What just happened to Apple, explained

The European Commission, the EU's executive arm, is ordering Apple to pay $14.5 billion in taxes to Ireland.

But Ireland doesn't want the money, and Apple says it shouldn't have to pay.

And the kind of tax breaks that the EU accuses Ireland of offering Apple are similar to the kind of deals common in - and legal in - the US.

What happened?

This is what the EU says:

Apple Inc., which is based in California, set up two companies in Ireland: Apple Sales International and Apple Operations Europe.

According to the European Commission, these companies had no employees or real offices yet realized large profits.

Apple paid virtually no tax to Ireland, or any country, on these profits because of a former law in Ireland. In the past year, the law was in effect - 2015 - Apple Sales International paid just 0.005% tax, according to the commission.

The EU's Competition Commission is run by Margrethe Vestager, a member of Denmark's social liberal party. The commission is not a tax authority. Instead, its job is to maintain fairness between the member states. And that brings us to the most important part for this story: The commission says this law specifically favored Apple for special treatment.

When Apple sold iPhones, iPads, and Macs in an EU Single Market nation like France, the commission said Apple would funnel the profits from France to Ireland, and would not pay tax in either place.

But this is not really about Apple's tax avoidance strategies, which are infamous. The European Commission's issue is really with Ireland, not Apple.

Aid vs. Tax

How's this for a tricky balancing act?

European Union leaders have no issue with different member nations charging different corporate tax rates. That's why it's acceptable for Ireland to charge businesses a 12.5% income tax, whereas France levies 33.3%.

This is crucial because nations want to maintain autonomy over their fiscal policies. That's part of the ongoing power struggle between individual nations and the EU (remember, Brexit?)

What's not acceptable is what the EU calls "state aid."

This is when a country offers something special that's seen as specifically benefiting an individual company.

It can be even more basic. If France taxed companies in the north less than those in the south, that's generally state aid in the EU's view. It's the same with trying to get a German company to move to Denmark by abating property taxes for a new headquarters.

"The view is that not levying taxes that everyone else has to pay amounts to the same result as giving money to just one company," Philipp Werner, a partner in the law firm Jones Day's Brussels office, who's represented multinational companies appealing state aid decisions, told Business Insider.

If Apple had just paid the standard 12.5% income tax in Ireland, the country wouldn't have EU leaders upset in Brussels.

Instead, the commission says Ireland gave Apple "selective tax treatment" starting in 1991, with the first of two tax rulings. In effect, Ireland signed off on a scheme where Apple would move money to a stateless "head office" with no meaningful activities.

"Therefore, only a small percentage of Apple Sales International's profits were taxed in Ireland, and the rest was taxed nowhere," the commission says in its press release.

Ireland explicitly said this was fine by its standards. But the EU contends that this arrangement "gave Apple an undue advantage that is illegal under EU state aid rules."

"Apple entered into a deal with Ireland to not pay tax on all those profits," Edward Kleinbard, a professor of law and business at the USC Gould School of Law, told Business Insider. Instead, Apple paid "an arbitrarily small amount to Ireland in return for a vague promise to keep jobs in Ireland."

Apple and Ireland aren't the commission's first targets. There were similar rulings against the Starbucks' tax dealings in the Netherlands and a division of Fiat in Luxembourg.

Apple and Ireland have a different view

Apple was one of the first major tech companies to set up shop in Ireland. At the time, in 1980, Ireland was in bad economic shape. Unemployment was high and many left Ireland to try to find work in other countries.

Low corporate taxes was one way Ireland improved its economy and attract big companies, and Apple was early to benefit.

Ireland's finance minister, Michael Noonan categorically rejected the notion that this was a special deal for Apple. "The Irish Revenue don't do deals," he told CNBC on August 30. "They issue opinions to clarify a tax situation for individual companies, but we never do deals."

He continued that Apple doesn't owe any taxes to Ireland. "They may owe it elsewhere, but not to the Irish authorities."

And to underscore the delicate relationship, Noonan accused the commission of meddling in the policies of sovereign governments.

For its part, Apple CEO Tim Cook shot back, too, saying in an open latter that the European Commission "has launched an effort to rewrite Apple's history in Europe, ignore Ireland's tax laws and upend the international tax system in the process."

Both Ireland and Apple say the company has become a big part of the Irish economy, with 6000 workers there.

Cook also objected to the ruling being retroactive. Under EU rules, it can compel a country to collect taxes going back ten years from the first date it asked for information.

Ireland doesn't want the money

Here's one of the ironies of this whole situation: The EU is, in effect, ordering Ireland to collect a lot of money. Most, if not all, of those $14.5 billion would go to Ireland, and could be used to pay down debts.

But Ireland is not interested.

"Although they get a huge amount of money back, they also want to fight it," said Werner of Jones Day. "They're not only thinking about Apple, they're thinking a whole lot of other companies established in Ireland."

Losing this battle will hurt Ireland's credibility as an inexpensive place to do business, and a place where tax laws are clear and settled.

Why is the US fighting this?

Here's another irony: You might think the US would applaud any effort to collect tax from US-based multinationals using Irish subsidiaries to pay less - or zero - tax. But there are a few reasons why the US Treasury department is so vehemently against this EU ruling, and other pending cases targeting companies like Amazon.

One is simple: it wants to protect US businesses, and Treasury says they're being unfairly targeted by this EU crackdown.

Second, the US wants to preserve tax revenue it hopes one day will come its way.

Companies like Apple say US taxes are too high, so they keep foreign earnings overseas. But Congress has long debated ways to get multinational American companies to repatriate some of that cash. The Treasury Department says if the Commission wins this case, US companies could use these taxes paid in Europe to offset US taxes. That, it says, "would effectively constitute a transfer of revenue to the EU from the US government and its taxpayers," according to a Treasury white paper.

What about other European countries?

In his letter, though, Cook may have stepped into another debate over its aggressive tax avoidance by saying, "A company's profits should be taxed in the country where the value is created."

This is a different issue.

If Apple made money in France, but realized those profits in Ireland, it's up to France - and not the EU - to complain and try to get some of that money back.

The whole reason why Apple's European operations are in Ireland, after all, are for its tax advantages. The question is just whether Apple received illegal special treatment.

Wait, don't these kinds of tax breaks happen in the US all the time?

One reason all this might seem odd to Americans is that the special treatment Ireland is accused of giving Apple is similar to incentives American states give companies all the time - and legally.

Massachusetts, for instance, put together $145 million in incentives to convince General Electric to move from suburban Connecticut to Boston.

Never mind that some research suggests these sweetheart deals often don't pay off, politicians can't stop offering them.

When Tesla said publicly it wanted to build a "Gigafactory" to build batteries, states like California, Nex Mexico and Nevada stumbled over themselves to offer the most generous tax breaks. In the end, Nevada agreed to $1.2 billion in tax incentives to win the deal.

If these deals were issued by France to attract a company based in Denmark, it would be illegal under EU rules.

What about inversions?

Some American companies have gone farther than Apple to take advantage of Irish tax breaks. Pharmaceutical firms like Allergan have acquired or formed Irish subsidiaries and then "inverted" - transferring their legal headquarters to Ireland. Even if their headquarters are in the US, they are effectively Irish companies.

"Inversions are separate, but related," Kleinbard said. Companies that invert "take advantage of an easily manipulated definition of what is a US company."

Nothing in the European Commission ruling affects inversions. It's up to US authorities to crack down if they want to stop the practice. Congress, for instance, could change tax law to consider a company American if its leadership and most of its workers are based in the US.

What's next?

Apple, as the most profitable company in the world, and Ireland, with some of the lowest corporate taxes around, made easy targets for the European Commission. But it's clearly not done yet.

It's targeting McDonald's for allegedly paying no tax on its earnings in Luxembourg.

The antitrust regulators are also looking into Amazon.

Ireland, however, will almost surely appeal the ruling against its dealings with Apple.

It has a lot more on the line than $14.5 billion.

NOW WATCH: Here's how LeBron James reacted when he learned Kevin Durant was joining the Warriors

Please enable Javascript to watch this video