The tax strategies of Apple get plenty of coverage in today’s papers. This follows from an extensive report published by the Australian Financial Review yesterday. There is no doubt that Apple aggressively manages its global tax affairs and while Ireland is a part of that it is by no means the most important part.
The first part is that corporation tax is not organised on the basis of the some form of “destination” principle like for VAT or sales taxes. Under a such a system (or one based on formulary apportionment) some corporate income tax would be collected in the jurisdiction in which the products are sold. There are many complaints from countries where companies like Apple have huge sales but pay very little corporation tax. This is an argument against the system of corporation tax, not Irish corporation tax.
Corporation tax is based on a combination of the residence and source principles and tax treaties help manage the crossover of taxing rights via rules on double taxation.
Source refers to where the value added is created (albeit subject to shifting through transfer pricing) and residence refers to the domicile or location of the company. In general, companies deemed resident in a country are taxed on all their net income regardless of where it is earned and non-resident companies are taxed only on their profits sourced within that country.
Apple has large sales in Australia but because corporation tax is only charged on the profits sourced there Apple is able to use transfer pricing to shift the profits out of Australia. Apple can (legitimately) argue that very little value added is created in Australia and that all it does there is sell to customers. In Australia, Apple is taking on limited risks, limited functions and has limited assets, thus the logic within transfer pricing principles would say that its return should also be limited.
An argument for corporation tax on the basis of customers needs a huge change in the international system of corporation tax. It could be done but it is not in place now.
For a company like Apple the key elements of its operation to which added value can be attributed are research and development, intellectual property, manufacturing, distribution and retailing. Under the current system Apple logically asserts that their added value does not come from their customers but principally from the creativity underpinning their products, which is captured through patents and copyrights.
So once Apple has attributed the value added to the intellectual property the next question is the residence of the company that owns the intellectual property. As the IP is owned in that country all the net income earned by the IP will be taxed in that country.
And this is where Ireland comes in. Or is it?
The company that owns Apple’s intellectual property (outside the US) in this case is Apple Sales International (ASI). ASI is an Irish-incorporated company but incorporation played no role in the description above – residence did.
ASI is not an Irish-resident company. It, for want of a better description, is like a company that was born here but now lives somewhere else. Under Irish tax law the residence of some companies is evaluated on the basis of where they are managed and controlled. ASI is one such company to which this test is applied. Where is ASI managed and controlled?
Here is US Senator, Carl Levin (D) on ASI:
Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in California.
In short, these companies’ decision-makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States.
Here is an extract from the questioning of Apple executives at the Senate hearing last May:
Senator LEVIN. Mr. Bullock, does Apple Inc. own directly or indirectly AOI, AOE, and ASI?
Mr. BULLOCK. Yes, Apple Inc. owns directly or indirectly AOI, AOE, and ASI.
Senator LEVIN. All right. So all those companies in Ireland are owned by Apple effectively. Is that correct?
Mr. BULLOCK. They are all legally owned by Apple Inc., yes.
Senator LEVIN. All right. Now, relative to ASI, Mr. Bullock, is ASI functionally managed and controlled in the United States?
Mr. BULLOCK. As a practical matter, applying the Irish legal standard of central management and control, I believe that it is centrally managed and controlled from the United States.
Senator LEVIN. And does Apple agree that it is functionally managed and controlled in the United States?
Mr. BULLOCK. Under Irish law——
Senator LEVIN. No. Under our law, do you believe that?
Mr. BULLOCK. I do not believe that central management and control is a legal term under U.S. tax law.
Senator LEVIN. All right. Do you believe it is functionally managed and controlled in the United States?
Mr. BULLOCK. Yes.
Senator LEVIN. Mr. Cook, do you agree?
Mr. COOK. We have significant employees in Ireland. We have about 4,000. And so there is a significant amount of decisions and leadership and negotiations that go on in Ireland. But some of the most strategic ones do take place in the United States.
Senator LEVIN. Would you agree on balance that ASI is functionally managed and controlled in the United States?
Mr. COOK. From a practical matter. I do not know the legal definition of the word.
Senator LEVIN. As a practical matter, you would agree that it is functionally managed and controlled in the United States?
Mr. COOK. Yes, Senator.
[If you want to watch this exchange, and the executives squirm a bit, go to around 02:40:00 of the video of the hearing. The full exchange on this issue lasts until around 02:49:30.]
Today we have reports in The Irish Times here and the Irish Examiner here making various claims about Ireland’s role in Apple’s tax strategies. The most important detail is that ASI is not resident in Ireland.
The report in the Irish Examiner begins:
More than $AUD8.9bn (€5.8bn) in profits have flown from Apple’s Australian operations in the past 10 years to Apple’s Cork subsidiary, it has emerged.
ASI is not Cork-based; it is based in Cupertino, California. The report subsequently says:
Certain Apple companies registered in Ireland pay no tax in the country due to a loophole in both the Irish and US tax codes.
There is no loophole allowing certain companies to “pay no tax” here. It is a standard rule. In fact, in the OECD’s Model Tax Treaty the tie-break rule for determining the residence of a company is the test of management and control, which is what is applied by Ireland.
In The Irish Times report it says:
According to accounts obtained by The Irish Times for one of those unlimited companies, Apple Sales International (ASI), the consumer electronics giant cut its Irish tax bill by more than €850 million between 2004 and 2008, using an unexplained “lower rate”.
ASI provides “sales and marketing services” to Apple subsidiaries around the world that sell iPods and iPads. Between 2004 and 2008, it reported profits before tax totalling $7.11 billion on sales of more than $29 billion.
The accounts for those years state the corporation tax that would be due using Ireland’s 12.5 per cent rate – €890 million over the five years. But they also show how much corporation tax ASI actually paid to Irish authorities – just €36 million.
As ASI is not resident here, it only has to pay corporation in Ireland here on profits actually sourced here. ASI generates most of its profits from the intellectual property it holds and that is not located here. It is located in Cupertino, California. These profits that ASI accumulates are managed by Braeburn Capital in Reno, Nevada and the money is deposited in New York banks. The money never even passed through Ireland.
Tax of €36 million on the profits indicated suggests a tax rate of 0.1%. A useful description that shows how such a low tax rate can be achieved was provided in a post from last May. None of this is news but it is deemed worthy of front-page coverage today.
So there is just one question that remains. Where is ASI resident? That is in the United States surely. Almost everything to do with ASI happens in the United States. Everything that is, except its incorporation. ASI is an Irish-incorporated or registered company.
Under US rules, the test of incorporation is used to determine the residence of a company. ASI is not incorporated in the US therefore is not deemed to be US-resident. Sen. Carl Levin again
Apple is exploiting an absurdity, one that we have not seen other companies use. The absurdity need not continue. Although the United States generally looks to where an entity is incorporated to determine its tax residency, it is possible to penetrate an entity’s corporate structure for tax purposes, and collect U.S. taxes on its income, if the entity is controlled by its U.S. parent to such a degree that the shell entity is nothing more than an “instrumentality” of its parent, a sham that should be treated as the parent itself rather than as a separate legal entity. AOI, AOE and ASI all sure seem to fit that description.
The “absurdity” he is talking about is not in Irish tax law; it is in US tax law. The “absurdity” allows a company that carries out all its operations in the US not be taxed there solely because it is incorporated somewhere else. Sen. Levin calls it a “sham”:
Our legal system has a preference to respect the corporate form. But the facts here present this issue: Are these offshore corporations so totally controlled by Apple Inc. that their identity as separate companies is a sham and a mere instrumentality of the parent, and if so, whether Apple’s claim that AOI and ASI owe no U.S. taxes is a sham as well.
Apple is exploiting a gap between tax codes rather than within them. Ireland uses the test of management and control to determine ASI’s residency. As it is managed and controlled in the US it is not resident here. The US uses the test of incorporation to determine ASI’s residency. As it is incorporated in Ireland it is not resident there.
It seemed incredible at the time but ASI was tax resident nowhere. The “lower rate” that The Irish Times refer to is that tax rate that applies to “stateless income”, i.e. zero. It is not a rate that is applied by either country [there are no “special” rates in Ireland – well not now anyway; see here and here] it is a rate created by claiming the company is resident nowhere. That is wrong.
Either or both of Ireland and the US could have moved against this. Ireland did with the announcement in last October’s budget that Irish-incorporated companies that are not judged to be resident here under the test of management and control must state to the Revenue Commissioners where they are actually resident or they will be deemed to be resident here. It closed the loophole between the Irish and US tax systems.
The US could have moved in a number of ways. Apple is, after all, a US company.
- The US could follow Sen. Levin’s approach and judge ASI to be an instrumentality of the parent and therefore taxable in the US through its parent.
- The US could apply the test of management of control to companies operating there.
- The US could amend Subpart F of the US tax code and limit Apple’s ability to defer the tax due on this income. [It is commonly said that Apple avoids tax using this scheme but the actual effect is to defer the payment of the 35% US corporation tax due on the profits. Though this deferral can be indefinite if the money is not transferred to a US-resident company.]
- And finally the US could examine the cost-sharing agreement between Apple and ASI that transfers the global rights of the intellectual property to ASI. After all, another possible source of the value added is not the intellectual property but the R&D that resulted in the design of the products in the first place.
But it was Ireland that moved.
Will it make any differences to Apple’s tax bills? Probably not. There are lots of provisions in the US tax code that will allow it to continue to defer its US taxes – the “check the box” provision, the “look-through” rule and the “same country” exemption will achieve the same result. Apple will have to adjust its tax strategy if it wants to maintain the zero rate that it achieved on the “stateless income” until repatriation but that can be achieved by shifting the profits to Bermuda where the rate of corporation tax is … … … zero.
The dance between companies and countries continues but there is no sign that the countries have cornered them. There are a lot of eyes on Pascal Saint Amans but apart from an increase in transparency it is still not clear what the OECD BEPS project will actually deliver. It will not be a shift to a destination-style system of corporation tax based on customers but some system of formulary apportionment is possible (though not in the near term). The dance will continue for a good while yet.Tweet