European Union Probes Tax Laws
Over the past few years, the European Union has targeted multinational corporations using tax planning strategies to reduce corporate tax burdens. Recently, the EU has launched an investigation into tax deals between Amazon (AMZN) and the country of Luxembourg. With an array of subsidiaries within European countries, Amazon’s European headquarters are located in Luxembourg under LuxOpCo.
LuxOpCo functions as Amazon’s principal operator of retail and business services in Europe and records most of Amazon’s European profit. In turn, LuxOpCo is owned by another Amazon holding company, Lux SCS, which is set up to sell intellectual property and collect royalties from LuxOpCo. While LuxOpCo is subject to corporate income taxes in Luxembourg, LuxSCS is not. As a result, LuxOpCo pays a tax deductible royalty to the holding company and declares yearly profits lower than in actuality. Stemming from a deal in 2003, this practice has continued for 10 years. A portion of the practice can be attributed to the transfer pricing and profit-sharing plans conducted by corporations such as Amazon, Starbucks (SBUX), and Apple (AAPL).
TRANSFER PRICING
Transfer pricing is a method by which divisions of a larger corporate entity conduct transactions between each other. In accounting and finance, transfer pricing is a required vehicle in the financial reporting of multinational companies. Recently, transfer pricing has garnered negative press as corporations attempt to reduce taxes by way of shifting profits.
When transactions between divisions of an entity occur, a transfer price must be evaluated to determine costs. In accounting, corporate groups are treated as a single entity, however, federal tax laws treat corporate subsidiaries as separate economic actors. As a result, multinational corporations record massive shifts in profits to countries with which operations are minimal. This is predominantly done through the transfer of intellectual property to tax-friendly countries. The exact price of royalties paid for intellectual property within companies can dilute taxable profits of the larger corporation. Due to the profitable nature of global commerce, distributions and supply chain transfer pricing procedures have come under scrutiny, particularly in Europe.
APPLE
In 1980, Apple established international headquarters in Ireland. Thanks to friendly corporate tax rates of 12.5%, Ireland has become an economic destination for international operations. Other multinational corporations headquartered in Ireland include Facebook (FB), IBM (IBM), and Dell.
Despite the relatively low tax rates, it is estimated that Apple has and continues to pay less than 2% in taxes in Ireland. Additionally, Ireland’s tax structure offers multinationals a 25% tax break for companies with R&D in the country. Defined as profit shifting, Apple has used this strategy to shift R&D costs to Ireland resulting in tax breaks and low income taxes on profits.
At the center of the European Commission’s investigations is the recognition of companies, including Apple, receiving state aid. In this case, state aid is the avoidance of corporate taxes for profitable means. Apple, however, insists the company’s tax strategies benefit the company itself and U.S. citizens through job creation.
AMAZON
In the EU, it is not illegal to incentivize businesses with low tax rates. However, tax deals that are not made available to competitors are classified as illegal tax aid. Amazon’s deal with Luxembourg in 2003 capped tax payments made by the company. The cap on taxable income is reported to be less than 1%, resulting in €75 million of Amazon’s €13.6 billion in European sales. The amount of taxable income comes from royalty payments made between corporate subsidiaries.
THE BOTTOM LINE
Through transfer pricing strategies, multinational companies have effectively avoided large corporate income taxes within the EU. The European Commission has launched investigations into the tax arrangements of Amazon and Apple in Luxembourg and Ireland, respectively. These investigations have spurred the EU investigations of Starbucks in the Netherlands and Fiat (FCAU) in Luxembourg. Both companies have been suspected of receiving state aid.
At the heart of the controversy are the profit sharing strategies used by such corporations. While transfer pricing is an intricate part of operating a global company, corporations can strategically incorporate the procedure for tax benefits. Likewise, profit shifting is estimated to have a more substantial effect on domestic tax bills. In conjunction with favorable tax structures, using several profit sharing procedures allows corporations to reduce income taxes.
Get Out of Debt – Start Making Money
Want to get out of debt, get a mortgage and save for retirement? Investopedia’s FREE Personal Finance newsletter shows you 7 Steps to Become Financially Independent. Take control of your money and Click here to start managing your finances like the pros.
