Legend has it that William Tell was forced by a medieval ruler to shoot an arrow at an apple placed on top of his son’s head. The risk was that he would kill his son in the process. Like all good fairy tales, there was a happy ending. William Tell scored a bullseye, striking the apple dead centre.

Will the recent €13 billion (+interest tax) arrow shot at Apple by the EU Commission hit its target or will it boomerang? That is a matter that will be decided on by the EU Courts in due course.

While the particular structures used by Apple to successfully reduce its Irish taxation bill would no longer work (due to a recent change in Irish taxation law), the arguments and principles surrounding the case are nevertheless interesting.

Apple appears to have successfully exploited the difference in taxation principles between those operating in the U.S. and those of other countries, including Ireland. However, due to the way it structured its Irish entities, it may have unwittingly provided the EU Commission with the ammunition to accuse it of having received illegal state aid from Ireland.

Taxation Exploited

Firstly, let me explain how differences in taxation principles were exploited.

Under the U.S. taxation system, company profits are taxable by reference to where a company is incorporated. Under Irish tax principles, company profits are taxable by reference to where management and control is exercised.

For example, a company incorporated in the U.S. would be deemed by the U.S. authorities to be tax resident in the U.S. However, a company incorporated in Ireland, despite being managed and controlled in the U.S. would not be deemed by the U.S. authorities to be tax resident in the U.S. unless it was actually trading there.

Apple appears to have incorporated an Irish registered HQ company, which owned Intellectual Property. However the management and control of this company was exercised outside Ireland. Therefore it was not deemed tax resident in Ireland. As it was not incorporated in the U.S., and not trading in the U.S., it was not deemed tax resident there either and was effectively stateless for tax purposes.

International Business Structure

Secondly, Apple appears to have structured its Irish entities in an unusual way.

Apple also setup, in Ireland, a branch of the Irish incorporated HQ company.

A branch office is often used to create a taxable presence in a country, without incorporating (and capitalising) a separate standalone legal entity. The branch office operates as a sub-office of its parent, with the parent being legally responsible for the liabilities of the branch, including taxation. It would be considered unusual for a foreign owned entity to have both a company and a branch operating in the same country.

Apple appears to have used its Irish branch to sell products outside Ireland. Presumably this branch was generating lots of income, taxable in Ireland (as the branch was tax resident in Ireland).

When a 12% Tax Rate is not 12%

So, how come it was not paying very much Irish tax?

Guess what, it had to pay lots of money for the use of the intellectual property which made the sales so valuable in the first place. This would have reduced its profits taxable in Ireland to a modest figure. However, it would appear that the payments (for use of intellectual property) were made to the Irish registered HQ company, which was effectively stateless and not liable to taxation in Ireland. Therefore this company was able to receive income from its Irish branch and pay little, if any tax. (The mechanics of how profits are allocated to a branch are not as simple as this, but the net effect is similar)

Remember that an Irish branch is legally an offshoot of its parent company, rather than being a separate legal entity, even though for Irish taxation purposes they are treated as separate entities. Based on the legal relationship, it is assumed that the EU Commission was able to argue that they were a single entity and calculated the tiny percentage of tax paid to Ireland by dividing the taxation paid by the branch (at 12½% of its taxable profits) by the taxable profits of both the branch and the Irish registered (but not Irish taxable) profits of the HQ company.

Had Apple structured its Irish affairs in the manner used by other multinationals, by using a second company (i.e “the double Irish”), rather than a branch office, the EU Commission might have found it more difficult to argue its case.

State Aid to Apple?

Finally, how did the Irish state manage to find itself being accused of providing illegal state aid to Apple ?

Ireland is accused of having provided a tax ruling to Apple which facilitated the manner in which it allocated its profits between the branch and its Irish registered, but not Irish taxable, HQ company. According to the EU Commission, Apple was provided with some comfort (in 1991 and 2007) in relation to the manner in which it allocated the charge to its Irish branch for the use of its intellectual property. As mentioned earlier, this appears to have been the method by which profits of its Irish branch were reduced, and effectively transferred to its (stateless) HQ company.

While not currently (November 2016) public knowledge, Ireland is likely to have provided comfort to Apple that its HQ company would not be deemed to be tax resident in Ireland. This is consistent with the principle that management and control was exercised outside Ireland and it was not trading in Ireland.

In conclusion, did Ireland do anything to justify a charge of providing illegal state aid to Apple?

In my opinion, there is little doubt that Apple structured its Irish affairs to avoid paying taxation. However I find it hard to understand how the Irish state can be accused, let alone found guilty, of failing to implement generally accepted taxation principles. Perhaps it can be accused of having ‘turned a blind eye’ to the existence of stateless companies. However, it is not the only country to have done so, and a country containing 1% of the EU’s population cannot be expected to take the lead in such complex global taxation issues.

John O’Keefe

John is a member of CAIM – Chartered Accountants Interim Managers. He helps businesses (particularly those with foreign owners) to get established and navigate their way around the Irish taxation system. He has particular expertise helping businesses with trading activities outside Ireland.

View and contact John via his CAIM professional profile