Apple and the EU

Apple and the EU:  Summary of the EU's latest ruling against Apple and the EU's proposed reforms of corporate taxation.

As previously covered in this blog, the EU ruled against Ireland granting tax benefits of up to €13 billion to Apple in violation of the State aid rules.  In their law review article, "Apple State Aid Ruling: A Wrong Way to Enforce the Benefits Principle?", Professor Reuven S. Avi-Yonah (Michigan Law) and Gianluca Mazzoni (SJD Candidate, Michigan) detail how Apple was able to utilize Ireland in reducing its tax liabilities.  The most notable facts of Apple's Irish arrangement as uncovered by the article are:

  • Apple's market capitalization as of October 7, 2016 was $614.61 billion dollars (or $612.66 billion as of the third quarter of 2016)
  • Apple used cost sharing agreements to shift profits from U.S. Developed intangibles to its Irish subsidiaries.
    • The article briefly discusses how cost sharing agreements (as used in pharmaceutical companies) should deter transfer pricing/revenue shifting because in pharmaceutical companies it is a gamble as to whether a particular drug will be a blockbuster drug and the pharmaceutical companies would risk losing R&D costs shifted to its offshore subsidiary if the drug didn't have profits generated in the offshore subsidiary.
    • The article states that this is not the case in technology companies, like Apple, because of Apple's track record of producing blockbuster technological products.
  • Apple utilized licenses of Apple's brand and intellectual property by its Irish subsidiary's (Apple Sales International, ASI's) subsidiary retail locations throughout Europe to shift royalty payments from the retail locations to ASI instead of paying taxes on the income in the European countries.
    • The article notes that the profits from other EU nations are paid to the Irish subsidiary as royalty fees for licensing Apple's logo and branding to the EU subsidiaries.

The article also discusses the reason why Apple was able to utilize its Irish structure to shield income from taxation.  The primary reason for Apple's ability to set up this structure are as follows:

  • Ireland and EU's lack of withholding tax on receipts fro EU member states.
    • The article highlights that the commentary regarding EU's position to not implement a withholding tax on receipts from EU member states could create a tax haven for EU profits to be shielded from tax because the countries where the profits are earned do not impose a withholding tax on the profits leaving that country and coupling that with certain countries (Ireland and Cyprus) that do not tax money not directly earned in that country's borders allows a sophisticated company to avoid tax on profits made in EU countries.
  • In 1997 U.S. adoption of Check the Box regulations.
    • The article points out that in 1997 under the direction of the U.S. Treasury and the Clinton Administration, Congress adopted the "check the box" regulations.  Check the box regulations allowed U.S. multinational corporations to treat (for US tax purposes) foreign subsidiary corporations as transparent and not separate taxable entities.  This also allowed the foreign subsidiaries to transfer royalties and interest payments between each other without generating tax (called Subpart F) on the transfers.
    • The article also makes the point that at the adoption of the check the box rules, the U.K. and Germany objected to this position because it would allow U.S. multinational corporations to utilize earnings stripping to reduce taxable income in their respective countries.  Congress at the urging of the U.S. multinational companies (namely the argument that reducing the taxable income in foreign countries would lead to larger amounts of tax paid in the U.S.) enacted the check the box regulations.
    • The article also, with the advantage of hindsight, makes the argument that the check the box regulation over time has shown that the U.K. and German objections were warranted because U.S. multinational corporations have stripped earnings from EU countries and have not resulted in more U.S. taxes paid by the sameU.S. multinational corporations.
    • The article points out that the check the box regulations created such a huge loophole (estimated $86.5 billion over a ten year period) that early on President Obama and the U.S. Treasury advocated for the reformation of the check the box regulation.  However, after intense lobbying by business associations, the Obama administration has since abandoned the check the box regulation reforms and extended the check the box regulation treatment for another 5 years.
  • Exploitation of difference between Irish and U.S. tax residency rules
    • As stated in the article, Irish laws taxes corporations for only income earned in Ireland.  U.S. law taxes income earned worldwide for companies that are resident in the United States.  This creates a gap in taxation for an Irish company with income earned outside Ireland, which as the article points out was exploited by Apple by also negotiating a corporate rate of less than 2% for its Irish income.

Finally, the article discusses how the EU Commission reached its determination that Ireland provided improper state aid by granting Apple such a sweetheart deal. The article summarizes the EU Commission position as follows:

  • Was there state aid provided by Ireland to Apple?
    • The EU Commission concluded yes, because a benefit was conferred on Apple, and was not conferred on all other companies.
  • The article states that the EU Commission found fault with the Irish determination because it was a result of a negotiation and not merely a summary of the comparable transactions.
  • The article also stated that the EU Commission questioned the methodology (Transactional Net Margin Method) chosen to determine the appropriate transfer price because the terms were not defined.
  • The article then stated that the EU Commission questioned the inconsistencies in the transfer methodology selected by Apple; and
  • The article stated that the EU Commission challenged the open ended duration of the ruling in Apple's favor.

Note: Apple has utilized this structure since the 1980s and as Tax Justice discusses, Apple continues to use this structure in 2016 to shield income from taxation in the U.S. based on Apple's most recent quarterly earnings report.

However, there might be a change to this structure starting in 2020, as Ireland has passed legislation in 2013, which took effect in 2015 for newly incorporated companies and in 2020 for existing companies, that in order to incorporate in Ireland the company must also be a resident of Ireland (meaning that the income received by Apple's Irish subsidiaries from its EU subsidiaries would be taxed in Ireland at 12.5%). See this Guardian article.

Additionally, the EU Commission has also proposed corporate tax reforms to address continued tax avoidance by multi-national corporations.  The EU Commission's proposals are as follows:

  • Common Consolidated Corporate Tax Base
    • The EU Commission is proposing to treat all profits earned in EU countries as one taxable base, so that multi-national won't be taxed separately by each EU member nation.  This proposal purportedly allows a corporation to offset losses in one EU country with profits in another EU country and provides one joint tax on the profits. This proposal also attempts to address profit shifting from one EU country to another in an effort to seek a lower or advantageous tax rate.
  • Improved Mechanisms to resolve double taxation disputes
    • Currently the EU has a double taxation dispute resolution only addressing transfer pricing.  This proposal by the EU Commission hopes to provide a timely response to companies seeking relief from EU members double taxing the same income in both EU member nations.
  • Measures to tackle tax loopholes with non-EU countries.
    • EU Commission proposes to address tax gaps between EU nations and non-EU nations which have been exploited by companies to reduce tax.  One key example is the Irish-US tax gap implemented by Apple to avoid taxation on its EU revenues.

Whether these proposals will curb aggressive tax avoidance by multi-national corporations is questionable. But the real question is: What are Congress and the IRS/U.S. Treasury proposing to address the existing tax gap (much of which is due to U.S. multinational corporations and their profit shifting (earnings striping)/transfer pricing/base erosion/inversions practices)?

If you have specific and credible evidence of a corporation's use of transfer pricing to avoid paying its tax liabilities you should consider filing a tax whistleblower claim.  Contact us to see if your information would permit you to receive a 15-30% award of the amount of taxes, penalties and interest collected by the IRS on your transfer pricing tax whistleblower claim.

 

 

Mylan CEO, Heather Bresh, called before House Oversight Committee

EpiPen maker, Mylan, called before House Oversight Committee to explain 400% price increase.

EpiPen maker, Mylan, called before House Oversight Committee to explain 400% price increase.

In the news recently, Mylan CEO, Heather Bresh, was called before the House Oversight Committee to discuss Mylan’s increase in prices of the EpiPen.  In case you missed it, EpiPen prices have risen about 400% with a two pack of the lifesaving injection drug at a retail cost of $600.

According to CNN, Ms. Bresh’s testimony before the House Oversight Committee will state that Mylan only makes about $50 for each $300 pen.  Money magazine also details how Mylan is trying to get EpiPen on the Preventative Medicines list, which would allow patients to receive EpiPen will little or no out-of-pocket costs, and so that insurance would have to pick up the cost.

What gets lost in the outrage over a drug price increase, is why the huge increase?  EpiPen has been around a long time, and the process to create EpiPen hasn’t changed for some time, so why the huge increase, and why is Mylan only getting $50 profit from a $300 item. 

One theory is Mylan has been increasing the demand of EpiPen through effective marketing practices.  See this Bloomberg article.  Another often not discussed aspect is transfer pricing, inversions and booking profits offshore.  As stated in the 10-K for Mylan for tax year ended (tye) December 31, 2014, Mylan inverted from a Pennsylvania Company to a Netherlands company with its principal executive offices in Potters Bar, UK. 

As previously discussed in this Blog, one of the key tools U.S. Multinational Corporations (USMNCs) utilize to lower its tax rate is to invert the corporate headquarters to a lower tax jurisdiction. 

Also as previously discussed in this Blog, a second tool used by USMNCs is transfer pricing.  In this case, as stated in this Time article, it costs Mylan about $30 to make each dose of EpiPen.  Mylan likely has the drug filled in the Netherlands or another tax favorable jurisdiction, and then re-sells the drug at the $600 price for a EpiPen 2 pack back to U.S. distributors, thereby booking the costs in the tax favorable jurisdiction. See this primer on transfer pricing.

By using this method (transfer pricing) USMNCs can claim a lower tax rate than the applicable 35% tax rate.  While I am not saying that Mylan utilizes transfer pricing, one indicator that Mylan may be utilizing transfer pricing is in its 10K, Mylan states that for 2014, Mylan only pays an effective tax rate of 4.2%.  (FYI, the statutory rate is 35% for corporations in the United States.)  Mylan also lists on is 10K that it approximately $693 million permanently reinvested in its foreign subsidiaries, which is how companies disguise on their 10K amounts they are holding offshore to avoid taxation in the U.S.

So this begs the question, why can Congress call Ms. Bresh to appear before the House Oversight Committee to discuss pricing, but the IRS can’t call Mylan to conduct an analysis of its transfer pricing or its inversion practice?

If you know of a corporation undervaluing assets in its transfer pricing models, contact our firm to discuss filing a tax whistleblower claim.  IRS will pay an award between 15-30% of collected proceeds (tax, penalties, and interest) to whistleblowers who provide substantial and credible information used by the IRS in prosecuting the alleged tax violators.