Amazon‘s European tax arrangements have long seemed a little suspect. On Friday 16 January, a 23-page letter sent by the European Commission to the government of Luxembourg in October was published which formally indicated that EU investigators believed they had found compelling evidence of wrongdoing.
The basic issue is simple: Luxembourg is alleged to have allowed Amazon to pay too little tax on profits accrued within the European Union. The mechanics which have allowed this to continue unchecked, however, are extremely complex, involving a web of holding companies, artificially-induced losses and royalty payments between different companies within the Amazon group, which is headquartered in Seattle, America.
The allegations levelled by the European Commission specifically relate to a ‘sweetheart‘ tax deal agreed in November 2003 between Amazon and Luxembourg, where Amazon‘s European headquarters are located. The gravity of the situation is increased by the fact that the deal took place during incumbent EU commission president Jean-Claude Juncker‘s 18-year presidency of the Grand Duchy.
Legally, the final issue is not one of tax evasion by Amazon but of an on-going illegal state subsidy provided by the Luxembourgish government to the e-commerce giant in the form of uncollected corporate taxes since the 2003 deal. In the EU‘s view, Luxembourg effectively allowed Amazon to operate in Europe with a cap on the level of its profit which was liable for taxation. This allowed the company to pay a fairly predictable amount of corporation tax on its European profits each year, in breach of EU law.
At the centre of the investigation are repeated ‘royalty‘ transfers between Amazon EU SÃ rl – Amazon‘s main European retail operation – and another subsidiary based in Luxembourg, Amazon Europe Holding Technologies SCS (AEHT).
Amazon EU SÃ rl made sales of â‚¬13.6bn in 2013 but posted pre-tax profits of just â‚¬23.3m. A large part of its ‘costs‘ consisted of royalties and license agreements paid to AEHT – under Luxembourgish law these kind of transfers are not taxable. The alleged breach of EU law relates to the way that corporate profits are taxed, in particular relating to a concept known as ‘transfer pricing‘. The EU Commission‘s letter lays out transfer pricing as follow:
“Transfer pricing refers to the prices charged for commercial transactions between various parts of the same corporate group, in particular prices set for goods sold or services provided by one subsidiary of a corporate group to another subsidiary of that same group.
The prices set for those transactions and the resulting amounts calculated on the basis of those prices contribute to increase the profits of one subsidiary and decrease the profits of the other subsidiary for tax purposes, and therefore contribute to determine the taxable basis of both entities. Transfer pricing thus also concerns profit allocation between different parts of the same corporate group.”
There is nothing illegal per se about transfer payments as long as they are not in breach of an ‘arm‘s length‘ principle – in other words, the principle of arm‘s length dictates that transfer payments between subsidiaries in the same overarching group must be priced as if they are transactions between independent companies.
The commission‘s letter goes on to state: “It appears that [the tax arrangements between Luxembourg and Amazon] are used to ensure a relatively predictable level of taxable profit; they do not seem to be based on any arm‘s length reasoning. The transfer pricing arrangement put in place by Amazon and accepted by the contested tax ruling effectively contains a cap on a remuneration which seems too low.” In practice the cap is less than 1% of Amazon‘s European operation‘s total corporate profits: approximately â‚¬75m in 2013.
The Commission alleges that this “profit ceiling” fails to fully re