On 21 May 2013, Apple’s CEO Tim Cook sat before a Senate panel, led by Michigan senator Carl Levin, that has accused Apple of legal, yet unethical methods of avoiding taxes in the United States.
Senator Levin has accused Apple of pursuing the “holy grail of tax avoidance,” saying, “They’ve created corporations that don’t exist anywhere for tax purposes.”
The Senate panel alleges that Apple paid only $4 billion in taxes on declared profits of $38 billion between 2009 and 2012, an effective tax rate of 10.53 percent — much less than the 35 percent corporate income tax rate in the United States. Also at stake is the more than $100 billion the company holds overseas that Apple says it will not repatriate due to a 35 percent tax rate for such transfers.
How is Apple avoiding so much tax, and why is it not illegal? There’s actually nothing new or extraordinary about it. Apple has employed a common tax-avoidance tactic called a Double Irish arrangement that it helped pioneer in the 1980s, according to Charles Duhigg and David Kocieniewski of the New York Times.
Make Mine a Dublin -- The Double Irish takes advantage of loopholes in Irish and U.S. regulations to avoid taxation in either locale. Apple and other multinational companies keep much of their holdings in Irish subsidiaries, which leaves much of the money in a “no man’s land” of taxation. Only a fraction is subject to Ireland’s modest 12.5 percent corporate tax rate.
The United States has only itself to blame for Ireland’s low corporate tax rate. After World War II, Ireland used U.S.-provided rebuilding funds to hire economic consultants from the United States. The consultants presented the Irish government with a lengthy report that briefly mentioned that Puerto Rico had successfully drawn in foreign corporations with low tax rates. Irish politicians seized on the idea.
But companies have moved beyond merely taking advantage of paying less to inland revenue. They’ve also invented other tricks to milk the shamrock, including:
The Ol’ Switcheroo: Apple juggles the books so that much of its revenue winds up in Ireland, where taxes are low, and many of its expenses occur in the United States, where deductions are plenty. According to Howard Gleckman of the Tax Policy Center, a deduction in the United States is worth 35 cents on the dollar because of the higher tax rate. Apple does this through cost-sharing agreements, as pointed out by Jeanne Sahadi of CNNMoney, where Apple treats its Irish subsidiaries as separate companies. Per CNNMoney, Apple Sales International, an Irish subsidiary, brought in $74 billion in profit from 2009 to 2012, but spent only $4.9 billion on R&D (research and development) — about 6.6 percent. By comparison, Apple’s U.S. entities brought in much less during that time (only $38.7 billion) but spent nearly as much ($4 billion) on R&D — about 10.3 percent of revenue.
No Man’s Land: Some of Apple’s Irish subsidiaries aren’t even legally Irish. In fact, they don’t belong to any jurisdiction. Apple Operations International, which controls many of Apple’s off-shore subsidiaries, made $30 billion between 2009 and 2012, but didn’t file tax returns for any of that money. Ireland allows Apple to have a physical presence there without being considered an Irish company for tax purposes. Harvard tax professor Steve Shay calls this “ocean income,” as it’s revenue that never quite makes it to land. Despite this, that money did somehow wind up back in the United States, where it’s held in bank accounts for those “Irish” subsidiaries.
Check the Box: Even more befuddling, Apple can actually pretend that some of its subsidiaries don’t exist. Under U.S. Treasury rules implemented to simplify tax filings, Apple can simply check a box to label its subsidiaries as disregarded entities that aren’t subject to tax. As a result, that money is locked behind a tax wall, which should cut 35 percent of whatever they brought back to the U.S. But they have a way around that, too…
Never Come Home: As noted earlier, Apple says repatriated income from outside the United States would have a 35-percent levy when it returned. But Apple skirts that by “borrowing” money from its foreign subsidiaries, which is yet another loophole. Under U.S. law, this dodges the 35 percent tax; instead, Apple just has to pay tax on the income generated by those “investments.”
Another trick Apple uses is borrowing money for things like its massive stock dividend and buyback program, despite being flush with cash. Overall, the interest rate on the loans is cheaper than the tax rate it would pay to repatriate the money. (See “Digging into Apple’s Financial Decisions,” 6 May 2013.)
The Villain of the Story -- Is there a place where fault should be laid for Apple engaging in these tactics, which are legal but fail the smell test? After all, any corporation making sufficient money uses one or more of these techniques, or others, to avoid paying America’s supposedly super-high 35-percent corporate tax. It appears only suckers pay that high rate, meaning smaller firms without the resources, or companies run by executives who find the legal behavior completely unethical in practice.
While Apple may have helped pioneer these techniques, like most Apple innovations, they’ve been copied by other companies. Microsoft, Google, Adobe, Facebook, General Electric, Johnson & Johnson, Oracle, and Eli Lily are just a handful of the companies that take advantage of Ireland’s temperate climate, rolling hills, and questionable laws.
Nor is Apple even the most egregious offender. In a study by NerdWallet for the 2011 tax year, Apple placed third lowest in effective tax rates, behind Exxon Mobil and Chevron. Exxon Mobil and Chevron paid only $1.5 billion on earnings of $73.3 billion and $1.9 billion on $47.6 billion to the United States, respectively, while Apple paid $3.9 billion. But General Electric makes its peers look like amateurs. In 2010, it paid no taxes on worldwide revenue of $14.2 billion. In fact, it received a refund of $3.2 billion from the United States government!
Cronyism is a better target for ire, as Congress has established all kinds of special tax advantages and loopholes through lobbying by high-dollar industry donors. Now the chickens are coming home to roost. Meanwhile, Ireland has lowered tax rates and turned a blind eye to funky accounting because it benefits from these shenanigans. The country denies any fault. Eamon Gilmore, Ireland’s deputy prime minister, has said, “Ireland doesn’t negotiate special tax rate deals with any companies.” That may be technically correct, but Ireland certainly provides all the tools companies need to avoid as much tax as possible. Other European Union Leaders, such as British prime minister David Cameron, have called out Ireland on their practices.
Why is Apple being singled out here, when there are far worse tax dodges operating in the United States? Perhaps it’s because Apple has such a high profile, or maybe it’s because John McCain wanted an excuse to lambast Tim Cook for having to update the apps on his iPhone constantly. Some have even suggested that Apple is being shaken down for its lack of congressional spending. There might be at least a hint of truth to this, as Apple has been slowly, but steadily, increasing its lobbying expenses, which used to be minimal.
To be fair, Senator Levin’s committee has, in the past, grilled Microsoft and Hewlett-Packard on their tax avoidance strategies. But Google has been an odd exclusion, despite the fact that its use of these same techniques has cost the United States at least $60 billion in tax revenues, and the search giant has been called out in Europe for its practices.
These methods may stink, but they are different from dodgy tax shelters employed by high-worth individuals and some companies that rely on sham transactions, which are often found illegal. Such tax dodgers are later forced to pay tax and penalties, and may also face jail terms.
Apple and other companies would likely be just as criticized by analysts for not using tax options available to them, as well as receiving complaints from shareholders — which include over half of all American households through direct investment, mutual funds, index funds, and pension plans. The directors of public companies are not, contrary to urban financial myth, legally required to maximize shareholder value. No such law compels them.
But shareholders have an increasingly active voice in corporate America, despite attempts to ignore them, and even the famously impassive Apple recently blinked. Activist investor David Einhorn successfully threatened Apple with a lawsuit over not sharing enough of its cash hoard with investors, and Apple responded by increasing its share buyback program and raising dividends.
As Kentucky Senator Rand Paul said at the hearing, “If anyone should be on trial here, it should be Congress. I frankly think the committee should apologize to Apple. The Congress should be on trial here for creating a Byzantine and bizarre tax code.” While Tim Cook and Apple should shoulder part of the blame, they are also working inside a convoluted system that practically demands abuse. Apple’s written statement to the Senate proposes tax reforms that would lower corporate income taxes, eliminate corporate tax expenditures, and implement a “reasonable” tax on foreign earnings so the company can bring its money back home.
Also in the statement, Apple counters claims that it doesn’t pay taxes on foreign earnings, saying, “Apple has substantial foreign cash because it sells the majority of its products outside the U.S. International operations accounted for 61 percent of Apple’s revenue last year and two-thirds of its revenue last quarter. These foreign earnings are taxed in the jurisdiction where they are earned (‘foreign, post-tax income’).”
Despite that, it’s evident that Apple makes as much of its revenue as foreign as it can. The question Congress must answer is how much of Apple’s legitimate foreign income belongs to the United States, and what measures will make Apple most likely to give it up?
Maximizing Taxpayer Value -- Instead of making Apple, or any company, the whipping boy, Congress should instead work on identifying the loopholes it has created, and how to close the ones it has missed. Furthermore, instead of asking companies why they’re bending the law, Congress should instead ask how business and government can work together to create a better situation for all. The fact is that businesses exist across borders, and our global economy means even the United States government has to compete.
The current system is a broken mess that benefits no one. We the people lose untold billions in tax revenue, while companies like Apple are throwing massive resources behind these insane, cockamamie schemes that lock their liquidity behind green bars. While I’m the last person to assume good faith from a multinational corporation, it’s just common sense that these tricks are a headache for Apple. Create a better business environment and everyone wins.