The EU Is Pulling Its Punches Against Tech Giants

(Bloomberg View) -- Margrethe Vestager, the European commissioner for competition, is again picking low-hanging fruit by ordering Amazon to pay 250 million euros ($294 million) plus interest to Luxembourg, deemed to have rendered illegal state aid to the U.S. company. But the European Commission should be aiming higher if they want to send a serious message to U.S. tech giants about doing business there.

The scheme Vestager attacked in Amazon's case turned on the tax ruling Luxembourg granted the retailer in 2003 and maintained until 2014. The ruling, according to the Commission, allowed the company to transfer 90 percent of its European operating profit as royalties for the use of intellectual property held by a Luxembourg partnership that was exempt from corporate tax. The U.S. owners of the partnership then simply deferred their tax liability. The commission said the amount Amazon paid to the partnership was 50 percent higher than necessary under the partnership's cost-sharing arrangement with the U.S. parent company, under which Amazon financed its research and development. 

Essentially, Vestager told Luxembourg that it should only have allowed lower payments and that Amazon owes it some back taxes. Both the Grand Duchy and the U.S. company hold, however, that nothing about the arrangement was unusual or amounted to state aid. It's on this basis that Amazon will probably appeal the ruling, as Starbucks and Fiat did after similar Commission decisions in late 2015 and as Apple did after Vestager hit it with a 13 billion euro unpaid tax bill in favor of Ireland last year.

The Commission's explanation of the ruling stressed, however, that "the Commission investigation did not question that the holding company owned the intellectual property rights that it licensed to the operating company, nor the regular payments the holding company made to Amazon in the US to develop this intellectual property." That's exactly what it should have done.

Now, Vestager is seen as having taken principled action against Amazon and other U.S. companies. Though 250 million euros looks like a mosquito bite for a company the size of Amazon, especially in comparison with Apple's 13 billion euro liability, it's actually quite a serious clawback. To put it in perspective, 250 million euros over 11 years is, on average, 22.7 million euros, or $26.7 million at today's exchange rate. In these same 11 years, Amazon's revenue outside North America -- most of it made in Europe -- was, on average, $12.2 billion a year. The company's average EBITDA margin -- the ratio of its earnings before tax, depreciation and amortization to revenue -- stood at 5.9 percent. Let's say the amortization and depreciation cut that rate in half; the implied "Vestager tax" rate on the remaining profit then works out to about 7.2 percent, nothing to sneeze at.

But, from a common sense point of view, there is no logic to Amazon's practice of paying an intellectual rights royalty to itself. The patents and code that allow it to do business are tools it owns, the same as a factory's equipment or a physical store's premises. It's fine for a company to amortize them over time, but not to pay itself for their use.

If you're in awe of technological innovation and consider the kind of intellectual property it generates somehow special, consider the Starbucks state aid case. In 2015, Vestager ruled that it owned 20 billion to 30 billion euros to the Netherlands in part because it had paid "a very substantial royalty to Alki (a UK-based company in the Starbucks group) for coffee-roasting know-how." Tax engineers don't care about innovation -- they'll use whatever they can get their hands on to reduce the taxable base.

There is no rational basis for the "intellectual property" arrangement as a whole, not just for the way specific tax rulings have made it even more lucrative. It's a tax scam, and it shouldn't exist, if only because Apple, Google, Amazon and other U.S. companies use it to pay less tax than European rivals with less reliance on technology. That's a key competitive advantage that has nothing to do with progress, and it's within Vestager's direct remit to fight that unfair advantage.

She can't do that, however, for a number of reasons. One is political. Vestager works for European Commissioner Jean-Claude Juncker, who was prime minister of Luxembourg while Amazon had its special tax arrangement there. In that role, he resisted new EU rules against tax avoidance by multinationals. He calls on critics not to judge him by that past and to "measure the credibility of this Commission on the basis of what it does now." But the past cannot be erased; Juncker wants as little personal reputation damage as possible, and Luxembourg, his home country, still wants to retain its tax competitiveness. Despite an international outcry, it hasn't lifted but merely reduced the sentences of the whistleblowers who made public major corporations' tax rulings in 2014. Under Juncker, the Commission has pushed for closing tax loopholes for U.S. tech -- but it has pushed so gently that nothing has actually happened, and now a number of EU countries are frustrated enough to demand turnover taxes on the multinationals.

The relatively small Vestager rulings in the Luxembourg cases -- up to 30 million euros in Fiat's case, 250 million euros in Amazon's -- fit in with the pattern of letting the small country lure multinationals with a preferential tax regime.

Another reason the competition commissioner can't afford to be bolder is the likelihood that more aggressive action against the intellectual property loophole wouldn't stand up in court. Two years after their rulings, Starbucks and Fiat, as well as the Netherlands and Luxembourg, are still appealing them. Based on the current legal framework, these are complicated cases, and if a huge one falls through, the whole edifice Vestager has been constructing with her application of state aid rules could collapse. The more important the case, the higher that risk -- the Commission is especially exposed with Apple and Ireland, which haven't accepted last year's ruling. Ireland, unlike the Netherlands and Luxembourg in the Starbucks and Fiat cases, hasn't even claimed back the taxes, and the Commission is trying to force it to do that.

Finally, more aggressive action against the American companies could anger the U.S., which itself would like some tax revenue on the firms' overseas profits. President Donald Trump has promised to motivate the multinationals to repatriate the foreign earnings. 

Vestager, in other words, is going as far as she can go with the multinationals. It would take concerted effort by the EU and its member states to take a step further and close the intellectual property loophole. Until that materializes, the obvious limitations of Vestager's approach can only embolden the U.S. companies; perhaps that's why they show no humility in their responses to her action despite the damage it inflicts on their public image in Europe.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

To contact the author of this story: Leonid Bershidsky at lbershidsky@bloomberg.net.

To contact the editor responsible for this story: Mike Nizza at mnizza3@bloomberg.net.

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