Monday, March 6, 2017

The EU Commission's Plan B in the Apple-Ireland "state aid" case: make Apple pay $1.2 billion

Several readers asked for a more specific number after I wrote last month that the European Commission's secondary line of reasoning in the Apple-Ireland "state aid" decision of last August (PDF) would come down to approximately one billion euros (not 13 billion).

The secondary line of reasoning is outlined in paragraph 355 of the EC decision. The gist of it is that the Commission looked at the profitability of other distribution companies and concluded that 3% on sales is an industry-standard profit margin. The numbers themselves are stated in paragraph 97 of the EC decision, with Table 1 (the one relating to ASI, meaning Apple Sales International) being economically relevant and the numbers for AOE (Apple Operations Europe) being pretty much negligible. So, let's apply the standard Irish corporate tax rate of 12.5% (a) to ASI's pre-tax profit as under the Commission's primary line of reasoning ("Plan A profit" column in my table below) and (b) to a hypothetical distributor profit of 3% of ASI's sales ("Plan B profit" column in my table below).

As in paragraph 97 of the EC decision, the numbers below are stated in millions of dollars. Wherever the Commission stated a range, I based my calculation on the middle of the range. Please note that the sum at the end may deviate slightly from the sum of the numbers above it simply due to rounding. Any such differences are negligible.

YearASI SalesPlan A profitPlan B profit
20031 68216550
20042 22326867
20054 068725122
20065 6261 180169
20076 9511 844209
200810 3783 127311
200915 4045 662462
201028 68012 140860
201147 28122 1341 418
201263 25035 2501 898
201362 75026 7501 883
201467 77524 7502 033
total316 068133 9959 482
12.5%:16 7491 185

The Plan A total of $16.7 billion is more than the €13 billion (i.e., approximately $14 billion) that the Commission said would be the starting point for additional taxes to be paid by Apple. But there are explanations for that. Some numbers must be deducted even under the Commission's Plan A, and currency fluctuations explain the rest. ASI's numbers are stated in US dollars but Ireland is a eurozone country. So, basically the EU Commission wants to apply Ireland's 12.5% standard corporate tax rate to ASI's (and AOE's) pretax profits in the relevant period, and that's why an amount of approximately $14 billion has been mentioned over and over.

Under Plan B, however, that recovery amount goes down to approximately $1.2 billion, or less than a tenth of the number that has been making headline news since late August.

Why does the Commission even outline that Plan B in its decision? In paragraph 356, the Commission "contests" that anything other than its Plan A is correct, yet uses it as a fallback line of reasoning in order to argue that Ireland didn't tax ASI on the basis of "a reliable approximation of a market-based outcome in line with the arm's length principle." It may not be the only way in which that EU Commission decision is unusual, but it is the most conspicuous one.

It would not have been unusual at all for the Commission to present two or three legal theories that arrive at materially the same result. If the EC had presented one theory based on Irish statutory law, one based on Irish case law and one based on EU law ("acquis communautaire"), and if all had pointed in the same direction, then that would have made the case stronger, not weaker. I've seen parties make multiple arguments that support a claim, and I've seen judges present more than one theory just to bulletproof their rulings before an appeal. But in all those cases, two or more theories support the same conclusion. Not so here. The Commission's Plan A (tax ASI's pretax profits at a rate of 12.5% even though Irish tax law and even the Commission itself recognize that companies essentially run outside of Ireland need not be taxed there at all) and its Plan B (apply the 12.5% rate to a hypothetical profit amounting to 3% of ASI's sales) share at least one fatal deficiency: the "arm's length principle" as discussed in great detail by the EC in its decision is neither part of Irish statutory law nor Irish case law on the taxation of such entities and the treatment of inter-company charges within a global group. I already talked about that fact last month.

So the fact that there are two theories--with a huge discrepancy (more than a factor of 10) between the results-doesn't make the case as a whole more solid. What must the Commission's approach then be attributed to?

No matter how one looks at it, the fact that there is a Plan A amounting to $14 billion and also a Plan B amounting to less than 10% of that (and even a Plan C, but there is such a lack of specificity at least in the redacted version of the decision and presumably even in the unredacted one that it's impossible to analyze) shows that the Commission is very unsure of what it's doing here.

Let's think of a fictitious parallel. There's one person, Mr. A, demanding money from another person, Mr. B. A tells B that the amount owed is 10 grand, but even if one applied a different theory, it would still be 1 grand, so in A's opinion there can be no opinion that A is right in some way.

The answer most likely lies in politics. The Commission isn't going to collect any of that money itself; it can only (and this is obviously subject to judicial review) order Ireland to collect something from Apple. The Commission wants the amount to be huge, but the Commission would still claim victory as long as any noteworthy amount (and a billion dollars is a lot as long as one doesn't know or consider that the Commission said $14 billion was roughly the right figure) ended up being paid. They would basically say: "Maybe we missed the correct number by a factor of more than 10, but there can be no doubt that we really had to do something in order to right a wrong!" In other words, they'd deny that they wasted taxpayers' money on an investigation of a non-issue.

It may not be necessary for me to reiterate this because I've taken a consistent position on this matter in several posts by now, but I don't even see a reasonably convincing basis on which Ireland would have to collect $1.2 billion. The correct outcome would be for the CJEU to tell the EC that this is all bogus. I just wanted to provide some quantitative analysis in order to complement my previous post on this subject.

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