On 9 November 2023, Advocate General Pitruzzella (the ‘AG‘) published his opinion for the Apple state aid case (the ‘Apple Case’). The AG advises the Court of Justice of the European Union (‘ECJ’) to set aside the judgement (the ‘Judgement’) of the General Court of the European Union (the ‘General Court’) and refer the case back to the General Court. The AG agrees with the European Commission (‘EC’) on the main points of its appeal against the Judgement. If the ECJ follows the AG’s (non-binding) advice (which statistically happens in a majority of the cases), the case will be referred back to the General Court and, as a result, it will remain unclear for at least another number of years if Ireland granted illegal state aid to Apple. The Apple case is one of the EC’s most important state aid cases, in which it claimed that Ireland granted Apple state aid for an amount of € 13 billion.
The opinion is important for the transfer pricing practice because according to the AG:
- the Authorized OECD Approach (‘AOA’) would require the General Court to consider the activities and substance of the head offices, while determining the allocation of the arm’s length profit to the Irish permanent establishments (‘PEs‘), not only the functions performed, assets used and risks taken by the PEs.
- The AOA would disallow to consider the functions performed by Apple Inc. in the US, while determining the allocation of the arm’s length profit to the Irish PEs.
- It was wrong for the General Court to determine that the Irish PEs were the least complex parties and moreover, it is relevant for the reliability of the outcome to test the most appropriate party (while the General Court determined that the transfer pricing result should be the same, regardless of whether the PEs or the head offices would be the tested parties).
What preceded the opinion of the AG
On 30 August 2016, the EC announced its decision that two advanced pricing agreements between the Irish tax authorities and Apple (together: the ‘APA’) constitute forbidden state aid (the ‘Decision’). The EC required Ireland to recover the illegal aid from Apple. On 15 July 2020, the General Court annulled the Decision because the EC did not succeed in showing to the requisite legal standard that the APA constituted illegal state aid.
In the Apple Case, ASI and AOE, two Apple subsidiaries that were incorporated in Ireland, but not tax resident in Ireland, were party to a cost-sharing agreement (the ‘CSA’) with Apple Inc. Pursuant to the CSA, ASI and AOE agreed to share the costs and the risks associated with the R&D concerning (part of) Apple’s IP. In return, Apple Inc. provided a royalty-free license enabling ASI and AOE to manufacture and sell Apple products in their territory, which comprised the entire world, except the Americas. As a result, ASI and AOE were the residual profit owners of (part of) Apple’s business in the rest of the world.
ASI and AOE each have a PE in Ireland. ASI’s PE is responsible for, inter alia, carrying out procurement, sales and distribution activities associated with the sale of Apple-branded products. AOE’s PE is responsible for the manufacture and assembly of certain Apple products.
Pursuant to the APA, the Irish PEs of Apple were remunerated as routine entities. As a result, ASI’s and AOE’s residual profit was not taxed in Ireland, but allocated to ASI’s and AOE’s head offices, which existed only ‘on paper’, according to the EC.
The General Court ruled that the EC used an ‘exclusion’ line of reasoning, by stating that the IP licenses should have been allocated to the Irish PEs for tax purposes, since the head offices of ASI and AOE had no employees or physical presence, and that this line of reasoning is inconsistent with the taxation of corporate profits in Ireland, the arm’s length principle and the AOA (the ‘Reference Framework’). This ‘exclusion’ line of reasoning, as interpreted by the General Court, is summarized as follows.
- Apple Inc. is the beneficial owner of the residual profits, because only Apple Inc. performs the functions relevant to the Apple IP; however
- Since (a) Apple Inc. does not receive the residual profits pursuant to the CSA, and (b) ASI’s and AOE’s head offices only exist on paper, ASI’s and AOE’s Irish PEs should be the beneficial owners of the residual profit.
Primary point of view of EC in appeal
The EC’s primary position before the ECJ is that the General Court has committed breaches of procedure, used contradictory reasoning and made errors of law by ruling that the EC used a line of reasoning that is inconsistent with the Reference Framework. In summary, the EC’s view is that, for the allocation of profits to a PE:
- Any functionality outside of the company (comprising the head office and the PE) is irrelevant; and
- The functionality of both the PE as well as the functionality of the head office are relevant, not just the functionality of the PE.
Based on the above, according to the EC, (a) Apple Inc’s functionality should be disregarded when allocating the profits of ASI and AOE to their head offices and PEs, and (b) as the functionality of the PEs of ASI and AOE is far more complex than the functionality of the head offices, the Reference Framework dictates that the residual profits should have been allocated to the PEs.
The opinion of the AG
The AG agrees with the EC that any functions performed by an entity that is not ASI or AOE are irrelevant for the determination of the taxable profit of ASI’s and AOE’s Irish PEs. According to the AG, the consequence of applying a different criterion would be “… to fail to take into account the reality of that agreement (author: the CSA) and of the tax structure of the Apple group…”, which the Irish tax authorities could not have disregarded when determining the taxable profits of ASI’s and AOE’s Irish PEs, because “… this would lead to the paradoxical outcome that the assets legitimately transferred by Apple Inc. outside the United States and the related profits, when determining the tax due in Ireland, would return – only virtually – to the United States, further reducing the tax liability of the group”.
The AG then states that, based on Irish case law, the functions performed by the head office are relevant for the determination of the taxable profits of the Irish PEs.
Based on the above, the AG agrees with the EC that the General Court made an error of law. The AG therefore advises the ECJ to set aside the Judgement, and refer the case back to the General Court.
Other relevant points
The opinion of the AG contains numerous other relevant points with regard to complaints made by the EC about the Judgment. On many of these points, the AG advises in favor of the EC. These points include both formal points, e.g., with regard to the inadmissibility of evidence provided by Apple, and the burden of proof, and technical transfer pricing points, e.g. with regard to the tested party, the profit level indicator, and the comparability of the peer group for the application of the TNMM.
Huygens take aways
Even though the opinion considers a state aid case, the opinion contains very outspoken views on transfer pricing. In our view, the most prominent views are as follows.
- The AG’s starting point is the reality of the CSA, without taking into account the functionalities underlying the CSA. In our view, this is remarkable, because, if the head offices were tax resident in Europe, the head offices could have taken the position that the benefit received under the CSA constitutes informal capital, since the functionality underlying the CSA is located in Apple’s Californian operations. According to the AG, however, these functionalities should be disregarded.
- The AG states that the Reference Framework requires that both the functionalities of the PE and the head office should be considered when determining the taxable profit of the PE. We are not certain whether this indeed is intended in the AOA, and we hope that the ECJ will clarify this.
- The AG’s main argument is based on Irish case law, in which it is determined that the functionality of both the PE as well as the functionality of the head office are relevant. If the ECJ agrees with the AG on this, and refers the case back to the General Court, it is likely that the General Court will conclude that ASI’s and AOE’s head offices indeed lack the functionality required for the CSA. However, this does not necessarily mean that the PEs of ASI and AOE do have the functionality required for the CSA. We are not certain of the consequences for the Decision if it is concluded that the PEs also lack the required functionality.
- The AG considers that the EC is not required to demonstrate that the profit allocation method set out in the APA has resulted in a reduction of the Irish tax liability of ASI and AOE to demonstrate the existence of a selective advantage. According to the AG, it cannot be ruled out that the profit allocation method contains fundamental errors, and therefore, the EC can rely on the fact that Ireland has failed to demonstrate that these errors have no effect on the arm’s length character of the profits of the PEs. In such cases, the burden of proof lies with the Member State.
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Mark van Casteren
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