Apple Grilled Over Tax Practices
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.
The money should be spent in the country in which it's earned to build more Apple stores, data centres R&D facilities etc. Why should the US government expect Apple to impoverish other economies around the world in order to enrich the US?
Congress should take a long hard look at itself and the way they have enacted byzantine, loophole ridden, antiquated tax laws for years, all while accepting large donations from their corporate masters. It's so much easier to feign moral outrage and have mock hearings than to enact real changes that the special interest groups that fund their reelection campaigns want nothing to do with. Corporations are soulless entities with no capacity to feel shame. I wonder what congress' excuse is.
Google gave $800K to Obama this cycle. Apple only gave $300K.
This explains pretty much everything.
Given that it was Republican senator John McCain giving Tim Cook a hard time about app updates (though the panel is led by a Democratic senator), and that the Obama administration is separate from Congress, I'm not sure there's any causation that can be inferred from presidential campaign donations.
Personally, I don't think there are any good guys here. Congress doesn't come up with loopholes on their own - that's what happens when lobbyists for corporations like Apple, Google, Microsoft, and HP - not to mention the General Electrics, Exxon Mobils, and Chevrons of the world - carve out exceptions that their representatives work into the law.
The whole thing strikes me as a bit hypocritical. Everyone's playing the game.
"that their representatives work into the law"
And therein lies the problem. The legislative branch is running a defacto protection racket. The Supreme Court calls it free speech. I see no way out of this either.
I am surprised Tim Cook did not use the well worn Mitch Romney response to his sending money to the Cayman Islands to avoid taxes, "I pay all my taxes under the law." As did Cook.
Grilling Apple/Cook was to make points as they being the "bad guys."
Cook should have said, "You don't like the laws YOU (Congress) made, YOU change them."
The irony is that lobbyists grease enough congressional palms, not to.
If the government is upset that big corporations can legally avoid most of the 35% corporate tax rate by means of foreign subsidiaries, isn't there a straightforward solution? Just require companies doing business in the U.S. to pay 35% on their profits no matter where in the world those profits are located and let them deduct taxes paid to foreign countries.
Obviously Sen. Levin didn't get the recent memo from his boss, Senate Majority Leader Harry Reid! Sen. Reid said that in the United States we have a VOLUNTARY tax system and NO ONE IS REQUIRED to pay taxes.
I second Adam's comment about how hypocritical Congress is, in general. Why aren't they going after companies like Dick Cheney's "former" company, Halliburton? This country gives them billion dollar contracts (many of them no-bid), and last I knew they had moved their corporate headquarters outside the U.S. to keep from paying taxes.
If you're going to veer from covering tech related stories to those with a more political bent, at least try to write it from a neutral stance by leaving out your obvious progressive bias with such words as "supposedly super-high" in reference to the 35% corporate tax rate. As the "sucker" owner of a small business that does pay the full 35% rate I grow weary of being caught in the crossfire of those trying to leach out tax revenue from the "big boys" with the big loopholes. Statements like "we the people lose untold billions in tax revenue" and "how much ... foreign income belongs to the US" start from the false assumption that "we" somehow have a morally valid collective claim upon the income of the shareholders of these companies. We do not. Dividend rates are "only" 10-15% because the income is already taxed at 35%. Make the corporate rate 0% and tax the actual owners when income is received at the normal income rate - that will eliminate all corporate tax games.
The author of this article seems focused on the issue of plugging the tax loopholes and does not address the root _cause_ of them.
If US corporate tax rates were competitive with other countries', then the need for loopholes to avoid them would go away.
Hmm, that's an interesting point. Should countries be attempting to synchronize their tax rates? Somehow I can't see that flying, given how it runs counter to self-determination. Planet Money has done some good reporting on how import taxes happen, and if it's as hard as it seems to negotiate those between countries, I can't really see corporate tax rates being easier.
No, they should not be attempting to synchronize them via some top down centralized approach, you're right that will never work. What is and does happen is natural competition between countries - tax competition - the countries that charge less get more "customers" in the way of businesses setting up operation on their shores. Just as vendors compete with each on price and prices tend to settle around a bell-curve distribution point so _should_ taxes... however governments are very slow (and obstinate) to react to these sorts of external pressures so we see a broad range of rates rather than a more focused range. If governments could respond quickly the way a private company can to price pressure you would see rates synchronize naturally to the minimum rate needed for governmental functioning (as tax competition drives them to get rid of waste and abuse to decrease the tax burden they impose).
The article used words like "stink" and "shenanigans" to describe how this works, but also admits that it's all perfectly legal and simply responds to the tax law. Please remember this the next time you drive up the road across the county border to buy gas where the tax is lower.
The most accurate and succinct observation was this part of your article: "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.'"
Fair enough. We all take measures to pay fewer taxes, but the methods used by Apple and its peers go far beyond purchasing goods in alternate jurisdictions to avoid sales tax, and the overall impact is much higher. They are shenanigans. Legal, even if the morality is questionable.
But, that's business. I used to work in the tax department for a Fortune 200 company, and of course we avoided as much tax as legally and ethnically possible, though I don't think we did anything that crazy.
So, while I'm not crazy about Apple's methods, I don't fully blame them for taking advantage of the situation. I blame Congress, and I agree with Senator Paul that the onus is on Congress to fix this.
And again, Congress doesn't come up with legislation in a vacuum - a lot of it stems from lobbying done by firms looking to boost their profits. So Congress may be to blame for being easily influenced and thus writing bad laws, but the companies lobbying for special treatment are equally at fault, if not more so, since they're doing it with intent.
I also find it funny when senators say that Congress is to blame, seemingly without any awareness that they're part of it!