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Recent Developments in State Aid

Nov 11, 2016

In August 2016, the European Commission (EC) issued a statement that “Ireland gave illegal tax benefits to Apple worth up to €13 billion.” According to the EC, Ireland granted a special exemption from the Irish tax system to Apple, thereby violating the European Union’s (EU’s) fair competition rules. The alleged special treatment Apple received is a violation of the EU’s general prohibition of “state aid,” according to the EC. To understand why Apple faces a potential €13 billion tax bill, we need to answer the following questions:

  • What is state aid?
  • What rules apply to state aid?
  • What policy objectives are associated with state aid?

What Is State Aid?

In the EU, state aid arises when a government uses state resources to provide benefits to a business, and those benefits are not offered to other businesses. In other words, the government grants special privileges or provides resources to one competitor without offering the same benefits to other competitors, thereby potentially distorting competition and trade under EU law. According to the EC, state aid exists when:

  • There has been an intervention by an EU member state or the misuse of EU member state resources.
  • The intervention gives the recipient an advantage on a selective basis.
  • Competition has been or may be distorted.
  • The intervention is likely to affect trade between EU member states.

The concept of state aid is distinctly European. In the U.S., state governments are permitted to offer incentives to companies, and state governments routinely make deals to encourage corporate investment and job creation in their states. According to the University of California at Berkeley’s Institute for Research on Labor and Employment, local governments sometimes offer cash or near-cash assistance to the private sector, such as tax breaks and subsidized loans.

Which Rules Apply to State Aid?

The Treaty on the Functioning of the European Union (TFEU), one of primary treaties establishing the rule of law in the EU, contains a general prohibition of state aid. Although the EC acknowledges that state aid is sometimes necessary “to offset market failure,” EU member states must notify the EC and receive permission prior to granting state aid. Any aid granted without prior authorization by the EC is considered “unlawful.”

The EC is required to immediately examine all information it receives concerning alleged unlawful aid. If the examination leads to the discovery of unlawful aid, the EC then opens a preliminary investigation. This investigation can lead to an in-depth one if the aid appears to be inconsistent with the TFEU. If the EC finds a TFEU violation and the state aid has already been paid, the EC can order the EU member state to recover the unlawful aid, with interest. The recovery period is limited to 10 years.

What Policy Objectives Are Associated with State Aid?

Both the EU and the U.S. have legislation that regulates business competition. In the U.S., the Federal Trade Commission (FTC) and the Department of Justice (DOJ) enforce U.S. antitrust laws, which are intended to promote “a vibrant economy.” Per the FTC: “Aggressive competition among sellers in an open marketplace gives consumers — both individuals and businesses — the benefits of lower prices, higher quality products and services, more choices and greater innovation.”

Similar EU antitrust rules exist, which are enforced by the EC. Like the DOJ and the FTC, the EC enforces antitrust rules that are intended to protect consumers from anticompetitive mergers and business practices.

However, the EU’s competition rules address an issue that U.S. competition rules do not: fair competition and a level playing field. Fair competition in the EU is governed in part by the EU’s state aid prohibition.

According to the EC, “A company that receives government support gains an advantage over its competitors.” As mentioned, in the case of unlawful aid, the EC may order the EU member state to recover the state aid from the unfairly advantaged party, theoretically restoring the market to its state before the aid was granted.

While advantages granted by state and local governments through state resources on a selective basis to any organization is not illegal in the U.S., there is some controversy associated with local governments offering special incentives to businesses. These programs draw criticism from some liberals as “corporate welfare.” On the other hand, some conservatives see the programs as government overstep and interference in the private sector.

Having defined what is meant by state aid, as well as the above discussion on the rules and policy objectives associated with state aid, we can now explore and discuss some of the recent controversy surrounding state aid.

State Aid Controversy

State aid controversy cases involving taxes occur in greater frequency and involve larger sums of money. The EC began investigating the tax ruling practices of EU member states in June 2013. Shortly thereafter, the EC created the Task Force Tax Planning Practices (the Task Force). The Task Force's mission is “to follow up on public allegations of favorable tax treatment of certain companies (in particular, in the form of tax rulings) voiced in the media and in national parliaments.” Currently, the Task Force has several open formal investigations of tax rulings.

The EC is not the only organization responding to the growing public perception that some large corporations do not pay their “fair share” of taxes. The Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting project is an internationally coordinated attempt to curb aggressive tax planning behavior, with tax authorities in different countries sharing information relevant to income tax examinations. The U.S. Treasury Department recently released regulations designed to make it more difficult for U.S. companies to engage in transactions known as inversions – which occur when the U.S. parent of a multinational company merges with a smaller foreign company and moves its tax residency from the U.S. into a low-tax jurisdiction.

However, some Europeans view the EC’s actions as a violation of sovereign government rights as well as a source of uncertainty for businesses.

Job Creation and Public Spending

Governments sometimes offer incentives to business because certain supply-side economic theories assert that corporations will move to low-cost locations, thereby increasing local employment. Ireland, a relatively small country that is geographically separated from much of Europe, uses its tax system to encourage corporate investment and job growth in the country. Its low corporate tax rate may have helped it attract companies like Apple, Google and Facebook. Furthermore, polls indicate the most Irish citizens do not want Apple to be held liable for the tax, and they fear that raising taxes on one of the country’s largest employers would incentivize it to relocate.

However, many also cite Ireland’s €180 billion of national debt, infrastructure and public service needs, and the 2010 bailout loan provided by the International Monetary Fund and the EU, which are strong arguments against appealing the EC’s decision. Another argument put forward in the media is that Ireland does not need to make “sweetheart” tax deals with large corporations and that Ireland would still be a place where multinational corporations choose to invest – even without tax incentives. Others feel that the tax breaks provided to big corporations are unfair to small businesses, which are unable to negotiate special tax exemptions. Some academics maintain that Ireland’s policy forces individual taxpayers and small businesses to “pick up the tab” for larger corporate taxpayers.

National Sovereignty

Part of the decision to appeal the EC’s decision has to do with concerns about national sovereignty. As such, Ireland accuses the EC of undermining its sovereignty. Irish Finance Minister Michael Noonan vowed to appeal the EC decision “to defend the integrity of our tax system, to provide tax certainty to business, and to challenge the encroachment of EU state aid rules into the sovereign member state competence of taxation.”

Some multinationals that established locations in EU states were incentivized, in part, by offers of low tax rates. These companies worked directly with high-ranking government officials. Reuters reports that members of government are reluctant to see their agreements invalidated by the EC. Per a Bloomberg story, there is also the reputational effect of EU member states that do not want to be perceived as countries that make secret and unlawful tax deals with large and powerful corporations.

Tax Certainty

Another concern is heightened tax uncertainty. Many commentators expressed concerned about the retroactive nature of the €13 billion worth of taxes accessed to Apple. Indeed, the EC states that “the Commission can order recovery of illegal state aid for a 10-year period preceding the Commission's first request for information in 2013.” This could result in "thousands of other companies risk seeing their tax arrangements re-examined … billions of euros could be at stake," notes The Wall Street Journal.

Stateless Income

Nevertheless, there is widespread agreement that "stateless income" that is not subject to tax in any country should not stand. The EC argues that the tax system agreed to by Apple and Ireland “did not correspond to economic reality: Almost all sales profits were attributed to a head office that existed only on paper and could not have generated such profits.” The EC stated that the ’head offices’ do not have a physical presence or employees in any country, and the “profits allocated to the ’head offices’ were not subject to tax in any country.”

U.S. Treasury

To the extent that multinational corporations are able to exploit mismatches in U.S. and foreign tax laws to generate stateless income, and these mismatches are uncovered during an examination by a tax authority, the question then becomes: Which country has the right to tax the previously stateless income? U.S. Treasury Secretary Jack Lew has expressed concern that EU officials are targeting taxable income to which the U.S. has a claim and that the EC’s actions “threaten to erode America’s corporate tax base.” Secretary Lew also expressed disapproval of “unfair retroactive penalties,” presumably a reference to the €13 billion of back taxes that the EU is attempting to assess Apple.

EC Commissioner for Competition Margrethe Vestager has stated that she has found no evidence of the EC targeting U.S. companies, and that the EC’s goal is to enforce the rule of law equally across Europe, regardless of a company’s foreign or domestic status. While the most high-profile state aid cases have involved companies such as Starbucks, Amazon, McDonalds, Apple and FCA US LLC (formerly the Chrysler Group LLC, and Fiat’s parent company), the EC has brought state aid cases against non-U.S. companies, too. In July 2015, the EC ordered France to recover €1.37 billion from Electricite de France SA, citing illegal tax breaks granted to the French electricity supplier. A year later, the European Commission ordered seven professional football clubs to repay state aid to the Spanish government. Many other relatively small cases exist, but the state aid cases involving the most euros tend to be associated with U.S. multinationals.


State aid is clearly a complex issue. Countries want to create jobs and prosperity within their jurisdictions and have the authority to write their own tax rules. Conversely, the EC is required to enforce the rule of law established by the TFEU and is responding to complaints that large corporations use their influence to gain unfair tax advantages.

Both Apple and Ireland vow to appeal the EC decision, so the matter will likely be tied up in court for several years before any euros are paid. Although there was bipartisan disapproval of the EC’s decision in the U.S. Congress, the possibility of tax reform in the current political climate is generally considered unlikely. Multinational companies and watchdog groups will carefully view this case, as it is the biggest of its kind and will likely set a precedent for future cases.

There is much uncertainty regarding the outcome of the case. However, one thing is certain – the days of aggressive international tax structures are coming to an end. According to The Wall Street Journal, large multinational companies may experience higher effective tax rates, as governments respond to complaints about tax policy, especially in Europe. Hundreds of multinationals in the EU will watch these tax rulings, particularly smaller states. The case will no doubt set a precedent, and some legal experts expect that big corporations will start to rethink their European tax strategies, says The New York Times. Many legal experts also forecast continued EC scrutiny.

In a world of heightened tax scrutiny, it is crucial to have business reality align with global tax structuring. As such, companies should frequently monitor policies and update transfer pricing strategies to ensure sufficient substance is in place.

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Henric Adey

Henric Adey is a Director in the firm’s Transfer Pricing Practice. Henric is responsible for advising clients over a wide span of industries concerning both international and multi-state transfer pricing matters

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