France, Italy, Germany, UK, Spain and Poland

EU tax crusade puts tax havens and multinationals in the crosshairs

The European Commission's (EC) decision that Apple must pay Ireland billions of euros in back taxes prompted a furious response from the tech giant, stirred EU-US tensions and left the Irish government in the awkward position of fighting a sudden fiscal windfall. The case is also part of the EU’s long-standing crackdown on corporate tax gymnastics, with the EC looking into 300 other tax arrangements between companies and EU member states.

The EC battle against treaty shopping will have wide-ranging investment implications for both multinationals with operations in Europe and their host countries. A number of global companies issued profit warnings amid the risk of retroactive taxes and/or higher tax payments going forward. Meanwhile, EU countries that have been benefiting the most from favorable tax environments (such as Ireland, Belgium, Luxembourg and the Netherlands) may have to reassess their growth models as a wider crackdown on corporate tax evasion may discourage future investments.

According to the EC ruling, Apple enjoyed more than two decades of favorable tax deals with the Irish authorities that allowed it to divert most of its European profits to a lightly-taxed Irish office. The EC determined that these tax arrangements amounted to anti-competitive state aid, slapping the tech giant with the €13bn bill in back taxes (plus interest). The total sum amounts to one quarter of Irish government’s tax revenues last year (although it will barely dent Apple’s $230 billion cash pile).

The Apple ruling is the biggest single case in the EU’s crackdown on corporate tax avoidance, but it is not the first. It follows similar inquiries into controversial tax treatments enjoyed by other multinationals, including Starbucks in the Netherlands and Fiat Chrysler in Luxembourg. A ruling against illegal tax arrangements in Belgium earlier this year demanded 35 multinationals cough up roughly €700 million in additional taxes. The majority of implicated companies were European, supporting EC’s claims that their tax evasion crusade is not only targeting US multinationals.

Meanwhile, the sheer magnitude of the Apple penalty has taken the battle against the corporate tax evasion to a new level and will have wide-ranging implications for the investment climate across the EU. The EC indicated it is in the process of investigating 300 other tax arrangements between companies and EU member states. The multinationals with operations in Europe - including US tech giants who sit on a growing pile of overseas earnings - are left wondering which other deals reached with EU governments may be undone retroactively. Soon after the Apple ruling, a body representing the biggest US tech companies warned the Dutch government that any changes to Netherland’s favorable tax regime (which drew companies like Uber and Netflix to set up their European headquarters in the country) might result in job losses and lower investment.

For EU countries that have heavily benefited from their competitive tax environments, the EC-led crackdown may diminish their appeal to multinationals and jeopardize future investment. To identify the countries that may be the most affected, we compared effective corporate tax rates (rather than statutory figures, which do not reflect various tax exemptions and arrangements offered). By this metric, the three countries with the lowest rates (Ireland, Belgium, and Luxembourg) have been also the biggest recipients of foreign direct investment (FDI) in the EU). However, a fast-changing and less favorable policy environment may discourage some of their FDI flows going forward.

This tradeoff between tax revenues and foreign investment explains Irish government’s awkward attempt to turn away extra cash and appeal the EC ruling. The country’s spectacular economic bounce-back from the depth of the financial crisis is partly attributed to its ability to attract multinationals, such as US tech companies (Facebook and Google have set up their European headquarters in Dublin) and pharma groups (such as Novartis and Pfizer). Moody’s estimates that around 20% of all Irish private-sector workers are employed directly or indirectly by multinational companies. Given the wide-ranging economic implications, Irish government is worried that the negative effect on foreign direct investment may ultimately outweigh the fiscal gains. However, declining a big tax handout (worth 5.1% of GDP or about 6.5% of gross general government debt) may be a tough political sell in country that endured years of painful austerity after requesting the IMF-led bailout in 2010.

On the other side of the Atlantic, the Apple case stirred fears of the US revenue losses. US Treasury branded the EC ruling an outright tax raid, arguing that only the IRS has the legitimate claim to Apple’s profits. Yet Apple, along with other US multinationals, is not keen to bring home the vast pile of overseas cash and pay the steep 35% US corporate tax rate. On the upside, the EU action may spur much needed tax reform in the US, which would include tax cuts and reform of provisions that allow indefinite deferral of taxes on corporate profits kept abroad (which Moody’s estimates at $1.7 trillion). According to Oxfam America data, the top 50 US companies amassed nearly $4 trillion in profits globally from 2008 –2014, but they used offshore tax havens to lower their effective overall tax rate to just 26.5% on average. The upcoming presidential election may provide additional impetus, as both leading candidates favor reforms that will crack down on tax loopholes and force companies to pay their dues at home.