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From the Double Irish to the Bermuda Triangle by Joseph P (C) Tax Analysts 2014. All rights reserved. does not claim copyright in any public domain or third party content. From the Double Irish to the Bermuda Triangle by Joseph P. Brothers In brief, the Irish Finance Department’s decision to Joseph P. Brothers is an toughen Ireland’s idiosyncratic corporate residency de- associate with Caplin & termination rules is unlikely to significantly impede the Drysdale in Washington. basic mechanics of the strategy or to allay the EU’s The ‘‘double Irish’’ tax concerns. The double Irish structure depends most cru- planning strategy em- cially on the U.S. check-the-box entity classification ployed by Apple and other rules to create a hybrid entity mismatch arrangement, multinational companies as well as the cost-sharing provisions of Treas. reg. sec- has been in the main- tion 1.482-7. stream press of late, as At its most basic level, the point of the structure is has the challenge brought simply to shift income from an Irish operating subsidi- by the European Union. This article explains ary into a holding company located in a zero-tax juris- how the strategy works, the gist of the EU diction, while also avoiding inclusions to the U.S. par- position, and the reaction of the Irish govern- ent that might result from outbound intellectual ment. property transfers. From the U.S. perspective, the oper- ating subsidiary is disregarded under the check-the-box regime so that the cash flowing into the holding com- ecently, the EU’s antitrust and competition regu- pany does not trigger subpart F inclusions to the U.S. Rlators have criticized aspects of the so-called parent. At the same time, the separate status of the double Irish arrangement, suggesting that some details holding company is recognized for Irish tax purposes of this scheme constitute unlawful state aid from the so that these payments can be deducted against the Republic of Ireland to Apple in contravention of ar- taxable income of the Irish subsidiary. The structure ticle 107(1) of the Treaty on the Functioning of the depends in large part on the cost-sharing rules of European Union (TFEU). The investigation relates spe- Treas. reg. section 1.482-7 to avoid the possibility of cifically to Apple, but similar complaints could be deemed royalty inclusions under section 367(d) or lodged against many other firms who employ the other transfer pricing adjustments between the U.S. par- scheme (or parts of it). ent and the foreign subsidiaries. By contrast, Ireland’s current management and con- This article is divided into four parts. Section I de- trol test for corporate residency (the rule behind the scribes the mechanics, beginning with a generalized double Irish neologism) plays a much smaller role in ‘‘double Irish Dutch sandwich’’ avoidance structure. At the structure compared with the other elements. It also each stage, the ways in which Apple’s use of the has attracted outsized media and regulatory attention double Irish structure differs from the typical arrange- compared with the more important factors. It appears ment are identified. Section II articulates the basic ele- that the EU is attacking the wrong target. It is focusing ments of the state aid doctrine under EU competition on Irish domestic tax law, when the real culprits, if any law and how it is relevant to the current controversy. It exist, are: also describes and analyzes the EU’s investigation of • the U.S. check-the-box rules; Apple. Section III describes measures recently under- taken by Ireland’s Finance Ministry in response to the • the U.S. cost-sharing safe harbor under Treas. reg. criticism. Section IV is devoted to commentary. section 1.482-7; and TAX NOTES INTERNATIONAL NOVEMBER 24, 2014 • 687 FEATURED PERSPECTIVES • the general international tax principle that wholly U.S. parent company and Ireland HoldCo jointly owned shell entities located in tax havens (regard- develop the IP embedded in the business’s products. (C) Tax Analysts 2014. All rights reserved. does not claim copyright in any public domain or third party content. less of whether the term ‘‘located’’ means incor- These entities typically enter into a cost-sharing ar- porated, managed, or something else) should be rangement in order to jointly fund and develop new IP respected as economically independent entities (such as new software code). Under this arrangement, rather than mere instrumentalities of their parent the U.S. parent typically retains the domestic IP rights companies or overall corporate groups. as well as legal ownership of the IP, with Ireland Accordingly, the Irish Finance Department’s re- HoldCo making a buy-in payment in exchange for the sponse (changing Ireland’s corporate residency rules so right to co-develop and exploit the software in the for- that the double Irish may give way to the Irish- eign marketplace. Ireland HoldCo sublicenses the for- Bermuda) will likely prove unsatisfactory to the EU. eign IP rights to Ireland OpCo in exchange for a roy- alty payment (in a Dutch sandwich scenario, there is I. Mechanics of the Strategy an additional layer of sublicensing, this time from Ire- land HoldCo to Netherlands HoldCo, and then from This section describes in broad terms a generalized Netherlands HoldCo to Ireland OpCo). Ireland OpCo or prepackaged double Irish or double Irish Dutch is responsible for manufacturing and selling digital sandwich structure, and at each stage describes whether products to customers in Europe and elsewhere. and how Apple’s specific structure differs from this generalized model. Ireland OpCo is taxed on income from sales to Eu- ropean customers at the Irish ‘‘trading income’’ rate of A. A Generalized Structure 12.5 percent. However, the entity’s taxable income base A typical version of the double Irish or the double is reduced via the deductible royalty payments flowing Irish Dutch sandwich structure involves at least three up the corporate structure to Netherlands HoldCo or or four business entities. The group’s top level parent is Ireland HoldCo. In Apple’s case, the company’s usually tax resident in the United States. In Step 1, the equivalent of Ireland OpCo does not actually subli- parent entity forms a wholly owned entity organized cense the IP from further up the corporate chain; in- under the laws of Ireland but managed and controlled stead, it may simply sell its digital products with the IP in a tax haven such as Bermuda (hereinafter ‘‘Ireland embedded in its product inventory. HoldCo’’). In Step 2, Ireland HoldCo forms another On the U.S. side, the parent minimizes potential wholly owned entity at a level one tier below, which is subpart F inclusions by checking the box and electing organized, managed, and controlled in Ireland (herein- to treat Ireland OpCo as a disregarded entity (along after ‘‘Ireland OpCo’’). The lowest level operating enti- with Netherlands HoldCo, if it exists). This has the ties are sometimes (as in Apple’s case) branches or per- effect of: manent establishments of Ireland HoldCo rather than separately incorporated subsidiaries (that is, ‘‘Ireland • combining the foreign operations into a single en- Operating PE’’ or ‘‘Ireland Operating Branch’’ rather tity so that the combined entity’s manufacturing than Ireland OpCo). But in most cases the operating activities are substantial enough to prevent base entities are separately incorporated, wholly owned, company sales income; and Irish-registered, and Irish-controlled companies. Apple • causing the intra-entity royalty payments to be is also unique in that its version of Ireland HoldCo ignored, in order to avoid any foreign personal (the intermediate level, tax haven resident entity) is not holding company income (FPHCI). resident in Bermuda but rather is resident ‘‘nowhere.’’ This article explains below how this subsidiary, Apple Graphically, the structure is shown in Figure 1. Operations International (AOI), avoids filing a B. U.S. Tax Treatment residence-based tax return in any jurisdiction, in addi- tion to skirting inbound tax obligations in any jurisdic- 1. Subpart F tion. Ireland HoldCo is typically a wholly owned subsidi- Many businesses have recently added another step ary of the U.S. parent company. It therefore qualifies to the structure. Ireland HoldCo, rather than directly as a controlled foreign corporation under subpart F of forming Ireland OpCo, forms a Dutch holding entity the Internal Revenue Code.1 Cognizant of Ireland (Netherlands HoldCo). Netherlands HoldCo, in turn, HoldCo’s controlled foreign corporation status, tax forms Ireland OpCo. planners carefully craft the structure to ensure that little Regarding actual business operations, Ireland OpCo or none of the income flow taking place within it gives typically sells products to consumers in Europe and the rise to foreign base company sales income (FBCSI) Middle East and collects the corresponding gross re- under IRC section 954(d) or FPHCI under IRC section ceipts. Operating subsidiaries in other countries typi- 954(c). cally perform customer service and marketing functions (for example, ‘‘France ServiceCo’’); these entities are usually reimbursed on a cost or cost-plus basis by Ire- land OpCo. 1See generally IRC section 957. 688 • NOVEMBER 24, 2014 TAX NOTES INTERNATIONAL FEATURED PERSPECTIVES Irish Sandwich With a Slice of Dutch (C) Tax Analysts 2014. All rights reserved. does not claim copyright in any public domain or third party content. U.S. ParentCo Joint Development of IP Ireland HoldCo Incorporated in Ireland Managed/controlled in Bermuda IP License Royalties Dutch HoldCo = Disregarded Entity per “Check-the-Box” Rules IP License Royalties Cost‐Basis Ireland OpCo France ServiceCo Reimbursements Marketing and service Incorporated/managed/ functions for customers controlled in Ireland Software/Advertising Sales Customers The parent company achieves both of these objec- scheme, Ireland OpCo conducts real business activity tives by electing to disregard the wholly owned Ireland and has a tangible, physical presence in Ireland.
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