Apple has been ordered to pay up to €13 billion ($14.5 billion) in back taxes, plus interest, to Ireland after the executive body of the European Union, the European Commission (the "Commission") found that the software giant had received illegal state aid, according to a statement released Tuesday. Under EU rules it is unlawful for any EU country to give financial help to selected companies in a way which would distort fair competition – referred to by the Commission as "state aid".

The Commission’s investigation centered around Apple Sales International and Apple Operations Europe, two Irish incorporated companies that are fully-owned by the Apple group and ultimately controlled by the US parent, Apple Inc. Under a cost sharing agreement, the two Irish companies:(1) hold the rights to use Apple's intellectual property to sell and manufacture Apple products outside the Americas; and (2) make yearly payments to Apple in the US to fund research and development efforts conducted on behalf of the Irish companies in the US. These payments are deducted from the profits recorded by Apple Sales International and Apple Operations Europe in Ireland each year, and contributed to more than half of all the Apple group’s research efforts worldwide, the commission said.

Pursuant to the agreed method under two favorable tax rulings issued to Apple by Ireland in 1991 and in 2007, most of the Irish companies' profits were internally allocated away from Ireland to "head offices" that had no employees or physical locations and whose activities consisted solely of occasional board meetings. Therefore, only a fraction of the profits of Apple Sales International and Apple Operations Europe were allocated to Ireland and subject to tax in Ireland, with the remaining vast majority of profits allocated to the "head offices", where they weren't subject to tax in any country. According to the Commission, "this endorsed method to calculate the taxable profits of each company in Ireland gave Apple an undue advantage that is illegal under EU state aid rules." "In fact," said EU Competition Commissioner Margrethe Vestager, " this selective treatment allowed Apple to pay an effective corporate tax rate of 1 percent on its European profits in 2003 down to 0.005 percent in 2014." Ireland’s tax treatment also allowed Apple to avoid taxation on almost all profits generated by the sales of its products across the entire EU market. That is because Apple established its sales operations in Europe in such a way that customers were contractually buying products from Apple Sales International in Ireland rather than from the stores that physically sold the products to customers.

Interestingly, the Commission's ruling does not call into question Ireland's general tax system or its corporate tax rate (currently at 12.5%). Furthermore, as the Commission specifically noted, "Apple's tax structure in Europe as such, and whether profits could have been recorded in the countries where the sales effectively took place, are not issues covered by EU state aid rules." Presumably this leaves the door open for other countries in the EU to require Apple to pay more tax on the profits of the two Irish companies under their own national taxation rules.

The scale of the Commission's ruling means that the issue of multinational tax will once again be a hot topic of debate. Both Apple and the Irish government will appeal the Commission's ruling. Additionally, in a white paper released last week the US Treasury Department in Washington said the Brussels-based commission is taking on the role of a “supra-national tax authority” that has the scope to threaten global tax reform deals. The U.S., unlike most other industrialized nations, imposes a tax upon repatriation of foreign profits. Any tax that Apple pays to Ireland as a result of the Commissions ruling could potentially generate foreign tax credits or reduce the pool of cash stockpiled abroad, both of which would ultimately reduce the U.S. tax the Treasury could collect. Alternatively, from Apple's perspective, these payments may be considered repayments of aid and not automatically be considered to be 'tax' for the purposes of double tax relief to Apple.

Over the past four years the Commission has been looking at similar tax arrangements of other multinationals, questioning whether they too amount to unlawful state aid. Tax rulings from Luxembourg and the Netherlands – granted to Fiat and Starbucks respectively – have already been found unlawful. In both cases the companies are appealing against the Commission’s findings. Meanwhile, the Commission is also investigating a similar tax ruling from Luxembourg awarded to Amazon. For multinational companies operating in Europe, the Commission's investigation of these tax arrangements creates an uncomfortable precedent where EU antitrust authorities are intervening in complex tax issues and questioning local and established tax rulings, thereby adding an element of complexity and unpredictability to foreign direct investment and cross-border intra-company transfer pricing arrangements.