Tax Break

John Fisher, international tax consultant

Archive for the month “July, 2020”

Apple bites back

In Plato’s Republic, Socrates is presented with the cynical argument that the appearance of justice is more important than the reality of it, an idea taken up two millennia later by Machiavelli in The Prince.

The General Court of the European Union’s rejection yesterday of the EU Commission’s claim that Ireland had given illegal state aid to Apple to the tune of 13 billion euro, was greeted by a disingenuous self-righteous statement of the Emerald Isle’s three week old government, that Ireland has “always been clear that, based on Irish law, the correct amount of Irish tax was charged and that Ireland provided no State aid to Apple”. Apple quickly chomped in with: “This case was not about how much tax we pay, but where we are required to pay it” followed up by: “We’re proud to be the largest taxpayer in the world as we know the important role tax payments play in society”. Everyone west of the Irish Sea was taking the moral high ground, and justice appeared to be done.

Really? To quote an old Yiddish saying: ‘Don’t urinate down my back and tell me it’s raining’.

‘Way back in 2014 (see Taxbreak 8/10/14), the European Commission decided to go after Apple and the Irish government over tax rulings provided to the multinational that meant it paid an insignificant amount of tax in Ireland. As a central feature of its Celtic Tiger economic policy, Ireland had operated a low corporate tax rate for years (in the period in question, 12.5%) which was unashamedly geared to attracting US multinationals looking to set up operations beyond the IRS’s immediate grasp. This provided employment, and the taxes arising from employment. Nothing wrong with that. However, in an international tax world where competition for low tax was not only between economically mature states like EU member Ireland, but also tax havens that were unfettered by extraterritorial rules, the competition was fierce. The Irish tax authorities – who could not lower the headline tax rate because of domestic revenue requirements, and could not provide special rates for inbound investment under EU rules  –  were by no means alone in rubber stamping the ideas of international tax planners that cleverly sought to minimize taxable income in Ireland while not picking it up at home in the US until repatriation sometime (perhaps) in the future. And thus were born a slew of Irish registered companies managed and controlled from abroad (that were not Irish resident for tax purposes), the Irish taxable branches of which were endowed with generous transfer pricing policies that shifted the vast majority of their profits to nowhere. All legal from an international tax point of view; all remarkably smelly from a moral point of view. But the European Commission had a trump card to play – internal EU law banned Illegal State Aid, which is what they claimed schemes, like that agreed between the Irish Treasury and Apple, were.

In truth nobody comes out of this week’s court decision, rejecting the European Commission’s claim, smelling of shamrock. The European Commission appears to have completely mishandled its case, leaving the court no choice but to throw it out. But, in so doing, the court made some very important points. The Commission’s primary argument (and the basis for a 13 billion euro assessment) was that the non-resident Irish companies owned intellectual property and, as there were no real HQ activities offshore, all the income of the companies should be taxable in Ireland. The court remembered that Apple was a US group, not an Irish one. Although not stated specifically, that HQ activity belonged somewhere else. The critically important takeaway here is that, as BEPS-era transfer pricing seeks to reflect reality and ensure the tax pie of the digital economy is cut fairly across the globe, the big money belongs in the US, where, since the US tax reform, it is more likely to be taxed. Apple’s reaction about ‘not how much they paid but where’, would be entirely acceptable, had they paid tax in the US on that income in the years under discussion, which it appears they didn’t. That might also result in a question mark over their pride at being the largest taxpayer in the world.

The secondary argument of the European Commission was that, even if income attributable to HQ IP was not taxable in Ireland, the transfer pricing methodology was wrong. The decision accepted that examination of the methodology by the authorities for the purpose of the ruling had been, at best, sketchy, but – in order to prove illegal state aid – it was necessary to show that the transfer pricing used produced less profit in Ireland than the correct method. Although the peanuts paid to the Irish Treasury imply this was a no-brainer, the court had not been presented with the required analysis, and therefore could only rule that the case was not proven. A far cry from the government’s claim that the right amount of tax had been paid to Ireland.

The decision is expected to be appealed. In the meantime, the threat of past Illegal State Aid will still hang over other cases, while EU members will have to be careful about chipping away at the US’s rightful share of digital economy income.

Two roads diverged…

For the last three and a half months I have felt like the protagonist in Monty Python’s ‘The Day Nothing Happened’. As the real world has been fighting to keep its COVID-19 head above water, the tax world has been treading water.

A recent Israeli court case that surfaced last week, however, jolted the rose-tinted spectacles from my pre-crisis, nostalgia ridden face. I was reminded that the world was already mad way back then.

A judge in the Tel Aviv District Labour Court issued a judgement in a case involving Israeli residence for National Insurance purposes. The case revolved around an Israeli family that left Israel in June 2013, maintained Israeli residence for National Insurance purposes, had second thoughts at the end of 2017 (and requested a refund for payments from 2015), and then promptly came back to Israel in September 2018.

What was notable was not the judge’s refusal to instruct a refund, but rather the muddled approach to residence in the case.  Over the last three decades, I have become used to the lack of consistency of  the National Insurance Institute in dealing with international issues.  It now looks like things can only get worse.

When it comes to defining income, the National Insurance Law is, albeit obliquely, joined at the hip to the Income Tax Ordinance. As a result, the National Insurance Institute derives an individual’s financial information from tax returns and/or local employers’ deductions reporting. Nothing silly about that.

When an Israeli resident goes abroad for a prolonged period, they often have an interest in trying to maintain their rights to national insurance benefits and health care. The published rule of the National Insurance Institute is that, if such an individual has ‘no income’ abroad, they pay a minimum monthly amount of NIS 177 (around $50). If, however, they have income, as an employee they pay up to 12% of their income, and as a self-employed individual substantially more. The exception is if there is a Social Security Totalization Agreement between Israel and the foreign country, when – depending on the specific circumstances – contributions will be restricted to one or other of the countries. For someone traveling to the United States (a popular destination for assignees and others) there is no such agreement, so Israeli residents are liable, in addition to US FICA contributions, to Israeli National Insurance payments with no set-off – which is potentially very expensive.

The good news, however, is that Israel and the US  DO have a double taxation treaty in respect of income taxes, such that – as long as non-residence can be established for income tax purposes according to the treaty – an employee of a US company will show no income on their tax return (if, indeed,  they file a return) which should lead the National Insurance Institute to charge NIS 177 per month if it considers residence is maintained according to its law. This, of course, is farcical logic – but not too painful.

The logic just became a little bit harder to swallow. The judge in the recent case had to decide on ‘residence’. The National Insurance Law does not contain a definition of residence, and relies on judicial precedent surrounding the concept of ‘Centre of Life’. That is the same overriding concept as in the Income Tax Ordinance, so it might be assumed that there was a clear road to consistency between the National Insurance Law and the Income Tax Ordinance to which, as previously stated, it is inexorably attached.

No such luck.

Firstly, the Income Tax Ordinance has developed over the years, providing a presumption of residence based on days in Israel, and a specific definition of foreign resident that provides a pretty clear exit route from Day One to anyone who can later prove that they were gone for at least 4 years. In the absence of any statutory guidance, the National Insurance Institute’s default period (always subject to alternative interpretation) is 5 years.

Secondly, the judicial precedent on which the judge  relied for her definition of ‘Centre of Life’ was not of the regular courts that hear tax cases, already implying a parting of the ways in interpretation.

Thirdly, the judge’s interpretation of the existing precedent was, to put it euphemistically, surprising. Suffice to say, it didn’t correspond to anything familiar to this writer.

Maybe it is all a plot to drive the population to an early grave and close the social security funding gap. Fiendishly clever, if so.

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