The Commission has released a 40-page report outlining the reasons why it opened an investigation into transfer pricing arrangements used to assess the tax position of a Starbucks manufacturing subsidiary based in the Netherlands.

This was one of three probes into so-called ‘sweetheart’ deals the Commission announced in June. The others are examining Amazon’s tax arrangements in Ireland and Fiat’s tax deals in uxembourg.

The June letter to Dutch foreign minister Frans Timmermans, who has recently taken up the new role of first vice-president of the Commission, explains that the Commission’s investigation will focus on the advance pricing agreement (APA) signed in April 2008 between the Dutch tax authorities and Starbucks Manufacturing BV (SMBV).

It concludes: ‘The Commission is of the opinion that the SMBV APA does not comply with the arm’s length principle. Accordingly, the Commission is of the opinion that through the SMBV APA the Dutch authorities confer an advantage on Starbucks Manufacturing BV. That advantage is obtained every year and on-going, when the annual tax liability is agreed upon by the tax authorities in view of that APA. That advantage is also granted in a selective manner’.

The letter states: 'The Commission wishes to remind the Netherlands that Article 108(3) of the Treaty on the Functioning of the European Union has suspensory effect, and would draw your attention to Article 14 of Council Regulation (EC) No 659/199967, which provides that all unlawful aid may be recovered from the recipient’.

SMBV is supplied with beans for roasting by a Swiss Starbucks subsidiary which it processes and packs in the Netherlands. It licenses IP from Alki which is necessary for the production process and for the delivery of coffee to shop operators in return for which it pays Alki a royalty. The Commission report says that SMBV allegedly does not carry out any sales activities.

The report indicates three areas of concern over whether the terms of the 2008 SMBV APA comply with the arm’s length principle or whether they give rise to a selective advantage conferred by the Dutch tax authorities.

The first is whether the Dutch tax authorities correctly accepted SMBV’s classification as a low-risk toll manufacturer; secondly whether the authorities were right to accept the adjustments made by SMBV’s tax advisor; and thirdly whether they were correct in accepting SMBV’s interpretation of how to calculate the IP royalties paid to Alki in its P&L.

The report says the Dutch tax authorities failed to perform a detailed examination of the level of risk carried by SMBV, and instead accepted assumptions relied upon by the tax advisor in the transfer pricing report which lowered the tax base of that company in the Netherlands.

It states: ‘The Commission has no indications that a contract between the Starbucks’ Swiss entity and SMBV was ever provided to the Dutch tax authorities to substantiate the claim in the transfer pricing report that Starbucks was a toll manufacturer. Such a contract is not contained in the file, nor are the conditions of any risk transfer specified.’

The report says the Dutch authorities were wrong to accept the assumption that there was no inventor risk. It also says: ‘The Commission is of the opinion that the SMBV APA tolerates questionable adjustments which allow SMBV to lower the resulting corporate income tax basis in the Netherlands which are not in line with conditions prevailing between prudent independent operators, so that the foregone tax revenues not claimed for this activity by the tax authorities would constitute state aid.’

Additionally, it goes on to state that Commission disagrees with the way in which the royalties due from SMBV to Alki have been calculated, stating: ‘The Commission is of the opinion that by accepting SMBV’s use of the SMBV APAs as regards the calculation of royalties in its P&L, in so far as the level of those royalties could be overestimated in view of the value of the IP in question, the Dutch tax authorities conferred an advantage on that undertaking.’

The Dutch government has issued a robust defence of its tax arrangements, stating that it adhered to the OECD arm's length principles.

In an open response published on the government of the Netherlands website, the director of the International Affairs and Consumption Taxes Directorate stated: ‘My conviction that the APA with Starbucks Manufacturing BV is fully in line with international transfer pricing standards is consistent with the policy framework applied by the government in its efforts to create an attractive business climate.

‘It is essential to respect internationally agreed standards and to give sufficient and targeted consideration to combating misuse, because only then will the policy pursued be truly sustainable. That is why the Netherlands is actively engaged in the base erosion and profit shifting (BEPS) project of the OECD and G20 and in the European Commission’s proposals in this regard. Our renegotiations with 23 developing countries aimed at including anti-abuse provisions in bilateral treaties should also be seen in this light.

In a statement, Starbucks told Accountancy Live: ‘We agree with the Dutch government that this investigation by the European Commission announced in June will find that there is no selective advantage and that we comply with all tax laws and OECD guidelines.’

The Dutch government response is available here http://www.government.nl/documents-and-publications/letters/2014/11/14/response-to-the-formal-investigation-procedure-concerning-alleged-state-aid-for-starbucks.html

The EU decision is available here