As reported in earlier articles on November 27, 2015 the Dutch State Secretary for Finance announced that the Netherlands is going to appeal against the European Commission’s decision in the Starbucks Case. In this respect the Dutch State Secretary sent several documents to the Dutch Parliament. One of this documents was titled: “Samenvatting besluit Europese Commissie inzake Starbucks tax ruling” (Summary decision European Commission on the Starbucks tax ruling). Since the Dutch Ministry of Finance only published a Dutch version of the document and some of our readers might be interested in the content of the document, below we did our best to draft an UNOFFICIAL ENGLISH TRANSLATION of the summary as published by the Dutch Ministry of Finance.

 

UNOFFICIAL ENGLISH TRANSLATION of the document titled: “Samenvatting besluit Europese Commissie inzake Starbucks tax ruling” as published by the Dutch Ministry of Finance on November 27, 2015

 

 

Summary decision European Commission on the Starbucks tax ruling

 

1. Introduction

 

In its decision of October 21, 2015 (the decision) the European Commission ruled that the advance pricing agreement (APA) as concluded on April 28, 2008 between the Dutch tax authorities and Starbucks Manufacturing EMEA B.V. (SMBV) and that applies to the period from October 1, 2007 through October 31, 2017, constitutes illegal State Aid (State Aid case number SA.38374).

 

An APA is an agreement between a tax authority and a tax payer regarding the application of tax regulations to (future transactions). In such an agreement it is determined which criteria are suitable for determining the at arm’s length transfer prices for intra-group transactions for a certain period. Based thereupon it is determined how much profits generated by the activities of a taxpayer will be taken into account in that (tax) jurisdiction and how much corporate income tax a taxpayer will have to pay annually. The APA process is started by a request that is filed by a taxpayer.

 

2. Judgement by the European Commission of the APA with SMBV

 

2.1. Conditions for the existence of State Aid

 

According to Article 107, Paragraph 1 of the Treaty on the Functioning of the European Union (TFEU) any aid (i) granted by a Member State or through State resources in any form whatsoever (iv) which distorts or threatens to distort competition (iii) by favoring certain undertakings or the production of certain goods shall, (ii) in so far as it affects trade between Member States, be incompatible with the internal market. (ITP: Please note that the numbers above are not in a logical order, this is caused by the fact that in Dutch the sentence is read in a different order. However since we want to follow the order of the Dutch document we appointed the same numbers to the different subjects as it was done in the Dutch version)

 

The first condition is met. The APA was concluded between the Dutch tax authorities, that is part of the Dutch Government. Therefore the APA is attributable to the Netherlands. Furthermore the APA cause a loss of tax revenue that the Netherlands would otherwise have had at its disposal. Therefore the APA is considered to lead to a loss of state resources.

 

Since SMBV is part of the Starbucks Group, which is worldwide active as well as in all Member States of the European Union, this means that the aid can effect the trade between Member States, which means that the second condition is also met.

 

The third condition is also met. The APA grants Starbucks a selective advantage for as-far-as the APA leads to a decrease in taxes that SMBV has to pay in the Netherlands. The majority of the ruling of the Commission is devoted to the decision of the Commission with respect to this condition.

 

Finally also the fourth condition is met. Since the APA relieves SMBV from tax that it otherwise would have to pay, the measure strengthens the financial position of Starbucks in comparison to other competing companies as a consequence of which the competition is distorted or is threatened to be distorted.

 

Since all conditions are met, the APA constitutes state aid as meant in Article 107, Paragraph 1 TFEU.

 

2.2. Existence of a selective advantage

 

2.2.1. Fiscal state aid test

To decide whether a specific tax measure constitutes a selective advantage a fiscal state aid test was developed in European case law. The test consists out of three steps. In the first step it has to be determined what general or normal tax regulation applies in the Member State: “the reference system”. The second step is to determine whether the tax measure involved constitutes a deviation from the aforementioned reference system. If the measure constitutes a deviation from the reference system in the third step of the analysis it is determined whether the measures can be justified by the nature or the general design of the reference system.

 

2.2.2. Reference system

The reference system consists of the general Dutch corporate income tax system which has the taxation of the profits of all firms that are subject to tax in the Netherlands as a goal. Regardless  whether it is a group company or a stand-alone company. The fact that integrated and non-integrated companies per definition realize their taxable profits in a different way, is not important for defining the reference system.

 

Differently than the Netherlands has argued, the reference system is not formed by Article 8b DCITA (ITP: Dutch corporate income tax Act) and the “Verekenprijzenbelsuit” (ITP: Decree on transfer prices) that contain specific rules for group companies. By assuming, as the Netherlands does, that the reference system only comprises group companies an artificial difference between companies is created based on their company structure. Especially when taking into account that the Verrekenprijzenbesluit wants to assure that, based on the Dutch system of corporate income tax, group companies and stand-alone companies are treated similarly. If the goal of the  Verrekenprijzenbesluit indeed is to establish special rules for integrated companies that deviate from the general Dutch regulations regarding corporate income tax, than the introduction of this in itself is selective in nature, so that consequently all advantages that are being granted based on that regulation are selective.

 

2.2.3. At arm’s length principle

Now, when it is established that the general Dutch system of corporate income tax is the reference system to which the APA should be compared, it has to be assessed whether that APA constitutes a deviation from that system because of which businesses that are in situations which are actually and legally comparable are being treated unequally. This based on the at arm’s length principle. The principle that the Commission applies when in the assessment of state aid, doesn’t result from the non-binding OECD Model Treaty on taxes, but is a general European legal principle of equal tax treatment.

 

The methodological choices as made in the transfer pricing report as drafted by Starbucks’ tax advisor and as accepted by the Dutch tax authorities in the APA, do not lead to a reliable 3/5 approach market outcome and do therefore not comply with the at arm’s length principle. More specifically it considers:

-        The choice to apply the transactional net margin method to estimate a taxable profit, while the OECD Transfer Pricing Guidelines and the Verrekenprijzenbesluit show a preference for the Comparable Uncontrolled Price Method (CUP);

-        If the CUP would have been applied the taxable profit of SMBV would have been significantly higher, because:

         i)   the royalty that SMBV pays to Alki LP for knowhow with respect to the roasting of coffee beans is too high;

         ii)  the purchase price of green beans that SMBV pays to a Starbucks Group company, Starbucks Coffee Trading Company SARL (SCTC), residing in Switzerland is too high.

 

Alternatively the Commission is of the opinion that the TNMM is applied incorrectly:

i)      It is wrongfully assumed that SMBV (in comparison with a company of the Starbucks Group that is residing in the United Kingdom: Alki LP) is to be considered “least complex entity” and therefore for the application of the TNMM is considered to be the “analyzed party”; and

ii)     In connection with the comparability of SMBV with other participants in the coffee trading business wrongly two adjustments to the cost base were made.

 

These choices have as a consequence that the tax base of SMBV is too limited, as result of which SMBV enjoys a tax advantage in the Netherlands.

 

2.2.4. Royalties

The royalty payments that SMBV makes to Alki LP do not provide a correct reflection of the value of the intellectual property rights and therefore it cannot be assumed to be at arm’s length.

 

The royalty is a correction variable, the height of which is determined by combining accounting profit of SMBV with the remuneration in the form of a fixed surcharge on the operational costs of SMBV as agreed upon in the APA. Therewith the APA does not contain a method to asses whether the  height of the royalties is at arm’s length. On top of that based on a CUP-test the actual price that SMBV would have been willing to pay for the royalty – in an arm’s length transaction -  would have been nill. This can be concluded from several comparable agreements for the roasting of coffee that Starbucks has concluded with other roasters from all over the world. Alki LPP should not have received a royalty. The royalty, that has been paid for many years can therefore not be considered to be at arm’s length, especially not because it seems that SMBV itself does not gain any business advantage from the use of this intellectual property in the field of roasting coffee beans. An independent company wouldn’t have been willing to pay for licenses if it would not be able to recover the royalties paid.

 

Neither does the royalty payment reflect a payment for the transfer of entrepreneurial risks. The argument made by the Dutch tax authorities that it is Alki LP (and not SMBV) that carries the economic risk of the loss of stock is not accepted by the Commission. If accepting such reasoning the application of the at arm’s length principle would become useless for the pricing of intra-group transaction, because de facto this would create the possibility to argue cq. contract the economic reality away. Furthermore Alki LP does not have the capacity to carry such risks. Illustrative is that said company itself doesn’t employ any employees. Neither can the height of the royalties be justified by the amounts that Alki LP pays to Starbucks US for that technology.

 

2.2.5. Purchase of green beans

The purchase price that SMBV pays to SCTC, is abnormally high and therefore doesn’t comply with the at arm’s length principle.

 

First of all it was neglected to examine to what extent the transactions between SCTC and SMBV – the purchase and supply of green coffee beans – are actually done for business reasons. Furthermore Starbucks did not provide a justification for the significant increase of the surcharge on the costs of the coffee beans supplied by SCTC that applied as of 2011. The Dutch tax authorities should therefore not have accepted this deduction from the accounting profit. That the activities of SCTC became increasingly more important, a.o. because of the evolving “C.A.F.E. Practices”-program is no justification. The numbers that Starbucks has provided in this respect  are, also when taking similar fair-trade programs (and the costs thereof) into consideration, problematic both in terms of consistency as well as the professionalism thereof. Moreover since 2010 the losses on the coffee roasting activities can be seen in (direct) relation with the increased surcharge. This also seems to show that the increase of the surcharge was not at arm’s length. The profits of SMBV are artificially lowered by buying green coffee beans against prices that are not at arm’s length (because they are too high).

 

2.2.6. Least complex entity

SMBV is improperly qualified as the least complex entity for the application of the TNMM.

 

The determination of the least complex entity precedes the application of the TNMM as transfer pricing method. In order to be able to determine which entity qualifies as the least complex entity a comparison of functions has to be made. The outcome of the comparison of functions results in an entity to which the transfer pricing method can be applied in the most reliable way and for which the most reliable comparables can be found.

 

With its roasting activities SMBV does not only perform routine activities. SMBV performs market researches (there are costs for market researches). SMBV is the owner of significant intellectual property (there are amortizations of intangible assets). Furthermore SMBV performs an important resale function. A routine producer would not perform such activities.

 

2.2.7 Alternative position of the Commission

Also when Article 8 of the DCITA and the Verrekenprijzenbesluit are considered to constitute the applicable reference system, with the APA a selective advantage is granted to SMBV. Even then the APA cannot be considered to provide a reliable approach to a market outcome that is in accordance with the arm's length principle and is the tax due is reduced in comparison with other group companies that owe taxes in the Netherlands.

 

3. Conclusion

 

The APA constitutes State Aid as meant in Article 107, Paragraph 1 TFEU and is incompatible with the internal market. Since the Netherlands did not report its intention to provide the disputed aid with the Commission, the aid constitutes illegal State Aid given to SMBV and the Starbucks Group that has been put into effect contrary to Article 108, Paragraph 3 TFEU.

 

This illegal aid, including interest to be calculated from the date the aid came available until the date of actual repayment, has to be immediately and effectively re-claimed of SMBV (and otherwise the Starbucks Group). The decision has to be implemented by the Netherlands within four months from the date of notification.

 

 

Copyright – internationaltaxplaza.info

 

 

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