The EU Commission’s Problematic Reasoning on Amazon

Today the EU Commission released a document detailing its reasoning behind its decision to consider Luxembourg’s tax treatment of Amazon to be a violation of EU competition rules. The full document can be found here (pdf).

The crux of the EU Commission’s argument is that Luxembourg gave Amazon permission to set up a transfer pricing structure that was inconsistent with the arm’s length standard, and that in so doing it conferred a “selective advantage upon Amazon in so far as it results in a lowering of its tax liability in Luxembourg.” And that’s where the problems start in the EU’s reasoning.

EU v AmazonTo begin with, one might think that in order for Amazon to have received a “selective advantage” it must be the case that Luxembourg would have rejected the same structure for another taxpayer. But there’s no evidence presented that Luxembourg would have interpreted its own tax code differently for any other taxpayer.

But even putting that issue aside, how does the Commission believe that the Amazon structure was inconsistent with the arm’s length standard? Its argument is based on the following points:

  1. Luxembourg did not provide the Commission with Amazon’s transfer pricing analysis supporting its transfer pricing policies.
  2. The method used to calculate Amazon’s transfer prices in Luxembourg (specifically royalty payments to the owner of the Amazon IP in Europe) “does not seem to correspond to any of the methods listed in the OECD Guidelines”.
  3. Amazon’s calculation of the royalty payments “is not related to output, sales, or to profit.”
  4. Luxembourg accepted a margin of 4-6% over cost for the Amazon entity without a comparability analysis, and that margin may be too low.
  5. Luxembourg also accepted a floor on the Amazon entity’s profitability of 0.45% of Amazon’s EU sales revenue, along with a cap equal to all of Amazon’s European profits.

There are problems with each of these points. Taking them in turn:

1. The fact that Luxembourg did not provide the Commission with Amazon’s transfer pricing analysis says nothing about whether or not the arrangement is inconsistent with the arm’s length standard.

2. The method described in the Commission report is easily recognizable as the income method (i.e. the TNMM as specified in the OECD Guidelines) for the calculation of payment for intangibles. The income method is a frequently used approach in determining an appropriate level of royalty payments, and in fact is the method preferred by many tax authorities, such as those in the US.

3. Amazon’s calculation methodology is in fact directly related to sales and/or profit. This is obscured somewhat by the two-step nature of the calculation, in which the royalty payments are calculated such that they leave Amazon’s Luxembourg entity with profits equal to either 4-6% of its cost base or at least 0.45% of total Amazon sales revenue in Europe. But it’s clear that as Amazon’s sales and profitability in Europe go up, the income attributable to Amazon’s Luxembourg entity will also rise. So it’s hard to see where the Commission arrived at this particular conclusion.

4. The 4-6% range of profitability for the Amazon Luxembourg entity is not obviously too low; a 5% margin is considered very typical for a wide range of service providers. Whether or not it’s the right range in this case depends on the specific functions performed by the Luxembourg entity. A full functional analysis and set of comparable companies would be necessary to form a final opinion on this issue, but given the widespread use of 5% margins for intragroup services it seems oddly ill-informed to pick on this figure. Regardless, this point is largely irrelevant due to the second portion of the calculation methodology, in which the profitability reported by the Luxembourg entity actually depends on Amazon’s European revenues, not its cost base, as discussed in the next point below…

5. Yes, Luxembourg accepted Amazon’s rather unusual policy of having its Luxembourg entity’s taxable income depend not just on its cost base, but on total sales revenue in Europe. But there are two important points to be made about this. First, it’s not at all unusual to see arm’s length licensing arrangements where two or more alternative calculations are used to arrive at the amount of the payment, so this is not an obvious flag that the arrangement is inconsistent with the arm’s length standard. Second, given reasonable assumptions it’s entirely possible that the second, sales-based condition could actually increase Amazon’s tax bill in Luxembourg over what it would otherwise pay. Consider that Amazon’s sales in Europe were around €13.6 bn in 2013. Applying the 0.45% floor on the Amazon entity’s taxable income means that it must have declared income of at least €60m in Luxembourg in that year. Amazon’s Luxembourg entity has about 1,000 employees, suggesting that its direct operating expenses are probably in the neighborhood of a few hundred million euro. Even if its operating costs were €600m in 2013, it would have earned a margin of 10% over its costs – arguably significantly more than would be expected in an arm’s length arrangement. The point is that it’s not at all clear that Amazon’s transfer pricing policy yields a lower-tax result than would be expected in an arm’s length arrangement.

More fundamentally, the weaknesses in the EU Commission’s argumentation remind us that the EU competition authority is taking on a vast new area of inquiry with its recent push to address transfer pricing issues. Are the EU’s competition regulators now going to try to seriously assume a new role as a review body for each member country’s interpretation and enforcement of transfer pricing policies? If so, they have a lot of work in front of them.


UPDATE: For a bit more on the issue of “selective advantage”, take a look at this post by Renata Ardous. In it she points out that the General Court of the EU has recently taken issue with the Commission’s attempts to characterize aspects of national tax laws as providing selective advantage, and that similar reasoning may apply to this case.


  1. Harold McClure says:

    Having read this EU ruling – two questions arise. Even if what they say is valid, isn’t the alleged profit shifting away from the US parent? Which of course is the subject of that US Tax Court case. But more importantly once anyone checks the 10-K. Over the past 3 years, worldwide income taxes have been 44% of worldwide pretax income as more than 100% of that income is sourced to the US. Which begs the question – what profit shifting? I guess country by country reporting aka operational transfer pricing is in order.

  2. Stéphane Dupuis says:

    Hi Kash,

    Having read the EC Alleged Aid letter to Luxembourg, I think you are maybe somewhat generous with the way this unilateral APA has been granted by Luxembourg…

    That said, your arguments are interesting. They lead to make you the following requests:

    – Regarding your point 2, it seems to be true indeed, at least in form, that the TNMM has been somehow used. But have you ever seen in any of the companies you may know the use of a TNMM using profit on operating expenses as the profit level indicator, the operating expenses being defined the way they are defined in the paragraph 38 of the letter (between other things, without any detail on the TP policy regarding the tested party’s (here, LuxOpCo) “intercompany expenses”, which should be an important detail in any APA)? If yes, I would like to talk with you about those companies, maybe they need some further help 😉

    – Regarding your point 5, do you have at your disposal, do you know of or have you ever seen an arm’s length agreement which states that notwithstanding the otherwise specified way to calculate the royalty rate to be paid by a licensee for a certain IP, the royalty rate should be such anyway that the licensee’s operating profit should be between 0.45% and 0.55% of sales (or for that matter in any range of returns the upper bound of which would be let’s say 0.75%)? If yes, that’s great, I would appreciate very much if I could get a hold of it to use it as a comparable for some clients !… I fear though that, on its face, such arm’s length agreement might never exist… 😉

  3. Kash says:

    Hi Stéphane – I don’t see anything particularly odd about how operating expenses is defined for LuxOpCo for use of the NCP as the PLI… and of course since this document is just a summary of the EU’s reasoning, we can’t tell from it exactly what the details are regarding how the cost base is calculated. At any rate the definition of the cost base doesn’t seem to be something that the EU had a problem with.

    I agree that the secondary (sales-based) calculation of the residual royalty is unusual, but my point was that I think it’s quite likely that the sales-based formula would have resulted in a tax bill for Amazon that was higher than we would have expected in an arm’s length situation, not lower. And that is consistent with the point made in the first comment — Amazon certainly seems to have paid plenty of taxes outside the US… so where exactly is the profit shifting? Or, to use the language of the EU Commission: what exactly is the nature of the selective advantage?

    • Stéphane Dupuis says:

      Hi Kash – I must say it is a subtle point but, regarding how LuxOpCo’s total costs are defined, my point was simply the following: I was finding odd that in the clause regarding the Royalty Rate Calculation the “intercompany expenses” constituting the cost base for the application of the TNMM are actually not defined and therefore not formally limited to charges only coming from the EU marketing affiliates. That’s only that: I was just finding that the total control on the cost base that it theoretically allows did not look arm’s length in its form. But I agree with you, the EC did not seem to see a problem there as such (it sees the same type of problem though elsewhere) and also we do not have all the information and it is true that those intercompany expenses are maybe defined in sections of documents we haven’t seen.

      Regarding the “unusual” 😉 royalty rate calculation and the delimited range of returns on sales that LuxOpCo was to obtain no matter what, I don’t think, if I understand the EC’s argumentation correctly, that the issue that the EC raises is limited to the potential profit shifting out of the EU marketing affiliates towards Luxembourg that may have occurred. The issue actually also concerns the potential profit shifting out of the US towards Luxembourg that may have occurred (that said, we the public do not have at least at this point enough information to have any clear view or idea on the extent of the potential profit shifting that might have occurred, whether from the EU marketing affiliates or from the US). And above all, and most importantly, it concerns the fact that Amazon’s profits brought into Luxembourg unjustifiably (i.e., squarely and on its face in a non arm’s length way: at least, that is the EC’s contention) end up in an entity (Lux SCS) that is knowingly basically untaxed by any jurisdiction whatsoever including Luxembourg. If I understand the EC’s logic and language correctly, to answer your question, the nature of Amazon’s selective advantage is the fact that the competitors of Amazon in Europe do not or may not have the luxury of having, like Amazon, a significant portion of their worldwide profits ending up untaxed through their obtaining a unilateral and apparently back-of-the-envelope APA (again, that is the EC’s contention) by a EU jurisdiction, namely Luxembourg.


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