Multinationals under fire

read time: 4 mins
06.11.15

Introduction

In an unparalleled decision pursuant to an investigation inaugurated last year by the European Commission Starbucks Corp. ("Starbucks")  and  Fiat Chrysler Automobiles  NV ("Fiat") are now compelled to pay tens of millions of euros in back taxes after the Commission ruled last Wednesday that nationally negotiated tax rulings that artificially reduce a company's tax burden are not in line with EU state aid rules and furthermore they are illegal. 

The Commission, said that tax deals granted to Starbucks in the Netherlands and Fiat in Luxembourg amounted to illegal state subsidies that must be repaid. The investigations are technically aimed at the governments, which have been ordered to recover the unpaid taxes. They will now be given two months to calculate the precise amount of tax to be recovered.

Issue

Tax rulings are comfort letters by tax authorities giving a specific company clarity on how its corporate tax will be calculated or on the use of special tax provisions. However, tax rulings may involve state aid within the meaning of EU rules if they are used to provide selective advantages to a specific company or group of companies.

According to Article 107(1) of the Treaty on the Functioning of the European Union (TFEU), state aid which affects trade between Member States and threatens to distort competition by favouring certain undertakings is in principle incompatible with the EU Single Market. Selective tax advantages may amount to state aid.

Tax rulings are used in particular to confirm transfer pricing arrangements. At the centre of this ruling was the issue of tax driven "transfer pricing". Broadly speaking transfer pricing legislation details how transactions between connected parties are handled and is based on the internationally recognised ‘arm’s length principle’.

The ‘arm’s length principle’ applies to transactions between connected parties. For tax purposes such transactions are treated by reference to the profit that would have arisen if the transactions had been carried out under comparable conditions by independent parties. However when two related companies trade with each other, they may wish to synthetically distort the price at which the trade is recorded, to reduce the overall tax bill.

Transfer pricing is not, in itself, illegal or necessarily abusive. What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing. For many corporations' the current decision means transfer pricing policy is no longer just a tax matter but a corporate reputation matter.

It is clear from the decision that the Commission's target is to abnegate corporate pricing arrangements that "have no relationship with the market". Holding, that where a  calculation is not based on remuneration on market terms, it implies a more favourable treatment of the company compared to the treatment other taxpayers would normally receive under the Member States' tax rules. This constitutes state aid. The Commission further held that such arrangements are biased against start-up companies and small and midsize businesses that cannot afford the advice essential for complex tax structuring.

The regulatory arm concluded that the companies in issue had used state sanctioned "transfer pricing arrangements" between subsidiaries that permitted both Starbucks to shift profits elsewhere internally in the form of royalty payments, and Fiat to pay taxes on "underestimated profits".

The commission held that Starbucks was inflating its costs internally by marking up the prices of coffee beans imported from Switzerland, making them cheaper than those available to competitors.

In relation to Fiat the commission held that it's financial arm kept its tax low by putting an artificially low value on its capital The Commission said taxable profits for Fiat's Luxembourg unit could have been 20 times higher under normal market conditions.

The Outlook

Whilst the sums to be reclaimed are temperate the decision has dealt a burdened blow to profit-shielding arrangements used by many multinationals and is seen as a curtain-raiser to a more high-profile ruling on Apple's tax arrangements in Ireland, and Amazon's deals in Luxembourg, which are due later this year. The decision has firmly set down a marker in the assault against tax avoidance by multinationals.

Starbucks immediately said it would appeal the decision, echoing the Dutch government in accusing the European Union executive of significant "errors" in its assessment.

Luxembourg, emulated saying it disagreed with the decision and the Commission had not established in any way that Fiat Finance and Trade received selective advantages with reference to Luxembourg’s national legal framework and there was no evidence that its tax deals with Fiat violated EU treaty law.

Both Governments have reserved the right to appeal. The tenacious objections by the Netherlands and Luxembourg could foretell that those countries are unwilling to drop low-tax arrangements that are routinely used as a form of stimulus to compete for jobs and foreign investment on an ever increasingly competitive stage.

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