Why the EC says Ireland has a tax problem with Apple

The European Commission’s ruling ordering Apple (AAPL) to repay up to 13 billion euros ($14.5 billion) plus interest in unpaid back taxes is the largest tax penalty in a three-year clampdown on advantageous deals given to multinationals by EU nations. 

The EC’s finding that the iPhone maker received illegal tax breaks from Ireland is an attempt to “rewrite Apple’s history in Europe, ignore Ireland’s tax laws and upend the international tax system in the process,” Apple CEO Tim Cook said in a statement. “In Ireland and in every country where we operate, Apple follows the law and we pay all the taxes we owe.”

The EC found that Ireland had substantially and artificially lowered the tax rate Apple paid in the country for more than two decades, thanks to two tax rulings Ireland issued to Apple starting in 1991 that allowed for a split of Apple Sales International’s profits for tax purposes between its Irish branch and its head office.

While the Irish branch was subject to the normal Irish corporate tax, the head office -- which exists only on paper, with no workers, premises or actual activities -- wasn’t taxed anywhere, thanks to Irish tax law, which until 2013 allowed for so-called “stateless companies.”

Only a fraction of Apple Sales International’s profits were attributed to its Irish branch, while the vast majority of profits was attributed to its “head office,” a scenario that meant Apple Sales International paid very little tax on its profits.

Here’s how it worked in 2011: Apple Sales International made 16 billion euros in profits, but less than 50 million euros were allocated to the Irish branch and the rest to the “head office,” where the profits weren’t taxed.

That meant Apple’s effective tax rate in 2011 was 0.05 percent. For every million euros in profit, it paid just 500 euros in tax. That effective tax rate dropped further to as little as 0.005 percent in 2014, which means less than 50 euros in tax for every million euros in profit.

Apple’s -- and Ireland’s -- practices drew scrutiny in a 2013 U.S. Senate subcommittee hearing, at which Michigan Democrat Carl Levin and his colleagues questioned how smaller U.S. companies could possibly compete with a private tax arrangement between Apple and Irish tax authorities in which Apple subsidiaries were subject to a maximum 2 percent rate in Ireland. 

The EC, it seems, took note of that hearing, and within a matter of weeks was inquiring about Ireland’s practice of issuing tax rulings. The EC said Ireland’s arrangement with Apple seemed to constitute a subsidy inconsistent with the principles of fair competition within the EU market. 

It’s not Apple that’s being accused of foul play, it’s Ireland. The country was apparently willing to grant a tremendous amount of ground on taxation to gain capital investment, along with potential jobs and economic growth. The trouble is Europe can use the Treaty on the Functioning of the European Union (TFEU) to curb such behavior among its member states.  

The stakes are now raised for other multinational companies engaged in European-related tax planning. There’s now reason to doubt whether privately arranged deals between corporations and EU member states will survive scrutiny by EU authorities, who have already declared as illegal tax arrangements between the Netherlands and Starbucks (SBUX). They’re also looking at Luxembourg’s dealings with Amazon (AMZN).