Commissioner Vestager’s edict on Apple’s tax arrangements in Ireland (1) sent forceful ripples through both sides of the Atlantic on August 30th, 2016. The European Commission is no stranger to ruffling corporate and sovereign feathers, most famously by blocking the GE/Honeywell merger in 2001 (2). However, the Apple ruling has the makings of a more divisive decision than any that came before.
Beggar-Thy-Neighbor Policies and the Ultimate European Public Good
At the forefront of the ongoing controversy stands the Irish Government. Even as the emerald isle stands to reap a windfall of €13 billion, the government hastened to denounce the ruling. Calling the ruling a crass encroachment on sovereign tax policies (3), Minister of Finance Michael Noonan has vowed to appeal the decision up to the EU courts (4). While a protracted legal battle is likely to take place, the government will have to claw back the alleged illegal aid and keep it in escrow until the last gavel drops.
In the zero-sum game of attracting multinationals beggar-thy-neighbour policies prevail. The staunch resistance highlights how the decision undermines Ireland’s carefully calculated foreign direct investment strategy. The recipe for success is simple: ask less than your competition to the extent the local political environment allows.
To be sure, the seducing mixture of a low corporate tax rate and individually tailored tax rulings has attracted a swarm of international heavyweights to set up shop along the Irish coast. To the irritation of other member states, conglomerates relying on vast amounts of capital and high-skilled labour rarely relocate once they feel at home. With effective tax rates in the low teens and single digits and a generous approach to transfer pricing, Ireland has eked a competitive advantage that other member states have found impossible to match.
As a result, Ireland has positioned itself as Europe’s most lenient gatekeeper. With the ultimate European public good – the internal market – at stake, the derision, jealousy and envy of other member states is only to be expected. Not surprisingly, Vestager’s decision was received by a smiling chorus of European finance ministers urging Apple to get ready to pay up (5).
For everyone crying foul over Ireland’s tax haven antics, Vestager’s decision was political vindication – pure and unadulterated.
Everything is Politics
In opposing the ruling, Ireland has found a staunch supporter in the United States. On August 24th the Department of the Treasury issued a vitriolic white paper laying out the demerits of the decision (6). The main concerns raised include how the decision undermines legal certainty, threatens multilateral cooperation on taxation and casts a chilling effect on American investment in Europe. The true motivation for the United States’ opposition is much more pecuniary.
At its core the case is about which government collects the money (7). The repatriation of trillions of offshored dollars (8) is high on the US government’s agenda, and as the white paper notes, each euro clawed back by Ireland is lost revenue to the IRS. Consequently, the United States has readily adopted a narrative according to which the retroactive recoveries go against current EU and international norms.
The implication is that the €13 billion rightfully belongs to the United States. However, from a European viewpoint the opposite is true. Had Ireland followed state aid regulations correctly, it would have collected €13 billion and more from Apple, reducing the company’s tax burden it faces at home.
Whichever narrative one follows is more an issue of politics than anything else. To be sure, Ireland was bound by EU state aid regulations that make illegal any advantage given on an arbitrarily preferential basis, including tax rulings. However, taxation policy remains the sovereign right of each member state. With the Apple decision Brussels is entering largely uncharted waters, raising valid concerns about legal certainty.
This uncertainty is most sharply felt by corporations that rely on the prima facie validity of member states’ tax rulings. Under state aid rules, dutifully obedient corporations can be subjected to retroactive payments they could not have foreseen. While Vestager hastened to note that these claw-backs are not penalties (9), there is little difference from a corporate perspective.
The political divisions ensure a heated discussion going forward. As long as the discussants continue to argue from parochial premises they will not be addressing the real issue at hand – tax avoidance by multinationals. More importantly, they will detract from ongoing efforts to promote tax harmonization that would surely be a win-win solution for all.
Returns to Scale and the End of Legal Fiction
The political uproar and pan-European schadenfreude have thus far masked a serious competitive concern. That Apple succeeded in negotiating its effective tax rate down to 0.005% in 2014 illustrates how large multinationals enjoy of returns to scale unavailable through mere skill, foresight or industry. Rather, these tax holidays are the result of holding leverage over the host country.
To a certain degree, competition between governments ensures that companies with more to offer often end up giving up less than their smaller competitors. That broad shoulders carry lighter loads will on its own raise moral and societal objections from certain groups that are growing more vocal by the day. Moral dilemmas aside, preferential tax treatment resulting from the possession of market power is certainly an issue in its own right. Among the competition questions raised by the Apple case are the dynamic effects of the capture of local decision makers by first-movers and global incumbents.
The decision also provides an entrepôt to discussions on reining in the wide-spread use of legal fiction in transfer pricing arrangements. Transfer pricing and licensing of intellectual property can be welfare-increasing activities, which should not be spurned on their own. However, welfare gains are bound to be limited when these tools are used for pure tax avoidance purposes by subsidiaries with no staff and headquarters. As has been the case with Apple, the most likely outcome is the accumulation of private gains derived from rent-seeking enabled by market power.
Fair competition can only be had on a levelled playing field. Questioning Apple’s preferential tax treatment and legally fictitious transfer pricing arrangements is a step on the right path towards removing harmful disruptions on the internal market. However, whether the EC’s laudable aims are best served by state aid inquiries rather than multilateral tax harmonization is not at all certain.
END NOTES
(1) State aid: Ireland gave illegal tax benefits to Apple worth up to €13 billion
(2) The Commission prohibits GE's acquisition of Honeywell
(3) Id.
(4) Europe's 'unfair' Apple tax ruling sparks US anger
(5) EU finance ministers line up behind tax ruling against Apple
(7) A Message to the Apple Community in Europe
(8) $2.1 Trillion in Corporate Profits Held Offshore: A Comparison of International Tax Proposals
(9) State aid: Ireland gave illegal tax benefits to Apple worth up to €13 billion
