Apple faces multi-billion dollar tax bill - but that's not the problem.

It hasn't been a brilliant month for Apple Inc. The world's largest company by market capitalisation is facing a legal, financial and reputational storm that promises to eclipse its latest hardware problems. It turns out that bending the rules on State aid is far more serious than a flexible phone!

Apple's rise and rise has been documented ad nauseam. Despite that, for many Apple products have changed the way we interact with technology and each other. For a company to whom so many are "emotionally" attached, and with over $150 Billion sitting in the bank, the stakes are high.

On 30 September 2014, the European Commission published a letter originally sent to the Irish Government in June 2014, accusing it of breaching State aid rules. The Commission is interested in two bi-lateral tax agreements made between Apple and Irish Revenue in 1991 and 2007. These so called "sweetheart" deals allow Apple to utilise transfer pricing mechanisms to cut the effective rate of corporation tax from an already generous 12.5% to just 2%. In excerpts of minutes of a meeting in 1990, the parties appear to agree a ceiling on Apple profits that would be subject to Irish taxation as well as setting mark-up rates chargeable on costs incurred.

As with all transfer pricing schemes, the deal struck in one jurisdiction causes a ripple effect, distorting foreign markets and diverting otherwise taxable revenues away from domestic tax regimes elsewhere. In figures published by the BBC, Apple's 2013 UK corporate tax liability was stated at £11.4 million, on revenues of just over £100 million - whereas Apple's gross revenue from its 37 UK stores is estimated to be in excess of £1 billion. The Commission's view is that huge streams of revenue are flowing through Apple's Irish base, providing a selective anti-competitive benefit. Barclays PLC, in a market update to its clients, note that Apple paid $1.1 Bn (US) on pre-tax overseas revenues of $30.5 Billion.

In short, the European Commission's view is that the 1991 and 2007 sweetheart deals constitute State aid in accordance with Article 107(1) of the Treaty of the Functioning of the European Union. Moreover, the aid given to Apple is not compatible with the internal market in accordance with Article 107(2) and 107(3).

The European Commission's letter is just the first step in a much longer and more involved process. Despite Apple's rejection of the allegations and the Irish state's belief the deals will hold up to scrutiny, Apple faces a multi-billion Euro liability if found to be in breach. For the Irish Government the problem is far more strategic - the sweetheart deals, in truth, are less about tax and more about job security. Apple's operations in Ireland provide over 4,000 jobs and significant economic benefits not just to Cork but to the Irish Republic as a whole; Apple's presence is a long-running good news story.

The European Commission has Apple firmly in its sights, but the likes of Amazon, Starbucks and Fiat are also facing investigation. In 2012, Starbucks' use of transfer pricing mechanisms hit the headlines as it emerged HM Treasury was unable to touch large revenues generated in the UK but being channelled through Luxembourg. What was striking about that incident was the public outrage it caused. Starbucks suffered a significant backlash from its customers, worsened by a ham-fisted offer to pay a voluntary contribution of £20 million to the British Government. Starbucks has since pledged to move its European headquarters and its intellectual property assets to London in a move designed to appease its biggest European market.

The European Commission's investigation into Apple promises to thrust the issue of State aid not just into the spotlight, but into the public's consciousness. What, on the face of it, looks like collusion between a corporate hyper-power and the Irish state will jar with taxpayers across Europe still struggling with straitened economic conditions. Commentators are predicting a widening of the debate on State aid and governments' relationship with big business. The technology market is particularly fickle where image comes second only to the product; whilst this issue won't derail Apple, a display of contrition may be the order of the day.

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