I have received several requests this July 4th holiday in the U.S. about my initial thoughts on the EU Commission’s 56-page published (public version from earlier this week) State Aid preliminary decision with the reasoning that The Netherlands government provided Nike an anti-competitive subsidy via the tax system.  My paraphrasing of the following EU Commission statement [para. 87] sums up the situation:

The Netherlands operational companies are remunerated with a low, but stable level of profit based on a limited margin on their total revenues reflecting those companies’ allegedly “routine” distribution functions. The residual profit generated by those companies in excess of that level of profit is then entirely allocated  to Nike Bermuda as an alleged arm’s length royalty in return for the license of the Nike brands and other related IP”


U.S. international tax professionals operating in the nineties know that The Netherlands is a royalty conduit intermediary country because of its good tax treaty system and favorable domestic tax system, with the intangible profits deposited to take advantage of the U.S. tax deferral regime that existed until the TCJA of 2017 (via the Bermuda IP company).  Nike U.S., but for the deferral regime, could have done all this directly from its U.S. operations to each country that Nike operates in.  No other country could object, pre-BEPs, because profit split and marketing intangibles were not pushed by governments during transfer pricing audits.

The substantial value of Nike (that from which its profits derive) is neither the routine services provided by The Netherlands nor local wholesalers/distributors.  The value is the intangible brand created via R&D and marketing/promotion.  That brand allows a $10 – $20 retail price sneaker to sell retail for $90 – $200, depending on the country.  Converse All-Stars case in point.  Same  $10 shoe as when I was growing up now sold for $50 – $60 because Converse branded All-Stars as cool kid retro fashion.

Nike has centralized, for purposes of U.S. tax deferral leveraging a good tax treaty network, the revenue flows through NL.  The royalty agreement looks non-traditional because instead of a fixed price (e.g. 8%), it sweeps the NL profit account of everything but for the routine rate of return for the grouping of operational services mentioned in the State Aid opinion. If Nike was an actual Dutch public company, or German (like Addidas), or French – then Nike would have a similar result from its home country base because of the way its tax system allows exemption from tax for the operational foreign sourced income of branches.  [Having worked back in the mid-nineties on similar type companies that were European, this is what I recall but I will need to research to determine if this has been the case since the nineties.]

I suspect that when I research this issue above that the NL operations will have been compensated within an allowable range based on all other similar situated 3rd parties.  I could examine this service by service but that would require much more information and data analysis about the services, and lead to a lesser required margin by Nike. The NL functions include [para 33]: “…regional headquarter functions, such as marketing, management, sales management (ordering and warehousing), establishing product pricing and discount policies, adapting designs to local market needs, and distribution activities, as well as bearing the inventory risk, marketing risk and other business risks.”

By example, the EU Commission states in its initial Nike news announcement:

Nike European Operations Netherlands BV and Converse Netherlands BV have more than 1,000 employees and are involved in the development, management and exploitation of the intellectual property. For example, Nike European Operations Netherlands BV actively advertises and promotes Nike products in the EMEA region, and bears its own costs for the associated marketing and sales activities.

Nike’s internal Advertising, Marketing, and Promotion (AMP) services can be benchmarked to its 3rd party AMP providers.  But by no means do the local NL AMP services rise to the level of Nike’s chief AMP partner (and arguably a central key to its brand build) Wieden + Kennedy (renown for creating many industry branding campaigns but perhaps most famously for Nike’s “Just Do it” – inspired by the last words of death row inmate Gary Gilmore before his execution by firing squad).

There is some value that should be allocated for the headquarters management of the combination of services on top of the service by service approach.  Plenty of competing retail industry distributors to examine though.  If by example the profit margin range was a low of 2% to a high of 8% for the margin return for the combination of services, then Nike based on the EU Commission’s public information falls within that range, being around 5%.

The Commission contends that Nike designed its transfer pricing study to achieve a result to justify the residual sweep to its Bermuda deferral subsidiary.  The EU Commission states an interesting piece of evidence that may support its decision [at para 89]: “To the contrary, those documents indicate that comparable uncontrolled transactions may have existed as a result of which the arm’s length level of the royalty payment would have been lower…”.  If it is correct that 3rd party royalty agreements for major brand overly compensate local distributors, by example provide 15% or 20% profit margin for local operations, then Nike must also.  [I just made these numbers up to illustrate the issue]

All the services seem, on the face of the EU Commission’s public document, routine to me but for “adapting designs to local market needs”.  That, I think, goes directly to product design which falls under the R&D and Branding.  There are 3rd parties that do exactly this service so it can be benchmarked, but its value I suspect is higher than by example ‘inventory risk management’.  We do not know from the EU document whether this ‘adapting product designs to local market’ service was consistent with a team of product engineers and market specialists, or was it merely occasional and outsourced.  The EU Commission wants, like with Starbucks, Nike to use a profit split method.  “…a transfer pricing arrangement based on the Profit Split Method would have been more appropriate to price…”.  Finally, the EU Commission asserts [para. 90]: “…even if the TNMM was the most appropriate transfer pricing method…. Had a profit level indicator been chosen that properly reflected the functional analysis of NEON and CN BV, that would have led to a lower royalty payment…”.

But for the potential product design issue, recognizing I have not yet researched this issue, based on what I know about the fashion industry, seems rather implausible to me that a major brand would give up part of its brand residual to a 3rd party local distributor.  In essence, that would be like the parent company of a well-established fashion brand stating “Let me split the brand’s value with you for local distribution, even though you have not borne any inputs of creating the value”.  Perhaps at the onset of a startup trying to create and build a brand?  But not Nike in the 1990s.  I think that the words of the dissenting Judge in Altera (9th Cir June 2019) are appropriate:

An ‘arm’s length result is not simply any result that maximizes one’s tax obligations’.

The EU Commission obviously does not like the Bermuda IP holding subsidiary arrangement that the U.S. tax deferral regime allows (the same issue of its Starbucks state aid attack), but that does not take away from the reality that legally and economically, Bermuda for purposes of the NL companies owns the Nike brand and its associated IP.  The new U.S. GILTI regime combined with the FDII export incentive regime addresses the Bermuda structure, making it much somewhat less comparably attractive to operating directly from the U.S. (albeit still produces some tax arbitrage benefit).  Perhaps the U.S. tax regime if it survives, in combination with the need for the protection of the IRS Competent Authority for foreign transfer pricing adjustments will lead to fewer Bermuda IP holding subsidiaries and more Delaware ones.

My inevitable problem with the Starbucks and Nike (U.S. IP deferral structures) state aid cases is that looking backward, even if the EU Commission is correct, it is a de minimis amount (the EU Commission already alleged a de minimis amount for Starbucks but the actual amount will be even less if any amount at all).  Post-BEPS, the concept and understanding of marketing intangibles including brands is changing, as well as allowable corporate fiscal operational structures based on look through (GILTI type) regimes. More effective in the long term for these type of U.S. IP deferral structures is for the EU Commission is to spend its compliance resources on a go forward basis from 2015 BEPS to assist the restructuring of corporations and renegotiation of APAs, BAPAs, Multilateral PAs to fit in the new BEPS reality.  These two cases seem more about an EU – U.S. tax policy dispute than the actual underlying facts of the cases.  And if as I suspect that EU companies pre-BEPS had the same outcome based on domestic tax policy foreign source income exemptions, then the EU Commission’s tax policy dispute would appear two-faced. I’ll need to undertake a research project or hear back from readers and then I will follow up with Nike Part 2 as a did with Starbucks on this Kluwer blog previously.  See Application of TNMM to Starbucks Roasting Operation: Seeking Comparables Through Understanding the Market and then My Starbucks’ State Aid Transfer Pricing Analysis: Part II.

See also my comments about Altera:  An ‘arm’s length result is not simply any result that maximizes one’s tax obligations’.

Prof. William Byrnes (Texas A&M) is the author of a 3,000 page treatise on transfer pricing


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  1. A reader made a comment about whether any indirect FTCs (the now repealed IRC 902) will be available to Nike. I’d like to hear other readers thoughts, but first I’ll share mine and then you can agree or disagree, set me straight.

    As to Nike and any potential (former) indirect (now “deemed paid”) FTC, Iikely very reduced tax credit of any at all because of IRC 965(g) and – I’m just an academic and not working every day with FTCs, but I think IRC 905(c)(2)(B) works to match a state aid payment to the year of the E&P. My common sense informs me that the accrual date is the year of the E&P. The EU Comm. is claiming state aid each year since 2006. So if the IRC 904(c) carry forward if from the date of the E&P, then the clock has run out on some of the potential FTC. For any eligible FTC, then such must be reduced by 55.7% b/c of IRC 965(g) to correspond to the income deduction to obtain the transition tax rate presumably for cash positions. My two cents.

  2. Comment and Response: Oliver Treidler Geschäftsführer bei TP&C GmbH – Pragmatische Beratung für Transfer Pricing & Controlling

    Dear William, Thanks also for sharing your thoughts on the Kluwer Blog. To me a common theme of the all the EU state aid cases and related disputes is a failure to appropriately delineate between routine and non-routine (unique and valuable) contributions. I thus agree 100% with your preliminary analysis on Nike and I think it is high time to stop the eroding consensus on the arm’s length principle (especially post-BEPS), by pointing-out that not all EU-based economic activity is by default (i.e. just because they are related to sales functions) of entrepreneurial nature. Kind regards Oliver

    My response: Thank you for the reply Oliver. Routine and non-routine contributions to the value chain, as you point out, seem to be combined by the EU Commission, or given equal footing, or perhaps the non-routine aspects are simply misunderstood or just simply ignored because it does not produce the desired result of the EU Commission. The lens for this case is pre-BEPS. Post-BEPS, perhaps .. [I am undecided but merely observing he perspectives to the debate] a new understanding of the nonroutine brand will emerge whereby local market engagement becomes an aspect of the valuation of the brand via its contribution captured by the local subsidiary. I think that arm’s length transactions allocate all that value to the owner of the brand, but arm’s length transactions are seemingly merely referential post-BEPS as opposed to controlling as the best method.

    If we use the lens of the entrepreneurial nature for this valuation, 3rd party relationships are even more so likely to reward the intangible brand value to the brand creator and holder than the local distributor. The OECD wants to move to a “cash box routine rate of return” for this entrepreneurial activity of the investments 20+ years before the APA was agreed. Guess we need to change corporate law going forward as well. Because a corporation will need to issue more shares, diluting current shareholders, to 3rd parties that do business with the company after the current shareholders have received the OECD’s set routine rate of return for their initial investment. I engage with Facebook and LinkedIn. Zuckerberg and Hoffman respectively certainly blew past the routine cash box return a decade ago. So … I think because of my “marketing intangible” user engagement, I deserve part of the new value, represented by a portion of the corresponding revenue, that I have helped create in these two companies. Consequently, I think the two companies should forward me a check that reflects my “fair share” of the USA or at least Texas business revenue (or stock representing my fair share).

    I am being facetious to make a point This is not how we have in the past understood how value is created or apportioned in society. That professors are valued much less in terms of salary relative to investment fund managers has always rubbed me wrong for obvious reasons. Going forward, our past understandings of value apportionment, reward, return for risk, may no longer serve our society. OK – that’s a raging discussion in many countries. But to interpret the pre-BEPS OECD Guidelines as if the post-BEPS has always been the meaning – it weakens the rule of law. If common understanding cannot be relied upon, then the underlying system will price this uncertainty into tax risk and such will lead to loss of public welfare (deadweight loss from an economists perspective at least). Now that I think about it, the tax risk associated with post-BEPS adjustments may make investing in the U.S. relatively more interesting. I wonder if the new TP Guidelines will be used as trade and investment protectionist barriers? Ah, musings musings….

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