Amazon's Latest Tax Penalty Should Be a Red Flag for Tech Companies

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The European Commission recently fined Amazon (NASDAQ: AMZN) 250 million euros ($294 million) to cover unpaid back taxes plus interest. The EU alleges that Luxembourg's government illegally allowed Amazon to set up subsidiaries that were designed to minimize its taxes.

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Most of Amazon's European profits are sent to Luxembourg-based subsidiary Amazon EU SARL. That subsidiary pays royalties to another Amazon subsidiary, Amazon Europe Holding Technologies, which is exempt from corporate taxes. The commission claimed that Amazon intentionally inflated those royalties to reduce taxes on Amazon EU SARL.

EU Commissioner for Competition Margrethe Vestager said in a press release that the setup enabled Luxembourg to give "illegal tax benefits" to Amazon, which allowed it to pay "four times less tax than other local companies subject to the same national tax rules."

As a result, Amazon was asked to pay eight years of back taxes plus interest. The commission says that the payment isn't a fine, preferring to call it a recovery of taxes. Amazon said it might appeal the ruling, even though $300 million would represent only 0.2% of its projected revenues this year.

Another red flag for tech companies

While the financial impact to Amazon should be minimal, the case is another clear indicator that the EU is cracking down on tax-minimizing setups and anticompetitive deals across the region.

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Last August, Apple (NASDAQ: AAPL) was ordered to pay a record 13 billion euros ($15 billion) in back taxes. The commission claimed that Apple received illegal tax breaks in Ireland that reduced its effective corporate tax rate of 1% on its European profits to 0.005% between 2003 and 2014.

In May, the EU fined Facebook (NASDAQ: FB) $122 million, claiming that it provided misleading information during its 2014 acquisition of WhatsApp. Facebook initially stated that it wouldn't link Facebook and WhatsApp accounts, but it allegedly broke that promise last year when it started sharing data between the two platforms.

In June, the EU fined Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) Google 2.4 billion euros ($2.8 billion) for promoting its own shopping service over other e-tailers. The commission is also probing Google's Android and AdSense, claiming that the platforms enable the company to dominate internet-based searches and ads.

Looking ahead, Microsoft (NASDAQ: MSFT) -- which sends its overseas profits through subsidiaries in Luxembourg, Ireland, and other low-tax countries -- could be next on the European Commission's list.

A question of jobs and national sovereignty?

In response to the European Commission's rulings, Amazon and Apple both touted the number of jobs they created in Europe. Amazon noted that it had "over 50,000 employees" in Europe. Apple, which employs 22,000 people in Europe, warned that the back taxes ruling could "have a profound and harmful effect on investment and job creation" across the continent.

Some countries are willing to give U.S. tech companies favorable tax rates if they create jobs. Ireland, for example, opposes the EU's crackdown, and refuses to collect back taxes from Apple or other targeted companies. The EU recently sued Ireland over the uncollected taxes, which could potentially boost support for an Irish exit from the European Union.

The key takeaway

The European Commission's position is understandable, since it sees low-tax setups as a short-sighted strategy that gives big companies' more leverage against national governments. But some other moves, like the antitrust cases against Google and a recently settled e-books antitrust case against Amazon, seem fiercely protectionist.

Vestager denied allegations of protectionist bias, claiming that the cases were "about competition in Europe, no matter your flag, no matter your ownership." Investors in U.S. tech companies should keep a close eye on EU regulators as the potential for monetary punishment is very real and the possibility of regulators making it harder for the companies to expand across Europe looms.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Leo Sun owns shares of Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, and Facebook. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.