Sunday 17 December 2017

Why Ireland is really only entitled to its seller's margin on Apple sales

The effect of the European Commission's decision is to tax the seller on the entire sales income and ignore any income due to the owner

EU Competition Commissioner Margrethe Vestager Picture: Bloomberg
EU Competition Commissioner Margrethe Vestager Picture: Bloomberg

Suzanne Kelly

A recent article written by a leading tax academic under the headline 'The myths behind Apple's manufactured tax crisis', is perpetuating a few myths of its own.

Its author, Edward Kleinbard from Southern California, argued in the Financial Times, that the Apple tax of ¤13bn is due and collectible by the Irish tax authorities when he says... "the remedy is to force Apple to pay the Irish tax that should have been collected from the income earned from its Irish subsidiary. This is source country tax to which Ireland clearly has the first claim".

In the case of Apple, it is not a subsidiary which is being taxed; it is a branch of a subsidiary.

US tax law is at variance with a lot of the rest of the world in the concept of corporate tax residence, in other words where the company is taxed. A US incorporated company is tax resident in the US, and thereby liable to US federal tax on its worldwide income.

In contrast, some countries, Ireland included, apply a management and control test, such as that a company is tax resident in the country where it is controlled. In the years under investigation of Apple by the European Commission, the relevant subsidiaries were not tax resident in Ireland at all, as they were not managed in Ireland,.

It is the profits economically attributable to the Irish branch only which were taxable in Ireland, and not the profits of the entire entity. Branch taxation law is a tax speciality of its own and it is the taxation of branch profits - not company subsidiaries - which is at the centre of the discussion of the recent European Commission ruling. It is an immutable principle of international tax law that a branch operation of a US company is only taxable on the income attributable to that of the home operation, in this case to an Irish-located branch of a US operation. An independent economic assessment is carried out to determine the proportion of the entire income of the US-controlled branch attributable to the Irish operations. Contrary to some commentators who believe this figure is achieved on a nod and wink basis, there is a formal calculation.

Put simply, worldwide sales were carried out by the Irish branches where the intellectual property attaching to those products were owned by American subsidiary companies, so total sales income needed to be divided between the branch and the US subsidiary.

For example, everybody knows when they buy a cola that the shopkeeper only gets a margin and that he must pay the inventors of the cola their proportion of the sales. So too with Apple products. We all know that the intellectual property is US-owned, in this case by a US-controlled company. The branch operator is only entitled to its seller's margin and the significant balance is due to the inventor. .

The effect of the Commission's decision is to tax the seller on the entire sales income and completely ignore any income due to the owner.

To confuse matters further, the Commission explicitly states that other countries can pursue the Irish Apple branch for some of the "state aid" sourced tax to be attributable to them based, one would assume, on sales in their country. Is this because they realise that they have attributed annual sales of ¤10bn to the Irish branch, which stretches credulity when you think that the entire population of Ireland is less than five million?

The Commission then suggests that other countries can take ownership of some of those Apple sales attributed to Ireland and seek tax appropriate to those sales in their country. If all the other countries in which Apple sales took place did claim their portion of tax, it would mean that there is no extra tax for Ireland. A contrarian might say that state aid is not state aid if other EU members share in it.

Ireland is not alone in a fundamental disagreement with the EU Commission. The US Treasury (by White Paper of August 26, 2016), Nellie Kroes (the former EU Commissioner), Luxembourg (Fiat decision) and Holland (Starbucks decision) are unanimous in their view that recent Commission decisions are flawed.

Lawyers specialising in international tax will make a fortune. America may allow repatriation of profits to the US to be taxed at a once-off 15pc where it perceives an unilateral act of tax aggression on the part of some in Europe. The European Commission's sense of righteousness will dissipate, and Ireland will have to keep finding ways to pay for its population's needs. Ideas, please, to the Department of Finance.

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