EU Crackdown Hasn’t Made U.S. Tech Change Its Behaviour

(Bloomberg) -- A pattern is emerging in the war between the European Union’s antitrust authorities and U.S. tech companies. The changes that Google and Apple made after adverse rulings and large fines appear to be little but window-dressing, and left intact the problems the penalties were intended to solve.

In June 2017, the European Commission fined Google 2.4 billion euros ($2.8 billion) for giving priority to its price comparison service, Google Shopping, over rival services in search results. The company put in place a remedy in September of that year: All services can bid on spaces in a special box that appears on the search result page when consumers type in an item they would like to buy; Google Shopping is supposed to bid like any other company. Yet it’s almost always the only offering in the box.

In February, one of the original complainants, the trade group FairSearch, wrote an open letter to Competition Commissioner Margrethe Vestager asserting that the new setup was no better than the one it was supposed to replace. Google Shopping remains part of the search giant even though it claims to maintain an arm’s-length arrangement, so Google incurs no real cost for the spots in the box while its competitors do. So far, Vestager’s office hasn’t directed Google to change anything, though. Instead, regulators are concentrating on other investigations against Google that could lead to more fines.

Apple has been similarly defiant, at least according to a recent report by Martin Brehm Cristensen and Emma Clancy for the European United Left–Nordic Green Left (GUE/NGL) faction in the European Parliament.

In August 2016, Vestager told Ireland to claw back 13 billion euros in back taxes owed by Apple. She argued that the company’s  arrangement with Irish tax authorities was a form of illegal state aid. The ruling claimed that Apple had paid an effective tax rate of 1 percent on its European earnings in 2003 and 0.005 percent in 2014 thanks to a deal that assigned most of the profit to Apple Sales International’s “head office,” a subsidiary that is technically based in Ireland but was considered a nonresident for tax purposes. At the time, Apple paid no tax on the European earnings in the U.S., either. The company avoided the levies by spending most of its  profits to pay for the use of its own intellectual property.

Ireland was in no hurry to recover the money, which it collected only under EU pressure; it has been helping Apple fight the ruling in the courts. The GUE/NGL report provides some evidence that it has also helped the company establish a new tax structure that allows it to continue to pay very little tax.

The report picks up where Vestager’s investigation left off in 2015. That year, responding to U.S. and EU efforts to curb its tax avoidance, Apple created a new European tax structure that it has never disclosed publicly but that can be inferred from data that became available in the November 2017 release of the so-called Paradise Papers,  a data leak detailing the use of offshore entities for tax purposes by rich individuals and some global companies, including Apple.

Here’s how the report describes the alleged new strategy: Apple transferred the intellectual property license, which still consumes most of its European profit,  onshore in Ireland, where it is now owned by its Apple Operations Europe (AOE) unit. To make the purchase, AOE borrowed billions of dollars from another Apple subsidiary, which is probably based in the tax haven of Jersey.  It is now making tax-deductible repayments from Ireland to Jersey with money received from another Ireland-based firm, Apple Distribution International (ADI). This company executes the iPhone maker’s non-U.S. sales and uses most of its revenue to AOE for the use of the intellectual property.  In addition, one of the Irish companies has a cost-sharing agreement with Apple, Inc. in the U.S.: It pays its parent company for research and development conducted in the U.S. For tax purposes, this is considered an investment in R&D in Ireland, creating credits for Apple.

This setup, according to the report, allowed Apple to pay an effective tax rate in Ireland that was much lower than the statutory 12.5 percent. The most realistic assumptions based on Apple’s financial disclosures point to a rate of between 1.7 percent and 5.6 percent.

Those rates are higher than those mentioned in Vestager’s 2016 ruling, and in any case, Apple makes no secret of wanting to pay most of its taxes in the U.S. “The changes Apple made to its corporate structure in 2015 were specially designed to preserve its tax payments to the United States, not to reduce its taxes anywhere else,” Apple wrote in November, after the release of the Paradise Papers. After President Donald Trump’s tax reform, Apple announced it would pay $38 billion in U.S. taxes on the foreign income it had accumulated offshore for years. The company justified the move with the common sense argument that most of the value it creates originates in the U.S.

But Apple hasn’t substantially changed its tax-avoidance practices in the EU since Vestager’s ruling. The only difference -- at least according to the GUE/NGL report -- is that, instead of paying an offshore entity for intellectual property rights, it is now repaying a debt to an offshore entity for the purchase of that same intellectual property. Ireland enables the new scheme just as it enabled the old one: The taxes Apple pays are much better than nothing, and Ireland wants to keep Apple from taking its business elsewhere.

Both with Google’s shopping comparison service and with Apple’s tax arrangements, it’s up to the courts to decide whether the U.S. companies are entitled to operate as they do. This isn’t, however, just a matter of who’s right, but also of relative power.

An activist EU official such as Vestager can challenge the U.S. giants’ practices and even make them pay fines (although they aren’t as painful as recent U.S. fines and settlements have been to Volkswagen and BNP Paribas). But the U.S. companies will essentially steamroll ahead without serious changes to their behavior. That’s a qualitative U.S. advantage in its trade war against Europe that cannot be fixed with quid-pro-quo tariff hikes. And it’s an incentive to other U.S. companies, such as Facebook, which lately have had trouble with European legislators and regulators: They, too, are confident about being able to move on without changing much.

*This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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