Starbucks, Netherlands say legal and factual errors undermine EU tax verdict

Starbucks and the Dutch government today attacked a 2015 EU decision that branded the coffee company’s EU tax arrangement illegal, and resulted in it having to pay back 25.7 million euros in unpaid taxes.

At a court hearing today, lawyers for the plaintiffs challenged the European Commission's powers to examine tax rulings, disputed its characterization of various Starbucks units and accused regulators of making several factual blunders.

The court case stems from a commission decision that ruled illegal a 2008 Dutch tax arrangement that allegedly reduced a Starbucks subsidiary's tax rate in the country to just 2.5 percent from the standard Dutch corporate rate of 25 percent. The commission said the Netherlands handed the world's largest operator of coffee shops an economic and competitive advantage that wasn’t available to other companies

"For Starbucks, this is a case about the facts and how these have been misrepresented in the decision," said Steven Verschuur, a lawyer representing Starbucks, who said the commission had misread agreements between the coffee brand and its franchisees and ignored other agreements that didn’t fit its analysis.

The Netherlands told the EU General Court in Luxembourg that the commission has no power to replace the Dutch taxman's assessment with its own.

But Europe's state aid regulator stood its ground. Starbucks had "completely changed its story" and the Dutch government was effectively telling the commission to accept its particular application of tax principles "whatever that may mean," said Paul-John Loewenthal, a lawyer representing the enforcer.

The EU decision was the first to deal with “transfer pricing,” a way of valuing dealings between the subsidiaries of a single multinational. Such intra-group transactions can be used by corporate groups to siphon profits to units in low-tax jurisdictions, reducing their overall tax.

At the heart of the dispute is a Dutch-based subsidiary called Starbucks Manufacturing EMEA BV, or SMBV, that operates a coffee-roasting facility in Amsterdam and supplies a range of products, including roasted coffee beans, to Starbucks coffee stores.

The Dutch 2008 tax ruling — or advanced pricing agreement — set out what remuneration SMBV was entitled to receive given its costs, which included buying coffee beans from a Starbucks subsidiary in Switzerland and paying royalties to a subsidiary in the UK for the use of the Starbucks roasting recipe. That royalty was deductible for Dutch corporate tax purposes, and was in part justified by the UK entity having borne the “entrepreneurial risk” of SMBV’s activities.

— Dutch subsidiary —

"What SMBV deserves is stable remuneration for its activities and that it is what it gets," argued Marlies Noort, a lawyer for the Netherlands, seeking to justify the government’s approach. "It runs a negligible risk, or indeed no risk at all."

But Loewenthal for the commission challenged the notion that the operation’s risks could be assumed by the UK subsidiary since the latter was "for all intents and purposes a shell company" with "no physical presence and no employees."

There was, he continued, no "economic justification" for SMBV paying 80 percent of its "operational profits" to the UK subsidiary in the form of royalties, in particular since it did not commercially exploit the intellectual property by selling coffee directly to consumers.

Verschuur, the lawyer for Starbucks, brandished franchise agreements between the company and its stores to debunk an associated claim of the commission, which questioned the value of what was covered by the royalty.

"The EC actually claims that one of Starbucks' most valuable assets is worth nothing," said Verschuur, referring to Starbucks' roasting recipe. "That's why the commission believes SMBV should not pay any royalties to the licensor of this intellectual property."

Both the Dutch government and Starbucks also said the commission ignored examples of other roasters making profits that were comparable with SMVB's.

"There is no question that the contract with company 3 is real-life evidence of a real-life 3rd party paying the same royalty as SMBV," said Verschuur.

Yet the commission disagreed, saying it had agreements showing Starbucks waived the royalty because roasters did not sell directly to consumers.

— National sovereignty —

Today’s hearing is the third challenge against a series of commission decisions that have obliged Ireland, Luxembourg and the Netherlands to recover billions of euros in alleged illegal tax breaks from the likes of Apple, Amazon and a finance unit of Fiat.

The General Court has already heard appeals in the Fiat case and a Belgian "excess-profit" case with similar taxation issues. The court hasn’t yet scheduled a hearing for Apple’s appeal against a record decision forcing Ireland to claw back 13 billion euros ($15.2 billion).

Lawyers for the Netherlands echoed concerns raised in those cases that the commission was over-stepping its state-aid powers when substituting its own tax assessments for those by national tax authorities and legislatures.

"Under the guise of equal treatment, the commission imposes on member states the way they must apply the arm's-length principle," said Marlies Noort, referring to a method for assessing how to tax intra-group transactions. "However this is an attempt by the commission to impose harmonization."

In the Starbucks decision, the EU regulator said Dutch authorities had applied an unsuitable methodology when seeking to establish arm's-length prices for SMBV's dealings.

The commission says that 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.”

Ireland, another staunch opponent of tax harmonization which intervened in the case in support of the plaintiffs and is currently appealing the decision against Apple, focused its attacks on that point.

Its lawyer Paul Gallagher highlighted alleged inconsistencies in the commission's statements in various decisions and hearings on that point.

"If you ... constantly have to evolve the basis for that decision, constantly have to evolve the legal basis, it begs the question whether there is a legal basis," he said.

That was a "caricature" of the commission's statements and positions, the commission's lawyer Loewenthal countered.