A shell company with no employees can’t lay claim to billions of euros in Amazon royalty revenue, European Union officials find.

(Bloomberg)—European Union regulators sent a warning to any company using fees on intellectual property rights to shift profits away from the taxman—slapping Amazon.com Inc. with a 250 million-euro ($294 million) bill and giving Luxembourg another rap on the knuckles.

The EU took a dim view of a structure that allowed Amazon, No. 1 in the Internet Retailer 2017 Top 500 and the Europe 500, to slash its taxable profits in Europe over about a decade by channeling them to a tax-free unit located in Luxembourg that was meant to license the technology behind its web shopping platform.

Officials found one big problem with the arrangement: the unit was just a shell company, how could it therefore perform complex duties such as licensing and managing intellectual property? Impossible, according to the EU. Both Amazon and Luxembourg deny they broke any rules.

As EU competition commissioner Margrethe Vestager put it on Wednesday, “an empty shell” with “no employees, no offices and no business activities” can’t possibly perform activities that would allow it to lay claim to billions of euros of royalty revenue. Yet according to the EU, that’s just what Luxembourg allowed the company to do, in breach of its own tax rules.

“It’s not enough to put IP rights in an empty shell and claim that all the revenue that generated these IP rights should be awarded from a tax perspective to that empty shell,” said Edoardo Traversa, a professor who specializes in tax law at Belgium’s Universite Catholique de Louvain.

Traversa pointed the finger at Luxembourg, referring to a time where its tax authority appeared to have been rubber stamping tax arrangements via what are known as rulings “without too much scrutiny.”

Clients “would basically write the ruling and then the Luxembourg tax administration would sign it,” he said in an interview. Luxembourg’s policy has completely changed since.

Lots of U.S. companies, including health care firms like Merck & Co. and tech firms like Facebook Inc., move their intellectual property assets to tax havens overseas. From there, they effectively rent out their core innovations to operating units of the same company.

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Such techniques are usually perfectly legal but, in Europe, they can run afoul of the EU’s state-aid rules when governments allow special exemptions to the detriment of other companies.

For tax purposes, the EU considers that transactions between a multinational’s subsidiaries should be set at the same price an unrelated company would pay—a concept that is known as the arm’s length principle. In the Amazon case, given that the unit collecting royalties had no employees, the EU said it’s hard to explain how the payments could be justified.

The Amazon decision comes a year after a record 13 billion-euro tax recovery-order against Apple Inc. (No. 2 in the Top 500). It’s one of a growing list of cases in the EU’s crackdown on loopholes that started in 2013, when watchdogs started to root out deals among the thousands of otherwise legal tax pacts governments have arranged for companies for years. At stake in all these decisions are billions of euros squirreled away in tax havens, out of the reach of authorities in the countries where they make most of their sales.

The set-up criticized by the EU was put together in the mid-2000s when Amazon transferred its IP rights to a Luxembourg subsidiary. Up until 2014, the Luxembourg unit, called Amazon Europe Holding Technologies SCS, or AEHT, recorded royalty revenue of about 5.2 billion euros before adjustments for inflation and exchange rates.

Amazon has defended its tax payments in Europe, asserting that regulators there are mistaking high revenue for high taxable profits. It has argued its profits there have been crimped by heavy investments in the IP and strong competition.

Luxembourg’s finance ministry said on Wednesday it “considers that the company has not been granted incompatible state aid.” Amazon also disagreed with the EU’s assessment and said it will consider an appeal at the bloc’s courts.

To move revenue from Amazon’s e-commerce businesses in France, Germany and Britain, those units first made royalty payments to the company’s European operating subsidiary in Luxembourg, called Amazon EU Sarl, the EU said. That unit is subject to taxes, but it slashed its taxable income by making deductible royalty payments to the tax-free AEHT unit for the regional sites’ use of Amazon’s web shopping platform and trademarks.

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Huge chunk

With Wednesday’s decision, the EU simply decided to reallocate a huge chunk of profits to the taxable Amazon EU Sarl unit. That move will cost the internet retailer about 250 million euros in back taxes and shows other multinationals what sort of profit shifting just won’t fly in Europe.

Amazon is the fifth in a series of EU decisions against special tax deals and appeals by the governments and companies concerned have been piling up in the bloc’s courts.

“It may take several years before the first cases are settled,” said Raymond Luja, tax professor at Maastricht University, and also counsel to law firm Loyens & Loeff in Amsterdam. “These processes could take many years, and the commission can’t simply wait and see what the final outcome is in the meantime.”

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“For the commission, dealing with transfer pricing is a learning process as well and we may gradually see a change in how they approach transfer pricing” and the application or not of “anti-tax-avoidance measures in the near future,” said Luja.

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