In the dim and distant past the apple tree was planted into the Irish soil.
Steve Jobs, the true icon of innovation and entrepreneurship elevated us to a very different plateau of computer usage. Hasn't he created a new market? This visionary man, nicely described in Walter Isaacson's book, was also a mercurial entrepreneur.This is why Jobs's ways of doing business are the object of managerial studies. Feeling a good opportunity, as the Irish economy in the early 1990's was in a rather moderate shape, Apple decided to take advantage of it and settle two companies, which played a key role in Apple's European activities. Apple applied for an individual fiscal decision upon which the both companies were allowed to include certain corporate costs as tax deductible expenses, which allowed Apple’s companies based in Ireland to pay virtually no taxes. Pursuant to a sharing agreement, both companies (Apple Sales International and Apple Operations Europe) were obliged to pay for R&D activities processed by Apple Inc.
Since 1991 Apple’s activities in Ireland were flourishing and the country was developing well. It would be untrue to say that Apple’s presence in Ireland disturbed the country, what is more- it definitely helped it. Everything worked well until June 2014 when the European Commission launched the investigation in order to find out if Ireland granted the state aid which could be defined as an illegal one. Following a number of analyzed facts and documents, the Commission issued a decision, stating that Ireland granted an illegal state aid to Apple (it is interesting which company is supposed to be a beneficiary of this aid, but we will see it as the decision is published). The decision says that Apple must pay back to Ireland an aid worth up to 13 billion EUR plus a given interest. All the facts and circumstances are described well in the Commission’s press release and in numerous articles and posts, including one from Neelie Kroes dealing with the question if the Commission is empowered to monitor the transfer prices through state aid regulations, thus I will not deliberate on what has already been stated.
The facts are as follows:
- Apple setup the business in Ireland using incentives granted by the Irish government
- Apple subsidiaries paid virtually no taxes in Ireland due to transferred profits to Apple Inc.
- The Commission opened an investigation on illegal State aid
- The decision has been issued stating that Ireland is obliged to recover 13 bln EUR from Apple due to illegal State aid granted in 1991.
The question remains open: can we draw a lesson from this case?
The notion of the State aid and its meaning in the real economy
The EU Treaty states that all measures that meet factors defined in art. 107.1 constitute the state aid and thus shall not be applied by member states. There is also a number of exclusions from this general rule, but a measure must meet given conditions then. As there has always been a dispute on what measure constitutes the state aid and how such analysis should be conducted,the European Commission has issued guidelines (the notice) providing factors that should be taken into consideration in the state aid analysis. This document deals with the notion of the state aid, and in brief words lays down that a given measure will be defined as a state aid only if all herein below stated factors are met:
- the beneficiary is an undertaking, which means, that it is insignificant what formal status one has, the real activity on the market plays the crucial role,
- a measure is imputable to the state and is granted directly or indirectly through State resources, so one must speak of the collusion of two factors combined: one- the state obliges a given company (companies) to proceed with a certain activity and two - the state provides resources for this defined activity,
- circumstances of the state intervention must provide the company (companies) with a selective advantage which is not available in normal economic conditions; this one is quite tricky, due to the very question - what are "normal market conditions" and how one can ever be in the position to make solid rock statement regarding this definition,
- a measure must be capable of affecting the competition; generally speaking, if a beneficiary is defined as an entrepreneur - regardless of the formal issues, has absorbed a selective advantage, one may be certain, that this notion will be fulfilled (excluding some specific cases),
- last but not least, a measure has to have an effect on trade between Member States, which brings the conclusion that once a beneficiary has had the previous notions fulfilled, in the majority of cases, the notion in question will be also fulfilled.
Apple and the state aid…?
Once all factors are fulfilled, a measure is considered to be given a state aid and certain procedures must be applied in order to make sure that it is in line with EC Treaty. In the Apple case we can be pretty sure that all state aid notions were fulfilled save one - the notion of selective advantage. As it was written by Rob Gehring in Comparing Apple with oranges there is a question whether Apple really received an advantage that could not be reached by other companies. If the Commission does not raise any doubts towards Irish tax system, it will be in trouble, as Apple will tackle this decision. But I do not want to debate on the case before the decision is published.
The Apple case gives rise to address the question of whether companies should include "state aid risk" into the scope of manageable risks that they are facing.
As we can assume, Apple has decided to invest in Ireland not only due to nice people (which might also be taken into consideration) . The Irish climate did not play a vital role in the investment process as well, did it? Apple's attention was triggered by economic incentive, i.e. tax ruling. This element presumably played a significant role in that given CAPEX. If the measure that might be defined as a state aid plays a significant role in a company's activity, one might come to the conclusion that this risk should be managed, it must be quantified and then processed.
Will a state aid issue be always a sleeping dog or one should rather prepare procedures and tools to reduce the risk of recovering the aid granted. The recovery of an illegally granted state aid should not be treated as a penalty (as the EC claims) but for every company it is a great deal. The gravity of this issue may be devastating.
In such circumstances, the state aid risk management might play a vital role in the company's investment processes. In order to introduce the designed system properly, one must include a proper mix of law and economic knowledge. But how should such a system be designed?
The first issue that should be covered is answering a general question - what are the risk generating areas of the company's business. Then, design a structure that would be engaged in the decision making process. Stating the aid risk management is not only going through the state aid notions (as mentioned above) but it is projecting alternatives and drawing alternative scenarios as well. And to do so, in a manageable manner, every risk should be quantified.
Quantification of the state aid risk is not an easy task, but it might help with doing business. How would it help, one might ask. Well, the answer is simple:
You adopt a lean learning method, by preparing yourself for more then one scenario and then adjust the strategy as the time flies by.
In order to do so, one must understand that introducing state aid into the project's financial structure, requires acceptance of certain risks. One of them is the risk that may be the pivot done by authorities. That is why, it is crucial for the organization to have internal procedures of measuring the abilities of coping with state aid related risks. The more state aid oriented business you have, the more attention should be dedicated to cover this matter.
One may take a step forward and ask some perfect question: how should it be designed and then executed? In the second part of the article I will put some light on the crucial points that must be taken care of. TBC...
Verified by Małgorzata Rogala - MiG School of English