EC v Apple:
Part 1 of this article reviewed the state aid legislation being applied in the Ireland/Apple case. It was argued that the remedy of retrospective recovery conflicts with the principle of legitimate expectations.
In the publicity for its case against Ireland, the European Commission makes much of its claim that Apple paid a tax rate of 1% or less on its European profits.
This suggests the Commission’s thinking may run as follows.
Apple’s corporate structure in Ireland was designed for purposes of tax avoidance. As a result, Apple paid less tax within Europe than was reasonable. We, the EU, pursue a variety of goals, including social justice. Having perceived a failure of tax justice, we have determined what would have been a fair level of tax for Apple to have been charged by Ireland, and ordered that this be paid retrospectively.
The narrative of a heroic EU, championing the cause of ordinary people against the machinations of multinationals (possibly in cahoots with national governments), may seem appealing, both to citizens of the EU and to Commission personnel themselves.
In some of its publications, the Commission seems to be invoking a narrative of this kind. In 2015, it argued that “tolerance has reached rock-bottom for companies that avoid paying their fair share of taxes”. In connection with Apple, it has proclaimed that “our work rests on the simple principle that [companies] must pay tax where they make their profits”.
However, the problem with the narrative is that tax avoidance is not within the remit of EU law, and certainly not within the remit of the EC division responsible for applying the state aid rules. Tax law, including anti-avoidance, is a matter for national governments. Tax avoidance is not an issue which the EC’s competition division should be trying to investigate or penalise.
Rather than welcoming it, the EC’s rhetoric on taxation is something that should be viewed critically. We may be dealing with competence creep.
“Competence creep” — an ongoing problem since the early days of the Community — arises whenever the jurisdiction of the EU is expanded via routes other than explicit changes in legislation agreed by member states. The process may involve the European Court of Justice, and often seems to proceed as follows.
1) The Commission makes an attempt at liberally interpreting some aspect of EU law, by applying it in a novel way, or to a novel area.
2) A member state, or other affected party, appeals against an instance of this application to the ECJ.
3) If (as seems to happen more often than not) the ECJ rules in favour of the Commission, a precedent will have been established.
4) In subsequent cases, the Commission can simply refer to the precedent: “It was established in [relevant case] that the Commission is empowered to ... etc.”
Competence creep is a form of the more general phenomenon of creeping statism. As a rule, states will always seek to expand their domestic powers and sphere of action. There will always be areas where there seem to be good reasons (from the point of view of state functionaries) to have more state intervention, or to have some where previously there was none. By contrast, the state surrendering a specific power is unlikely, except when this is vociferously demanded by the state’s subjects.
Another phenomenon of the state is inertial activity: the tendency for elements of the state apparatus to continue being active even when their original raison d’être has receded. Set up a government department to tackle some supposed evil, give it a hundred employees and appropriate powers of investigation and intervention, and set it going. Even when the object of its activities has drastically diminished, the department is likely to go on trying to combat would-be offenders, to some extent regardless of the facts. After all, this is what it has been set up to do. Alternatively, the department may try to employ its under-utilised resources to tackle an entirely different problem area, one for which it was not intended.
On a national level, we are likely to see some resistance to state power creep provided by a variety of agents. Journalists, commentators, protest groups — and the judiciary, to the extent it is genuinely independent — can provide at least a modicum of opposition to proposed increases in government power.
Who resists the expansionary tendencies of the EU superstate? In theory, citizens’ representatives who sit in the European parliament (i.e. MEPs) and, perhaps more importantly, the ministries of national governments.
In practice, we have the problem of democratic disconnect that is becoming all too familiar: the failure of the political class to reflect voters’ wishes, preferring instead to engage with pro-state ideologies that are then imposed top-down. We therefore see relatively little resistance from national politicians to EU expansionism. Even when the electorate clearly signals its dissatisfaction, the political class persists in its pro-state and pro-superstate preferences, showing every indication of being in a condition of denial.
Rather than there being a balanced process on matters of EU power, then, with eventual resolution after opposition between equally matched forces, we have something that might better be described as knife-through-butter expansionism.
The Apple case, and the three similar cases running in parallel (Fiat, Starbucks, Amazon), provide a good example of competence creep in action. They also illustrate how a department set up to carry out one job (e.g. monitor state aid), and given a very broadly defined power to do that job, can end up pursuing a quite different agenda.
In arguing that Ireland’s tax treatment of Apple is illegal, the EC is trying to employ Article 107 on state aid, which asserts that
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
In practice there are numerous let-outs from this prohibition, in cases where aid is held to be compatible with EU objectives. A canny government can find ways round the rules, allowing it to provide its own industries with de facto support. It has been pointed out that states such as France and Germany pursue policies which give de facto protection to sectors such as steel, arms and energy.
Potential state aid must (in theory) receive approval from the EC’s competition division before it can be regarded as lawful. But what counts as state aid is not always clear, given the vague wording of Article 107. It is this vagueness that has enabled the EC to apply the law to situations which were probably never envisaged by member states when they signed up to it.
With the state aid rules being applied to exotic areas such as tax avoidance, it is easy to lose sight of what they were originally aimed at. Their primary purpose was to prevent governments supporting inefficient businesses which, from the wider European perspective, might be better left to decline.
Aid of the kind originally conceived by EU legislators appears to have become rarer, following the era of so-called neoliberalism. However, one can still find occasional cases being targeted by the EC.
A recent such case concerns the state-owned and dominant rail freight operator in Romania which (it is suggested) may have been receiving financial support, e.g. by way of the Romanian government’s failing to collect monies due from the company. The relevant EC press release states that the company has been “in financial difficulties since at least 2009”, and that “the freight rail transport market in Romania is highly competitive, with numerous private operators”. Here then is a situation which prima facie fits with the original intentions of anti-state-aid law. Efficiency might be increased if the financial support in question were removed and the company allowed to fail.
By contrast, the Apple case seems not to fit the model of an inefficient company being supported to the detriment of economic efficiency. And Apple’s overall success surely has little to do with how much or how little tax it has been paying. What then is the Apple case really about? The most plausible answer appears to be: it is about attacking what the EC regards as “harmful tax competition”.
Tax competition occurs when countries attempt to influence the location choice of multinational corporations or wealthy individuals by competing in offering a favourable tax environment, usually via low tax rates.
The OECD — sometimes described as a club of rich countries — has been critical for some decades of what it calls “harmful tax competition”. What this appears to refer to, primarily, is a dislike of tax havens. Tax havens, many of which levy dramatically lower tax rates than OECD nations, are seen as frustrating the efforts of countries to tax their own companies and citizens.
The phrase harmful tax competition implicitly acknowledges that some tax competition is beneficial. “Tax competition can help to keep taxes closer to their optimal level, constraining wasteful government excess”, says the Tax Foundation. Indeed, tax competition may be one of the few forces tending to keep tax rates down in countries where the political class subscribes to an interventionist ideology.
The notion of “harmful” in this context is too vague to be readily defensible from an economics standpoint. Competition, of whatever kind, is generally beneficial, and there is no convincing evidence to support the claim that the presence of low-tax jurisdictions generates welfare losses for other nations. Countries who wish to stop resident individuals or businesses from making use of such jurisdictions to shelter income can always impose anti-avoidance legislation to block this.
Nevertheless, since 1997, the EU has been echoing the OECD’s cry against harmful tax competition. While it is understandable that the Community should take a dim view of businesses that use non-EU jurisdictions to escape taxation by EU states, it is less clear why it should find fault with tax competition among EU members themselves.
Consider, for purposes of illustration, a hypothetical US technology company XYZ Inc, planning to locate in Europe. Imagine that one EU country decides to offer a heavily discounted tax rate solely to XYZ, and that this is prima facie legal.
In theory, every other EU country could do the same. Which country offered the best tax deal would depend, at least to some extent, on how much benefit each country expects to get from having XYZ located within its borders. But this is analogous to the way ordinary competition between businesses works.
There are likely to be other factors influencing which country wins the suit for XYZ, which may appear to have little or nothing to do with economic efficiency. Again, however, this is analogous to ordinary competition. The process may be imperfect but in the long run, and on balance, we expect it to generate a more efficient outcome than if there were no tax competition. Foreign companies will tend to locate where it would be most efficient for them to do so.
Tax deals such as the one in our hypothetical example, whether offered to a single business or a widely defined class of companies, are currently regarded as falling foul of the state aid rules. For example, Ireland’s special 10% rate of corporate tax for manufacturing companies — arguably a key element in the country’s spectacular growth during the 1990s — was held illegal by the EC in 1998 (though the 10% rate had been in force since 1981). Whether Europe as a whole has benefited from Ireland being forced to end the 10% regime is however not clear.
The EU and taxation
Historically, the EU has not had jurisdiction in the area of direct taxation. Member states are supposedly free to set whatever tax rates they like. They are free to have a simple system of tax rules or — as in many cases — a complicated one. They are free to permit legal arrangements that shelter income from tax, or alternatively to implement fiendishly complex anti-avoidance rules.
However, a tax regime could in theory be used to generate a similar effect to a subsidy. If a country wanted to support its textile sector, for example, it could try to introduce a measure that meant companies operating in that sector suffered a reduced tax burden. There is an argument that the EC should look out for such scenarios, and use the state aid rules to prohibit them.
In a mid-1970s case, a situation of this kind was deemed to be operating in Italy and was held by the ECJ to constitute illegal state aid. Following this precedent, the EC extended its application of the state aid regime to include tax measures that were said to give a “selective advantage” to one or more businesses. Such cases became known as fiscal state aid. Ireland’s 10% regime was held to fall under that heading.
The problem, however, is that the application of state aid rules to taxation inevitably muddies the competence boundary between the EU and member states. And the further the application of the rules is pushed in this direction, the more one is likely to get undesirable conflicts on matters of jurisdiction, with negative repercussions for the businesses and individuals affected.
This argument seems to have been appreciated by the EU in its early decades. It was acknowledged that, since direct taxation was a sovereign area of member states, it would be inappropriate for the Commission to police national tax laws too stringently, even when those laws could technically be regarded as contravening state aid legislation. A softly-softly approach was adopted.
In the 1990s, however, under an initiative launched by Commissioner Mario Monti, the EC changed tack. It decided that unwanted tax competition should be attacked by means of the “strict application” to tax laws of Article 107 on state aid — a piece of legislation that was surely never intended for this purpose.
Pushing the boundaries
As with the choice of deterrents against subsidies, discussed in Part 1, the EU was faced with a conflict between doing what may have seemed ‘logical’, and respecting principles such as legal certainty. Having the power to apply the law in a particular area does not mean that the power should be used; at least not when a supranational entity is in potential conflict with national law.
Fiscal state aid cases, unless they involve scenarios where inter-state competition is obviously being undermined, are likely to involve legal uncertainty, and — when the courts rule in favour of the EC — breaches of legitimate expectations.
When a tax measure is held to involve implicit aid, the measure is often retrospectively annulled and the affected companies are required to pay back taxes. Such retrospective withdrawal of tax advantages violates legitimate expectations, and is unfair on the taxpayers affected. However, at least what was held to constitute fiscal state aid was until recently relatively unambiguous. If tax law is unequivocally altered in favour of a particular class of business, it is not difficult to see that this could be regarded as equivalent to financial aid. A government implementing such an alteration ought to be aware of the risks, even if it could be argued that taxpayers should not have to be.
By contrast, the latest advance in the Commission’s creative use of the state aid rules (applying them to tax rulings) represents a more serious infringement of legal certainty, since it involves an intrusion into the realm of judgment.
A tax ruling (sometimes called “comfort letter”) is a written clarification, issued by a tax authority to a taxpayer, about how taxation provisions will be applied in a specific case. Tax rulings are used in cases where there would otherwise be uncertainty about how the tax authority will interpret the law. Such rulings typically last for a number of years, thus protecting taxpayers from the risk that an authority will unexpectedly change its interpretation. Hence tax rulings facilitate businesses’ efforts to engage in long-term planning.
Most tax rulings are highly specific agreements, applied to complex situations. Judging that such a ruling deviates sufficiently from normal practice to be interpretable as aid is thorny, to say the least. It can only properly be done by an observer steeping himself in all the facts of the particular case, and then coming to a different conclusion from that of the tax authority. This gives enormous scope for subjectivity and disagreement, characteristics to be avoided where possible in matters of law. These points are particularly pertinent in the case of transfer pricing, a notoriously imprecise field where there is rarely, if ever, a single ‘right’ answer.
The final part of this article will examine whether the EC is using the Apple case to claim jurisdiction over transfer pricing, and consider the possible presence of ‘judicial creep’.
© Fabian Tassano
published 24 June 2018
1. EC quotes on tax avoidance are taken from EC Press Release 18 March 2015 and EC Press Release 30 August 2016.
2. The EC’s competition division is currently known as the Directorate-General for Competition (“DG Comp”).
3. In 2016, after the period that is under scrutiny in the Apple case, the EU Council adopted a new Directive on tax avoidance issues. The rules of the Directive will need to be implemented by member states, via changes in national legislation, within a specified period.
4. Current DG Comp Director-General Johannes Laitenberger has tried to make the case that tax avoidance is a suitable target for competition policy by blaming it for the 2008 meltdown — a somewhat far-fetched connection. See his 2016 speech to the International Competition Law Forum, ‘State aid tax cases: Sine timore aut favore’.
5. Regarding de facto national protection of key industries by member states, see for example Glyn Gaskarth, ‘Gamekeeper or poacher? Britain and the application of State aid and procurement policy in the European Union’, Civitas, 2013.
6. Italian fiscal state aid case: Italy v Commission (1974).