Tax Analysts Blog

Competition Policy and Tax Policy in The Twilight Zone

Posted on Mar 7, 2016

For your consideration:

An American multinational sits down to negotiate an agreement with the tax administration of an EU country. Representatives of the multinational come to the table armed with a few powerful tools:

Information asymmetry;
A significant impact on employment and commerce in the country; and
The ability to reduce its presence in the country, or eliminate it entirely.

In that negotiation, the multinational wields those tools as a cudgel to reach an understanding memorialized in an advance pricing agreement. In essence, the member state agrees to significantly reduce the multinational’s future tax liability, and the multinational agrees not to reduce its presence? in the member state. (After all, given the agreement, why would it?)

What’s wrong with this picture? It depends what side of the Atlantic you are on. It also depends on whether you are answering from the perspective of tax policy or competition policy. From a tax perspective in the U.S. (and probably Europe), this is simply a garden-variety case of a taxpayer negotiating a good deal with a foreign tax authority. From a European competition perspective, the answer is a bit more complicated.

According to the European Commission’s letter opening the investigation into whether Ireland improperly provided state aid to Apple, in 1991 representatives of Apple sat down with Irish Revenue ostensibly to negotiate a transfer pricing agreement. But instead of facilitating a discussion about the arm’s-length method, Apple’s presentation may have more closely resembled an episode of The Sopranos. Reading between the lines of the commission’s letter, the conversation may have gone something like this:

Apple: We’re considering how we should deploy our resources around the world. It would be a shame if we had to eliminate the 1,500 jobs we support in the Cork area, just because we were paying too much tax in Ireland. Perhaps you can do something about that.

Ireland Revenue: You make a good point. Let’s see now. Last year Apple earned $271 million in Ireland, a 36 percent net profit on three quarters of a billion in sales here. What would be a fair amount of profit for Apple to pay tax on?

Apple: Well, that 36 percent doesn’t really reflect the actual profitability of our operations in Ireland. After accounting for everything, including depreciation, royalties, wear and tear, costs of capital, yada yada, we’re barely able to even scrape by here. In fact, we think it’s fair to pay Irish income tax on $30 to $40 million, but only if we actually make that much.

Irish Revenue: [Gulp]

Apple: Let’s make it real simple. We’ll pay tax on $30 to $40 million in profit and, because you’re such good sports, we’ll stay right here in Ireland. And we’ll even prepare all that pesky paperwork and tie it up with a nice bow. We’d hate to see something bad happen to your beautiful country just ‘cause you couldn’t recognize a good deal. Whaddya say?

Irish Revenue: Ummmmm. OK.

Great deal for Apple, horrible deal for Ireland, right? Maybe.

The commission is investigating whether the sweetheart tax deal that Apple negotiated with Ireland 25 years ago distorts competition within the common market, under article 107 of the Treaty on the Functioning of the European Union. If the commission is right and it does, the story ending will take an ironic turn. It would be a shame if Ireland “had to” recover from Apple all the taxes it should have paid, with interest. But that’s what would happen in The Twilight Zone.

 

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