Enzo, Seungmin, and Kate
In 2013, Tim Cook (CEO, Apple Inc), Peter Oppenheimer (CFO, Apple Inc), and Phillip Bullock (Tax Chief, Apple Inc) testified at a US Homeland Security and Governmental Affairs sub-committee Hearing. Presiding were Sen McCain and Chairman Levin to question representatives of Apple Inc. on why and how is it that billions of dollar worth of profits made by Apple in Europe has virtually not been taxed by any State (US, Ireland or otherwise) – their Double Irish with a Dutch Sandwich scheme. The proceedings of the Hearing revealed that Apple Inc. was mainly cleverly manipulating a legal loophole or limbo created by the difference in US tax laws and that of Ireland in determining the subject of taxation. Under their strategy, Apple Inc. was not legally required to pay taxes for its profits in either Ireland or US. In response to these findings, Ireland updated its taxation laws in 2014 so that all Companies incorporated in Ireland must also be tax residents in Ireland beginning from 2015: Apple’s subsidiaries in Ireland must begin paying taxes to Ireland starting 2020.
Here, we shall initially examine the not-so-much-complicated yet fascinating-all-the-same process of this rather unscrupulous tax evasion strategy deployed by Apple Inc.
“Long story short, offshore firms of Apple Inc (AOI, ASI, and AOE etc) do not fall under any tax jurisdiction – have no tax residence – therefore can not be legally taxed by any State”
Double Irish with a Dutch Sandwich, An Examination of How Its Done
- Offshoring IPRs via Parent – Subsidiary Cost Sharing Relations
- “Centrally Controlled and Managed” v.s. “Where Incorporated”
- “Functionally controlled” by US
- Apple Inc. – Ireland Reduced Tax Agreement
- Tax Presence and Tax Residence
- Transfer of Balance
(1) Offshoring Intellectual Property Rights via Cost Sharing Agreements
Apple Inc. initially establishes a Company in Cork, Ireland (offshore of US) and gives it rights to exploit Apple’s intellectual properties. This Company is a subsidiary or daughter company of Apple Inc. which means that it is owned or controlled by Apple Inc. – for example, Apple Operations International (AOI). In any case, pursuant to the US Transfer Pricing Rules, Apple Inc. (Parent or Holding Company) enters into a Research and Development Cost Sharing Agreement with the subsidiary company (as if it were a separate company) which allows the subsidiary company to receive all of the profits from exploiting Apple Inc’s Intellectual Property Rights (IPR) abroad without paying US tax.
There are five subsidiaries of Apple Inc. based in Ireland: Apple Operations International (AOI), Apple Operations, Apple Operations Europe (AOE), Apple Sales International (ASI), and Apple Distribution International. In addition, ASI is a subsidiary company of AOI (a subsidiary of Apple Inc.). Apple Inc. claims that profits earned by AOI, AOE, and ASI do not fall under the US tax jurisdiction.
(2) “Centrally Controlled and Managed” v.s. “Where Incorporated”
“AOI is incorporated in Ireland; thus, under US law, it is not tax resident in the US. AOI is also not tax resident in Ireland because it does not meet the fact specific residency requirements of Irish Law – which is to be centrally controlled and managed in Ireland.”
US law requires companies like Apple Inc to pay taxes to the US Government based on the fact that it is incorporated and headquartered in Cupertino, State of California, US (place of formation). However, AOI is incorporated in Ireland. Therefore, AOI’s profits do not fall under US jurisdiction.
On the other hand, Irish law only taxes companies “centrally controlled and managed” in Ireland. AOI, as a subsidiary company of Apple Inc. is centrally controlled and managed in Cupertino, State of California, US. Therefore, AOI’s profits do not fall under Irish jurisdiction either.
Corporate tax in the US is imposed at the federal, state, and even some local levels. Like individuals, corporations must file tax returns every year. Preparation of US federal corporate tax returns are extremely complicated and time-consuming which require the computation of taxable income and reconciliation of taxable income to financial statement income on top of others.
A company tax resident in Ireland, like that in any other State, would be subject to Irish tax on dividend income from its participation in its foreign subsidiaries, other significant corporate investments, as well as all worldwide trading income including IPR interest and royalty. However, AOI is virtually exempt from all of the above responsibilities.
The Senate panel found that “AOI, one of ASI’s parent companies, hasn’t filed a corporate tax return in the past five years – anywhere. AOI which reports directly to California HQ, had took in $29.6 billion from smaller subsidiaries including ASI between 2009 and 2012” (Fortune).
(3) Apple Inc – Ireland Reduced Tax Agreement
Apple had negotiated a special corporate tax rate of 2% or less in recent years with the Irish government. Since the early 1990s, Irish Government has used ASI’s corporate tax returns regarding its operation presence in Ireland to calculate Apple’s taxable income in such a way to produce an effective low single digit rate. ASI is not a tax resident of Ireland, however, has provided its tax returns to the Irish Government willingly. Based on this data, Ireland is known to have calculated the infamously low tax rate just for Apple Inc. This is well below Ireland’s statutory corporate tax rate of 12% and 35% of US.
For example, let us assume that ASI signs a contract with an independent third-party manufacturer in India to assemble Apple Inc. products and sell it back to them. ASI then can re-sell the finished products from India to other Apple affiliates around the Globe at a higher price to generate revenue. ASI incorporated in Ireland will benefit from the above Tax Agreement and will only pay a minimal-bordering-on-none tax rate for its massive amount of profits.
In 2011, ASI by selling iPhones, iPads, MacBooks and other Apple Inc. products to overseas distributors recorded $22 billion in pretax earnings, but paid $10 million in taxes (Fortune). This is approximately a 0.05% tax rate. In 2009, ASI paid 0.1% and in 2010, 0.06%.
(4) Tax Presence and Tax Residence
“AOI, ASI, AOE have no tax residency… that does not mean it does not pay taxes. ” –
– Phillip Bullock (Tax Chief, Apple Inc.)
There is no tax residence for any of the three above subsidiary companies in Ireland of Apple Inc. In the last five years, none of the subsidiaries have filed a Corporate Income Tax while Apple Inc. has received 30 billion dollars in dividend from these companies without paying a single dime.
Bullock here seems to emphasize the fact that the income earned by the subsidiaries of AOI (Holding Company) have already been taxed at the local rate in full. However this only means that it has paid for the 2% maximum rate negotiated between Apple Inc. and Ireland.
Bullock goes on to suggest that because there is no requirement in the Irish law that Apple Inc. should declare a tax residence should it not be in Ireland, Apple Inc.’s subsidiary companies having no tax residence or presence is perfectly legal. Tim Cook expressed his opinion that the US government is not being cheated of any tax by Apple Inc in that the dividend that is sent to Apple Inc by AOI is taxed at the full US corporate tax rate of 35%.
(5) Transfer of Balance
“Apple has roughly 60% of global sales outside of the U.S., but Apple only allocates 6% of profits to rest of the world. The way they accomplish this is by paying very small sales commissions in other countries to reduce their tax burden. It’s not illegal, but it’s a gimmick.”
No tax is paid on the transfer of funds from subsidiaries to AOI. So, it is about time we ask is any part of this strategy legal?
Legality of the Double Irish with a Dutch Sandwich Strategy, An Examination
Personally, while Apple Inc’s strategy is highly questionable to say the least, the legality of it seems to come down to the definition of a Paper or Shell Company and whether Apple Inc.’s subsidiaries satisfy such definition.
A paper company is a non-operating, but properly constituted and formed firm that exists only as a registration or incorporation certificate and has nominal or zero assets. Establishing paper companies to evade tax is illegal.
Apple Inc.’s official position is that AOI is a Holding Company which means that it is a parent corporation to other subsidiaries and is a limited liability company that exists for the sole purpose of owning property – in this case, patents, trademarks, and other assets. This term is in used in contrast to that of a operational company which focuses on producing its own goods or services. There is nothing new in structuring your business in a way so that one could reduce financial, legal, and tax liability. Strategically basing certain parts of the business in jurisdictions with lower tax rates after dividing them into Holding-Subsidiary relations is widely common.
Strictly speaking, it is quite difficult to conclude that AOI is a paper or shell corporation of Apple Inc. There is no doubt Apple Inc. is enjoying a significantly reduced tax burden in comparison to other domestic firms of US, finding its practices as illegal seem to be more than a challenge. In fact, as part of expert testimony to the US Senate sub-Committee Hearing to Examine Offshore Profit Shifting and Tax Avoidance by Apple Inc., J. Richard Harvey (Distinguished Professor of Practice, Villanova University School of Law and Graduate Tax Program) conceded by stating that what Apple Inc. has done is acceptable under current international tax law (Guardian).
True wonder is in that nobody (except Executives of Apple Inc) exactly knows how much money is transferred where and why due to this tricky business structure. What is only clear is the following facts that Apple Inc has:
(1) funneled 64% of its earnings into Ireland (over 78 billion over four years into an Irish subsidiary with zero employees)
(2) nearly 95% of it’s R&D infrastructures in the U.S. (Sen McCaine)
Looking at all this, the explosion of interest for the Panama Papers in 2016 seem to be more than belated. It is difficult to deny that Apple Inc unfair advantage over domestic corporations when it comes to taxation at the state and federal level in the U.S. The hard truth, however, is that this specific tax policy was an NOT original masterpiece of Apple Inc., but a rather commonly deployed scheme by market whales such as Google and Facebook as well as other multi-national corporations.
Ultimate Question :
McCain asks about how successfully a repatriation deal, for companies to bring home earnings under a lower rate, could be done. Harvey sees such a tax holiday as a bad idea, as the last time it was done in 2004, companies used it to distribute dividends and pay down debt – not expand domestically. Shay concurs, calling such holidays a temporary “windfall” for companies that does little long-term help.
Harvey says that the real question is what to do about all of this. Apple is doing nothing illegal, he says, but what’s legal here is an issue. “Something needs to be done when so much income can be allocated to an entity with no substance.”
But this is a whole new question for another time.
Joining in 2016, Enzo Miraslov is a Junior Editor at J&S Associates. The comment, writing, or column does not represent the official position of YULS.
“Injustice Anywhere is a Threat to Justice Everywhere” – King, Jr.
Joining in 2010, Seungmin is a Founding Member of and Senior Partner at Yonsei ULS. Please be advised: the comment, writing, or column does not represent the official position of YULS.