In January 2016, more than two years into the European Commission’s state aid investigation into the taxation of Apple in Ireland, the firm’s CEO Tim Cook landed in Brussels. There, he held his first meeting about the case with then European Competition Commissioner (and now Commission Vice-President) Margrethe Vestager. 

By then, the probe had homed in on one issue that had already reshaped Apple’s Irish subsidiaries, rippled through two Irish budgets, and was about to trigger a wave of corporate restructuring among technology multinationals: where their intellectual property (IP) is located, and how the companies handling it are taxed.

IP is mentioned 200 times in the European Commission’s 2016 decision, and nearly 100 times in the judgment of the General Court of the EU which annulled it on Wednesday. 

The superficial layers of the case are well known: how the Revenue Commissioners granted successive tax rulings to Irish-registered Apple subsidiaries in 1991 and 2007, recognising a portion of their Irish branches’ operating costs as taxable income while the majority of their profit ended up in head offices that were not tax-resident in any country; how the European Commission found that those head offices “existed on paper only” and should have booked all profits through their Irish tax-resident branches instead – the decision that has now been quashed; and how this resulted in the Silicon Valley firm placing €14 billion in tax and interests in an Irish escrow account to cover the potential liability arising from the case over the 11 years covered by the investigation.

The commentary usually ends here, with maybe a mention of the disputed allocation of IP between Apple Sales International and Apple Operation Europe’s immaterial head offices and their branches in Cork. Yet this is where things get interesting.

Reading both decisions by the Commission and the court in full today, in light of the far-reaching changes made by legislators and corporations in the intervening years, is illuminating. Details of the case reveal that Apple put in place a cost-sharing agreement (CSA) between the group’s parent company in Cupertino, California and its main Irish holding company as soon as it first invested in the country in 1980. In exchange, Apple concluded an “Agreement to Transfer Intangible Property” with the Irish company, cascading into a sub-agreement with the subsidiary which made computers in Cork, granting it “an exclusive, royalty-free license to use the trade names, trademarks, trade secrets and patents in, initially, Western Europe and, later, the Europe, Middle East, India and Africa region, and to sublicense those rights and licenses,” according to the European Commission. 

Successive versions of the CSA ever since, later complemented by a marketing services agreement, have reflected the fact that any business conducted in Ireland is dependent on the unique technology and brands developed in Cupertino – and Irish subsidiaries pay their US parent for use of this intellectual property. 

The court considers that Apple is nothing without its IP, concluding in its judgment that the activities and risks detailed in the CSA “are, in essence, all of the functions at the heart of the Apple Group’s business model, which is centred on the development of technological products”.

When a consumer buys an iPhone or a Mac, part of the purchase money pays for the device manufactured by outsourced suppliers such as Foxconn in China. But the real value for Apple lies in the margin reflecting the consumer’s choice of its product, not a Foxconn one. For years, the firm has channelled both income components through its Irish subsidiaries.

When Brussels competition investigators first asked questions about Apple’s Irish tax rulings following a US Senate hearing in 2013, then opened a formal investigation one year later, they quickly hit a complex question: how much of the profits generated in its ASI and its parent AOE were derived from IP, and where should they be taxed? In March 2015, they began to collect information from Apple on the IP licenses held by its Irish subsidiaries. They faced an uphill battle: as they put it themselves, “intangible assets owned or held by the company, such as IP licenses, cannot be observed in a physical form and are therefore more difficult to allocate for tax purposes”.

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In its 2016 decision, annulled by the court this week, the Commission based its state aid guilty verdict on the way Apple had divvied up the allocation of IP assets in its Irish subsidiaries between their stateless head office and their branches in the Holyhill industrial estate in Cork, judging that the Revenue had blindly rubberstamped this. 

“The Apple IP licenses held by ASI and AOE should not have been allocated outside of Ireland, but to the Irish branches. Consequently, ASI’s and AOE’s Irish branches, if they were separate and independent companies engaged in the same or similar activities under the same or similar conditions, would not have accepted from the perspective of their own profitability that all the profit of ASI and AOE beyond a limited mark-up on a reduced cost base is allocated outside of Ireland. Rather, all profit from sales activities, other than the interest income obtained by ASI and AOE under normal market circumstances, should have been allocated to the Irish branches of ASI and AOE,” the decision reads.

For example, the Commission included figures for 2007, which show that ASI, instead of paying $9 million in corporation tax out of an $1.8 billion profit as agreed with Revenue, would have received a tax bill closer to $230 million if all company profits were taxable in Ireland.

“The consequence of Irish Revenue accepting the unsubstantiated assumption that the Apple IP licenses held by ASI and AOE should be allocated outside of Ireland is a significant reduction of ASI’s and AOE’s annual taxable profit in Ireland, which constitutes the taxable base upon which corporation tax is levied under the ordinary rules of taxation of corporate profit in Ireland,” the Commission concluded – and that’s a form of illegal subsidy.

“Those rulings endorse a taxable remuneration which the Irish branches would not have accepted, from the perspective of their own profitability, if they were separate and independent companies.”

European Commission decision

Anticipating a possible appeal of this full allocation of profits to Irish branches, the Commission added a separate argument, concluding that even if the Revenue had been right to accept the allocation of IP licenses outside Ireland, the method endorsed in tax rulings to calculate taxable profit still offered Apple’s subsidiaries an unfair advantage.

“Those rulings endorse a taxable remuneration which the Irish branches would not have accepted, from the perspective of their own profitability, if they were separate and independent companies engaged in the same or similar activities under the same or similar conditions,” the Commission found.

This reference to a fictitious situation where the Irish branches of Apple’s subsidiaries would operate as independent companies was used through the investigation as a way of testing the taxation of Apple in Ireland against the contentious “arm’s length principle”. The Commission used this concept enshrined in EU law to verify that transactions between subsidiaries’ branches and their head offices were conducted in the same way as those observed between similar businesses in an open market – also a foundation of transfer pricing rules within multinational groups developed in international forums such as the OECD.

“The Commission considers that Irish Revenue’s acceptance of the unsubstantiated assumption that the Apple IP licenses held by ASI and AOE should be allocated outside of Ireland, upon which the profit allocation methods proposed by Apple and endorsed by the contested tax rulings are based, results in an annual taxable profit for ASI and AOE in Ireland that departs from a reliable approximation of a market-based outcome in line with the arm’s length principle,” the 2016 decision found.

The only way to find out if the two Irish branches were being taxed as regular market actors was to conduct a full analysis of their business and the IP licenses underpinning them, the Commission argued – a point that would come back to haunt it later. “It was incumbent on Irish Revenue to confirm that those licenses should indeed be allocated outside of Ireland by taking into account the assets used, the functions performed and risks assumed by those companies through the Irish branches and through their respective head offices,” the decision reads. “Had Irish Revenue undertaken such an examination, it should have concluded that the absence of activities related to the Apple IP at the level of the respective head offices meant that those licenses should be allocated to the Irish branches for tax purposes, which was the only possible consequence of those licenses not being allocated to the head offices.”

This is where the Commission’s claim that the subsidiaries’ head offices “existed on paper only” took a fiscal meaning. It noted that the two subsidiaries had no employees outside Ireland, with only board meetings recorded at head office level. “Those minutes do not demonstrate that ASI’s and AOE’s board of directors performed active and critical roles with regard to the management and effective control of the Apple IP licenses,” the Commission found. In fact, directors started to discuss the management of IP only after the investigation started.

Routine only: Apple’s defence

Throughout the investigation, Apple argued that research and development took place in the US, with Irish branches conducting “routine localisation and product testing” only. This means the work resulting in the creation of Apple’s IP was not taking place in Ireland. Once assets such as patents, software and brands were ready for use, the Irish subsidiaries had no role in IP management, and only a limited role in the negotiation of commercial contracts to generate income from it, the company added. “All the functions that drive Apple’s profits are directed by Apple Inc. executives in the US and performed largely in the US. Additionally, no IP created or acquired by Apple is legally owned by, or registered to, ASI or AOE,” according to Apple evidence.

“In its letters of 25 January, 18 February and 14 March 2016, Apple explains that Apple, Inc. holds the legal title to the IP which is developed and controlled outside of Ireland and that it would be contrary to Irish law and international tax principles for Ireland to tax any profits resulting from the IP. Furthermore, Apple explains that the profits of ASI and AOE, other than the profits from the activities of the Irish branches, are subject to deferred taxation in the US”, investigators wrote. President Donald Trump would later prove this last point correct, as we will see later.

Within its subsidiaries, Apple argued that directors did play an important role outside Irish branches, for example when they signed successive versions of the cost-sharing agreement. By contrast, “no decisions concerning the exploitation of Apple’s IP or the development of Apple products (such as decisions regarding what IP to commercialise and how to manufacture products) are made in Ireland”.

“Irish Revenue attached critical importance to the fact that the Irish branches had no rights to, or interest in, the Apple IP licenses which was a significant source of the companies’ income.”

Ireland’s evidence

The Irish Government, too, vigorously defended the tax rulings in favour of Apple, describing the profits taxable here as commensurate with the value of the contribution made by the Irish branches. “In particular, Irish Revenue attached critical importance to the fact that the Irish branches had no rights to, or interest in, the Apple IP licenses which was a significant source of the companies’ income.”

What the branches did generate was trading income, with “no separate IP income stream”, and it was correctly taxed. Anything else was to do with the US, and Ireland’s lawyers pleaded that the country could not be blamed for an American decision not to tax Apple’s overseas profits outside Ireland.

The Government relied on expert opinions including a PwC report which concluded that “ASI’s and AOE’s Irish branches did not make a unique, valuable contribution to the Apple global value chain, but merely executed routine activities”. “The report further identifies areas where the branches did not contribute, such as the creation, management, deployment or strategic direction of Apple IP.”

Ireland even enlisted the support of retired High Court and EU General Court Judge John D Cooke, who wrote that it would be “untenable” to attribute the entire revenue of ASI and AOE, which distributed 60 per cent of Apple products worldwide, to their Irish branches. “This is illustrated by the fact that customers do not queue overnight outside Apple stores around the world for the latest iPhone or iPad because they are sold from Cork, but because of the value generated for such products by the extensive investment, engineering and technological innovation, design reputation and all that goes into the Apple product range, most of which is attributable to what is accomplished in the US or elsewhere.”

What happens in Cupertino stays in Cupertino

In Wednesday’s judgment, the court essentially took every grievance from Apple and Ireland and checked whether the Commission had gone far enough in proving its position against them. On a number of points crucial to prove whether tax rulings constituted illegal state aid, the 2016 decision failed the test – and again, all related to IP.

The first killer blow came when the court slammed the Commission for using an “exclusion” approach when determining where IP licenses should be allocated. When Brussels investigators found that ASI and AOE’s “paper” head offices had no employees and therefore no resources to control assets, they concluded that all IP and related income should be allocated to Irish branches – the only ones with boots on the ground in Cork. Not good enough under Irish tax law, said the judges: 

“The Commission did not attempt to show that the Irish branches of ASI and AOE had in fact controlled the Apple Group’s IP licences when it concluded that the Irish tax authorities should have allocated the Apple Group’s IP licences to those branches and that, consequently, under section 25 of the Taxes Consolidation Act 1997, all of ASI and AOE’s trading income should have been regarded as arising from the activities of those branches.”

The court went on to examine evidence from both sides on the location of actual IP control. It accepted the argument from Apple that the Commission should have considered its business at group level – not just inside the subsidiaries enjoying tax rulings. “Consequently, in so far as it has been established that the strategic decisions — in particular those concerning the development of the Apple Group’s products underlying the Apple Group’s IP — were taken in Cupertino on behalf of the Apple Group as a whole, the Commission erred when it concluded that the Apple Group’s IP was necessarily managed by the Irish branches of ASI and AOE, which held the licences for that IP.”

Although the head offices of the Irish-registered subsidiaries had no physical existence, their directors were Apple executives mostly based in Silicon Valley and participated in group decisions executed by the Irish branches: “The fact that the minutes of the board meetings do not give details of the decisions concerning the management of the Apple Group’s IP licences, of the cost-sharing agreement and of important business decisions does not mean that those decisions were not taken.”

ASI’s functions in Ireland were “routine” and did not justify the allocation of income from IP licenses to the branch, the judges found. “It must be concluded that these are support activities for implementing policies and strategies designed and adopted outside of that branch, in particular with regard to the research, development and marketing of Apple-branded products.”

“The Commission cannot confine itself to invoking a methodological error but must prove that an advantage has actually been granted.”

General Court judgment

The subsidiary line of reasoning developed by the Commission – to torpedo the allocation of profit under the tax rulings even if IP was correctly located outside Ireland – fell victim to a similar fault to the “exclusion” approach above. However defective the calculation devised by Apple and accepted by the Revenue in locating taxable profit in Ireland, it does not constitute illegal state aid until the Commission proves that the companies are better off as a result. “The Commission cannot confine itself to invoking a methodological error but must prove that an advantage has actually been granted, inasmuch as such an error has actually led to a reduction in the tax burden of the companies in question as compared to the burden which they would have borne had the normal rules of taxation been applied,” the judgment reads.

It is, however, by no means a home run for Apple and Ireland. Against their pleas, the court found that the Commission was fully justified in applying the arm’s length principle and checking whether the taxation of the branches was aligned with that of an Irish company that would need to access IP independently. By the time the case reached Luxembourg, it appears the Irish government itself had agreed with this. “It is apparent from Ireland’s written pleadings and from the oral arguments of the parties at the hearing that, for the purpose of applying section 25 of the TCA 97, account must be taken of the factual background and the situation of the branch in Ireland, in particular the functions performed, the assets used and the risks assumed by that branch,” the judges wrote. “Ireland confirmed that the application of section 25 of the TCA 97 by the Irish tax authorities required the actual activities of the Irish branches in question to be identified and the value of those activities to be determined according to the market value of that type of activity.”

“Insufficiently documented” tax rulings

While the court found that the Commision had failed to prove that the Revenue’s tax rulings were illegal, it stopped short of endorsing them. “The findings made above concerning the defects in the methods for calculating the chargeable profits of ASI and AOE demonstrate the incomplete and occasionally inconsistent nature of the contested tax rulings,” the judges wrote. 

Despite questioning Apple and Ireland, they could not obtain an explanation on the removal of some operating costs from the formula to calculate taxable income in 2007. Overall, the tax rulings are “insufficiently documented” and little evidence was available on their justification. “That lack of documented analysis is indeed a regrettable methodological defect in the calculation of ASI and AOE’s chargeable profits, endorsed in the contested tax rulings.”

While it didn’t find it conclusive, the court also noted the allusion to Apple’s role as a major employer in Cork in exchanges between Apple and the Revenue prior to the 1991 tax ruling. The Commission had highlighted the mention of jobs in a November 1990 meeting alongside the fact that “the company is at present reviewing its worldwide operations and wishes to establish a profit margin on its Irish operations”. It concluded that the 1991 tax ruling appeared to have been negotiated to fit what Apple was prepared to pay in taxes if it was to stay in the country, but judges have found there is insufficient evidence of this.

Meanwhile, the court dismissed Apple and Ireland’s accusations that the Commission was trying to impose tax harmonisation through the disguise of state aid and ignored their pleas alleging breaches of fair procedure.

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Four years on, Wednesday’s judgment announcing Apple and Ireland’s win was delivered in a largely different world to the one where the European Commission had found against their tax arrangements. 

Apple’s stateless subsidiaries and their Irish branches were an extreme form of the double Irish scheme, under which many more multinationals organised IP transactions between a tax-resident Irish company and another Irish-registered subsidiary resident in an offshore low-tax jurisdiction. Under pressure from the European investigation, Ireland closed the stateless option, the double Irish, and finally the alternative single Malt in countries enjoying tax treaties with Ireland such as Malta – though existing companies were able to use the double Irish until last January.

In the US, where Apple’s Irish tax rulings first came to light in 2013 Senate hearings, the Tax Cuts and Jobs Act (TCJA) passed through Congress by the Trump administration at the end of 2017 put an end to the decades-old indefinite tax deferral on overseas profits parked offshore by American-based multinationals. Apple’s €13.1 billion potential tax liability as estimated by the European Commission is equivalent to over €100 billion in profit at the standard Irish corporate tax rate of 12.5 per cent. The claim by Apple in 2016 that this accumulated cash would be subject to deferred US taxation was correct: under the TCJA, a deemed repatriation tax at the rate of 15.5 per cent applies to such past overseas profits. In the past two years, the company brought it all home, with Irish-registered subsidiaries paying their US parent €112.8 billion in dividends, largely used in turn to pay dividends to shareholders of Apple Inc or to buy back their shares.

As Irish legislation changed, so did Apple’s corporate structure. In 2015, all its Irish companies became tax-resident here and onshored IP assets estimated to be worth around €180 billion at the time. The details of this transaction remain obscure – in the past 15 years,  Apple has filed only one consolidated set of accounts for its top Irish holding company and myriad companies outside America, for 2018. 

Many more technology multinationals have followed suit, moving tens of billions worth of intellectual property here one after the other since the 2016 European Decision and subsequent legislative changes in Ireland and in the US. Using the so-called green jersey scheme inaugurated by Apple, they are combining capital allowances for intangible assets under Irish law with the reduced rate applicable to global intangible low-taxed income in the US since the 2017 tax reform. It remains to be seen whether they pay more or less overall tax in the long run as a result. So far, they have clearly paid more in Ireland, as the inflated corporation tax intake has shown.

The European Commission has put pressure on jurisdictions that had facilitated the double Irish, imposing a substance test with sufficient resources and employees in the country to justify the tax residence of assets such as IP rights. Some Caribbean nations have changed their laws along these lines to avoid EU sanctions. 

Efforts to turn such initiatives into a more systematic, global set of rules on the geographic allocation and taxation of profits by multinationals have continued at the OECD, although the US has now pushed back the conclusion of one key work stream in this so-called Beps process until after its election in November.

The pros and cons of an appeal

Wednesday’s judgment leaves room for the European Commission to appeal to the Court of Justice of the EU. The General Court vindicated the use of the arm’s length principle, criticised the weakness of Ireland’s tax rulings in favour of Apple and hinted that Brussels might have won the case along its subsidiary line of reasoning if it had gone all the way and demonstrated a tax benefit to Apple in a calculable way. This would certainly not apply the maximum €13.1 billion liability, but would go part of the way.

Apple cannot lose. Any profits routed through its Irish-registered subsidiaries prior to 2004 are unaffected by the dispute. 

The company has always accepted that the €100 billion in profit at stake must be taxed somewhere. After Wednesday’s judgment, this liability is due in the US, at the deemed repatriation rate of 15.5 per cent. Should the Commission win on appeal, these profits would be subject to the lower Irish standard rate of 12.5 per cent. An unlikely doomsday scenario for Apple would see both jurisdictions claim their tax, resulting in a combined rate of 28 per cent. 

Yet if Apple had not moved to Cork and continued to sell its products to the non-American world out of the US, the corporation tax rate there during the entire disputed period would have been 35 per cent.

In Brussels, Vestager said she would “carefully study the judgment and reflect on possible next steps”. There are pros and cons.

A win on appeal against the validity of IP offshoring as a way of bringing down income taxable in the EU would create a precedent, which could potentially apply more widely to other multinationals that used the double Irish – a terrifying prospect for the IDA. As the Commission pointed out in its 2016 decision, it has the power to look back ten years. 

If, however, Vestager’s objective was simply to shut down the double Irish, move on to the next scheme and “continue to look at aggressive tax planning measures under EU State aid rules,” as she put in on Wednesday, then the Commission has already won.

Further reading

The inside story of how Apple got a taste for Cork, and how Cork gave Tim Cook a break

Mapping multinationals: The story of how just 25 companies booked €100bn in profits in Ireland