On November 9, 2023, Advocate General Pitruzzella (“AG”) issued his Opinion on the Apple case (Case C-465/20 P European Commission v Ireland, Apple Sales International and Apple Operations International[1]), which represents the latest development of one of the fiercest battle fought by the European Commission (“EC”) in the past few years.
The AG believes that the European General Court (“EGC”) made a legal error in its initial judgment by overturning the Commission’s assessment in the Apple case. In the AG’s Opinion, the Commission’s appeal, filed in 2020, is legitimate. Therefore, the AG recommended that the European Court of Justice (“CJEU”) set aside the EGC’s previous judgment.
It’s important to note that the AG’s Opinion is not binding. Hence we must wait for the ECJ’s official findings in the case.
1. Background
- The Rotten Apple
The Apple case is unprecedented: the European Commission sanctioned Ireland over the tax ruling it issued on Apple’s Irish incorporated branches, Apple Sales International and Apple Operations Europe (“ASI” and “AOE”, respectively), for several billion euros.
In 2013, the United States began to suspect the low taxes paid by Apple to US tax collectors and started investigating Apple’s home-incorporated companies. In this aim, it should be noted that the Apple group comprises Apple Inc., a company based in the USA, and all the companies it controls.
In a hearing, Tim Cook, Apple’s Chief Executive, faced intense scrutiny from a US Senate committee, accusing Apple of sheltering billions of dollars in profits in “ghost companies” incorporated in Ireland that did not pay tax elsewhere.
On June 12, 2013, the European Commission asked Ireland to provide documents to verify its status regarding its tax practices. The European Commission decided to investigate the rules of Ireland’s home-based companies, believing that the tax rulings provided by the Irish Revenue could constitute illegal state aid.
After a lengthy investigation, the Commission found in 2016 that two tax rulings issued by Irish Revenue to Apple had substantially and artificially lowered the tax paid by Apple in Ireland from 1991 to 2014[2].
The Commission felt that these determinations rubber-stamped a method of determining the taxable profits for two Irish-based companies, managed from outside Ireland and responsible for all Apple’s sales outside America.
In its Decision, the Commission claimed that the Irish Revenue determinations did not correspond to economic reality. Almost all the profits recorded by the two companies were attributed internally by Apple to a head office that only existed on paper and could not have generated such profits.
According to the Commission, Apple was booking all its sales across the EU in Ireland instead of the countries where its goods were being sold and not paying tax on almost all its profits.
Under long-established EU state aid rules, it is illegal for any country to give preferential treatment to one company over another when they are both subject to the same tax rules in that state. Therefore, the Commission declared that Apple owed all unpaid taxes to Ireland until 2014, plus interest, since Apple changed its structures that year.
- The Big Irish Apple in a Nutshell
When Apple opened its branches in Cork in 1980, it aimed to create employment opportunities in Europe and serve its European customers. Apple agreed with its Irish branches to share its intellectual properties to manage the retail aspect of its products and provide customer support.
At the time of the branch opening, Ireland was struggling with an economic recession, and Apple’s decision to open its branches in Cork helped reduce unemployment. With increasing sales, the company hired nearly 1500 employees by the end of the 1990s.
The ASI branch in Ireland was responsible for customer support and logistics operations, acquiring Apple products from suppliers and subsequent sale and distribution to related parties and customers worldwide, among several other activities. The AOE Irish branch was responsible for producing (manufacturing and assembly) a series of computer products intended to be sold to various entities within the Apple group (including ASI), which subsequently sold them to end customers.
Apple negotiated a tax ruling with the Irish Revenue to bring more investment and resources into its Irish-incorporated branches in response to its financial performance.
The first tax ruling authorization was granted in 1991, allowing Apple to execute a tax ruling on a one-sided profit allocation method between the headquarters and the Irish branches. This ruling lasted until 2007, when a new ruling was set and signed by both parties. The new ruling involved AOE and ASI and allowed the company to share intellectual properties, management, resources, and business risks between the headquarters and its branches to allocate profits. This significantly improved Apple’s performance from a tax efficiency point of view for several years
Both tax rulings focused on the distribution of profits between the Irish branches and the registered offices of ASI and AOE, which did not have tax residence in any State then.
The first tax ruling (1991) established that the net profit allocated to the Irish branch of ASI should correspond to 12.5% of all operating costs, excluding material intended for resale. Regarding AOE, the tax ruling also established a branch profit margin based on a percentage of operating expenses, including depreciation, but excluding the cost of materials for resale and the sharing of the costs of intangible assets charged to Apple affiliates.
The second tax ruling (2007) revised the tax base calculation method for both branches. According to the new tax ruling, in the case of ASI, the net profit allocated to the branch started to correspond to a margin between 10% and 15% of its operating costs, excluding charges for Apple branches and material costs. In turn, in the case of AOE, the percentage of the profit margin to be considered ranged from 10% to 15% of operating expenses, and it provided for the consideration of remuneration between 1% and 5% of the volume of business, relating to the intellectual property that the branch had developed in the product manufacturing process.
ASI and AOE were parties to a cost-sharing agreement under which they agreed to combine their research and development efforts and share the costs related to these functions with Apple Inc. Due to the cost-sharing agreement, 45% of the expenses were allocated to Apple Inc. during the validity of the tax ruling, with the remaining 55% being supported by ASI and AOE. Additionally, AOE was granted an exclusive, royalty-free license to use the Apple brand and trade secrets and patents. Regarding initial access to these intangible assets, no remuneration was agreed between the parties.
Although ASI and AOE were incorporated in Ireland, they were not considered residents in that state, carrying out their activity through branches. Non-resident status was only possible due to one exception provided for in Irish legislation (in force until 2014). Since ASI and AOE were ultimately managed and controlled outside Irish territory by Apple Inc., they could obtain non-resident status without proving their residence in any other State. As a result, during the years at stake, the companies in question were not considered tax residents in any State.
Due to the application of the tax rulings, the Apple group reduced its effective corporate tax rate in Ireland, which led to the loss of tax revenue of the Irish State.
However, the European Commission conducted an investigation that spanned over two years and concluded that the two tax rulings issued by the Irish tax administration relating to ASI and AOE, attributed State aid to companies incompatible with the TFEU.
- The “Exploding Card” – The Commission’s Decision in Apple’s Case
In order to reach the conclusion referred above, the European Commission concluded that three of the five requirements in Article 107(1) of the TFEU were met, but it also had to prove the controversial requirement of a selective advantage.
The European Commission’s decision followed a three-step analysis of the situation.
Firstly, the standard tax regime applicable in Ireland to companies comparable to ASI and AOE was identified. Secondly, whether the adopted tax measure constituted a derogation from that reference system was assessed. Finally, it was established whether the action in question was justified by the nature or general economy of the system of reference, with the burden of proof in this third phase falling on the Member State in question.
The European Commission found that none of the tax rulings were supported by a contemporary study that substantiated the chosen methods or a report that justified fixing the transfer prices in question. Furthermore, the internal delimitation of accounts was non-existent, and no report on the allocation of profits and transfer pricing matters existed when the tax ruling was granted. Moreover, during the period in which the tax rulings were in force, the ASI and AOE registered offices existed only on paper, and they all had a physical presence and employees outside of Ireland.
The European Commission claimed that Ireland should have taken into account the assets used, the functions performed, and the risks assumed by those companies through their Irish branches and concluded that the income attributed to the licenses in question belonged to the branches, given the lack of any active management of the licenses by their registered offices. Although the allocation of intellectual property rights is a complex matter due to its natural intangibility, the Commission believed that it was up to the Irish tax administration to confirm whether the allocation of property licenses intellectual property of ASI and AOE outside Irish territory could have been agreed between companies in a context of full competition.
In conclusion, the European Commission considered that the terms that Apple and the Irish Revenue had negotiated for determining the profit of those two branches were different from market conditions and the tax rulings granted by Ireland to Apple were found to be incompatible with the TFEU due to the loss of tax revenue incurred by the Irish State.
- The “Defuse Card” – Apple/Ireland’s Appeals
Both Apple (ASI and AOE) and the Irish Government have decided to appeal the European Commission’s ruling.
In August 2016, Tim Cook, CEO of Apple, expressed concern that the Commission’s efforts to rewrite Apple’s history in Europe, ignore Ireland’s tax laws and upend the international tax system in the process would profoundly impact investment and job creation in Europe.
In their appeal, ASI and AOE argued that the arm’s length principle should not be considered a reference as it was not in force in Ireland at the time of the facts.
Moreover, this principle does not constitute a criterion that allows the existence of State aid to be determined, as per Article 107(1) of the TFEU. The grounds for the appeal also include the allegation that the European Commission incorrectly identified the reference system for measuring the selectivity of tax rulings, wrongly treating ASI and AOE as companies’ residents in Ireland. Lastly, the Commission’s decision was challenged for not explaining the amount to be recovered by Ireland.
The Irish Government also decided to appeal the ruling, namely considering the external perception of the country to the entire world. The Government argued that the European Commission misinterpreted Irish law and the relevant facts in its decision.
The Irish Government’s position diverges from the European Commission’s, claiming that the Irish subsidiaries of ASI and AOE only perform routine functions, with all relevant decisions regarding the activities of these companies being approved in the USA.
As a result, the related profits with them could not be attributed to Irish subsidiaries, nor could intellectual property licenses, taking into account the crucial role played by Apple Inc. – a company also residing in the USA.
The Irish Government further claimed that the Commission ignored the distinction between resident and non-resident companies in Irish tax legislation. By arguing that the Irish tax administration should have applied “its version” of the arm’s length principle, the Commission attempted to use a principle that is not only not part of European Union law but also not part of Irish law, violating the sovereignty of Member States in matters of direct taxation.
The Irish Government stated that even if such a principle had been in force in its territory at the time concerned, the European Commission would not have applied it consistently, as it did not analyse the global situation of the Apple group.
Furthermore, from the Irish Government’s perspective, the Commission never clearly explained its theory regarding State aid during the investigation. This prevented Ireland from commenting on several decisive elements in the case. Consequently, the Irish Government concludes that the rules on State aid cannot resolve divergences between tax systems at a global level by their very nature.
- In Apple’s Favor
The European General Court heard the case over two days in September 2019. In July of the following year, the Court decided, ruling in favour of Apple, and overturning the Commission’s decision[3].
The Court found that the Commission was incorrect in claiming that ASI and AOE had received state aid, as it had not proven that Ireland had given Apple a particular advantage over other companies.
The Court stated that the Commission should have demonstrated that the income represented the activity value of the Irish branches due to their strategic decisions.
Additionally, the Court ruled that the methodological errors in the challenged tax rulings the Commission pointed out were insufficient to conclude that there was an illegal advantage.
The European General Court decided that the challenged tax rulings were not the result of the discretion of the Irish authorities in granting an unlawful advantage to Apple’s two subsidiaries.
Therefore, Apple was not granted state aid incompatible with EU law and the internal market. The Court emphasized that the Commission should be extremely diligent in collecting and assessing all pertinent evidence on issues it bears the burden of proof.
- An Apple a Day did not keep the Commission away – EC’s appeal
The European General Court’s decision regarding Apple’s tax arrangements was not accepted by the European Commission, which appealed the decision[4].
The Commission claims the judgment was based on an “incorrect interpretation” of their decision and key aspects were ignored.
According to the Commission, the European General Court misunderstood that the conclusion for granting an advantage to Apple was solely based on the lack of employees and physical presence in the Irish headquarters of the company.
Additionally, the Commission argued that the European General Court ignored the parts of the decision analysing the real functions performed by the central offices and the Irish subsidiaries to justify assigning Apple’s intellectual property licenses to the Irish branches.
Finally, the European Commission alleges that the European General Court did not respect the arm’s length principle or the separate entity approach for tax purposes, treating them as separate units within a group.
2. The Pitruzella’s Setback – a Landmark Opinion?
On November 9, 2023, Advocate General Pitruzzella issued his Opinion[5] in this case, partially agreeing with the European Commission’s appeal to CJEU.
The AG found that the General Court made multiple legal mistakes in its judgment, advising the CJEU to set aside the decision and refer it back to the General Court for a fresh hearing on its merits.
If the CJEU follows the AG’s judgment in the appeal case, it could have significant implications for when tax rulings may constitute unlawful “State Aid” for the purposes of Articles 107 and 108 TFEU.
In the AG’s understanding, the General Court committed an error in its legal interpretation of the evidential requirements resulting from Articles 1017 and 108 TFEU.
Considering the high standard of proof, combined with the allocation of its burden and in the context of the inherent limitations of the EU Arm’s Length Principle, the AG held that the General Court did not decide correctly when it concluded that the Commission failed to meet the required legal standard to establish that the profits attributable to intellectual property licenses and associated gains obtained from global Apple product sales outside the USA should form part of the Irish Apple branches’ tax base and hence constitute taxable profits in Ireland, contrary to what is assumed in the Tax Rulings.
Furthermore, the AG considered that the European General Court’s assessment of the substance of the case was inadequate.
Therefore, the Advocate General recommended that the case be referred back to the General Court for a new comprehensive revision of the merits and allegations in the case.
3. So what now – May the AG’s “Nope Card” stop Apple’s “Defuse Card”?
It should be noted that the AG’s Opinion is not binding, which means that the CJEU is not obliged to follow it.
However, in practice, the CJEU often follows the recommendations of the Advocate Generals when passing judgment.
In this case, the Advocate General clearly stated that the EU State Aid rules cannot be used to harmonize the national tax rules of the EU Member States. However, the AG fueled the legal basis for national tax rulings to be considered unlawful State Aid when a selective economic advantage is established to the required evidential extent.
Therefore, if the CJEU follows the Advocate General’s Opinion, it is advisable to consider and assess the potential State Aid risk of each tax ruling obtained by a company from an EU Member state authority.
Dalila Mendes Leal
November 2023
[1]Available at https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:62020CC0465
[2] Available at https://ec.europa.eu/competition/state_aid/cases/253200/253200_1851004_674_2.pdf
[3]Cfr. Press Release available at https://curia.europa.eu/jcms/upload/docs/application/pdf/2020-07/cp200090en.pdf
[4] Available at https://eur-lex.europa.eu/legal-content/EN/TXT/?toc=OJ%3AC%3A2021%3A035%3ATOC&uri=uriserv%3AOJ.C_.2021.035.01.0022.01.ENG
[5] Disponível em https://www.courthousenews.com/wp-content/uploads/2023/11/apple-tax-deal-ireland-opinion.pdf