Interview with Damien Neven, The Graduate Institute, Geneva - Compass Lexec...

Interview with Damien Neven, The Graduate Institute, Geneva - Compass Lexec...

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Interview with Damien Neven (The Graduate Institute, Geneva - Compass Lexecon)

In anticipation of the 8th edition of the New Frontiers of Antitrust Conference to be held in Paris the 26 June 2017, Damien Neven (The Graduate Institute, Geneva - Compass Lexecon) has been interviewed by Frédéric Jenny (OECD Competition Committee - ESSEC) on the recent Apple case. They will participate in the panel « State aid and tax ruling: Is there really a competition issue? ».

To see the full program and register, please visit the event website .

In your view, was the EU Apple case motivated by a concern about competition (and if so, on which market)? Under which general conditions could a difference in direct corporate taxes between competitors distort competition?

The decision (see in particular § 222) relies on the finding that the Irish tax ruling reduces the tax liability of Apple relative to the application of the normal system of taxation and thereby constitutes a selective reduction in the profit tax rate. In what follows, we will not question this finding (which however raises interesting questions by itself). According to the Commission, these tax rulings should then be considered as operating aid and according the CJEU, operating aid distorts competition . On the face of it, the decision is thus motivated by a concern about distortions of competition in the product markets in which Apple operates. The extent to which a selective reduction in the profit tax rate distorts competition and more generally the qualification of a reduction in the profit tax rate as operating aid is however economically dubious. Operating aid is defined by the Commission as support which relieves firms from « a charge that they would normally have to bear in their day to day management or normal activities ». A profit tax, can, in a purely textual interpretation, presumably be qualified as « a charge » that companies have to bear (at least if they make profit) to the extent that it involves a payment to a third party. However, such a formalistic approach fails to distinguish between the economic consequences flowing from a relief of charges that have the effect of reducing marginal cost and those flowing from the relief of charges through a reduction in the profit tax rate. A reduction in marginal cost will involve a distortion of competition to the extent that it will reduce profit maximizing prices (as it reduces marginal cost without affecting marginal revenue) and thereby increase the pressure on competitors. By contrast, a reduction in the profit tax rate will distort neither prices nor investments, as long as investments can be amortised and the cost of capital can be deducted. This is a well know result from the tax literature (Stiglitz, 1973). The intuition is also straightforward ; a reduction in the profit tax rate will increase after tax marginal revenue (a greater proportion is kept from any increase in revenues resulting from the expansion of output) but it will also increase after tax marginal cost (the increase in cost resulting from the increase in output will reduce the tax by less). To put it another way, when the profit tax rate falls, cost deductions which reduce the tax base become less valuable. Given that after tax marginal revenues and marginal cost are shifted proportionately, the profit maximising price is unaffected 1.

Hence, there is no first order effect on competition in the product markets from a selective decrease in the profit tax rate. The Commission’s claim that such a reduction involves a distortion in competition relies on an abuse of the concept of operating aid (assuming that it involves aid in the first place). The fact that this abuse is possibly sanctioned by the Court would be a poor excuse.

Hence, the tax relief granted to Apple (assuming that there is one) does not make Apple more competitive on the market and does not allow it to grow its market share at the expense of competitors. There is also an immediate corollary to the observation that a change in the profit tax rate does not change the price and investment decisions; the gross profit will be unaffected by a change in the rate. This also implies that the net profit fall in line with the tax rate, so that a selective reduction in the profit tax rate would be fully appropriated by the shareholders of the Irish entities (i.e. Apple US).

What other motives could the Commission have had if not to address distortions of competition?

The motivation behind the Commission’s decision could be to reduce competition among member states in attracting the tax base. As discussed in the Commission decision, the Irish entities established by Apple essentially manage the sales of Apple outside the US; the Irish entities buy the devices from third party manufacturers and sell them. These entities have obtained (from Apple US) the right to use intangibles and intellectual property rights in the context of a cost sharing agreement, which arguably reduces the remuneration for these assets. As a result, a significant share of the variable profits (before remuneration of IP and intangibles) on sales undertaken much beyond Ireland (and the EU for that matter, more on this latter) accrues to the Irish entities. In those circumstances, any member state will have a strong incentive to attract the tax base, as it might obtain profit taxes on profits generated on a much larger scale than its territory and on the inflated basis (to the extent that profits after an economic remuneration of the IP and intangibles would be lower); even a small tax might generate substantial revenues in relation to the size of the country. In addition, if the location of the tax base is associated with (real) investments which generate external effects, member states will have an added incentive to attract the investment (and the tax base) by selectively offering low rate. Since, as discussed above, shareholders will appropriate the full benefit of a reduction in the tax rate, they will respond to such incentives. As one would expect, competition between member states in attracting the investment will then result in very favourable conditions: member states are in a prisoners’ dilemma and the investor is likely to be able to extract most of the rent. In these circumstances, the Commission’s approach (assuming that the tax relief was selective in the first place) is to ensure that the tax rate offered by Ireland corresponds to the normal profit tax rate in Ireland. Ireland (or any member state) can still reduce its own profit tax rate to attract the tax base but it has to do so for all firms. This will not suppress incentive to compete for the tax base among member states but it is likely to moderate its consequence; as discussed above, the main consequence of the competition between member states in providing selective reductions in the profit tax rate is a shift of rent in favour of shareholders of the Irish entities (as it does not affect overall profit) without improvement in inefficiency. Hence, by preventing selective tax relief, the Commission will merely shift rents away from the shareholders of the Irish entity and in favour or Ireland. This is all about equity, not about efficiency 2.

Is the Commission motivated by equity or the reform of international taxation?

The reallocation of the surplus from Apple’s operation outside the US away from the shareholders of the Irish entities, namely Apple US, and in favour of Ireland. would merely involve a shift in tax revenues across countries if these profits were eventually taxed. In principle, Apple US should pay tax in the US on the profit of the Irish entities that it owns (according to the residence principle that prevails in the US). It should pay taxes at the high US rate of 35% after having made allowance for the taxes already paid by its subsidiaries. However, this principle admits a number of exceptions and Apple’s profit outside the US can actually remain deferred, possibly for a long time. This exception is of course only attractive if the countries in which Apple makes sales outside the US do not tax its local profit at a high rate to start with, in particular when these countries apply the territoriality principle, such that profit are taxed where they are made (and not where the ultimate owners of the firms are located). This is what that the tax ruling achieves and from this perspective, Ireland is an accomplice of the US in allowing Apple’s profit outside the US to remain largely untaxed. The Irish entities play an important role in this respect to the extent that they also aggregate the sales throughout Europe (and beyond), thereby allowing profits from a larger base to remain largely untaxed; indeed, the sale of an Iphone anywhere in Europe is a transaction with the Irish entities and leads to a profit in Ireland. This structure ensures that Apple US does not have to deal with a number of jurisdictions in Europe in order to make sure that the profit that it makes in Europe remains favourably taxed, but can actually deal with a single entity 3. In any event, by making sure that Apple’s profit on sales in Europe are taxed on what application of the territoriality principle (as applied to Europe) at normal rates would dictate clearly reduces the benefit of the exception from the residence principle that Apple Inc benefits from. In this respect, the Commission’s decision reduces the attractiveness of a particular arrangement that is made possible by the lack of harmonisation (and coordination) in international tax regime. This may a second best in a world in which further harmonisation is difficult to achieve. But it would not seem to be motivation that fits well with the objective of the state aid regime, except perhaps to the extent that the Irish schemes reduces equity. If equity can be a justification for state support that distorts competition (as recognised by the Treaty), presumably a state support that exacerbates inequality without distorting competition should not be allowed.

1 A similar reasoning holds with respect to investment decisions that are financed by debt as long as interests and amortization can deducted from the tax base. When investments are financed partly by equity, as dividends can typically not be deducted in prevailing tax system, an increase in the profit tax will increase the user cost of capital and thereby reduce investment. This would in any event involve a second order effect in the case at hand given that relevant investments are decided on the basis of global returns.

2 There may even be a loss of efficiency to the extent that member states will be unable to discriminate across companies in the relief that they provide (See Besley and Seabright, 1999). As a consequence, each company may not be attracted where its marginal benefit in terms of external effects is largest.

3 It is not entirely clear why other jurisdictions in Europe, which apply the territoriality principle accept this situation; indeed, as discussed in the Commission’ s decision, Italy insists on taxing Apple on the profit that it makes on sales in Italy, thereby denying the benefit of the aggregation of sales in Ireland. Other countries would presumably have an interest to do the same.

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