An in-depth investigation has opened to examine whether five tax rulings granted by the Dutch tax authorities to two Dutch entities of the Nike group of two Nike group companies based in the Netherlands (Nike European Operations Netherlands BV and Converse Netherlands BV) between 2006 and 2015 have given Nike an unfair advantage over its competitors, potentially in breach of EU state aid rules.

Paradise Papers

This investigation does not directly imply that the European Commission has already reached a verdict, it means that the European Commission has doubt about specific rulings granted by the Netherlands that could contain state aid elements.

In particular, the European Commission’s concern focuses on the method used to calculate royalty payments endorsed in the tax rulings contrary to the arm’s length principle.

Nike was among a group of companies highlighted in the so-called Paradise Papers. In June 2018, Nike Chief Tax Officer, Patti Johnson, answered questions from the TAXE special committee created in the EU Parliament looking into tax evasion and tax avoidance.

In 2013, the Director-General for Competition, Commissioner J. Almunia, announced the investigation of tax ruling practice of Cyprus, Malta, U.K., Netherlands, Ireland and Luxembourg. This work continues with the current Director-General for Competition, Commissioner M. Vestager, whose mandate (2014–19) is a crusade against potentially selective tax rulings.

Following the Paradise Papers leak, the European Commission intensified its investigation and requested additional information from the Netherlands.

Responding to news of the Nike investigation, the company said: “We believe the European Commission’s investigation is without merit.” It added that Nike was “subject to, and rigorously ensures that it complies with, all the same tax laws as other companies operating in the Netherlands.” The Dutch finance ministry said it would cooperate with the European Commission’s investigation.

What Next?

The Directorate-General for Competition will have to prove the aid element in the tax ruling investigation and the Dutch authorities will have to prove that the tax rulings granted are not selective or if the derogation from the reference system can be justified. Nike has to prove that they have paid fair taxes. After the investigation the European Commission can issue a negative decision with recovery or a no state aid decision.

In a recent press release, it was stated that: “the Netherlands have announced plans for a broad reform tightening the requirements for tax rulings concerning international structures. For example, no rulings will be granted if a tax structure involves a tax haven or if the purpose of the ruling is essentially to avoid Dutch or foreign taxes. Moreover, to enhance transparency and consistency, all Dutch tax rulings involving international structures will be centrally managed and monitored, and the tax authorities will publish an anonymous summary of all these rulings. Finally, the Netherlands have also announced plans to introduce a withholding tax on interest and royalty payments made to companies in tax havens.”

Nike also faces a separate EU antitrust case into its sales practices with the Directorate-General for Competition. The anti-trust directorate will examine whether the company illegally restricts traders selling licensed merchandise outside one country or online.

Outcome of the Preliminary Investigation

Nike European Operations Netherlands BV and Converse Netherlands BV are two Nike companies based in the Netherlands.

These two operating companies develop, market and record the sales of Nike and Converse products in Europe, the Middle East and Africa (the EMEA region). They have more than 1,000 employees and are involved in the development, management and exploitation of the intellectual property ("IP") rights relating to, respectively, Nike and Converse products.

The two companies obtained the licenses, in return for a tax-deductible royalty payment, from two Nike group entities, which are currently Dutch entities that are “transparent” for tax purposes (i.e., not taxable in the Netherlands). In contrast with the two BVs mentioned, the recipients of the royalty are Nike group entities that have no employees and do not carry out any economic activity.

From 2006 to 2015, the Dutch tax authorities issued five tax rulings, two of which are still in force, endorsing a method to calculate the royalty to be paid by Nike European Operations Netherlands BV and Converse Netherlands BV for the use of the IP.

The European Commission added in its statement that the royalty payments endorsed by the tax rulings seems not to reflect the economic reality and appeared to be higher than what independent companies negotiating on market terms would have agreed between themselves in accordance with the arm’s length principle (commercial and financial transfers between associated enterprises should not differ from the arrangements that would be made between independent companies). As a result of the rulings Nike’s BVs are only taxed since 2006 in the Netherlands “on a limited operating margin based on sales.”

The European Commission is not questioning the tax ruling practice of the Netherlands as a scheme but specific individual rulings. This investigation concerns individual tax rulings and should, therefore, not directly impact other taxpayers. Also, the European Commission has stated that the Nike group’s corporate structure itself is outside the remit of EU state aid rules.

Tax Ruling, Transfer Pricing and State Aid

The Directorate-General for Competition clarified the relation of tax rulings and state aid in the 2016 communication on notion of aid.

According to the communication, tax rulings are fine if established in advance of the application of the ordinary tax system to a particular case, as a result of specific facts and circumstances. It can create certainty and predictability on the application of general tax rules, which is relevant for taxpayers, but always have to respect state aid rules.

The economic advantage in the case of tax rulings exists if in the absence of state intervention an undertaking would not have been obtained under normal market conditions from what is recognized in the tax ruling.

If a tax ruling endorses a result that does not reflect in a reliable manner what would result from a normal application of the ordinary tax system, that ruling may confer a selective advantage if it is recognized an unjustified exclusion of income in the taxable base in favor of the company receiving this ruling.

The question is, under what conditions do tax rulings (containing advance transfer arrangement) constitute state aid?

A system which is based on methods accepted by the Organisation for Economic Co-operation and Development ("OECD") guidelines is not open to objections. If a transfer pricing arrangement complies with the OECD transfer pricing guidelines and thus within the arm’s length principle, it is unlikely to give rise to a state aid investigation.

Nevertheless, the OECD recognizes, depending of the type of transactions and how the company operates in the market, other methods when the determination of prices equivalent to arm’s length prices are difficult.

In matters relating to tax rulings that include a transfer pricing agreement (e.g. Apple, Fiat, Starbucks, and Amazon), given the limit of the Directorate-General for Competition attributions regarding the fiscal sovereignty of the states, it is questionable to state that when the tax authorities recognize the application of a specific transfer pricing method instead of the arm’s length they do so based on the wide margin of discretion they enjoy and automatically derives a selective advantage and hence illegal state aid.

It all comes down to whether national law is properly complied with. If the method used by the taxpayer (that differs from the arm’s length principle) can be justified by the basic or guiding principles of that tax system, and the law in itself does not contain characteristics that gives it a selective advantage.

Readers should consider that if the tax authorities accept a tax position by a taxpayer, and after having looked in to it, this turns out to be advantageous in comparison with other tax audit results, it could amount to aid even in the absence of any tax ruling.

Planning Points

This investigation seeks to penalize the tax ruling containing a transfer pricing method in contradiction with the arm’s length principle.

The Directorate-General for Competition has pushed to tighten tax rules in accordance to state aid regulations, but they have not been named as a supra tax authority which can oblige a member state to change their corporate income tax (fiscal policy is an element of the sovereignty of member states that depends on tax collection) but they can push for changes in the tax code in accordance with state aid regulation.

This investigation concerns individual tax rulings and as such should not directly impact other taxpayers.

Examine the tax ruling and potential selective elements in order to quantify the risk. Tax adjustments, due to a recovery decision, will cause serious economic damage to a company, without mentioning the administrative burden.

Dr Patricia Lampreave is an independent European tax/state aid expert and tax professor (Intituto de Estudios Bursátiles, Universidad Complutense) and former senior policy officer on taxes, European Commission.

She may be contacted at patlampreave@icam.es.