EU says Apple, Starbucks tax deals may be illegal

European Union regulators have ruled that some European tax deals of Apple (AAPL), Starbucks (SBUX), and Fiat (ADR) seem likely to breach antitrust restrictions. The European Commission, which is responsible for antitrust enforcement, will now open "in depth investigations" that could result in the companies facing massive bills for back taxes.

Although the investigations, which began in June 2014, specifically target the three companies, many multi-nationals will pay close attention, because the basic strategies of Apple, Starbucks, and Fiat to shift profits to low-tax districts are commonly used by many companies, including Google (GOOG), Facebook (FB), and Microsoft (MSFT). Such tactics have become increasingly controversial as national economies struggle and governments look to improve tax revenues.

In a statement to CBS MoneyWatch, Apple noted that it employed 4,000 people in manufacturing, tech support, and other functions in Ireland. "Our success in Europe and around the world is the result of hard work and innovation by our employees, not any special arrangements with the government," the statement read. "Apple has received no selective treatment from Irish officials over the years. We're subject to the same tax laws as the countless other companies that do business in Ireland." Neither Starbucks nor Fiat has yet responded to requests for statements.

What these three companies and others employ is something called transfer pricing. A company that wishes to reduce its overall tax burden creates a foreign division or holding company and transfers its intellectual property -- patents, trademarks, copyrights, business processes, trade secrets, and branding -- to that entity. The foreign company is created in a country that has low tax rates on the profits generated from such properties.

Next, the new entity licenses the property back to the parent organization or another national division, charging a fee for its use. The parent or other division pays the fee and deducts it as a business expense. The entity set up to own the intellectual property receives it as profit. But because of the deliberate choice of where to set up headquarters, the tax rate is far lower than it would have been in the other countries in which the overall company operates. The technique is a common one, particularly among high tech companies, where intellectual property is a large portion of the products and services offered.

Often the intellectual property-holding entity expands operations, hires researchers, and becomes an R&D center to further establish the credibility of the structure. Then the overall company can have the R&D center use its "profits" to fund research and development done at other divisions, as well as undertake its own R&D. The move allows the companies to effectively move some foreign profits back into their home countries without declaring it as native revenue subject to higher tax rates.

The schemes can become incredibly complex, as in Google's documented use of wholly-owned companies in the Netherlands, Ireland, and Bermuda. Google shifts money from one division to another, sometimes with multiple entities in a single country, to make a lot of money virtually tax-free. Such structures have even received nicknames in the accounting and tax-planning worlds: the "Double Irish" and the "Dutch Sandwich."

Such dealings are supposed to be done in so-called arms-length transactions. In other words, the technically independent companies are supposed to act as though they aren't related, charging and paying each other market rates in their dealings. However, establishing what fair rates would be can be difficult for tax authorities.

In addition, countries have entered competitions for business, much as happens among states in the U.S. The result can be a tax rate race to the bottom, where some nations significantly lower rates in key areas, even working out deals specific to a particular company, to attract significant facilities and jobs. Concern over corporate tax shifting has become a point of major concern for countries in the Organization for Economic Co-operation and Development, which has released recommendations for "a co-ordinated international approach to combat tax avoidance by multinational enterprises."

The European Commission has charged that, in the cases of these three companies, countries have effectively given better-than-market deals to the companies to attract their business. Such deals could have a direct effect on other EU member countries, depriving them of business that they might otherwise enjoy.

In the case of Apple, specifically, some of the deals "appear to be reverse engineered so as to arrive at a [predetermine] taxable income" although the reasoning "does not have any economic basis" or "[do] not seem justified by any actual plant or machinery expenditures," but, rather, seem nothing more than negotiated settlements.