Tax Analyst, october 2014

EU to investigate Amazon Tax Ruling for state and breach

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The European Commission on October 7 formally launched an investigation into whether Amazon's Luxembourg subsidiary received a favorable transfer-pricing-related tax ruling that violates EU state aid rules.

According to a commission release (Doc 2014-24202), the investigation focuses on a tax ruling granted by the Luxembourg government in 2003 to Amazon EU Sarl, a subsidiary that records most of Amazon's European profits. Under the ruling, which is still in force, Amazon EU Sarl pays a tax-deductible royalty to a limited liability partnership set up in Luxembourg. The LLP is not subject to corporate taxation in the Grand Duchy. The terms for calculating the royalty are set out in the ruling.

The commission contends that the tax arrangement enables most of Amazon's European profits to be booked in Luxembourg but go untaxed. It said that at this stage, it believes that the royalty rate "might not be in line with market conditions" and that the ruling "could underestimate the taxable profits of Amazon EU Sarl, and thereby grant an economic advantage to Amazon by allowing the group to pay less tax than other companies whose profits are allocated in line with market terms."

The formal opening of a state aid investigation gives interested third parties and EU member states a chance to submit comments and "does not prejudge the outcome of the investigation," the commission said.

In an October 7 statement (Doc 2014-24204), Joaquan Almunia, European Commission vice president and competition commissioner, emphasized that by beginning the investigation into Amazon, the commission is not questioning Luxembourg's general tax system but is examining "whether the tax authorities of Luxembourg have been too accommodating to Amazon in applying transfer pricing rules."

Almunia said the unusual thing about the tax ruling is that it contains a cap on the tax base, meaning that Luxembourg's tax authorities agreed to limit the proportion of Amazon's tax base in Luxembourg no matter how much profit it makes.

He said that while "Amazon is not the only company shifting profits through royalty payments," in this particular case, the commission doubts that an objective basis was used to determine how much profit should be taxed in Luxembourg and how much should be left untaxed as royalty payments.

Almunia noted that the investigation is in line with the work being carried out by the OECD under the base erosion and profit-shifting initiative. The G-20 finance ministers and central bank governors endorsed the OECD's first set of BEPS deliverables, including a report on action 5 (Doc 2014-22458) concerning harmful tax practices, at a September 21 meeting in Cairns, Australia. (Prior coverage (Doc 2014-23040).)

An Amazon spokesman denied the commission's allegations, saying that the company "received no special tax treatment from Luxembourg" and is subject to the same tax laws as other companies operating in the Grand Duchy.

The Luxembourg Ministry of Finance said in a statement that it is "confident that the allegations of State aid in this case are unsubstantiated and that the Commission investigation will conclude that no special tax treatment or advantage has been awarded to Amazon." The ministry also said it has fulfilled the commission's request for information, and it vowed to "fully cooperate" with the investigation.

The announcement comes a week after the release of two "opening decision" letters the commission sent to the Irish and Luxembourg governments in June explaining its reasons for initiating state aid investigations into tax rulings given to Apple Operations Europe and Apple Sales International in Ireland and to Fiat Finance and Trade Ltd. SA in Luxembourg. The commission is also investigating Starbucks in the Netherlands. (Prior coverage (Doc 2014-23655).)

The investigations follow the commission's September 2013 confirmation that it was conducting a broad inquiry into several EU member states' tax ruling practices and intellectual property regimes to determine whether formal state aid investigations should be started. (Prior coverage (Doc 2013-21927).)

The state aid rules are in articles 107 and 108 of the Treaty on the Functioning of the European Union (TFEU). Article 107(1) of the TFEU says that unless otherwise provided in the founding treaties, any aid granted by an EU member state or through state resources in any form that distorts or threatens to distort competition by favoring some undertakings or the production of some goods is incompatible with the internal market as far as it affects trade between member states.

A nonconfidential version of the commission's opening decision letter to Amazon will be made public after the commission and the Luxembourg government resolve any confidentiality issues. The letter will then be published in the EU Official Journal, and interested third parties will have 30 days to submit comments to the commission.

More Questions Than Answers

Practitioners contacted by Tax Analysts appeared to have more questions than answers about the basis of the commission's latest state aid investigation.

Interested stakeholders will have to wait until the nonconfidential version of the commission's opening decision letter is published to find out exactly why the EU executive arm decided to investigate Amazon, according to Jurjan Wouda Kuipers of EY's Luxembourg tax desk.

In his view, there are several problems with the commission's news releases about the investigation. For example, the commission says that it is not questioning Luxembourg's general tax system, but in order for the commission to determine whether Amazon received state aid, it will have to consider Luxembourg's general tax system as the tax system of reference, Wouda Kuipers said.

"It needs to be taken into account that, to this day, Luxembourg does not have comprehensive transfer pricing legislation," he said, adding that generally, Luxembourg would follow OECD transfer pricing guidelines.

Wouda Kuipers said that in examining Luxembourg's tax system, the commission must determine whether Amazon had an edge over other Luxembourg companies that were in a "comparable factual and legal situation," adding that it is unclear if that is the case.

"The commission, however, is taking a different approach by stating that it has concerns that an economic advantage was granted by allowing the group to pay less tax 'than other companies whose profits are allocated in line with market terms,'" he said. "This is quite a different analysis."

J. Clark Armitage of Caplin & Drysdale pointed out that although the news release indicates that the commission's investigation will not prejudge the outcome of the investigation, there are some comparisons to the state aid investigation into Apple in Ireland that suggest the commission will find the Amazon ruling to be problematic.

First, as in the Ireland Apple case, which focuses partly on a 1991 ruling that was applied by Apple for 15 years, the Luxembourg Amazon ruling appears to have an open-ended duration, as it is now in the 12th year of operation. "The EU found this to be suggestive of state aid in Apple Ireland because other countries typically issue advance pricing agreements for only three to five years," Armitage said.

Second, the Amazon Luxembourg ruling involves the application of tax rules that allow a nonresident Luxembourg company to avoid Luxembourg tax on certain partnership income -- a concept that is similar to a factor in the Apple Ireland case. Although the commission does not reveal where that partnership's income is taxed, it is presumably exempt or subject to tax in one or more low-tax countries, according to Armitage.

"The EU may be attacking the seemingly minor transfer pricing aspects of these transactions as a way to address its real concern with the more substantial tax benefits that come from these non-transfer-pricing regimes," he said.

Finally, as in the Apple Ireland case, there appears to be a lack of comparison with other resident companies, since the commission has not indicated whether it will ask Luxembourg about other similar royalty rulings. "The EU seems to be willing to make state aid determinations without having any basis for comparing the ruling in question to comparable rulings for other companies," Armitage said.

Wouda Kuipers also questioned why the commission brought up the fact that royalties were paid to a Luxembourg LLP that was not subject to corporate taxation in Luxembourg. "This should not come as a surprise," he said, since partnerships are normally considered to be transparent from a tax perspective in many other countries. He also noted that even though a partnership reports income, the partners, not the partnership itself, are usually taxed on the partnership's income.

"It is also unclear why the commission thinks it matters in the state aid analysis to which entity the royalties were paid by the Luxembourg company," Wouda Kuipers said.

Without seeing more details on how the royalty was calculated, it's difficult to assess the merits of the commission's case against Amazon, said Jean Schaffner of Allen & Overy in Luxembourg. "I don't know what Amazon paid for similar services in other jurisdictions, whether they did a transfer pricing study, and so on," he said.

Schaffner said it can be difficult to assess a 2003 transfer pricing arrangement when the tax environment has changed so much since the BEPS project took hold in the last couple of years. "Yes, in 2003 the OECD's transfer pricing guidelines were out there, but they were applied differently then," he said. "You can't judge something done in 2003 through today's standards."

When Amazon obtained the tax ruling in 2003, the Luxembourg tax authorities didn't require as much justification as they do now, Schaffner said. "Today the Luxembourg authorities won't accept a company's ruling without further investigating," he said. "The world has changed. But I don't think because it was done a different way in 2003 means it was wrong. In 2003 other tax authorities simply didn't require as much justification."

It's also unclear whether the case against Amazon implicates the EU state aid rules, Schaffner said. "I don't think this is state aid if you've simply obtained an agreement saying that under certain conditions [the tax authority] considers your transfer pricing to be at arm's length," he said. "That is not selective. Everybody can obtain that kind of ruling."

Armitage compared the commission's recent efforts to identify "sweetheart deals" between governments and large multinational companies with the U.S. Senate Finance Committee's 2004 investigation of the U.S. APA program. The committee's probe ended up petering out because it is difficult to challenge transfer pricing determinations after the fact because they often involve the evaluation of numerous facts and circumstances and subjective comparability analyses, Armitage said. (Prior coverage (Doc 2004-728).)

However, "the EU seems more willing than the Senate Finance Committee to allow its subjective views to trump those of the local tax administrations," he said.