What’s this all about? So, in 2016, the European Union ruled that Ireland had given illegal tax advantages to Apple, that it had not given to other companies. Therefore, the company had to pay 13 billion euros (plus interest) in back taxes to Ireland. These 13 billion euros are the taxes that were not paid (on 104 billion euros of profits earned by Apple through sales in the EU from 2003 to 2014).
This month in July 2020, the EU overturned that decision because the European Commission could not provide enough evidence to prove that Apple had received illegal advantages. This is a major victory for Apple. This article explains the modus-operandi Apple used to avoid paying taxes.
First things first, Ireland is the biggest tax haven in the world. Most US multinationals set up subsidiaries in Ireland to get around to paying higher than average corporate taxes in the US. Though Ireland’s corporate tax is already the lowest in the world at 12.5 %, the companies exploited loopholes to not pay even that.
Most companies used a double Irish structure that helped American companies keep their profits nearly tax-free. Under this structure, corporations set up two different Irish subsidiaries to avoid paying taxes. But, the structure used by Apple was slightly different. It used only one Irish subsidiary. Let us explain.
Under the double Irish structure, there are two subsidiaries registered in Ireland (let’s say- A & B). A is a tax-resident in Ireland and it is responsible for all sales of the company ABC ltd. across Europe. Even if the goods are sold in other parts of Europe, profits are booked in Ireland.
B is a tax-resident in a tax haven like the Bahamas which imposes 0 % corporate taxes. It is possible for B to be registered in Ireland and be a tax-resident in the Bahamas because of Irish tax laws as per which B will be taxed in the Bahamas if it has a ‘management and controlling presence’ in that country. Now B owns the intellectual property rights of ABC ltd for sales of its products across Europe. Therefore, A has to pay a royalty to B. If A pays a substantial part of its profit as royalty, its taxable profit declared in Ireland will be very low. But, B will make high profits, but it will not be taxed as the Bahamas has zero taxes. This is the double Irish structure.
[But, there is a catch. A will have to pay withholding tax to Ireland on its royalty payments. To avoid it, ABC ltd will incorporate a Dutch subsidiary C. As per an agreement between Ireland and Netherland, no taxes are levied on royalty payments (and certain other kinds of payments) between these countries. So, A will pay a royalty to C (Dutch subsidiary) to pay to B. This is called the Double Irish Dutch Sandwich. This structure was used by Google for its European operations. It decided to abandon this practice in response to the 5-year window offered by US regulatory authorities in 2015 to tech companies to give up this practice. Also, Ireland has plugged the loopholes in its taxation laws, and this structure will be phased out by 2020 for existing companies as well.]
Now let’s come to Apple. Most of the other American MNCs used structures similar to the above (forming two Irish subsidiaries, with one tax-resident in a tax- haven). But, Apple created similar results to the Double Irish structure using only one subsidiary.
Apple did not put Intellectual Property rights in a separate subsidiary. IP was owned by Apple Inc headquartered in the US and it gave license to sell Apple products outside of the US to its subsidiary in Ireland. This subsidiary was called Apple Sales International or ASI. In return, ASI paid the research and development cost-sharing payments to Apple Inc.
The research and development cost-sharing payments were actually very small relative to the profits earned by ASI. Therefore, most of the profits from sales to Europe, the Middle East, Africa, and India accrued to ASI (and not to Apple Inc which had to pay higher taxes in the country in the US) and was subject to taxation in Ireland. Apple wanted to avoid paying taxes in Ireland as well.
Therefore, out of these profits, a significant proportion was attributed to a head office of ASI which existed only on papers and was stateless. It was not taxed anywhere. As a result of the above, in the year 2014, Apple paid taxes of only 0.005 % on its European sales. (It has to be mentioned that, Apple had closed down this tax avoidance structure in 2015.)
Apple could allocate its profits between an Irish branch and a stateless head office because of an agreement reached with Ireland in 1991 (replaced with a similar agreement in 2007). This was at the centre of the ruling by the EU. The EU allows its member countries to charge different tax rates, but it cannot grant special tax benefits to a company or a group of companies. This is termed as ‘illegal state aid’.
Therefore, it had ordered Apple to pay unpaid taxes to Ireland in 2016, but the irony was that even Ireland refused to comply. It did not want the ruling to adversely impact its image as an attractive investment destination due to the low tax regime. But, this year, the EU had to overturn the decision because of a lack of adequate evidence.
This tax ruling is a huge blow to the European Commission’s efforts to recover lost taxes from these MNCs. EU had also gone after Starbucks in Netherland, Fiat in Luxembourg. It lost against Starbucks last year.
Other articles from Economyria that you should read:
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- What is the trade war between US and China?- Explained
- The Financial Crisis 2008 Explained
- The India-Mauritius Treaty Amendment
- Understanding General Anti-Avoidance Rule or GAAR
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