EC v Apple:
retrospection is immoral
In 2016 the European Commission alleged that Ireland had broken the EU law against “state aid” by providing preferential tax treatment to Irish subsidiaries of Apple Inc.
The Commission says that for over twenty years, preferential treatment has been given via “tax rulings” granted by the Irish Revenue to Apple companies. These rulings, it is claimed, resulted in Apple benefiting from an artificial reduction in Irish corporation tax. The reduction is tantamount, the Commission argues, to Apple receiving aid to that amount from the Irish government.
If it is true the law has been broken, someone must of course suffer penalties – otherwise the law has no teeth.
The supposed failure to apply EU law was committed by the Irish state. Its tax authority agreed the tax rulings which the Commission finds objectionable. The Irish state is therefore the obvious party to suffer punishment.
The penalty is not payable to the EU. A peculiarity of the state aid regime is that the Commission does not punish an offending company directly, but orders that the national government in question “recovers” from the company the financial advantage held to have been illegally granted.
Apple is being asked to pay to the Irish Revenue the cumulative tax benefit that the EC has decided it received illegally during the period 2003 to 2014. This is likely to total about €13 billion. On top of this, interest will be charged. Last month it was announced that Apple is starting to pay the money into an escrow account.
What this case is about
On the face of it, the Irish government is in the enviable position of having first successfully tempted Apple into its jurisdiction by means of a low-tax regime, and now being able to demand a much bigger tax take than the company was led to expect.
The EU might be thought to be taking a decisive step forward if it can win a major case about the extent to which taxation falls into the net of the state aid rules. The playing field will have been levelled, and we shall be closer to the desired goals of tax harmonisation, elimination of harmful tax competition, and ‘fair’ tax burdens for corporations — so fans of the decision may wish to argue.
However, any gains from this case are likely to be short-term.
By extending its powers into the field of interpreting tax law, the Commission has dealt a blow to legal certainty, and hence to corporate planning, for businesses based in Europe. From the long-term perspectives of both the EU and Ireland, the resulting efficiency losses and likely eventual migration of jobs out of the area may outweigh any supposed benefits for competition.
Fundamentally, this case is not about whether Apple paid insufficient tax, though some commentators have encouraged their readers to see it that way. At its heart, rather, is an important legal principle, and the question of how readily the principle may be overridden when it conflicts with other considerations.
The rule of law requires that persons should be able to predict the legal effects of their actions. This is known as the principle of legal certainty.
One application of legal certainty is that individuals have a right to rely on representations made by government authorities. If a government department tells me that the legal consequence of action A is effect B, I have a right to assume the advice is correct.
This principle is sometimes referred to as “legitimate expectations”, or “reasonable reliance”. The principle is subject to limits — in a burglary case, the fact that a government official had said the theft would be legal might not carry much weight — but in many situations it is recognised as a valid defence.
In particular, a person has a right to assume that, having acted in good faith on the basis of government advice, the advice will not retrospectively be invalidated. To do so would mean that he now retrospectively suffers any applicable legal punishment; that financial benefits accrued over the past are withdrawn; and that any cumulative costs avoided during the period have to be paid. Retrospective effects contravene legal certainty.
The principle that changes in the law should not have retrospective effects is a key feature of civilised legal systems. Article 1 of the US Constitution, for example, forbids what it calls ex post facto laws. A person should not be penalised by the law for an action which only became illegal after the action.
Noted legal theorist Joseph Raz has argued that all laws should be prospective. Raz also asserts that the law should be clear:
An ambiguous, vague, obscure, or imprecise law is likely to mislead or confuse at least some of those who desire to be guided by it.
The EU itself, on the face of it, gives weight to the no-retrospection principle. An entire Article of the European Convention on Human Rights is devoted to it. And earlier this month, it flagged its ostensible commitment to legal certainty with a proposal to make receipt of EU funding conditional on a member state’s respect for the rule of law.
Apple’s legitimate expectations
The Irish Revenue, via a series of tax rulings, gave Apple an understanding that a certain method of calculating its profits was consistent with prevailing tax laws. By doing so, the Revenue held out an interpretation of the law — in an area subject to uncertainty, where a variety of approaches could be considered correct — on which Apple could reasonably expect to rely. The Revenue did not, it appears, say to Apple: “we are agreeing this treatment, but please bear in mind that it may well be reversed by a higher authority, with retroactive effect”.
If it is now decided that the treatment agreed by the Irish Revenue was illegal then it will have to cease. The EC, however, goes further than this. It says that past tax advantages which flowed from the rulings having been ‘incorrect’ were illegal and must be reversed.
There is a 10-year time limit on this procedure, extending back from when the Commission first asked for information on the particular case. In the case of Apple, this happened in 2013; the ordered reversal is therefore limited to the period 2003 onwards. Nevertheless, it means paying a substantial amount of back taxes. Interest on the supposedly underpaid tax is also being charged.
This draconian measure represents an extraordinary breach of legitimate expectations.
Some may find it hard to have much sympathy with America’s largest company being forced to pay more tax. But the case is likely to establish an important precedent which will affect smaller companies. And it may have negative repercussions for the rights of individuals vis-à-vis government, since it strikes at the heart of whether the state has to abide by its legal promises.
The EC’s strange logic
In theory, EU law is supposed to respect legitimate expectations. “The principles of legitimate expectation, and assurance of legal certainty, are part of the legal order of the Community” said the European Court of Justice in an oft-cited case from the 1980s.
In practice, the application of Community law often seems to be driven by political goals. Unlike national legal systems, the EU legal edifice has not been subject to centuries of conflict between individual rights and collective interests, culminating in a fragile balance of power and continual scrutiny of possible abuse. By contrast with major changes in national law, which typically do not proceed without opposition and heated debate, changes in EU law often seem to forge ahead willy-nilly. This is one aspect of the EU’s so-called democratic deficit.
As might be expected from an organisation which exists to promote broad higher-level objectives, expediency in relation to the need to drive forward EU goals often seems to trump questions of principle such as legal certainty — even if the EU feels obligated to give lip service to such principles.
How does the European Commission respond to the charge that the principle of legitimate expectations is being violated in the Apple case? It has asserted that this argument cannot be permitted in cases of this kind. If it was permitted, it would render the state aid provisions ineffective.
While this may seem to be acceptable legal reasoning, it is indicative of a problem with the underlying law. It amounts to saying:
“The attempt to invoke legal certainty must be rejected whenever a law itself demands a breach of legal certainty – because not rejecting it would make it impossible to apply that law.”
There is another possible line of reasoning, sometimes adopted by judicial reviews:
“Since the application of this law requires systematic violation of a key legal principle, the law should be abolished in its present form, and meanwhile declared void.”
The law on state aid
In holding Ireland’s tax treatment of Apple to be illegal, the Commission is relying on legislation on state aid dating from the early days of the Community, and currently found in Article 107 of the EU Treaty:
any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings [shall] be incompatible with the internal market
Although the EU long ago moved on from pursuing only economic goals, it was originally conceived — by at least some of its architects — primarily as the means of creating a single, freely competitive European market. As part of the programme for achieving this, it was considered desirable to remove barriers to trade such as tariffs and quotas. This meant getting member countries to sign up to prohibitions on such barriers.
It was also thought important to limit subsidies and similar anti-competitive practices. Subsidies were seen as undesirable since they advantage some businesses over their rivals, for reasons not related to efficiency. This led to the ban on state aid.
The relevant legislation is drafted very widely. The term “aid” is not defined, and the phrase “in any form whatsoever” provides encouragement to innovative interpretations. Whenever there is a financial transaction between state and business sector, the state aid provisions are potentially applicable.
On the other hand, there are numerous let-outs from the ban, in cases where the aid is regarded as compatible with EU objectives.
The vagueness of the wording may have been thought desirable as a means of allowing the Commission to catch any possible form of subsidy it might wish to prohibit, including back-door methods. However, it means a good deal of discretionary judgment is required in applying the law. This in turn generates legal uncertainty.
The other risk with loosely-worded laws is that they start to be applied to areas where they do not belong.
Every club has the problem of how it will enforce its rules. If expulsion is not an option, the club needs a system of penalties for non-compliance.
A supranational organisation has a particular problem in this area. It may wish to control the behaviour of a national government by means of penalties, but such penalties are likely to affect those who are in no position to avoid them: individual subjects of the government. This issue bedevils, for example, the UN’s use of sanctions. Sanctions typically cause harm to the citizens of the offending state, but often fail to change the behaviour of the state’s rulers.
The EU should balance the need for compliance with the need to avoid harm to individuals. Where the fault lies solely or primarily with a government authority, penalties which directly impinge on individual citizens or businesses should be avoided, in favour of penalties levied on governments.
The European Court of Justice has scope to levy penalties on member states. In 2001, for example, Greece was punished with a fine of nearly €5 million, for permitting illegal dumping of waste into a river in Crete. In 2008, France was fined €10 million for failing to comply with an EU directive regarding genetically modified organisms.
When the EU began to consider remedies against illegal state aid several decades ago, it seems not to have given a great deal of weight to the principle of legitimate expectations. It simply opted for the solution that any illegal aid must be repaid. The EU could have considered using penalties on member states, with repayment of aid only in cases where the aid continues after notice is given of illegality. Instead, it decided on the relatively straightforward — but brusque — remedy of trying to restore the status quo ante.
Clearly this approach can be expected to violate legitimate expectations and legal certainty, given the lack of clarity over what might constitute “aid” and under what conditions it might be illegal. A recipient of a grant, for example, will have been given actual or implicit assurances by national state authorities that the grant was lawful. Provided he has acted in good faith, he should be entitled to rely on those assurances, and not find years later that he must repay the grant because the Commission has decided it contravened the rules on aid.
The requirement that unlawful aid must be reversed is not actually stated in the EU Treaty. The Treaty limits itself to asserting that where aid is found to be “not compatible” with the internal market, the member state concerned shall “abolish or alter such aid” (Article 108). Prima facie this could mean merely that any aid found to be illegal must cease.
The convention that any unlawful aid that has already been given must be repaid by the recipient began to be established via a series of cases in the 1970s. However, it did not start to be applied in earnest until the 1980s. Not surprisingly, its initial application generated some dissatisfaction.
In a case from the late 1980s, for example, Germany refused an order to recover what the Commission had decided was state aid, arguing that its domestic law required respect for the legitimate expectations of the recipient.
The European Court of Justice rejected the argument, saying that a member state whose authorities have granted aid contrary to the provisions of the Treaty may not rely on the legitimate expectations of recipients. If it could do so, those provisions
would be set at naught, since national authorities would thus be able to rely on their own unlawful conduct in order to deprive decisions taken by the Commission [...] of their effectiveness.
This line of reasoning has recurred several times in decisions on state aid, and indeed is employed in the Apple decision. It may be noted that it is not strictly correct.
If financial penalties for breach were incurred by member states, rather than by those held to have received unlawful aid, the system would give effectiveness to EC decisions without violating legitimate expectations.
Part 2 of this article will examine the EC’s recent attempts to extend the retrospective recovery provisions to a new area of application: advance tax rulings.
© Fabian Tassano
published 20 May 2018
1. In suggesting that any penalty for breach in this case should be borne by the Irish state, I am not meaning to cast Ireland as the villain.
The Irish government has appealed against the EC decision, though there was some disagreement within the Irish parliament about whether to do so.
Apple has been very important for Ireland’s economy. In 2017 the country experienced GDP growth of 8%, of which a quarter was reportedly due to increased iPhone sales.
2. Other orders to collect back taxes, similar to the Apple case, have been issued by the EC to Luxembourg in relation to Amazon and in relation to Fiat; and to the Netherlands in relation to Starbucks.
3. Joseph Raz: ‘The rule of law and its virtue’, reprinted in The Authority of Law, Clarendon Press, 1979.
4. Article 7 of the European Convention on Human Rights states: “No one shall be held guilty of any criminal offence on account of any act or omission which did not constitute a criminal offence under national or international law at the time when it was committed.”
5. If treatment agreed by the Irish Revenue markedly departs from normal Irish practice in a way that favours the taxpayer, then technically the ruling may be at variance with EU law against state aid.
The principle of the primacy of EU law dictates that where national law conflicts with EU law, the latter takes precedence. Primacy of EU law is not accepted unequivocally by all member states, but it appears that Ireland’s acceptance of it is written into its constitution.
6. “The principles of legitimate expectation, and assurance of legal certainty, are part of the legal order of the Community” — from Judgment of 21 September 1983 re Deutsche Milchkontor v Federal Republic of Germany.
7. Regarding Apple’s legitimate expectations, the EC argues in its decision of 30 August 2016 that a member state may not plead the legitimate expectations of a recipient
to justify a failure to comply with the obligation to take the steps necessary to implement a Commission decision instructing it to recover the aid. If it were allowed to do so, Articles 107 and 108 of the Treaty would be deprived of all practical force, since national authorities would be able to rely on their own unlawful conduct to render decisions taken by the Commission under those provisions of the Treaty ineffective. [paragraph 442]
Nor will the EC accept that plea from the recipient himself:
where aid is implemented without prior notification to the Commission, the recipient of the aid cannot, in the absence of special circumstances, have a legitimate expectation that the aid is lawful. [ibid.]
In cases where it was not clear that an action might constitute aid, and the action was endorsed by a government agency, it seems unreasonable to assert that the recipient cannot normally have a legitimate expectation.
The EC seems to be employing a special version of the legitimate expectations principle, according to which expectations can be regarded as legitimate only if they arose as a result of statements made by the EU:
the principle of legitimate expectations may only apply to an individual in a situation in which an institution of the Union, by giving that person precise assurances, has led him to entertain well-founded expectations. [paragraph 443]
8. By “EU Treaty” I mean the Treaty on the Functioning of the European Union.
9. Introducing a regime of penalties on member states for breach of EU law may present a challenge if there is no provision for such penalties in the relevant Treaty. (The Maastricht Treaty, which came into force in 1993, expressly provided for penalties where a member state fails to comply with a judgment of the ECJ, but not penalties for breach per se.) However, finding a way to achieve this is presumably not beyond the ingenuity of a Commission capable of applying the law creatively in other contexts.
10. The requirement for member states to recover unlawful aid was codified in 1999 by EC Council Regulation 659.
11. ECJ case on German refusal to recover aid: Commission v Germany,
C-5/89, 20 September 1990.
12. For another critical perspective on the state aid recovery regime, see Jeremy Lever, ‘EU State Aid law — not a pretty sight’, European State Aid Law Quarterly, 12 (2013), pp.5-10. Among other things, Sir Jeremy points out that the economic benefit of a grant or subsidy is often significantly less than the ostensible monetary sum.
Clawing back the full monetary amount years later is thus likely to mean a net economic loss for the recipient, and not simply “restoration” or “reestablishment” of the previously existing situation, as the EC contends.