant and groups should carry out a ‘health-check’ on past investments.
The EU is introducing automatic exchange of information on tax rulings between tax authorities every six months. It is aiming for a 1 January 2017 start date.
There is no current proposal for making this information publicly available but this will be kept under review – and tax campaigners in Europe have been pushing for more and more publicly available information about the tax affairs of multinationals.
News of further investigations by the Commission is likely in the coming months, as the EU continues to look closely at the tax affairs of multinationals – and US multinationals in particular.
Shortly before the Apple decision was released, the US Treasury department published a white paper, criticising the Commission’s approach which it said is “inconsistent with international norms and undermines the international tax system” and the fact that its investigations appear to be targeting US companies disproportionately.
What action should companies take?
Companies whose effective tax rate in any EU country has been reduced by a ruling should consider the potential impact of the State aid challenge.
It is likely to be particularly relevant to any group that has intellectual property, financing operations or group debt in the EU. Although all 28 Member States will be investigated, Luxembourg looks likely to remain a particular focus of the Commission’s investigations.
Taking action now, before an approach by the Commission, could minimise a company’s liability and significantly reduce the risk of adverse publicity.
We can help clients understand the EU process as well as the potential tax issues. We can provide strategic risk mitigation advice as well as advising on alternative tax structures which are compliant with State aid law.