Clark Armitage Weighs in on Amazon Case Against European Commission in Tax Notes

Although the EU General Court reached different conclusions in Amazon and Engie, its decisions in both cases illustrate the limits of state aid law as a transfer pricing enforcement tool.

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The General Court’s rejection of what Donohue described as a “novel” set of arguments may reflect a misplaced focus on transfer pricing as a target of state aid enforcement, according to some observers. J. Clark Armitage of Caplin & Drysdale said a fundamental issue that connects Amazon with other state aid cases targeting transfer pricing arrangements is that the real issue isn’t actually transfer pricing. The untaxed income that drew the commission’s scrutiny in Amazon was ultimately caused by Luxembourg’s tax treatment of the intellectual property holding company, which was treated as a partnership and subject to no entity-level tax, and its foreign partners, Armitage said.

“A bunch of these cases — Fiat, McDonald's, Apple, and Amazon — all suffer from the same thing, which is they're trying to use transfer pricing to challenge something that has nothing to do with transfer pricing,” Armitage said. “You can't use transfer pricing to attack the way the laws are structured to encourage low-tax local investment. You’ve got to use a different tool.”

To the extent that Amazon’s European transfer pricing practices were inconsistent with the arm’s-length principle, the issue would be better addressed by national tax authorities’ examination of the Luxembourg operating company’s transactions with the individual European affiliates, Armitage said.

Armitage criticized multiple aspects of the commission’s transfer pricing analysis, noting that the minimum and maximum royalty thresholds may not be as arbitrary as they appear and that reimbursing the holding company’s cost-sharing payments at cost would ignore the investor risk that Amazon faced during its European expansion effort. More broadly, he questioned whether there is any one authoritative interpretation of the arm’s-length principle that can appropriately serve as a baseline for assessing selectivity.

The parties’ dispute in Amazon over the relevance of concepts added to the OECD transfer pricing guidelines after the relevant APAs illustrates the problem noted by Armitage. In arguing that the Luxembourg holding company was not entitled to the residual returns associated with the cost-shared Amazon IP, the commission emphasized that the entity merely sublicensed IP rights to the operating company without performing or controlling any of the functions associated with the development, enhancement, maintenance, protection, and exploitation (DEMPE) of the IP. The guidance on DEMPE functions, which was incorporated into the OECD transfer pricing guidelines by the base erosion and profit-shifting project's report on actions 8-10, remains one of the most controversial aspects of the OECD guidelines.

Armitage agreed with the General Court’s holding that the DEMPE guidance was a substantive change, not a mere clarification that should be retroactively applied. But the ongoing disagreement regarding the DEMPE guidance raises the possibility that endorsing a relatively common interpretation of the arm’s-length principle could be construed as state aid, he said.

“DEMPE could be a place where the Luxembourg's rules are noncompliant with the OECD guidance, but I guess the question is: Are they required to adopt the OECD guidelines when it comes to transfer pricing? The [commission’s] assumption is that DEMPE is definitely part of the arm's-length standard, but a lot of people don't agree with that,” Armitage said. “Is it state aid to disagree with how to interpret transfer pricing rules?”

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