August 30, 2016

Europe's Tax Grab


  • The European Union is attempting to penalize American companies for organizing their businesses in a way that legally minimizes their tax burden.
  • The EU’s real complaint should be with EU nations’ complicated tax laws.
  • The EU is attempting to retroactively increase the tax burden on American companies, which will increase U.S. deficits.

Today, the European Union announced a ruling against Apple, ordering Ireland to collect up to $14.6 billion in back taxes from the company. This and other investigations by the EU have shown the incredibly complex European legal system, the bias in these investigations against American firms, and the lengths to which Europe will go to get revenue from them.

Who is being investigated?

European officials have called a “fallacy” the idea that their investigations have an anti-U.S. bias. There have been five investigations into individual companies – four are American, while the fifth is Fiat-Chrysler, an American company that merged with an Italian company and is headquartered in the U.K.

 logo-apple  Investigation opened June 2014; ruled against on August 30, 2016 (regarding their operations in Ireland). May have to pay up to $14.6 billion in back taxes.
Starbucks Investigation opened June 2014; ruled against in October 2015 (the Netherlands). May have to pay up to $34 million in back taxes.
Fiat-Chrysler Fiat Chrysler; investigation opened June 2014; ruled against in October 2015 (Luxembourg). May have to pay up to $34 million in back taxes.
Amazon Investigation opened October 2014; still ongoing (Luxembourg).
McDonald's Investigation opened December 2015; still ongoing (Luxembourg).

Also, in February 2015 the EU opened an investigation into Belgium’s “excess profits” tax rulings. The European Commission ruled in January 2016 that the Belgium system was illegal, and it ordered Belgium to collect 700 million euros from “at least 35” companies. A comprehensive list of the companies affected by the Belgium investigation is not available, but it appears that most of the prominent companies are European, not American.

Another EU investigation into Google is related to antitrust charges, but a formal investigation into Google’s tax treatment could occur in the future. Google and Facebook have tax issues in the U.K. that are unrelated to this EU investigation.

What is being investigated?

Under EU rules, member nations are not allowed to provide “state aid” to companies in order to give them an unfair advantage in the marketplace. This is not controversial, and most EU investigations into state aid involve questionable loans, grants, special statutory tax breaks, or other arrangements that a country uses to try to advantage its own domestic firms.

The EU is now interpreting “tax rulings” as state aid. Tax rulings are essentially interpretations of existing tax law and do not change a particular country’s tax law. The EU itself said that tax rulings are “common practice” in Europe, and the European Parliament has explained that in tax rulings “tax authorities give an explanation to the taxpayer on how they will apply tax law in his particular situation.” Tax rulings provide certainty to businesses and help promote investment that uncertainty might scare away.

Many tax rulings regarding Luxembourg have been characterized as special deals for corporations, but they appear to be letters that asked for confirmation that an accounting firm’s interpretation of tax law is correct. One European example is Ikea, which outlined how it proposed to change its structure. An American example is GE, which did the same. Both of these letters sought to verify the tax treatment that would result if the companies changed their structure in a particular way.

A political point to prove

In the Starbucks and Fiat-Chrysler rulings, the EU said that all companies should “pay their fair share of tax.” These two rulings as well as the Apple and Amazon cases turn on the fair market value of assets sold between different entities within each corporation’s umbrella of companies. This is known as “transfer pricing” and this issue is one of the most complex in corporate tax law. The EU disagrees with the method used and adjustments made to determine what a fair price would be, despite the fact that the companies in these cases used one of five methods included in the OECD’s transfer pricing guidelines, and the country in question approved their use of it. By using an OECD-approved methodology, apparently the EU believes these companies are not paying their “fair share.”

This is a highly questionable interpretation, and the facts seem to point to a political motivation rather than a solid legal case. The EU is taking a highly technical issue on which reasonable people can disagree and pretending that the pricing methodology they favor is the empirically correct one. Even worse, the EU has decided that the maximum penalty available under EU law, a retroactive tax increase for the past 10 years, will be the penalty for this questionable interpretation. The additional tax must be paid immediately, and this requirement is not suspended pending an appeal.

The U.S. Treasury Department has strongly argued against what the EU is doing in these cases. The Netherlands’ Ministry of Finance also has said that the ruling against them and Starbucks “deviates from national law and the OECD’s system.” The EU’s rulings and rhetoric show that they are out to prove a political point about corporate complexity and tax minimization. Tax rulings on cross-border business organizations necessarily involve foreign companies and complex decisions, even though typical EU state aid cases involve relatively straightforward assistance for domestic companies. In her response to the U.S. Treasury Department, the EU commissioner responsible for these investigations said that the EU is using these investigative actions in conjunction with legislative changes “with the aim of establishing fair tax competition.” Legislative changes alone should be used to establish a new “fair” tax regime.

Impact on the U.S.

The decision by the EU to apply a full, 10-year, retroactive penalty will affect the U.S. Treasury. Because foreign taxes paid are creditable under U.S. tax law when a corporation repatriates profits, any retroactive tax increase will increase the amount of foreign tax credits. Corporations will be able to claim these increased credits by amending past tax returns. When they amend returns to claim this credit, they will have overpaid their U.S. taxes in past years and will get a refund for those past years, increasing current U.S. budget deficits.

“The retroactive application of a novel interpretation of EU law calls into question the basic fairness of the proceedings.” – Robert Stack, deputy assistant Treasury secretary for international tax affairs, 12-01-2015

The Treasury Department is considering using authority provided by Section 891 of the Internal Revenue Code to respond to the EC’s investigation into taxes paid by American companies. This section of the code grants the president the power to proclaim that U.S. citizens or corporations “are being subject to discriminatory or extraterritorial taxes” by a foreign country and to retaliate by doubling the U.S. tax rate on citizens and corporations of that foreign country. The way the European Commission investigation is structured, both the United States and the companies concerned are not parties to the investigation. The case is between the EC and the applicable member government. Section 891 could give the U.S. a voice on the issue and Finance Committee members Orrin Hatch, Rob Portman, Ron Wyden, and Chuck Schumer have asked Treasury to consider whether the EC’s actions would fall under Section 891.

Conclusion

These rulings are troubling for transparent, representative government. These investigations are retroactively declaring legal business organizational structures to be illegal and then demanding additional taxes.

The EU is proposing reforms to increase future business taxes. If that is their policy goal, there is an honest way to achieve it. But the current investigations are combining a highly questionable legal interpretation with retroactive enforcement, calling into question the EU’s sense of fairness.

The businesses’ complicated organizations and these rulings are a large reason why governments, both the U.S. and the EU, should simplify their tax systems. This would let companies focus on creating value for consumers instead of creating jobs for tax lawyers and accountants.

Issue Tag: Taxes