Pride Partners International

Global association of transfer pricing and valuation consulting firms with presence in the most entrepreneurial cities around the globe.

Read more

Opinion: Behind the European Raid on McDonald’s

Back to news

Dec. 3, 2015 7:12 p.m. ET

On Thursday the European Commission announced an investigation of McDonald’s for allegedly illegal behavior. This follows decisions in late October that FiatChrysler and Starbucks would each be assessed 20 million-30 million euros ($21.2 million-$31.8 million). The EC (the European Union’s executive arm) has announced similar investigations of Amazon and Apple, which are expected to result in much larger assessments.

These companies’ offenses? Tax agreements they entered into with the governments of Luxembourg and the Netherlands (and with Ireland, in the case of Apple) that supposedly gave the companies an unfair competitive advantage. The EC claims that under European Union treaties this constituted illegal “state aid.”

To a U.S. lawyer steeped in the requirements of due process and the rule of law, the process by which these fines were decided doesn’t pass the smell test. And they are only the beginning.

The agreements mostly concerned intercompany transactions. The Starbucks agreement with the Netherlands, for example, involved the pricing of coffee beans. Fiat’s agreement with Luxembourg involved interest rates charged on intercompany loans. The McDonald’s agreement involved a maneuver to reduce taxes on the royalties its franchisees paid the company.

Transfer pricing refers to the prices established for the exchange of goods or services between two related companies that are, for example, international subsidiaries of the same multinational. Companies routinely set transfer prices to minimize their taxes by locating their deductions in a high-tax country and their income in one with lower rates.

Tax laws insist that intercompany transactions occur at a “market price”—though actual market prices rarely exist, especially for the creation or use of intellectual property that isn’t exchanged outside the companies. So disputes over transfer prices between companies and the revenue authorities are commonplace.

In practice, the complexities of “transfer pricing” disputes are legendary—especially where intellectual property, such as patents, know-how or brand names, are involved. The Organization for Economic Cooperation and Development recently issued a 190-page report on transfer pricing, but the member nations failed to reach a consensus over a number of important issues. In July the U.S. Tax Court took 70 pages to explain why the judges struck down an IRS regulation governing the treatment of stock-based compensation in determining lawful intercompany prices.

In levying fines against Starbucks and FiatChrysler, the EC claims that the special tax breaks that the Netherlands and Luxembourg gave the multinational companies were based on “inappropriate” considerations, such as how many jobs each corporation agreed to locate within its borders. What allows the EC to challenge these agreements as “state aid” is that not every company operating in these countries got the same deal. However, the national governments and companies claim that in issuing its rulings, the EC used “unprecedented criteria.”

The governments of the Netherlands and Luxembourg are charged with collecting the amounts levied on Starbucks and FiatChrysler and McDonald’s, if it is fined. (Apple’s agreement is with Ireland.) Astonishingly, these governments—which entered into the agreements found to be illegal—get to keep the money. The governments may appeal the EC’s determinations in the European courts, but if they lose, they still win.

Ironically, if the EU labels these assessments as underpaid back income taxes, instead of fines, the companies’ payments may be used to offset their U.S. income taxes dollar-for-dollar, and American taxpayers would ultimately pay the bill.

A company’s reliance on a national government’s representations and on its written rulings or agreements is of no avail. And there is no statute of limitations. The fines levied by the EC so far involve agreements going back as far as 2008. Moreover, the EC’s Competition Directorate has established a task force on tax planning that says it will review up to 300 tax rulings and agreements entered into between the nations of Europe and multinational corporations. The U.S. Treasury told Congress this week that it is “concerned” that the EC is improperly targeting U.S. companies.

The deals the governments made with the multinationals now facing large claims for back taxes may constitute illegal state aid as defined in the European treaties. But the EC’s Competition Directorate never before treated transfer pricing agreements for tax purposes this way. Had it announced that it would review all such arrangements in the future, there would be nothing for the companies or the national governments to complain about. Instead, the European bureaucrats have found a new offense and imposed massive liability retroactively.

Attacking multinational corporations—especially U.S. multinationals—for paying too little taxes is a political winner. But at what cost to the rule of law?

Mr. Graetz is a professor at Columbia Law School.