TP Courtroom Around The World | 2020

Foreword

We are pleased to present Nexdigm (SKP)'s annual publication 'TP Courtroom' for 2020. This is our second edition that analyzes the findings of key judicial rulings of the global Transfer Pricing landscape for the year 2020.

While we focus on court judgments, we also clearly recognize that the quarantine induced by COVID-19 has created damaging repercussions in court activities. In the efforts to slow the spread of COVID-19, the functioning of the justice system has been massively impacted across all countries. Most of the judicial cases are or will be, inevitably deferred, if not paralyzed. The worldwide extent of the COVID-19 crisis has confronted us again in our history, with humanity's eternal fragility.

That being said, the year 2020, despite the unprecedented challenges, saw some interesting court judgments on critical issues, including the importance of identifying 'Control over risk' in Transfer Pricing (TP) analysis, intangible issues arising in business restructuring, the importance of adopting consistent TP analysis approach Year over Year (Y-o-Y), etc. This edition of TP Courtroom scrutinizes the key arguments in prominent judgments published during 2020, like Coca- Cola, Puma, Apple, Glencore, etc.

One common theme that one could observe from the judgments covered in this edition is that the tax world is getting 'BEPSed.' The enormous amount of work done by the Organisation for Economic Co-operation and Development (OECD) on its landmark Base Erosion and Profit Shifting (BEPS) project has equipped the tax authorities with more tools to detect tax leakage due to transfer pricing arrangements deployed by MNEs.

We hope that the key takeaways of every case in this edition assist the MNEs in laying a framework for robust defense strategies in the event of an audit by tax authorities. This booklet can also serve and support the MNEs while they revalidate/formulate their key transfer pricing strategies. As global entities like OECD become a standard, it is prudent for MNEs to evaluate their tax positions and adopt sound practices to avoid coming under the radar of tax authorities.

Apple| Ireland|General court provides relief to 'Apple', confirming that there is no 'State Aid'/selective advantage in the advance tax ruling

Advance tax rulings are a common feature of mature tax jurisdictions. Companies enter into such agreement with tax authorities to get clarity and consistency regarding the application of tax law, fixing on the tax liability and ensuring smooth compliances.

This case pertains to an advance tax ruling entered between Apple group entities in Ireland and Ireland tax authorities in effect for the tax period 1991 to 2014. Ireland is one of the Member states in the EU region.

The EU Commission (The Commission), in its final decision in 2016, adjudicated the advance rulings granted by Ireland in 1991 and 2007 as unfair, offering 'selective advantage' and digressing from principles of Arm's Length Price ('ALP') as prescribed by OECD transfer pricing guidelines. It stated that the attribution of profits to the Irish branches of two Irish incorporated, non-resident companies constituted unlawful State aid, thus ordering an immediate recovery of the aid.

What is selective advantage/State aid?

State aid is defined as an advantage in any form whatsoever conferred on a selective basis to business undertakings by national public authorities (Ireland in the instant case).

The Ireland tax authorities and Apple group (vide its affected group entities - Apple Operations Europe AOE and Apple Sales International - ASI) appealed to the General Court against the decision pronounced by the Commission.

Facts

• The Apple Group is engaged in designing, manufacturing and marketing, mobile communication and media devices, personal computers and portable digital music players, and sells software, other services, networking solutions and third-party digital content and applications.
• It markets its products and services worldwide through retail stores, online stores and direct sales force, as well as through third-party cellular network carriers, wholesalers, retailers and resellers. The relevant group structure and entities are illustrated as above:
• Among the Apple Group companies incorporated in Ireland, a distinction can be made between companies incorporated in Ireland that are Ireland tax residents and companies incorporated in Ireland but are not tax residents. The ASI and AOE were managed and controlled from outside Ireland but carried out the trading activity in Ireland through their respective branches. The ASI and AOE, although incorporated in Ireland, are considered as non-resident entities whereas their respective Irish branches are considered as residents in Ireland for tax purposes.
• Under the Cost-sharing agreement (CSA) between Apple Inc., ASI and AOE, both parties agreed to combine their R&D efforts and to share the costs and rights relating to the 'Development Programme.' The right to use Apple's intangible property to manufacture and sell Apple products is shared amongst parties in the agreement. Apple Inc. holds the right to manufacture and sell Apple products in the Americas. The ASI and AOE hold right to manufacture and sell Apple products in markets outside of the Americas. The legal title to all intangible property is held solely in the name of Apple Inc. The ASI and AOE have beneficial ownership in their territory of intangible property developed as a result of R&D conducted under the CSA.
• In the advance tax ruling effective 1991, a profit allocation formula largely based on operating costs/manufacturing process turnover was agreed for Irish branches of AOE and ASI. The Commission opened a formal investigation concerning the chargeable profits allocated to Irish branches of ASI and AOE on the ground that these could constitute state aid for the Treaty on the Functioning of the European Union (TFEU).
• The Commission, in its decision, established that these arrangements conferred an advantage to Ireland branches as it departed from a transfer pricing agreement based on arm's length principle in an open market scenario. The Commission concluded and ruled in favor of AOE and ASI constituting an aid within the meaning of Treaty, thereby directing Ireland tax authorities to recover this aid from the AOE and ASI along with interest on below premise:
• 1. Profits derived from the IP licences held by the ASI and AOE not allocated to Irish branches
  2. Inappropriate choice of methods for allocating profits to ASI and AOE's Irish branches
  3. Incorrect application of arm's length principle and the OECD TP Guidelines.

Issue: Whether advance tax ruling entered between Apple group entities in Ireland and Ireland tax authorities in effect for the tax period 1991 to 2014 are unfair and offering 'selective advantage'?

Key Contentions of Commission

• Regarding activities of the Apple entities:
• • Head offices of the ASI and AOE did not have any employees. It could not perform any functions concerning product quality control, R&D facilities management and business risk.
  • The ASI's branch performs functions crucial for developing and maintaining the Apple brand in the local market and ensuring customer loyalty to that brand.
  • The ASI's branch incurred local marketing costs directly with marketing service providers.
  • ASI's branch was responsible for gathering and analyzing regional data to estimate demand forecast for Apple-branded products.
  • The AOE's branch developed specific processes and manufacturing expertise and ensured quality assurance and quality control functions to preserve the value of Apple brand.
  • Costs covered by the CSA agreement are allocated as an IP return, meaning that the AOE's branch was involved in the development or management and control of IP
• In view of the above, in its primary line of reasoning the commission contended that –
• • The, profits resulting from the allocation of economic ownership of Apple Group's IP licenses should be allocated to branches of ASI and AOE
  • The arm's length principle should be applied in determining allocable profits following the authorized OECD approach
  • As the head offices of ASI and AOE were unable to control or manage the Apple Group's IP licences, these head offices should not have been allocated, in an arm's length context, profits derived from the use of those licenses. Accordingly, those profits should have been allocated to ASI and AOE's branches (Exclusion approach).

Key Contentions of the taxpayer/Ireland authority

• Commission did not have the jurisdiction to analyze the advantage and selectivity conditions for non-resident companies (i.e. ASI and AOE) who were governed by separate charging provisions.
• Commission erred in adopting the approach to examine non-resident company's profits in entirety and extent to which profits cannot be allocated to other parts of that company, are allocated by default to Irish branches.
• The principles of arm's length pricing cannot be applied under normal provisions of the Irish Tax. Ireland did not have transfer pricing regulations in place during the covered period. The taxpayer argued that the existence of an advantage by way of reduction in tax burden to taxpayers can be established only when compared with 'normal' taxation. The Commission erred in placing reliance on the OECD Model Tax convention for allocation of profit.
• Regarding activities of Apple entities:
• • Activities and functions performed by Irish branches of ASI and AOE represent only a tiny part of their economic activity and profits.
  • Irish branches neither perform management nor strategic decision-making related activities towards the development or marketing of the IP.
  • All strategic decisions, including product design and development, were taken in accordance with commercial strategy determined in the USA and were implemented outside Ireland.

Decision of General Court (the Court)

• The General Court observed that contested tax ruling was issued to allow ASI and AOE to determine their chargeable profits in Ireland for the purpose of tax. The objective of general Irish corporation tax regime is to tax profits of companies carrying on activities in Ireland, be they resident or non-resident. Therefore, the provisions concerning chargeable profits of non-resident companies cannot distinguish it from the ordinary rules. Accordingly, the jurisdiction question was answered in favor of the Commission.
• Regarding activities of the Apple entities in Ireland, the General Court upheld that –
• • The Commission failed to demonstrate that functions were actually performed by branches.
  • If the Commission argues that ASI cannot perform functions outside its branch due to lack of staff, it will have to consider the same in case of ASI's branch, which had no staff till 2012.
  • CSA doesn't indicate that ASI's branch performed activities in relation to development and maintenance of Apple brand.
  • Payment of marketing cost to third parties doesn't make branch responsible for designing marketing strategy.
  • These activities are clearly support roles and cannot be regarded as key functions to determine that Apple Group's IP licences should be allocated to the Irish branches

Also, the court ruled that while Commission did not err in relying on authorized OECD approach for determining the arm's length price, Commission erred in application of such rules.

In its subsidiary line of reasoning, the Commission contended that profit allocation methods which resembled Transaction Net Margin Method (TNMM) as adopted by the taxpayer had below inconsistencies:

• Choice of branches as tested party is a methodical error in the instant case
• Choice PLI
• Comparable companies selected by the taxpayer for benchmarking

General Court ruled that the above contentions of the Commission are not justified without providing any evidence as to the actual performance functions by these branches. Thus, the Commission was not correct in questioning reliability of comparability studies without proving the fact that tax rulings led to a reduction in tax liability.

Key Takeaways

• For all taxpayers, the key take-away from this judgment is to re-evaluate their operating structures and intra-group arrangements with respect to intangible related returns. In the modern scenario, with the implementation of three-tiered documentation - Country by Country Reporting (CbCR), Group master File and Local Files, tax related transparency has increased multi-fold and any misalignment between economic substance and tax incidence will likely get questioned aggressively.
• Lastly, it would not be out of context to mention that all the work that is currently happening in the area of currently happening would have a very significant impact on such operating structures that give rise to double non-taxation. A 'consensus' as well as 'conscious'-based solution is the only way to deal with such situation!

Click here to continue reading . . .

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.