Starbucks’ ruling by EU raises questions about profit shifting

8th July 2016. Matthew Newman

Starbucks has been ordered to repay the Dutch government 23 million euros (about $25 million), following months of discussions on the precise amount it must return for an alleged tax break.

The European Commission told the Dutch government in October 2015 that it must recover between 20 million and 30 million euros from Starbucks because an agreement it struck had “artificially lowered” the company’s tax over seven years.

The Seattle-based coffee chain plans to file an appeal at an EU court in Luxembourg in the coming weeks. It will challenge European regulators’ conclusion that its bean-roasting contracts were part of an elaborate scam to avoid taxes.

The EU antitrust investigation into Starbucks focused on “transfer pricing,” the corporate practice of lowering tax bills by recording profits at units in low-tax jurisdictions.

Scrutiny centered on a Starbucks roasting operation in Amsterdam that paid royalties to another unit in London for seven years. Investigators at the commission in Brussels concluded that the arrangement had transferred profits to the UK, effectively lowering the roaster’s tax rate to 2.5 percent from the standard Dutch corporate rate of 25 percent.

This gave Starbucks an unfair “selective advantage” over purely domestic Dutch companies, breaking EU competition rules, the commission has said.

Tables and charts

Details on how commission officials reached their conclusion surfaced last week, when the EU regulator published the official version of its decision, which runs to more than 100 pages of analysis, tables and charts. The document chronicles how Starbucks managed to minimize profits at its Dutch subsidiary under an “advanced pricing agreement” struck with Dutch tax authorities in 2008.

In other high-profile cases, the commission has ruled against Luxembourg’s tax treatment for a finance unit of Fiat Chrysler Automobiles and a program endorsed by Belgium to lower multinationals’ tax bills. EU antitrust chief Margrethe Vestager’s ongoing probes into Ireland’s tax deals with Apple and Luxembourg’s alleged tax breaks for Amazon.com and McDonald’s have sparked confrontation with US Treasury Secretary Jacob Lew.

During a June 22 telephone call, Lew told Vestager that the EU is “retroactively applying a sweeping new state aid theory with an outsized impact on US companies.”

At the heart of the dispute with Washington is the commission’s argument that European governments roll out the red carpet to multinationals and offer them breaks unavailable to domestic companies. It’s no coincidence that the probes focus on small countries — Belgium, the Netherlands, Luxembourg and Ireland — that have used tax deals to attract foreign investments.

The commission ramped up its scrutiny after the “LuxLeaks” release of confidential tax agreements exposed how thousands of corporations, including Walt Disney and Microsoft, had shifted money around the planet to lower their tax bills. Since then, public anger has been compounded by the disclosure of millions of similar documents involving Panama law firm Mossack Fonseca.

Arm’s length

Multinationals routinely seek to minimize taxes by shifting profits within a group and landing them in low-tax jurisdictions. To address that problem, the Organization for Economic Cooperation and Development has written guidelines on how to compare internal profit transfers to transactions between independent companies.

These calculations vary according to whether enough information is available to compare the transfer profit to real transactions. But the idea is that corporate units should deal with each other as they would with outside companies — at “arm’s length.”

The Dutch tax authority approved Starbucks’ methodology for transferring profits in 2008. The government said it applied the arm’s length principle, which has been integrated into the country’s tax law.

The commission’s Starbucks decision says the Netherlands applied the wrong methodology to royalty payments that Starbucks Manufacturing, a bean-roasting unit in Amsterdam, made to paid Alki, a limited partnership in London.

The Dutch government, which has already appealed the decision, argues that the EU regulator incorrectly found that the methodology was applied in an “erroneous manner.”

In its Starbucks decision, the commission says that — under EU treaty rules — it applies the arm’s length standard during its reviews of state subsidies, regardless of whether a government has integrated this principle in its national legislation.

In its appeal, the Dutch government rejected this approach, saying there “is no arm’s length principle in EU law.”

Green beans

Another strand of the commission’s decision focused on a Starbucks unit in Switzerland. In this case, Starbucks Manufacturing allegedly paid inflated prices for green coffee beans from the Swiss subsidiary, shrinking the Dutch company’s profits even more, according the commission.

The regulator concluded that the pricing methodology accepted by the Dutch government “cannot be considered to result in a reliable approximation of a market-based outcome in line with the arm’s length principle.”

This market-based approach was endorsed in a 2006 EU court ruling involving Belgian tax breaks for multinationals, the commission says.

A key point in Starbucks appeal is likely to focus on this point. The Dutch government argued that the national tax authority’s agreement with Starbucks should be compared to the country’s tax regime rather than theoretical concepts on transfer pricing. In its appeal, Starbucks is also likely to focus on this point.

Starbucks may also challenge the chronology of the evidence that the commission relied on in making the decision. It emerges from the decision that the commission used contracts dating from the years 2010 and 2014, long after the tax authority’s ruling.

 ‘Significant errors’ 

In its decision, the regulator concluded Starbucks’ transfer of profits to the UK unit was an elaborate way to avoid taxes in the Netherlands.

The commission says that the payments for the know-how involved — essentially roasting instructions — couldn’t be justified. No other Starbucks subsidiary in the world paid royalties for this intellectual property, it concluded.

Starbucks says the commission’s decision contains “significant errors,” starting with the assertion that no outside companies paid royalties for its roasting know-how. This intellectual property “cannot be exploited on the market,” the regulator said.

The Starbucks’ case involves a relatively modest recovery order. At multinational whose net profit hit $19.2 billion in fiscal year 2015, 23 million euros might be viewed as a rounding error.

Yet the case raises important questions about the EU’s views on taxation and how it affects companies operating in the bloc.

The commission’s market-based approach is now fully integrated into the state-aid policy it published in May. So companies that thought they had solid deals with tax authorities will now have to think twice about whether their transfer-pricing arrangements are based on market realities.

The commission has sought to reassure companies that the “majority” of tax rulings granted to multinationals in Europe are economically sound. But the regulator’s approach in recent years is certain to increase concerns about legal uncertainty for multinationals.

	Eliot Gao