On August 30th, the European Union (EU) Commission ordered the Irish government to reclaim some $14.6 billion of so-called back taxes plus interest from Apple Inc. The order challenged sovereign tax authority within the EU and well-established international tax rules. The aggressive stance of the Commission set off a furor of high level political argument among taxing authorities and multinational companies accustomed to complex but legal international tax planning. Apple's case was big enough to place it at center stage in a simmering problem for governments in striking a balance between attracting businesses, creating jobs, generating taxes and deciding precisely what type of earnings can be taxed.

In a testament to how strange the taxing regimes have become, the Irish government has protested loudly and is reluctant to take the nearly 15 billion the EU says it is entitled. When small countries turn down such sums, it should be clear that the stakes are much higher.

With uncontrolled socialism and Keynesian monetary policies killing economic growth around the world, governments have ever greater need to wring revenue from the relatively stagnant pool of corporations and wealthy individuals. While the crackdown on personal tax havens, in Switzerland and the Channel Islands for instance, has been largely successful, corporations have become extremely adept using legal loopholes and creative international accounting to move revenues from high tax jurisdictions to countries where rates are lower. As of October, Reuters reported that U.S. based companies have some $2.1 trillion parked abroad in order to avoid high domestic taxes. Apparently Apple, the world's largest company by market capitalization, accounts for over $180 billion of this total.

The U.S. corporate tax rate of 35 percent is widely considered to be uncompetitive and even excessive when compared with Ireland's 12.5 percent rate (and even the 20 percent in the UK). It is an old adage that capital flows to where it is treated best. Ireland rolled out the red carpet for Apple, a decision that greatly benefited both.

Apple established a company in County Cork, Ireland in October 1980, sometime before Apple blossomed financially. Since then, Apple has become one of the largest taxpayers in the world and, according to its CEO, Tim Cook, the largest taxpayer in Ireland where it employs almost 6,000 people, mostly in high paying jobs, adding great benefit to the Irish economy both directly and by encouraging copycat corporations. (A Message to the Apple Community in Europe, 8/30/16)

In the last quarter, Apple paid nearly $3 billion in taxes or about $12 billion at an annual rate. Naturally, by using such mechanisms as licensing, pricing differentials and overhead allocations, profits, unlike sales revenues, are somewhat mobile. This is so especially since high value commerce evolved from trading physical goods to intellectual property.

The World Bank reports that in aggregate (2015) the EU is the world's second largest economy. However, despite its population of over 510 million, the EU has failed to spawn new technology giants such as Apple, Google, and Amazon. Many observers blame the socialist and over-regulated nature of the EU. Certainly these factors provided reasons for the Brexit vote in June 2016. Many feel that the Brexit vote may have persuaded EU officials to soften their regulatory aggression, out of fear of encouraging other countries to seek the exits. Regardless, for some two years, the unelected EU Commission has been investigating the theoretical tax liabilities of U.S. companies such as Apple, Google, Amazon, McDonald's and Starbucks.

Until August 30th, all EU member countries were free to establish their own tax regimes. The EU's order for Ireland to demand some $14.6 billion in 'back' taxes from Apple was an unexpected and unabashed power grab by unelected EU regulators over the democratic government of Ireland. The assessment did not result from the non-payment of an actual tax but on a theoretical tax that the EU Commission felt should have applied. This is a bold move.

EU Competition Commissioner Margrethe Vestager described the prior arrangements made between Apple and the Government of Ireland as an "inconsistency" or state aid, illegal under the EU rules. The Irish finance minister, Michael Noonan, said that his government would appeal the decision, adding that it was "...necessary to defend the integrity of our tax system; to provide tax certainty to business; and to challenge the encroachment of EU state aid rules into the sovereign Member State competence of taxation." (Lexology, Ronan Daly Jermyn, 8/31/16)

Understandably, the Irish government is balking at what it sees as EU overreach into Ireland's sovereign right to administer its own tax affairs. They maintain there was no 'special' or 'sweetheart' deal. Meanwhile, some UK government ministers, soon to negotiate their freedom from the EU, reportedly told The Daily Mail that they see the Commission's demand as representing a significant "opportunity" for the UK to attract more international companies.

The U.S. government is faced with somewhat of a conflict. Bloomberg reported a U.S. Treasury spokesman illustrating this point when he said, "We believe that retroactive tax assessments by the [EU] commission...call into question the tax rules of individual [EU] Member States. ..." That all sounded very fair and pro free enterprise. But then, in a stinging globalist sentence, the Treasury spokesman added, "...we will continue to work with the [EU] commission toward our shared objective of preventing the erosion of our corporate tax bases." (Nate Lanxon, 8/30/16)

The U.S. Treasury has described the EU ruling as "deeply troubling." The U.S. Congress is bringing pressure on Treasury Secretary Jacob Lew, urging him to consider retaliation including taxes on European companies and individuals. Meanwhile, Secretary Lew maintained in a speech at the Brookings Institution that the EU Commission "is using a theory to make tax law, is doing it in a way that is retroactive and that overrides national tax law authority." (Alan Rappeport, The NY Times, 8/31/16)

Apple is just one of the companies holding profits offshore to avoid paying U.S. taxes. According to Bloomberg, Apple has $232 billion in cash, of which about $214 billion is held outside the U.S. with its 35 percent corporate tax rate. The thought that the EU might grab some of the offshore money may reinvigorate Congress to revise the complex U.S. tax code. In other words, allow repatriation now to avoid the grasping claws of foreign governments later. It may even pressure Congress to bring the U.S. corporate tax rates down to more competitive levels.

It is conceivable that the litigation will continue over the next three or four years. Whatever the EU court decides ultimately, the ramifications for international commercial tax planning could be profound. It might lead to major changes in corporate structures. Investors should be aware that this issue could affect corporate profitability to an important degree.

Most importantly, the affair provides a clear example of how high taxes kill growth. Regrettably, those lessons appear to be lost on regulators on both sides of the Atlantic.

Read the original article at Euro Pacific Capital