State Aid & Taxation - Netherlands -v- Starbucks
Commission v The Netherlands and Starbucks
The Commission’s case against Starbucks derived from an arms-length advanced pricing agreement (“APA”) that was agreed on between the Netherlands tax authorities, Starbucks Manufacturing EMEA BV (“SMBV”), and Starbucks Coffee EMEA BV (“SCBV”). The Starbucks Corporation are a MNC that have their headquarters in the United States. They are the parent company to SMBV, SCBV, Starbucks Coffee Trading Company SARL (“SCTC”), and Alki Limited Partnership (“Alki”).
The Operation Value of Subsidiaries
Alki is a UK based company that are shareholders of SCBV. They possess a number of IP rights that are essential to the Starbucks brand.Their function does not stop there. They are also the “principal that bears all the company risks and performs the associated activities” and as such the remunerative royalty that they receive is indicative of this position.
SCBV operate as the head office for Starbuck Corporation in Europe, the Middle-East, and Africa (“EMEA”). In their role as the head office they, among other activities, source franchisees to create and run Starbucks coffee shops which they sub-license their intellectual property (“IP”) to in return for a royalty payment, the basis of which is the financial performance of the franchised shop.The IP that they sub-license to the franchisees includes “trademarks, technology and knowhow”and it is originally licensed by SCBV from Alki in return for a royalty payment.
SCTC are a Swiss company that supplies the green unroasted coffee beans to not only SMBV but all of the franchisees of the Starbucks Corporation.The Commission report that in the five years prior to 2010 the average mark-up by SMBV on beans bought from SCTC was 3%. However this increased by approximately 15% between 2011 and 2014. SMBV are pivotal in the investigation by the Commission. The activity of this company is the reasoning for the state aid ruling given by the EC.
SMBV are the purchaser of green beans from SCTC which they then roast and distribute, along with complementary products such as cups, to Starbucks shops. They are also responsible for a royalty payment to Alki for the use of IP that has been described as “necessary to utilize the coffee roasting manufacturing process and the right to supply coffee to Developers”.
The Advanced Price Agreement
The development of the ‘arms-length’ principle was to be used as a means of determining whether a corporation that comprises of a number of companies is at an advantage as per Article 107(1) in the way that they organise their tax affairs through profit shifting.The basis of this principle is that where two companies owned by the same parent corporation perform functions that complement each other, the financial benefit given from one of the companies to the other cannot be significantly greater than it would be if the other company was independent of the parent corporation.
According to the report the APA became effective from the 1st October 2007 and is set to last for a period of 10 years.The nature of the agreement is that the taxation to be paid from SMBV to the Netherlands is set at an agreed rate of 9-12% on a predefined cost base using the transactional net margin method (“TNMM”). The agreement further allows the payment to Alki to be deducted from SMBV’s corporation tax liability in the Netherlands and to not be susceptible to withholding tax in the Netherlands. This form of agreement may be construed as a means for Starbucks to determine the level of taxation that they should be liable for within this jurisdiction. The royalty payments could be manoeuvred to outweigh the tax liability and therefore a company that makes hundreds of millions of euro pays little to no tax. The figures for 2014 are a testament to this. In the same year Starbucks made profits in the Netherlands of €407 million while using this agreement the tax they paid was a mere €2.6 million, an effective tax rate of 0.64%.
The EC decided to initiate proceedings against the Netherlands claiming that they had unjustly provided state aid to Starbucks. They raised three specific concerns over the legitimacy of SMBV’s APA with the Netherlands. The first of which referred to the decision to classify SMBV as a low-risk manufacturer which would benefit them by paying a lower rate of taxation such as that applied. The second issue considered the legitimacy of two adjustments made by Starbucks agents after the conclusion of the APA. Finally, and most significantly, the Commission considered the arms-length principle of SMBV’s royalty payments to Alki. The fluctuation of the amount of income received by Alki and its correlation to the remaining balance after the 9-12% of profit on operating expenses had been drawn concerned the Commission.
The European Commission’s Decision
The decision handed down by the EC should be analysed under the breakdown of Article 107(1) that this paper has given in previous sections. This is in line with the precedent recently endorsed in the CJEU which states that all criteria of Article 107(1) must be met in order for state aid to be considered present.
“Any aid granted by a Member State or through State resources”
In the case before us the APA has been granted by the Netherland’s taxation authority. They are considered a public entity and therefore this can be considered a granting by a member state. As previously mentioned in this paper states failing to collect the adequate amount of tax due to them can also be considered a granting of state resources due to the opportunity cost suffered. This is applicable to the agreement between Starbucks and the Netherlands.
The transfer pricing report delivered by Starbucks’ tax advisors outright fails to distinguish between intra-corporation and independent transactions. This is unequivocal when determining the arms-length nature of the transactions.The repercussions of this are that greater sums of money could be transferred from SMBV to SCTC therefore lowering the liability of tax due to the Netherlands. Secondly, based on the market research conducted from four of Starbucks competitors the status quo for sub-contracting out roasting coffee beans with the exact instructions would not justify a royalty payment being made from the sub-contractor to the contractor.The payment of this royalty from SMBV excuses the excess, after the 9-12% of the cost base is taxed, from also being subject to Netherland’s corporation tax. Finally, the increase in income per green bean received by SCTC from SMBV has no realistic market justification. The increase has resulted in SMBV making unsustainable losses on its roasting activities while still paying a royalty of €22.8 million to Alki in 2013. Once again this is a result of the terms within the APA and has resulted in the Netherlands losing out on tax revenue.
“Which distorts or threatens to distort competition”
The criterion for distorting or threatening to distort competition is almost immediately met where an entity receives a financial benefit that is not received by similar entities. This has been satisfied as noted above.
Previous articles in this series mention a two tier system where distortion can apply. Firstly, the APA agreement with SMBV distorts competition by increasing the competitive position of Starbucks in the Netherlands while competitors in the same jurisdiction are not susceptible to the same taxation benefits. Secondly, the fact that the Netherlands operate within the EU’s free trade market any benefit bestowed upon Starbucks in the domestic market has repercussive effects on the European common market.
“Favouring Certain Undertakings”
This aspect of the judgement caused the most controversy for two main reasons: the incorrect reference system being used; and the different interpretation of the arms-length principle set in the OECD’s Model Tax Convention.
The CJEU has created a three step test for determining if state aid had been selectively advantageous in their judgement for Paint Graphos. This test is assessed by looking at the usual tax system that would be applied to similar organisations; it then focuses on any deviation from this system; and finally it concludes whether the deviation is justified in the circumstances.
The European Commission determined that the system used should be the generally applicable system for corporation tax in the Netherlands. This was disputed by the Netherlands as they conceived that the APA is being granted to a group company and therefore the agreement should be judged against other group companies in similar factual and legal situations. The EC then stated that there should be no distinguishing rules applied to group or individual companies that compete in the same market and to do so could be considered granting a select advantage. The interesting and controversial facet of this ruling is that it contradicts the earlier decision granted by the EC in Groepsrentebox in which they stated
“Finally, the Dutch authorities support the confederation’s view that in order to establish whether there is selectivity… the relevant frame of reference consists of all companies that are part of a group.”
The incorrect application of the general Dutch national law to Starbuck is one of the points of appeal. The Netherlands believe that the reference system should include only group entities as they are the basis for interpretation of the arms-length principle set out in Article 8b of the Dutch Corporation Tax Act 1969 (Wet op de Vennootschapsbelasting 1969) (“CIT”). This deviation from the principle which states the entities must be in the same legal position could be construed as the EC actively seeking out any means possible to support their case against Starbucks not matter how unjustifiable. The inconsistency of judgements and test laid down in the CJEU regarding state aid has been recognised by legal practitioners and scholars. The case before us is no exception as demonstrated by the points raised in this section.
The issue regarding the interpretation of the arms-length principle concerns the vague and subjective nature of the OECD’s guidelines. The OECD is a soft law instrument that can be interpreted in a number of compliable manners in a cross-jurisdictional analysis. The Netherlands have interpreted the arm-length principle as per the guidelines in article 8b(1) CIT. However, in arriving at their decision the EC rejected to examine the national interpretation of arms-length between Alki and SMBV, and SCTC and SMBV. They instead insisted that the OECD Guidelines (on which article 8b(1) CIT are based) did not provide the ideal definition of arms-length for the purpose of Article 107(1) and instead based the definition on the “general principle of equal treatment in taxation”.
The lack of consideration from the EC regarding the national interpretation of the internationally endorsed OECD guidelines is a point that is certain to be subject to much controversy. The Commission should not feel that they have the power to overlook a national interpretation on such an instrument just because they are in disagreement with it and insist that member states follow their elucidation. This behaviour could be deemed dictator-like which would be unsettling within the relatively democratic EU. The transition of creating a hard law principle from an international soft law instrument in such a manner as this has been described as overrunning the sovereignty of national taxation principles.
In summary, the EC failed to present any substantial case for the selective nature of the benefit being granted. They inadequately applied a referencing system that did not consider the legal position of the group company in order to create a stronger case against Starbucks. Similarly, they ignored domestic legislative interpretation of international principles in favour of their own understanding as a mechanism for reinforcing their case. In light of these two reasons, and in conjunction with the facts laid out in the above sections, the author understands that the judgement should be overturned on the basis on law.