Thursday, April 9, 2015

US MNCs at the Australian Senate

The Economics References Committee of the Australian Senate is undertaking an inquiry on “corporate tax avoidance”.  The inquiry was initiated last October with a call for submissions and oral hearings began this week. 

On Wednesday representatives from Google, Apple and Microsoft appeared before the committee.  The transcript of the session is here.  Unsurprisingly, numerous references were made to Ireland (27 times) and Irish (14 times – half of which were to “double irish”) during the course of the hearing.  Some extracts from the hearing are below the fold.

First, here is a very useful summary of Google’s global structure from the managing director of Google Australia:

Google is now a global company. We have operations in about 70 offices, both in terms of sales and R&D, across 40 different countries. Our users and customers come from all around the world. Google's global corporate tax rate is just over 19 per cent, and we incurred taxes of $3.3 billion last year. Almost all of those taxes were paid in the United States by our headquarters, Google Inc. In Australia, Google employs about 1,000 people and we perform two very important functions for Google globally. The first one is that we provide sales and marketing support services. What that means is that people on the ground in Australia help to explain our very new-to-the-world services, including advertising services, both to users but also to businesses. Because the services are new to the world, users often require a lot of education in terms of what they are, why you should use them, how you should use them, and when you should use them; and we provide a lot of education. We also provide a lot of work to drive awareness of what those new services are. Our team works with our regional head office in Singapore, and our regional head office in Singapore is responsible for serving advertisers across over 30 different countries in the region. So that is the first thing. The second thing we do in Australia is that we provide R&D services to Google globally. So we have about 500 engineers based in Australia, and they support the about 28,000 engineers Google has globally. In Sydney we work on products such as Google Maps.

So the way to think about us like an external agency. Google Australia gets revenue from two places. We get revenue from Google Inc. because of our R&D services, and we get revenue from Google Asia Pacific, based in Singapore, for our marketing and sales and service support that we give. Now, in order to calculate how much revenue and how much profit Google Australia should receive, we use something called the cost-plus basis, and we ensure that the revenue and the profit Google Australia gets is absolutely comparable to what an external agency or an external company would get if they provided the equivalent services. So, specifically for 2013, Google Australia was paid $358 million in revenue and we generated profits of just over $46 million, and as a result we paid $7.1 million in taxes. So that is the context.

So now let me answer the question, why is it that Google Australia does not pay more corporation taxes in Australia? And the answer to that is because, like many other multinational corporations, whether they are digital or otherwise, we pay the lion's share of our taxes to the country where our headquarters is based. That is because typically, head offices—and in our case, our head office in the US—are where we take the majority of our risk and where we make the majority of our funding in investments such as research and development. And that in turn is what drives our profits. So at Google, our success and our profits stem from our intellectual capital, and that is the technology that helps to drive things like the algorithm which provides what we think is the most relevant answer to whatever search you put into Google Search. It also drives things like the technology to help us do the auction that prices the advertising that you would see on YouTube or on Google Search. This intellectual capital was developed outside of Australia, and this intellectual capital is owned outside of Australia. It is very easy to underestimate the risks and also the costs that were required to today, to develop that intellectual capital. It is also very easy to underestimate the on-going risks and investment required to develop the next type of innovation, such as driverless cars. For perspective, last year alone Google invested more than $9.8 billion in R&D. If you think back to when we made our first investment in Search, Google in the US funded that, even though there was already an incumbent well entrenched in the search space. When Google in the US made the decision six years ago to buy YouTube for $1.65 billion, that business at the time was generating virtually no revenue and was riddled with legal risk. In both cases, it was a very, very risky and a very, very expensive proposition for Google in the US to go after those business areas.

The explanation for why an Australian multinational, whether they be in mining or in biotech, is able to generate the majority of their revenue outside Australia but pay the majority of their taxes inside Australia is that the Australian based headquarters does most of the investing and carries most of the risk. The Australian headquarters invest in things like infrastructure and R&D, so it makes sense that the profits and the taxes made and paid are in Australia. That explanation is also why Google pays most of the taxes in our US headquarters, because the US is where the majority of our risks and our costs are borne.

This is useful but of course it leaves out one hugely important point. It is true that Google incurs substantial tax payments to the US Treasury on profits from its non-US sales but a large part of the tax payment is not actually made – it is deferred.   In Google’s most recent 10k filing with the SEC the company notes that (bottom of page 77):

We have not provided U.S. income taxes and foreign withholding taxes on the undistributed earnings of foreign subsidiaries as of December 31, 2014 because we intend to permanently reinvest such earnings outside the U.S. If these foreign earnings were to be repatriated in the future, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2014, the cumulative amount of earnings upon which U.S. income taxes have not been provided is approximately $47.4 billion. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable.

The whole purpose of the “double irish” structure is to trigger this deferral under Subpart F of the US tax code using a combination of “check the box”, the “same-country” exemption and the “look-through” rule.  If Google did transfer these $47.4 profits to a US-incorporated entity within its structure then the tax payment that would be made would be something up to $16.5 billion (assuming a rate of 35 per cent). However, the actual amount due would be reduced by any non-US corporate income taxes paid on those profits (if any!).  It is only the payment of this $16.5 billion of US tax that is affected by the “double irish” structure.

This was pointed out by the Google representative who said:

I acknowledge there is a lot more complexity to the Google global tax structure than that. None of that other structure impacts the tax that Google pays in Australia.

But the Australian Senators weren’t buying it and particular when the Google representative said she was unaware of the link to Bermuda. 

Senator XENOPHON: Most of the profits of Google go to the tax haven of Bermuda. Are you aware of that?

Ms Carnegie: No, I am not. As I said in my opening, I believe that most of the profits are taxed in the US.

Senator XENOPHON: So, when Bloomberg Business reports that most of the profits went to the tax haven of Bermuda, which had a population, back in 2013, of 65,024 people, you are not aware of any of that?

Ms Carnegie: I am aware that Google has a relationship in Bermuda.

Senator XENOPHON: What is the tax rate in Bermuda? Remind me.

Ms Carnegie: I am not aware.

CHAIR: Zero.

Senator XENOPHON: If I said it was zero, would that be right?

Ms Carnegie: I would not debate it. I would take it on face value.

Senator XENOPHON: You are a senior executive for Google—their most senior executive in this country—and you are not aware that profits from Australia's operations somehow end up in Bermuda, where there is a zero tax rate?

CHAIR: It is a zero tax rate. It is actually zero.

Ms Carnegie: As I said, the profits from Google Australia—basically we pay them in Australia. The profits from the other revenue generated here are paid in Singapore. So those profits are taxed. They are taxed in Singapore.

This structure obviously raises the heckles of many but the point that it only affects US tax was also made by the OECD’s Pascal Saint-Amans to the Oireachtas Finance Committee when they looked at this issue.  When talking about these companies he said:

Assuming the best action plan translates into domestic legislation in all countries, including the US, the companies in question would be taxable in the US and would not benefit from what they currently enjoy, which is double non-taxation.

Ireland should also consider it is not the only country in the world and there is an interaction with other countries. For example, part of the tax is due in the US rather than in Ireland for the simple reason that the intangible has been developed in the US, is owned by the US and should be taxable in the US, so there is a reason [not] to tax profit which is not accruing in Ireland. Therefore, this issue cannot be solved unilaterally and there is need for interaction with another country in order to deal with this.

There was not one mention of deferral at the Australian Senate hearing yet this is the one of the keys to the tax strategies adopted by the US MNCs. The key aspects are:

  1. Set up a licensing agreement with a subsidiary for the rights to sell the US MNCs products or services outside the US, and
  2. Engineer a deferral of the 35 per cent US corporate income tax payment that is due on the profits made from these sales.

The Senators got very vexed about the amount of corporate income tax the companies pay in Australia but the reality is that the current source-based system means that very little of the profits should be taxed in Australia.  Profit is allocated via transfer pricing to the source location of risks, functions and assets not the destination location of sales.  This is the system as it is now but it does not seem to meet the approval of the Senators as this exchange shows:

Senator CANAVAN: If I move to you, Ms Carnegie, and if I instead now open Safari and google, say, phones, I am pretty sure it will bring up an ad for a Samsung phone—unfortunately, Mr King!—and I click on that. You will get some money from advertising revenue, presumably it is only in cents not in dollars, but how much of that do you report to the ATO? If I click on that ad, and you get AdSense money, how much of that do you report to the ATO?

Ms Carnegie: We do not report any of that. All of that revenue goes through to Singapore.

Senator CANAVAN: So even though I have clicked on that ad in Australia—and I have used Telstra's mobile phone network; it has all happened in Australia—none of that gets reported to the ATO.

Ms Carnegie: No. All of that revenue gets booked through Singapore, and gets taxed in Singapore.

Senator CANAVAN: What is the tax rationale for that arms-length transaction or that economic location? That transaction has happened here. I understand you have to pay costs for that, and for your IP, as you said earlier, that you would have to deduct from that income—but I have paid for it, I have clicked on the ad. It is for a shop in Australia—it is Harvey Norman, a Samsung Galaxy—I could go down there right now and buy it. Why is it that you do not report any of that income to the ATO?

Ms Carnegie: We have a bit of a different business model to other people in that we do not set any of the prices for that. That is all done via an auction. Price discussion is all basically done through technology, and the intellectual property and intellectual capital for that auction is very sophisticated. It takes hundreds, if not thousands, of engineers to create. It can all be run, quite frankly, outside of Australia. There is very little need to have people in Australia to be helping to look after that transaction.

Senator CANAVAN: Except for me, who is an Australian, who is effectively using your service and providing you revenue. The equivalent would be reading a newspaper or watching TV in Australia, and my eyeballs help provide them revenue, but we expect those media companies to pay taxes in this country. You are effectively a media company in one sense of the word, but none of that income is reported here. I find that extraordinary. From a public policy perspective, there is an issue there for us because it is economic activity that is occurring in Australia. It is leading to a store that is in Australia, but we cannot touch it.

Ms Carnegie: As I said earlier, if we look at how Australian multinationals are operating outside of Australia, for me it is not remarkably different—for example, an Australian mining company which is generating more than a third of its revenue in a market like China, yet is only paying China 0.4 per cent of its taxes. Again, these are international tax arrangements. What Google is doing in Australia is very similar to what Australian companies are doing outside of Australia. That is why, in my opening, I am not sitting here today trying to defend whether those practices by Australian miners or Australian biomedical companies or American companies or Google are right or wrong. It is simply the way the global tax system is currently working. We are trying to operate within that. If the government chooses to create a different system, then obviously we will abide by that.

Of course, the comparison with mining isn’t exactly fair.  It is pretty clear where the source of a mining company’s profit is – it is where ever the hole in the ground is.  Australian mining companies might sell huge amounts of their output to Chinese customers but there is little doubt that the functions that generate the profits are located in Australia. 

The reason the comparison is not fair is that Google can essentially choose the location that acts as the source of their profits.  This is because the profits come from intangible rather than physical assets.  Google’s revenues go to Singapore and Ireland and then subsequently to Bermuda. This exchange with Microsoft  shows something similar:

Senator XENOPHON: How much revenue do you take from Australia?

Mr Sample: Two billion dollars.

Senator XENOPHON: How much of that goes overseas?

Mr Sample: The revenue is in payment for products and services provided—

Senator XENOPHON: No, please answer the question. Please do not do this to me. How much of the $2 billion goes overseas?

Mr Sample: The $2 billion is billed by the Singapore group and it is paid to the Singapore group.

Senator XENOPHON: So all of it goes to Singapore?

Mr Sample: Of that $2 billion, that is correct, Senator.

Senator XENOPHON: Thank you for your direct answer.

Senator MILNE: I would like to follow up on this particular issue of how Microsoft has done this. In that US Senate inquiry I note that Microsoft sold the intellectual property rights to its subsidiaries in Ireland and in Singapore. Is that a matter of fact that the US parent company sold the intellectual property rights to those subsidiaries?

Mr Sample: All our intellectual property is owned by Microsoft Corporation in the United States.

Senator MILNE: I am sorry. It is not the IT; it is the licence to sell Microsoft in Europe and in Asia?

Mr Sample: Our Irish and Singapore regional operating centre groups have licensed the right to—

Senator MILNE: Thank you. They have bought the licence to sell those products in the regions.

Mr Sample: In exchange for significant licence payments back to the US made every year.

Senator MILNE: Those licences are paid back to the US and then those licence fees get passed on to the customers in Australia, et cetera, as part of the cost structure, which goes straight back to Singapore, which goes straight back to the US—or, more particularly, to Bermuda.

Mr Sample: The selling prices of our product and services to customers are in no way related to licence fees. They are not based on the licence fees that are paid by the regional operating centres to the US.

Again a big issue is that, given the nature of their products, companies like Microsoft can choose the location of these nodes and it is pretty obvious that tax plays a significant role in their decision to choose locations like Singapore and Ireland.

As was pointed out to the Committee politicians can change the current system if they want to.  They could move to a corporate income tax system based more on the destination principle rather than the source principle (i.e. where the product ends up (customer) rather than where it comes from(supplier)).  We already have destination taxes (VAT and sales taxes) but maybe politicians want the corporate income tax to be based on the same principle.   A move in this direction could be achieved with significant changes to the definition of permanent establishment.

The rhetoric of the Australian senators suggests that they would favour such a move but it is doubtful they will act on it.  Under such a system, Australia would gain additional tax revenue from the profits made from sales by the likes of Apple, Google and Microsoft to Australian customers but it would loss tax revenue from the profits made by Rio Tinto and BHP Billiton [it should be noted that the Senate Committee will also be looking into these companies for large payments they are making to Singapore for "marketing hubs" – so maybe the source of their profits isn’t as clear as a hole in the ground].

The issue of transfer pricing was central to the discussion that took place with the Apple representative.  The hearing could have provided some useful information in relation to the EU Commission into Apple’s tax affairs in Ireland but the Apple representative was incredibly evasive.  He basically said nothing and kept saying it as the following exchanges show.

Senator MILNE: I want to follow up on that question about Apple subsidiaries. We had evidence today from Professor Antony Ting. In his submission to the inquiry he said:

Another implication of the separate entity doctrine is that tax administrations are bound by the tax law and therefore in general have to respect intra-group transactions even if they do not have economic substance. Taking Apple’s international tax avoidance structure as an example, it has successfully shifted US$44 billion to its Irish subsidiary from 2009 to 2012. The Irish subsidiary was a shell company with no employees before 2012.

Do you accept that that is a true statement?

Mr King: What I can say is that we book all of our revenue and sales that we do in Australia in our books locally, we book all of the costs associated with doing business here, we buy our products from affiliate companies within the Apple group and we pay all of our taxes on our sales here in Australia.

Senator MILNE: No doubt—that is what you are saying. I asked you about the allegation that Professor Ting made in his submission ,which is that basically you have an international tax avoidance structure—'a double Irish sandwich with Dutch associations'. What is a double Irish sandwich with Dutch affiliations?

Mr King: I have no idea what you are talking about.

Senator MILNE: Oh come on, you have not come here today to say that!

Mr King: What I can say is that all of our revenue is recorded in our books here, all of our costs of doing business are reported in our books and we buy products from affiliate companies outside of Australia.

Senator MILNE: So why does this money go straight to Ireland and then through the Netherlands and then back to Ireland? What is going on with that?

Mr King: All of our business here is clearly reported in our books.

Senator MILNE: I am not asking what you are reporting. I am asking you about this arrangement that you have.

Mr King: The arrangement that we have is very clear in the business that we do in Australia. All the revenue and all of the costs of doing business are clearly reported in our books here in the Australian market.

Senator MILNE: Professor Ting goes on to say:

when Apple’s Australian subsidiary sells an iPad for $600 to a customer in this country, it is estimated that about $550 (that is, approximately 90%) is shifted to Ireland. To make it worse, out of this $550, about $220 (that is, approximately 36%) is never taxed anywhere in the world. This is called “double non-taxation” in the tax world.

Are you involved in double non-taxation?

Mr King: I am not an international tax expert. I am not familiar with any of our tax activities offshore. I can talk clearly about our tax activities in Australia. When we buy an iPad, an iPad has a cost. Apple Australia pays the cost of that iPad when we purchase it from an affiliate within the Apple group.

Senator EDWARDS: That is the issue.

Senator MILNE: That is the point. What are you buying it for and what are you selling it for?

Mr King: We buy it for an arms-length price, which is determined in accordance with our advance pricing agreement, which has been clearly worked for many, many years on a consistent basis, transparent and open with the Australian tax office.

Senator MILNE: What I am asking you is: what are you buying it for and what are you selling it for?

Mr King: We buy it at an arms-length price.

Senator MILNE: Yes, I heard you say it is an arms-length transaction and your advance pricing agreement. What I am asking you, though, is: what is the actual dollar terms? What are you buying an iPad for and what are you selling it for in Australia?

Mr King: We are buying it at an arms-length price, which would be the same price—

Senator MILNE: I heard you say that. I said: how much?

Mr King: I do not have a specific dollar value for each one of our products here today.

Senator MILNE: Relative to what you buy and sell an iPad for in Australia, how does that compare with the price that you sell it for and the cost you buy it for in other places?

Senator EDWARDS: Say, America.

Mr King: I am not familiar with the tax practices in America. I can talk about the tax practices here in Australia. That iPad would be bought at the arms-length price, which would be as if Apple in Australia were an independent entity buying that product from an offshore—

Senator MILNE: Therein is the problem. You are acting as if you are a separate entity and you are not a separate entity; you are part of a global structure and you are fixing the prices around the world so you maximise your expenses here in this jurisdiction and then maximise your tax avoidance in a low-tax jurisdiction. Isn't that what Apple is doing?

Mr King: Senator, I reject that. We are following—

Senator MILNE: Why? What is wrong with that statement?

Mr King: We are following globally accepted transfer pricing principles. We are following Australian transfer pricing principles in everything that we do here in the Australian market.

Senator MILNE: I am not saying you are not following the law or you are not following principles. I am asking you as a matter of fact. You are sitting here saying that you are just familiar with the Australian tax arrangements of your Apple subsidiary here. What I am saying is that it is ridiculous to regard you as a single entity when you are part of a global company which is avoiding tax.

Mr King: We do not avoid tax. We pay all of our taxes that are due in the Australian market in accordance with the law.

Senator EDWARDS: You know where Senator Milne is going. It is getting painful again.

Senator MILNE: Yes.

Senator EDWARDS: If you buy an iPad for $550 in Australia and sell it for $600, you have tax on $50—that is your gross margin, right? Then you have costs out of that and that leaves your net profit. Your net profit might be $10, of which you pay 30 per cent, which is $3, on every iPad. However, in America or other more favourable tax jurisdictions, do you charge the equivalent of $550 or does your parent company charge $550 for the same iPad, or do they charge $220, which means your gross profit is much higher? Your costs may be similar, depending on the region you are in and therefore you have a much higher net profit. Am I helping you?

Senator XENOPHON: Very good questions.

Senator EDWARDS: I am going to go mad otherwise.

Mr King: I can only restate what we do here on the Australian market.

Senator XENOPHON: You are not answering the question.

CHAIR: You do not know?

Mr King: Senator, I do not know what we do elsewhere in the world.

Senator CANAVAN: How do you work out the transfer price? How do you calculate the arms-length basis for the iPad that you buy here?

Mr King: That is subject to the advance pricing arrangement with the ATO. And the transfer pricing—

Senator CANAVAN: But you do not have that agreement with them right now.

Mr King: For the worked example that we are talking about?

Senator CANAVAN: Yes.

Mr King: I do not have a specific number for every product that we sell.

Senator CANAVAN: But you said in your submission that you do not have an APA with the ATO any more.

Mr King: Our APA first started in 1991. Our most recent APA expired just recently—

Senator CANAVAN: Yes. So you do not have one right now.

Mr King: and we are just working on the basis—as if that APA were still in existence.

Senator CANAVAN: Mr King, we are mere senators—and you are not an international tax expert, I understand that. But you are responsible for a company that pays tax and is obviously involved in these arrangements to determine your tax. I think we are hoping for you to give us a layman's explanation of how you determine an arms-length price under these arrangements. It seems to me very difficult. It is not a simple business—you said your business is simple; this is not simple, because there is no alternative purchaser of iPads, there is no alternative market that we can go to to check this price and benchmark it. How do you determine the price, given it is an internal party or a related party transaction?

Mr King: So it is a function of a couple of things: first and foremost, the economic activity that Apple Australia undertakes here, and so we are a distribution business in the Australian market. We bring Apple product into Australia and it is sold. Second, when we look at specific products, we are looking at the arms-length test, and the arms-length test involves economists working through companies that would be similar in size, shape, and style to that of being a distribution company. And those comparables are pulled together, in conjunction with analysis that the ATO does on their side of the fence, to determine what an arms-length basis would be for imported products coming into Australia.

Senator CANAVAN: So is it a building-blocks approach then?

Mr King: It is a building-blocks approach from the bottoms up. It starts with, what does Apple do here? We do not do any development. We do not do any manufacturing. We distribute and sell products.

This pattern was repeated in a subsequent exchange that saw as many accusations thrown at Ireland as at Apple:

Senator XENOPHON: Mr King, you have been with Apple for 12 years now?

Mr King: Yes, sir.

Senator XENOPHON: When was the last time you went to Ireland on business?

Mr King: I have never been to Ireland on business.

Senator XENOPHON: I find that strange, because, according to investigative journalists in this country, Apple in Australia has moved almost $9 billion in untaxed profits to its operations in Ireland. You have moved close to $10 billion to Ireland and you have never been there.

Mr King: Apple in Australia is owned by Apple Ireland. That is our parent company. I will reiterate that I have never been to Ireland for business purposes—only pleasure.

CHAIR: Do you FaceTime?

Senator CANAVAN: Do you FaceTime with Ireland?

Mr King: Not recently.

Senator XENOPHON: So you have shifted close to $10 billion in untaxed profits to a place you have never done any business with?

Mr King: We have not shifted any profits. We book all of our revenues here, all of our costs—

Senator XENOPHON: But you have shifted $9 billion from Australia to Ireland. Is that not the case?

Mr King: We have not shifted any profits outside of Australia.

Senator XENOPHON: No. I am asking: have you shifted $9 billion in revenues to Ireland, as reported?

Mr King: No, sir.

Senator XENOPHON: So what have you shifted?

Mr King: We have not shifted any profits.

Senator XENOPHON: Are you sure about that?

Mr King: Yes, sir, I am.

Senator XENOPHON: What do you say to this? Back in 2013, Apple reported pre-tax earnings in Australia of only $88.5 million, after sending an estimated $2 billion from its Australian sales to Ireland via Singapore, where Apple negotiated a secret tax deal in 2009.

Mr King: We are very transparent in everything that we do in the Australian market. All of our revenue, all of our costs, are clearly reported in our Australian business. We do buy products from affiliate companies outside of Australia, and we pay for those products.

Senator XENOPHON: Can I just go to a report of the United States Senate Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations. It reported on 20 May 2013. The US Senate concluded that Apple's tax arrangements have nothing to do with its business. Effectively it was highly effectively of Apple's tax arrangements. Do you know anything about that US Senate committee's findings?

Mr King: I watched the Senate inquiry at which our executive team presented, and they gave a very comprehensive description of Apple's tax affairs, not only in the United States but internationally, at that Senate investigation, and that is in the public domain.

Senator XENOPHON: As a consequence of that, the US Senate made quite significant findings against Apple about its activities—that it was aggressively minimising tax.

Mr King: I do not believe that there were any adverse findings against Apple from that inquiry.

And here is an exchange which resumes with the ‘building block’ reference from above and the Apple representative is a little less circumspect and indicates that the transfer price for Apple products is “consistent” around the world.

Senator CANAVAN: I just want to go back to what we were talking about before on the transfer pricing. I am mindful of time. I will try to keep this to five minutes or so. Mr King, you mentioned that you use a building blocks approach, but this question is for everybody. I am still interested to know how you come up with those costs and that building blocks approach?

For example, for an iPad for $600 or whatever it costs, how much of those costs are for physical wages you are paying people in China or for the aluminium or glass that you buy—things that we can pretty easily measure? What proportion is for a physical constraint and what proportion is for intangibles—marketing, fixed costs, overheads or IP et cetera?

Mr King: I will break that down into two portions. The economic activity that we undertake in Australia is very, very clear: wages for our people, all the buildings, leases, activities that we undertake and then an assessment of all of the value that the Apple team in Australia contributes to the distribution of our products in the Australian market. So a lot of that is time and costs of staff. The first part of the building blocks in an APA process is to ascribe value to the economic activity that is undertaken by a multinational such as Apple in the Australian market, then that is essentially worked up the stack to the product side. Each one of our products is intensely complex and is a mix of components, hardware, software and many, many years of research and development. I do not have the numbers for the split between intangibles and tangibles off the top of my head.

Senator CANAVAN: Presumably you are using some method of cost accounting to tally up all the costs of a global business and allocate those to different products. A lot of your costs would be overheads, I presume—or common, or fixed, costs.

Mr King: A great deal of the costs within Apple is for the procurement of components. The manufacturing processes associated with the building of our products is an enormous cost load in terms of operations and transference of products around the world, and a very considerable amount of money goes into research and development and all of those intangibles. All of that development activity is undertaken in our headquarters in Cupertino in the United States. That is where all product design takes place.

Senator CANAVAN: In this allocation of your costs to Australia—that is, the transfer price to Australia—so for the Australian who is buying an iPad from somewhere overseas to sell here, do you charge every Apple subsidiary around the world the same price for that iPad? Is the iPad you are buying here in Australia the same price as what a Singaporean or—that is probably not the best example—an Indonesian Apple would buy it for? Is it the same price across the world, or do you allocate your costs differently?

Mr King: To the best of my knowledge it is consistent around the world.

Senator CANAVAN: Could you take that on notice, and consistency from then what I mentioned was the same.

Mr King: I took that question on notice before. The APA process that we have in Australia is deployed in many of the OECD tax jurisdictions around the world. The process of determining the transfer price is consistent here with principles that would be deployed in other tax jurisdictions around the world. But I will take the overall question on notice to give you more specifics.

Senator CANAVAN: Thank you very much for giving us the figure for, I believe, the last financial year—that is $6 billion, is that right? I get a taxable income margin of 4.1 per cent, which is $250 million on $6 billion. It seems low. I know you have got other costs and you do not necessarily have all that much value added here in this country, but it still seems a relatively low margin.

A four per cent margin seems low but for retailing consumer electronics it would be about right.  If a third-part retailer was buying Apple products for resale they could not expect to make huge margins.  If, say, SC Electronics was selling iPads for €600 it could not expect Apple to wholesale the product to it for €400 or anything approaching it.  Why would Apple let SC Electronics pick up a huge amount of the profit for an activity that contributes very little of value added.  Retailing is not a high-skill activity. Apple would wholesale the iPad to any third-party retailer for €550 keeping most of the profit for itself leaving only a small margin for the retailer.  A net margin of four per cent seems about right, 

And this is what Apple does when it wholesales iPads to its subsidiary Apple Australia.  If the transfer price was at anything other than $550 Apple would be breaking Australian tax law – the transfer price must be set at a level which would be charged to an unrelated third party.  This led to a further circular exchange:

Senator XENOPHON: And you do not disclose those either, do you, Mr King?

Mr King: We do disclose those. We reported revenues last year in Australia of $6 billion.

Senator XENOPHON: How much of that went overseas?

Mr King: We reported all of our revenue and all of our costs, and we—

Senator XENOPHON: No. I asked you how much of that went overseas.

Mr King: Our net profit was $250 million.

Senator XENOPHON: How much of the money went overseas? How much of that $6 billion paid by Australian consumers went overseas? Can you please tell us that?

Mr King: I will take that question on notice to give you a specific number.

Senator XENOPHON: Are you serious? You have come to this inquiry on tax minimisation and aggressive tax minimisation and you were not expecting a question like that?

Mr King: We pay using the 'arms-length' basis, which I have been into several times before. It is an established tax principle for the cost basis of all of the products that we bring into the country. All of this is clearly worked and disclosed with the ATO. It is very transparent in advance pricing agreement discussions with the ATO.

Senator XENOPHON: Mr King, I find it extraordinary that you cannot tell us that. I think it is important that this committee—and, Chair, as a voting member of this committee I will be asking that Mr King, and indeed all the witnesses, appear again. Maybe we can do it via FaceTime for you, Mr Sample.

CHAIR: That is not their product. It would be Skype.

Senator XENOPHON: Skype, sorry. So you cannot tell us how much of that $6 billion has gone overseas?

Mr King: We pay for all of our products—

Senator XENOPHON: No. Answer the question, please, Mr King. How much of the $6 billion that Australian consumers have paid for Apple products has actually gone overseas? It is a very simple question.

Mr King: We buy all of our products from international subsidiaries at an arms-length price—

Senator XENOPHON: You are not going to answer the question, are you?

Mr King: The purchase price of our products does go offshore. I will take that on notice to give you—

Senator XENOPHON: You were not expecting a question like that today, were you?

Mr King: I will take that on notice for the purchase price of our products last year.

CHAIR: To clarify for the purpose of the committee, do you not know or are you not telling us?

Mr King: I do not have the number.

CHAIR: You do not know the number?

Mr King: Correct.

Whatever the precise number and the displeasure exhibited by the Australian senators that this results in little profit to be taxed in Australia it is fact that retailing consumer electronics is not very profitable.  Designing consumer electronics that millions of people want to buy is very profitable but Apple do that in California not Canberra.

Of course, we also got the usual accusations thrown at Ireland.  Ireland does use low-tax to attract MNCs but that does not mean that every bit of mud that is thrown at Ireland should stick.  Very little of it should.

One senator says “Apple negotiated a secret tax deal in 2009” with Ireland and another quotes an Australian academic who says “when Apple’s Australian subsidiary sells an iPad for $600 to a customer in this country, it is estimated that about $550 (that is, approximately 90%) is shifted to Ireland.”

Neither of these is true.  There was no special tax deal or two per cent rate as claimed at the US Senate.  And when Apple Australia buy Apple products the money does not come to Ireland.  The money goes to the US.  It does go to an Irish-registered company but, as pointed out at the US Senate hearing, those companies carry out almost all of their activities in the US.  The intellectual property that drives Apple’s profitability is held in the US and the profits that are derived from that intellectual property is subject to tax in the US.  The European Commission will confirm as much later this year (though will probably find Ireland guilty of some minor misdemeanour).

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