European Union regulators sent a warning to any company usingfees on intellectual property rights to shift profits away from thetaxman—slapping Amazon.com Inc. with a 250 million-euro ($294million) bill and giving Luxembourg another rap on theknuckles.

The EU took a dim view of a structure that allowed Amazon toslash its taxable profits in Europe over about a decade bychanneling them to a tax-free unit located in Luxembourg that wasmeant to license the technology behind its web shoppingplatform.

Officials found one big problem with the arrangement: The unitwas just a shell company, how could it therefore performcomplex duties such as licensing and managing intellectualproperty? Impossible, according to the EU. Both Amazon, which is amajor employer in Luxembourg, and the country's government denythey broke any rules.

As EU Competition Commissioner Margrethe Vestager put itWednesday, “an empty shell” with “no employees, no offices and nobusiness activities” can't possibly perform activities that wouldallow it to lay claim to billions of euros of royalty revenue. Yetaccording to the EU, that's just what Luxembourg allowed thecompany to do, in breach of its own tax rules.

“It's not enough to put IP rights in an empty shell and claimthat all the revenue that generated these IP rights should beawarded from a tax perspective to that empty shell,” said EdoardoTraversa, a professor who specializes in tax law at Belgium'sUniversite Catholique de Louvain.

Traversa pointed the finger at Luxembourg, referring to a timewhere its tax authority appeared to have been rubber-stamping taxarrangements via what are known as rulings “without too muchscrutiny.”

Clients “would basically write the ruling and then theLuxembourg tax administration would sign it,” he said in aninterview. Luxembourg's policy has completely changed since.

Lots of U.S. companies—including health care firms like Merck& Co. and tech firms like Facebook—move theirintellectual property assets to tax havens overseas. From there,they effectively rent out their core innovations to operating unitsof the same company.

Such techniques are usually perfectly legal but, in Europe,they can run afoul of the EU's state-aid rules when governmentsallow special exemptions to the detriment of other companies.

For tax purposes, the EU considers that transactions between amultinational's subsidiaries should be set at the same price anunrelated company would pay, a concept that is known as thearm's-length principle. In the Amazon case, given that the unitcollecting royalties had no employees, the EU said it's hard toexplain how the payments could be justified.

The Amazon decision comes a year after a record 13billion-euro tax recovery-order against Apple. It's one of agrowing list of cases in the EU's crackdown on loopholes thatstarted in 2013, when watchdogs started to root out deals among thethousands of otherwise legal tax pacts governments have arrangedfor companies for years. At stake in all these decisions arebillions of euros squirreled away in tax havens, out of the reachof authorities in the countries where they make most of theirsales.

The set-up criticized by the EU was put together in themid-2000s when Amazon transferred its IP rights to a Luxembourgsubsidiary. Up until 2014, the Luxembourg unit, called AmazonEurope Holding Technologies SCS, or AEHT, recorded royalty revenueof about 5.2 billion euros before adjustments for inflation andexchange rates.

Amazon, which said it will have 65,000 employees in Europe bythe end of this year, about 1,500 of whom will be in its LuxembourgEU base, has defended its tax payments in the region.

It asserts that regulators there are mistaking high revenue forhigh taxable profits. It has argued its profits there have beencrimped by heavy investments in the IP and strong competition.

Luxembourg's finance ministry said on Wednesday it “considersthat the company has not been granted incompatible state aid.”Amazon also disagreed with the EU's assessment and said it willconsider an appeal at the bloc's courts.

To move revenue from Amazon's e-commerce businesses in France,Germany and Britain, those units first made royalty payments to thecompany's European operating subsidiary in Luxembourg, calledAmazon EU Sarl, the EU said. That unit is subject to taxes, but itslashed its taxable income by making deductible royalty payments tothe tax-free AEHT unit for the regional sites' use of Amazon's webshopping platform and trademarks.

Huge Chunk

With Wednesday's decision, the EU simply decided to reallocate ahuge chunk of profits to the taxable Amazon EU Sarl unit. That movewill cost the internet retailer about 250 million in back taxes andshows other multinationals what sort of profit shifting just won'tfly in Europe.

Amazon is the fifth in a series of EU decisions against specialtax deals and appeals by the governments and companies concernedhave been piling up in the bloc's courts.

“It may take several years before the first cases are settled,”said Raymond Luja, tax professor at Maastricht University, and alsocounsel to law firm Loyens & Loeff in Amsterdam. “Theseprocesses could take many years, and the commission can't simplywait and see what the final outcome is in the meantime.”

“For the commission, dealing with transfer pricing is a learningprocess as well and we may gradually see a change in how theyapproach transfer pricing” and the application or not of“anti-tax-avoidance measures in the near future,” said Luja.

From: Bloomberg News

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