EU tax probes turn Belgian decision from 2003 into battleground

19 February 2016. By Matthew Newman and Lewis Crofts.

The EU’s ability to wrest unpaid taxes from companies including Apple, Starbucks and Fiat Chrysler Automobiles will hinge on its interpretation of a 2003 competition decision against Belgium’s tax treatment of multinationals’ subsidiaries.

In the eyes of EU competition officials in Brussels, this decision made it clear that companies needed to treat internal business units as if they were separate commercial entities. But European governments, US officials and the companies under scrutiny disagree.

How this fight ends up could determine the fate of billions of euros in fiscal subsidies.

The decision — on what Belgium called “Coordination Centers” — was the crowning achievement in the European Commission’s fight against “harmful tax competition,” according to former EU antitrust chief Mario Monti. The commission ruled that special tax breaks in Belgium violated the bloc’s rules against government subsidies that warp competition.

The question now is whether this decision gives the EU a green light to tell governments how to tax multinational profits.

If the commission is right, governments could be forced to recover back taxes running, for US device maker Apple at least, into the billions of euros.

If the commission is wrong, it will be accused of applying a new approach to state-aid rules that companies and governments could never have foreseen. This would seriously curtail the regulator’s ability to claw back unpaid taxes.

‘Arm’s length’

As in the late 1990s and early 2000s, the commission has been ramping up its scrutiny of special tax deals that national governments have granted to multinationals. The renewed interest follows the “Lux Leaks” release of thousands of documents showing how the world’s biggest companies benefit from sweetheart tax deals.

Public anger about those deals prompted the commission to investigate tax arrangements struck with Starbucks in the Netherlands, with Apple in Ireland, and with Amazon.com and Fiat’s finance arm in Luxembourg. The regulator has also ruled against a Belgian regime that allowed multinational companies to deduct “excess profits” from their tax liabilities.

The regulator has focused on whether national tax authorities gave special treatment on profits from transactions made between multinationals’ various units. To avoid double taxation and to ensure fair taxation, governments have agreed on a set of guidelines on calculating profits for these intragroup transactions.

But these calculations can be tricky. Governments want to ensure that multinationals aren’t manipulating the price of transactions by shifting profits to low-tax countries, and overstating costs in high-tax countries — a practice known as “transfer pricing.”

To ensure fair taxation, the Organization for Economic Cooperation and Development has developed guidelines to apply an “arm’s length” standard to such intracompany dealings. This means identifying profits as if the transactions were conducted between independent companies under “market conditions.”

In its 2003 decision on Belgian Coordination Centers, the commission examined the government’s tax policy for multinational units that provide services such as banking, insurance and legal advice. The regulator ruled that the government’s approach to transfer pricing was overly generous, finding that a flat rate profit margin didn’t reflect the “economic reality” of the coordination centers’ services.

Court decision

Belgium appealed the decision, but the EU Court of Justice upheld it in 2006.

That ruling is highly significant for the commission’s current investigation. That’s because the court upheld the regulator’s conclusion that Belgium’s approach granted a “selective advantage” to companies that had coordination centers.

The court also ruled that the commission correctly compared the tax treatment of coordination centers to the “ordinary tax system.” The transactions of multinationals should be treated “in conditions of free competition,” the court said.

This “market-based” approach underpins the commission’s state-aid investigations into Amazon, Apple, Fiat and Starbucks: The regulator says that the tax treatment extended to these companies puts them in a more favorable position than rivals in a “comparable factual and legal situation.”

The commission says that its approach to these investigations is directly in line with the Belgian Coordination Centers decision. Even if a government has applied OECD guidelines to transfer pricing, the commission’s view is that it must use a market-based approach.

In the Starbucks case, the commission concluded that the coffee roaster paid a royalty to a UK unit that didn’t reflect a market value for a roasting recipe. The Dutch government has argued that the commission shouldn’t second-guess its tax ruling and application of OECD guidelines.

But the commission insists that governments shouldn’t allow multinationals to use “artificial and complex” methods for transfer pricing. The way to avoid breaking state-aid rules is to ensure that transactions are based on “market realities,” the commission says.

Retroactive?

Governments are chafing under this approach. The OECD has set the rules of the game, they say; the commission shouldn’t take a novel approach to state-aid investigations.

The US government is particularly unnerved. Treasury Secretary Jacob Lew expressed those concerns in a letter to commission President Jean-Claude Juncker last week, writing that the commission’s “new interpretation” of EU state-aid rules “creates disturbing international tax policy precedents” (see here).

Underlying this complaint are concerns about a “retroactive” approach to tax policy. Companies that received tax rulings decades ago — as in Apple’s case — shouldn’t face the threat that they’ll have to repay billions of dollars just because the commission decides that OECD guidelines weren’t appropriately applied.

But the commission can argue that it’s merely applying a long-established legal review that the Court of Justice validated in its 2006 ruling on the Belgian Coordination Centers. Multinationals surely should have been aware that the regulator would take a market-based approach to tax rulings. As a result, there is no new legal standard, the commission could say.

Cracking down on tax avoidance is popular with the public, but governments are concerned that a retroactive approach to taxation will scare off investment. Companies invest when they’re certain of a future return. If they can’t rely on a stable tax policy, they may find other places to park their funds.

For the moment, the commission is plowing ahead, with decisions expected soon in the Apple and Amazon cases. But it will be years before the EU courts decide whether the commission has been right to rely on a 2003 state-aid case — or if its “market-based” approach represents a classic case of administrative overreach.

	Eliot Gao

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