Here’s how investigators say Amazon’s ‘cosmetic’ European tax scheme works

European Commission regulators continued their campaign against illegal tax deals by publishing details of their investigation into an arrangement with Luxembourg that let Amazon pay almost no taxes.

In the 23-page document, the EC all but rules that Amazon’s deal with Luxembourg violated fair competition laws that forbid giving selective tax breaks to some companies but not to others, something known as “state aid.”

“The Commission takes the view, at this stage, that it constitutes state aid within the meaning of that provision,” the report says.

While the report doesn’t put a sum on the amount of taxes Amazon avoided, the company could be looking at a bill in the hundreds of millions of dollars if the decision becomes final. It is just one of many U.S. companies caught up in the EC’s tax investigation. Apple is also under scrutiny for a tax deal it struck with Ireland that regulators have said let the company avoid huge tax bills.

According to the document, Amazon has created an array of subsidiaries in Europe. But there are two main ones.

The first is “Amazon EU Société à responsabilité limitée,” also known as “Amazon EU Sarl” or “LuxOpCo.” This is Amazon’s European headquarters, which has 1,000 employees and runs all of its European websites.

The second is Amazon Europe Technologies Holding SCS, or “Lux SCS.” Lux SCS is purely a holding company that owns all the shares of LuxOpCo. Lux SCS licenses Amazon’s intellectual property to LuxOpCo to allow it to operate the websites. In turn, LuxOpCo pays a royalty back to the holding company.

In 2003, Amazon struck a tax deal with Luxembourg to approve its European structure, a deal that is still in place today. According to the EC report, LuxOpCo is subject to taxes on profits in Luxembourg, but the parent company, LuxSCS, is not.

Under this structure, regulators say, LuxOpCo would overpay royalties to LuxSCS, to reduce its European tax bills. In the report, regulators say the relationship “seems to contain a cosmetic arrangement for how to present the royalty and has no bearing on the amount of the royalty.”

“It also follows from the above that Amazon has a financial incentive to exaggerate the amount of the royalty when applying the transfer pricing arrangement approved in the contested tax ruling,” the report says. “This is because the royalty is deducted from the taxable profit of LuxOpCo in Luxembourg and paid to Lux SCS.”

Investigators have yet to put an amount on the taxes it believes Amazon has avoided as a result of this arrangement. However, LuxOpCo had revenues of €13.6 billion ($15.8 billion) in 2013, about 20 percent of Amazon’s worldwide revenue of $74.5 billion, according to the report.

Both Amazon and Luxembourg have denied the arrangement constitutes state aid. And both will have additional opportunities to submit a response to the report before a final ruling is issued later this spring.