A European Commission decision that Apple Inc. owed $14 billion in back taxes to Ireland was annulled by the European Union’s lower court last week. There are three things to understand about the ruling. First, the commission was right that Apple dodged its taxes. Second, the commission decision trying to collect that tax was wrong, so the court was right to annul it. Third, our broken international tax system is to blame.
The case was an appeal of a 2016 decision in which the commission determined that Ireland illegally subsidized Apple by allowing it to pay too little tax. At that time, Apple CEO Tim Cook called the decision “total political crap.” He had a point. The investigation followed on the heels of the 2008 financial crisis, a time when Europeans were fed up with corporate tax avoidance by U.S. companies. Responding in part to this dissatisfaction, the commission introduced a highly controversial legal theory that allowed it to pursue companies like Apple for back taxes.
The Apple case was part of a larger plan by the commission to become more involved in curbing corporate tax abuse. Along with the case against Apple, it opened other investigations of household-name U.S. multinationals, including Starbucks and Amazon. After sleeping through the corporate depredations of the turn of the century, EU bureaucrats had suddenly decided to take tax avoidance seriously, and Europe’s rules against subsidizing corporations seemed to be the handiest tool.
Tim Cook wasn’t the only one who thought the Apple decision was wrong. I have extensively documented the legal mistakes in these cases in my scholarly work. These cases concerned U.S. officials not just because Europe seemed to target American companies disproportionately, but also because the United States had a clear revenue stake in them: Any U.S. business’s profit not taxed in Europe would eventually be taxed in the United States. So, the Apple case boiled down to a fight with the commission over whether the United States or Ireland was the more appropriate country to tax Apple’s enormous profits.
President Obama’s treasury secretary, Jack Lew, sent a letter to the president of the European Commission criticizing its “sweeping” legal interpretation and warning that targeting U.S. companies could “undermine the well-established basis of mutual cooperation and respect that many countries have worked so hard to develop and preserve.” In 2016, the Treasury Department’s lawyers hit the commission hard. In an unprecedented 25-page white paper, they explained, point by agonizing point, how the commission bureaucrats had misunderstood and misapplied EU law.
It is for these technical legal reasons that the European court was right to throw out the decision.
And yet Apple has been a notorious tax dodger; it took advantage of gaps in law to form stateless companies that filed full tax returns nowhere on Earth. Apple funneled staggering profits into these stateless companies. And even though, under laws in effect at that time, the United States would eventually tax those profits, the timing of that tax was largely under Apple’s control. So, even though the commission was wrong on applying the law in the Apple case, it was right that the company avoided taxes.
The truth is that at the time the facts of the Apple case arose the international tax system was badly broken, and although countries have made major progress since then on preventing tax abuse, including by filling some of the loopholes used by Apple, the system is still broken.
Modern tax treaties are based on a model written in the 1920s that no longer serve states’ needs in the digital economy. But piecemeal approaches cannot fix the international tax system. Instead, states must cooperate to devise a new regime fit for today’s economy. The new regime must be robust against corporate tax avoidance, and it must fairly distribute tax revenues from international commerce.
So far, however, even though states agree that the international tax system is obsolete and in need of reform, they have not been able to agree on what should replace it. Part of the problem is that the negotiations are zero-sum: When one country gains entitlement to tax a company’s income, another country loses. Unilateral measures like the commission’s case against Apple or the French digital tax are attempts to grab taxes outside the treaty framework; they are frustrated responses to a failing system.
Making matters worse, the United States recently withdrew from multilateral talks at the Organization for Economic Cooperation and Development (OECD) that represent the world’s best chance to reform the international tax system. But this week’s decision by the EU court makes clear that the United States cannot withdraw into splendid isolation, leaving its multinationals and its own tax base exposed to the uncoordinated actions of other countries.
Even though Apple won this case, the commission will appeal it. Meanwhile, $14 billion remains tied up in escrow, and digital taxes are popping up everywhere. To make business safe for American companies abroad, and to secure its own tax revenue, the United States must cooperate to reform international tax.
Ruth Mason is Edwin S. Cohen Distinguished Professor of Law and Taxation at the University of Virginia School of Law. She is an expert on EU and international taxation.