On Wednesday, the Italy weekly L'Expresso reported that Milanese prosecutors had ordered the seizure of a substantial batch of computer and telephone equipment from Apple's (AAPL) Italian HQ in the Piazza San Babila in Milan as part of an investigation into allegations of defrauding the Italian state to the tune of $1.3 billion in tax revenue.
According to Sky News,
Apple's Irish subsidiary ASI contracts with mainly Chinese companies to manufacture iPads and iPhones. ASI then sells these products to another Irish company which resells them to retail subsidiaries in Italy and other European countries.
Naturally, there are plenty of fine hairs left to be split, such as what constitutes the definition of a "permanent establishment". (Forbes' Tim Worstall gives a layman-friendly breakdown of Apple's legal situation here.)
For the record, Apple's much imitated technique of exploiting loopholes in the Irish tax code (the so-called Double Irish with a Dutch Sandwich) is clearly an efficient and (probably) legal way for multinationals to duck the tax man by playing one tax regime off the other. What's becoming increasingly clear with every new lawsuit is that Europe's technocrats are determined to shake down Silicon Valley regardless of whatever they agreed to.
Bail-In Means You, Too
Investors keen to dismiss the seizure of Apple's records in Milan as due comeuppance for Cupertino are missing the forest for the trees. European prosecutors aren't singling out Apple. In fact, Italian authorities ransacked Facebook's (FB) offices in the same fashion less than 12 months ago.
Not to be outdone, France called on the European Commission in September to draw up proposals by spring 2014 aimed at "establishing a tax regime for digital companies that ensures that the profits they make on the European market are subject to taxation and that the revenues are shared between the Member States, linking the tax base to the place where the profits are made." Italy's center-Left Democratic Party, who evidently can't wait that long, recently proposed a "Google Tax" that would force all U.S.-based internet and social media companies to collect advertising revenues through Italian-based firms.
It's no secret that Europe -especially southern Europe- has a love affair with taxation. In Italy, a country where "only fools pay" and high rates of taxation result in a booming shadow economy, which in turn results in (you guessed it) high rates of tax evasion, a shakedown isn't news, it's par for the course. Italy is broke. Italy we understand.
But why the sudden urgency on France's part?
An Unwatched Pot Always Boils
According to a secret government report prepared by France's prefects that was leaked to the conservative daily Le Figaro on Thursday points out, the reason is simple -
- French society is rife with tension, frustration and anger (over a seemingly endless tax hikes)... A progressive roll-call of bankruptcies and forced redundancy plans is having a marked effect...And as the bad news mounts up, there is an atmosphere of pain and despondency. There is a lack of hope for the future, and this is fertile territory for a social explosion in France.
(Translation courtesy of France 24)
"Are we really in 1789?" was the title of a recent Le Figaro opinion piece by Jean-Christian Petitfils, the historian and biographer of Louis XVI, who compared Hollande to the late (and headless) king, as "two hesitant optimists… disconnected from reality…" "Monsieur le président, 15 angry French people call you to account," was the front page banner headline of yesterday's Aujourdh'hui en France tabloid.
In the words of former Prime Minister Jean-Pierre Raffarin:
We're going from anger towards violence.
The reality that Mr. Hollande is having difficulty connecting with is that the European technocrats can no longer tap their own populations for revenue to fulfill their political promises without inviting a widespread social conflagration. And as social tension in the Eurozone increases, foreign (i.e. non-voter) expropriation is looking increasingly attractive from a political perspective, and Europe is now turning, albeit in a disjointed and haphazard fashion, to levies on U.S.-based businesses operating on the Continent to fill the gaps.
The problem is that Europe has shown little evidence that it knows how to run a ranch without milking the cows to death. Exhibit# A is a 200-page internal report leaked to The New York Times (notice how leaky the French government is lately?) back in January, in which the French government argues that by providing personal information free of charge, Google (GOOG) and Facebook's users were, in fact, unpaid employees of these companies. Of course, since these employees received no pay, they could be not taxed.
But the report then goes on to argue that Google and Facebook's collection of data from these "unpaid employees" is taxable, as it involved "a business transaction" with French citizens. When you also consider the fact that the average web surfer downloads 112 cookies a minute, most of which are resold in the form of targeted advertising at one point or other, Mr. Hollande's proposed data collection tax is nothing less than a tax on all French internet traffic billed directly to Silicon Valley and, by extension, shareholders.
Multinationals already have to fight tooth and nail to adapt to local differences. McDonald's (MCD) has had a devil of a time adjusting its menu to Asian and Middle Eastern palettes. The five-fold increase in Chinese comps (read: refunds and free meals) alone has cost the company millions in Asia, while adapting to Europe's higher employment standards in the midst of the austerity has led to even worse damage on the Continent.
The whole reason that social media companies like Facebook and Twitter (TWTR) trade at such lofty multiples is due to the perception they have plenty of run-room to expand their global advertising activities.
The French and Italian proposals also threaten to set a dangerous precedent: If France is allowed to tax data collection, what's to stop every member state in the European Union from doing the same? If the EU is allowed to tax the internet, how long will it be before the Washington D.C. pols and Russian oligarchs demand their own pound of flesh? Will it stop at data collection, or will another downturn lead to a tax on digital consumption?
Once the door to an Internet Tax is open, it will be next to impossible to shut it again.
The austerity regime imposed by Germany on its southern allies appears to entering a new phase in which the Cyprus template of "bail-ins" via mass expropriation is being applied to U.S.-based businesses operating in Europe. I believe that Apple's Italian woes are a prelude to what I expect will be a litigious year for Silicon Valley as a whole in Europe.
While the evolving legal environment in Europe may not have a significant near term impact, the potential long term damage of cumulative tax increases across the world's largest common market is substantial. As Senator Everett Dirkson once said, "a billion here and a billion there, pretty soon, you're talking about real money."
Investors should take a hard look at Europe's economic situation and ask themselves the question of who's really going to end up paying for these mistakes.