The latest insight into Apple’s use of capital allowances

At the start of 2015, Apple revised the structure through which the company’s sales to customers outside the Americas were organised.  This was responsible for the 26 per cent real GDP growth reported for that year.

We initially examined the revised structure here and in recent years have been tracking the consolidated outcomes for the group headed by Apple’s central international subsidiary, Apple Operations International (AOI). 

• AOI’s 2018 Accounts: Some insight into Apple’s use of capital allowances
• AOI’s 2019 Accounts: Further insight into Apple’s use of capital allowances

The recent publication of the AOI Group’s 2020 consolidated accounts gives us the latest insight into Apple’s use of capital allowances.  The two posts above contain details that are not repeated here.

We will start with the consolidated statements of operations and note that this covers the holding company AOI and around 80 subsidiaries operating beneath it, with the group as a whole having just over 50,000 employees.  Most, but not all of the amounts shown, arise in or pass through subsidiaries in Ireland.

Some pretty big numbers there.  As the accounts note:

The Group develops, manufactures and markets smartphone, personal computers, tablets, wearables, and accessories, and sells a variety of related services.

It certainly sells a lot.  For the four years shown, cumulative net sales were close to $600 billion.  And it is massively profitable.  Pre-tax income summed to $165 billion over the four years and the provision for income taxes was a chunky $25 billion.

But we should check a few things before we get excited about that tax figure.  A company making a provision for income taxes in its financial accounts is not the same as a company making a payment for those taxes in cash.  The balance sheet is a useful place to look next.

For our purposes we are interested in the line for Deferred tax asset.  We can see that the AOI Group had $25.6 billion of deferred tax assets at the end of its 2016 financial year.  These reduced each year and by the end of its latest financial year stood at $10.9 billion.

Thus, while there might been tax provisions averaging around $6 billion in the income statement for each of the past four years this was not resulting in an equivalent payment out of cash reserves but in the reduction in the deferred tax asset on the balance sheet.

[As we have pointed out before it is also worth noting what this balance sheet does not contain: a huge amount of intangible assets.  Ireland’s national accounts have recognised massive intangible assets yet the consolidated accounts of the group which contains the company with that asset does not. Anyway back to the tax payments.]

The difference between the provision for tax and the payments for tax is is confirmed by a supplemental item included with the consolidated statements of cash flows.

There might have been tax provisions of $6 billion each year but, as the final line above shows, cash payments for income taxes averaged $2 billion a year over the past four years.  And a variation of the following paragraphs are included a number of times in the accounts:

The corporate income taxes in the consolidated statements of operations, balance sheets and statement of cash flows do not include significant US-level corporate taxes borne by Apple Inc., the ultimate parent of the group.

US-level taxes are paid by Apple Inc. on investment income of the Group at the rate of 24.5% (35.0% in 2017) net of applicable foreign tax credits. In addition, under changes in US tax legislation that took effect in December 2017, Apple Inc. is subject to tax on previously deferred foreign income (at a rate of 15.5% on cash and certain other net assets and 8.0% on the remaining income), net of applicable foreign tax credits.  The new legislation also subjects certain current foreign earnings of the Group to a new minimum tax.

The posts linked above that went through AOI’s 2018 and 2019 accounts go into detail on how the provisions for income taxes were arrived at and show the reconciliation with Ireland’s 12.5 per cent headline rate.  The earlier posts also discuss how the deferred tax asset came about – capital allowances under Section 291A of the Taxes Consolidated Act. 

For now, we will just focus on the evolution of those deferred tax assets using a table from the note to the accounts on the provision for income taxes.

We are interested in the deferred tax asset that arises due to Intra Group Transactions.  This likely includes the purchase by a now Irish-resident subsidiary of the license to sell Apple products in all markets outside the Americas.  That outlay (which may have been around $240 billion) will be eligible as a tax deduction with this provided via capital allowances.

At Ireland’s 12.5 rate of corporate tax a $240 billion deduction would be worth $30 billion which is probably where the value of the group’s deferred tax asset from intra-group transactions was in January 2015.

As we can see from the above table tax was being charged against that deferred tax asset.  The utilisation was $4.4 billion in both 2017 and 2018, $3.2 billion in 2018 and $3.3 billion in 2020.  This meant there was $7.4 billion remaining and at the current rate of utilisation will be fully exhausted in the next two to two and a half years.

The utilisation of capital allowances at that scale means that something in and around €25 billion of gross profit is being offset by a deduction for capital allowances.  As the transaction occurred before October 2017 no cap applies and, if sufficient capital allowances are available, the company can fully offset its profit with capital allowances and this is was happened in 2015, 2016 and 2017.  A small amount of profit may have been subject to tax in 2018.  Any unused capital allowances in the earlier years are carried forward as losses but essentially remain as a deferred tax asset.

As before, the key question is the amount of profit that will be subject to tax when the deferred tax asset is fully exhausted.  If nothing changes at that point then somewhere in the region of €25 billion of gross profit will be added to the taxable income of the Irish-resident Apple subsidiary that currently holds the license to sell Apple products outside the Americas. 

This would see tax payments in Ireland rise by €3 billion or so and that Apple subsidiary would almost certainly become Ireland’s largest taxpayer.  If nothing changes.

We have already seen a number of major US ICT MNCs transfer their IP back to the US (from which it should never have been allowed leave in the first place).  Apple have the option to do the same and maybe this becomes more likely as the amount of capital allowances available nears exhaustion.

If Apple were to do so, this would reverse the GDP surge that occurred in 2015 and the value added would be rightfully recorded where it is generated – in the US.  Changes that add 0.2 per cent to US GDP won’t make headlines in the same way a 10 per cent reduction in Irish GDP would.  But they essentially involve the same thing.

And further it probably won’t significantly change the company’s tax payments  - not in Ireland at any rate.  With capital allowances the profit is not currently exposed to Ireland’s 12.5 per cent Corporation Tax.  As pointed out above the profit is subject to tax in the US under the minimum tax on foreign earnings introduced by the Tax Cuts and Jobs Act (TCJA). 

This is the tax on Global Intangible Low Taxed Income – GILTI.  The Biden administration are proposed to double this from 10.5 per cent to 21 per cent.  If Apple relocates their IP to the US and continues to use a licensing structure (they could also decide to simply sell the products from the US) then the income from that license would be taxes under the Foreign Derived Intangible Income (FDII) provisions also introduced by the TCJA.  The Biden administration are proposing to abolish FDII.

There is lots of uncertainty.  But as shown here there is no doubt that the amount of remaining capital allowances Apple has in Ireland is reducing.  What was probably around $30 billion in 2015 was down to $7.4 billion in September 2020.  We won’t get many more insights into Apple’s use of capital allowances – because soon enough they will be gone. 

Why there’s no pot of gold from suggestions of German multinationals reporting low-taxed profit in Ireland

Last week’s New York Times op-ed by Prof. Paul Krugman got some attention though mainly for some of the characterisations used.  And there is a difference between a pithy remark about a set of national accounts and the pejorative use of language to describe the residents of a country.

But let’s focus on the substance of some of the points made and, in particular, this extract which draws on some comments made by Prof. Gabriel Zucman on the recent G7 agreement:

Which brings us to that G7 deal. How would the 15 per cent minimum rate work? Here’s how Gabriel Zucman – who has arguably done more than anyone else to highlight the importance of international tax avoidance – summarises it:

“Take a German multinational that books income in Ireland, taxed at an effective rate of 5 per cent. Germany will now collect an extra 10 per cent tax to arrive at a rate of 15 per cent – same for profits booked by German multinationals in Bermuda, Singapore, etc.”

It seems it is to be taken as given that the suggestion of a German multinational booking profits in Ireland is a relevant example.  But has there ever been evidence of German multinationals with profits booked in Ireland and taxed at five per cent?  Unfortunately, Germany has yet to provide aggregate data to the OECD from the country-by-country reports filed by German multinationals with the German tax authority.

There is, though, this recent CESifo working paper which uses the firm-level reports filed with the German tax authority to assess profit shifting by German multinationals. The conclusion of the paper includes the following:

However, compared to the profits in non-haven countries, profits reported in tax havens are small – only accounting for 9% of global profits.

[.]

Our findings suggest that annually, EUR 3.8 billion of EUR 125 billion of total foreign profits of German MNEs are shifted to tax havens, yielding a share of approximately 3%.

In general, estimates of the extent of profit shifting in the literature tend to be higher, although some studies, in particular Blouin and Robinson (2020), find similar magnitudes. The differences in the results may result from different methods or data sources, but they may also reveal that German MNEs are less prone to shift profits than MNEs from other countries. That in turn could reflect tighter anti-tax avoidance policies in Germany and in important host countries of German foreign investment. Another reason could be differences in profit shifting opportunities due to firm characteristics such as the importance of intangible assets.

The final points on policy and opportunities are important considerations when examining US multinationals.  While we don’t have aggregate data for German multinationals from country-by-country reports there are other salient sources that can be used.  One is Eurostat’s dataset on foreign-controlled EU enterprises.

It is not a perfect match for tax data but does point in the right direction.  Here is the gross operating surplus of foreign enterprises operating in Ireland in 2018 by controlling country.  This measure is not the same as taxable income and gross means before any adjustment for depreciation.

It it clear that there is only one bar that matters.  Most of the other numbers are non-zero but are not large enough to be visible due to the axis range needed to include the figure for the US.  Germany is up towards the top of the chart and the gross operating surplus in Ireland of German-controlled enterprises is small compared to that of US-controlled enterprises.

We can see more detail of the distribution of profits of German companies across EU countries with the following table which shows the gross operating surplus of enterprises ultimately controlled from Germany by the location of those enterprises.

Unsurprisingly, the vast majority of the profits of German controlled-enterprises is generated in Germany.  The figures for Germany in the table include both multinational and non-multinational enterprises.  For German multinational enterprises, the rest of the table gives the amount of gross operating surplus they record in other EU countries.  The table is in rank order based on the most recently available outturn.

For Ireland, we can see that the figure has typically been around €1.2 billion in recent years which can be compared to the €117 billion of gross operating surplus that US MNEs had in Ireland in 2018.

In the above table, Ireland is below Finland, Portugal, Denmark, Slovakia and Sweden as a location for the profits of German MNEs.  And that €1.2 billion will include the profit of Germany companies which have come to Ireland to service the domestic market such as grocery retailers.

Having people take an example of a German company booking profit in Ireland stumbles on two bases. First, in overall terms, German companies do not shift large amounts of their profits to low-tax jurisdictions (likely because they can not do so under German law). And, second, aggregate data suggests that German companies do not report significant amounts of profit in Ireland (unlike US companies).

Indeed, using an approach that is incorrect but frequently used, the argument could be made that German companies are shifting profit out of Ireland.  Here are the recent accounts for BMW Automotive (Ireland) Ltd.

For the years shown BMW sold about 5,000 vehicles in Ireland – across its BMW and Mini brands.  The sale of these vehicles generates the revenue for this company.  In 2019, it can be seen that after €147 million of cost of sales and €9 million of administrative expenses the company recorded an operating profit of €871,000 and incurred an income tax expenses of €120,000 (or around €24 per vehicle sold).

In 2019, BMW as a whole had revenue of €104 billion and a pre-tax profit of €7 billion.  The overall margin of the company was around 15 times higher than the margin reported by BMW Automotive (Ireland).  Why was BMW’s Irish subsidiary so unprofitable?  The result was mainly driven by the cost of sales figure.

The cost of sales is the price BMW in Ireland had to pay for the cars it sells.  It is a transfer price.  And BMW has set this price at such a level that almost no profit is left in Ireland.  Most of the profit will be reported in Germany. 

And this fine.  BMW Automotive (Ireland) does little more than wholesale cars.  It has very limited functions, assets and risks and a low profit margin is appropriate.  The designing, manufacturing, branding, pricing and lots of other things necessary before a BMW car can be sold all take place somewhere else.

Why doesn’t BMW manipulate the transfer price so that more of its profit is reported in low-tax Ireland rather than high-tax Germany? It can’t.  BMW Germany has to charge BMW Ireland the same price it charges to other wholesalers of its vehicles. 

BMW could try to have more of its profit reported in Ireland by charging BMW Ireland a much lower price.  But the German tax authority would simply ask for the price charged in other similar transactions and challenge the transfer price used.  Just as they would for all other German MNEs that might try to shift profit to Ireland. 

There might be suggestions of German MNE booking profit in Ireland to be taxed at five per cent but there aren’t many examples of it. 

Is this Ireland’s largest taxpayer?

Ireland’s Corporation Tax revenues are concentrated along two dimensions: by company and by country.  Concentration by company can be readily seen with the figure for the top 10 payers published in a research report by the Revenue Commissioners.

Over the last ten years, the share of Corporation Tax arising from the top 10 payers averaged 40 per cent.  The greatest level of concentration was seen in 2020 when the top 10 share exceeded 50 per cent for the first time. 

Since 2014, overall Corporation Tax receipts have almost trebled.  The amount that comes from the top 10 has quadrupled (though it should be noted that the top 10 is not made up of the same companies each year).

If the top 10 companies all made equal payments, then their individual payments of Corporation Tax would be just under €600 million each.  These would be very large tax payments.  However, the distribution is not likely to be uniform and it is very likely that the very top payers paid much more than this average.

The second dimension along which Irish Corporation Tax revenues are concentrated is by country.  Of the numerous unusual features of Ireland Corporation Tax revenues one of the most significant is that around four-fifths of payment come from foreign-owned companies.  As the Revenue report notes:

[F]oreign-owned multinationals paid €9,657 billion (82 per cent of net CT receipts), Irish-owned multinationals €841 million (7 per cent) and non-multinationals €1.335 billion (11 per cent).

Some of those foreign-owned multinationals have a presence here to serve the domestic markets (such as retailers, banks etc.) but most of the payments in this group come from what could be considered “the FDI sector”.  There aren’t many US companies here to serve the domestic market but they have a very large presence in Ireland.  And are making very large tax payments.

Since 2016 US MNCs who are required to do so have been filing country-by-country reports (CbCR) with the IRS.  Aggregate statistics have been published here.  For the years available, the corporate income tax paid (on cash basis) in Ireland of the US MNCs who filed CbCR reports are recorded as being:

• 2016: $4,281.3 million
• 2017: $5,189.7 million
• 2018: $7,944.4 million

We cannot compare these directly with the total figures in the first table above as they are in a different currency and the time periods covered do not exactly coincide.  Taking an annual average exchange rate would give a figure of €6.7 billion.  In rough terms in looks like around 60 per cent of Irish Corporation Tax receipts in recent years was paid by US-owned multinationals. 

And the IRS data shows a further remarkable outcome: the $7.9 billion paid by US MNCs in Corporation Tax to Ireland for accounting periods ending between July 2018 and June 2019 placed Ireland as the third-highest recipient of corporate tax from US MNCs across all countries.

Anyway, what we can take from this prologue is that one:

1. The largest payer of Corporation Tax in Ireland is likely to making annual payments that now exceed €1 billion.
2. This company is likely to be part of a US MNC.

So, now we need a few candidates.  Or maybe we just need to look at one: Microsoft Ireland Research.  In recent months there have been a number of stories about a different Microsoft subsidiary, Round Island One, which is based in Bermuda. 

That these stories did not reflect the tax outcomes for the overall Microsoft Corporation or for Microsoft’s operations in Ireland is par for the course.  There haven’t been too many stories about Microsoft Ireland Research and none that have set out its tax outcomes.

In its latest annual report, Microsoft Ireland Research describes itself as:

The principal activity of the company is licensing the rights to assets owned and developed by the company to other group companies, to enable them to sell and distribute Microsoft products.  These other group companies pay a royalty to the company under these agreements.  In addition the company is engaged in product localization and product research and development activities.

Microsoft Ireland Research is an Irish-resident company.  As noted in the annual report its “accounting records are maintained at One Microsoft Place, South County Business Park, Leopardstown, Dublin 18.”  Its operations do appear to be concentrated in Ireland, including the 500 staff it had in 2020, but the annual report does say that “the company also has a branch in Turkey.” 

A 2012 report for the US Senate Subcommittee on Investigations contained this summary for Microsoft Ireland Research:

Microsoft coordinates all of its consumer product sales for Europe, the Middle East, and Africa (EMEA), out of a group of entities in Ireland. One key entity called Microsoft Ireland Research (MIR) is a cost share participant with Microsoft Corporation, sharing 30% of the costs of Microsoft’s world-wide research and development expenses in exchange for the right to sell finished products in EMEA. MIR, which is located in Ireland, is a wholly-owned disregarded CFC of Round Island One, a wholly owned Microsoft CFC which operates in Ireland but is headquartered in Bermuda. The bulk of the research and development that MIR helps finance is performed in the United States at Microsoft Corporation, with MIR responsible for conducting less than 1% of the company’s total R&D.

Filings for Microsoft Ireland Research with the CRO show that the performance of the company in recent years has been very strong. Here are the profit and loss accounts since 2017.

Turnover has increased from $11.6 billion in 2017 to €33.5 billion in 2020 with operating profit rising from $5 billion to $14 billion.

Although the company describes its turnover as being derived from royalties the CSO does not seem to do the same.  Ireland’s royalty exports do not match the figures shown above.  It is likely the CSO put the revenue of this company into its “computer services” export category.  These are now running at an annual total of more than €125 billion.

In its International Accounts releases, the CSO notes for the Computer Services category that this:

Covers exports and imports of software that were not incorporated as part of computer hardware or physical media but separately transmitted by electronic means. The value of sales and purchases of additional software licences is also included.

The licenses sold by Microsoft Research Ireland are covered by the second sentence.  Our primary interest here is in the company’s tax payments.  We can see from the profit and loss accounts that Microsoft Ireland Research’s tax charge has gone from $628 million in 2017 to $1,803 million in 2020.  This is not out of line with the aggregate figures set out at the start of this piece.

But a company making a tax charge on its income statement is not necessarily the same as a company making a cash tax payment to a tax authority.  The payment of the tax charge could be deferred leading to a deferred tax liability on the balance sheet or the charge could be offset against an existing deferred tax asset on the balance sheet.  In both instances the tax charge would not be matched by a tax payment.  However, the balance sheet for Microsoft Ireland Research does not show substantial amounts of either deferred tax assets or liabilities.

We can get further insight if we look at the tax reconciliation statement.

And there isn’t really a whole lot that stands out here.  There is reference to the impact of capital allowances which further reduces concern about deferred tax assets.  The second item with the increase from effect of different ROI tax rates on some earnings reflects the 25 per cent Corporation Tax rate that applies to non-trading income such as interest in this case. 

The effect of foreign tax rates is very small indicating that almost all of the profit is subject to tax in Ireland.

The effective tax rate bounces around a bit but that is likely because of the inclusion of income that is not subject to tax in profit before tax.  It is possible that income from shares in group undertakings and gains on the liquidation or disposal of subsidiary would not trigger a tax liability.  As a result of that looking at the tax charge relative to operating profit may be a more reliable gauge.

It is not the definitive word on effective tax rates but, given the aggregate figures in the profit and loss account, does seem to give a consistent indicator of what is going on.  The impact of the 25 per cent rate on non-trading income (which itself is not included in operating profit) likely accounts for the difference in recent years to the standard 12.5 per cent rate.

Using an average exchange rate would give a figure of around €1.6 billion for the 2020 tax charge which is included in the accounts in US dollar terms.  The time periods don’t coincide, and assuming the vast majority of the tax charge is paid to Ireland, then Microsoft Ireland Research could be responsible for 10-12 per cent of Ireland’s overall Corporation Tax revenues.  Such a share for the highest payer would not be out of line with the finding from the Revenue Commissioners that the top 10 companies were responsible for 50.5 per cent of payments in 2020.

Microsoft’s tax outcomes attract some attention but very little of that is directed to the tax payments made by Microsoft Ireland Research.  A Microsoft subsidiary based in Bermuda, Round Island One, makes up for it though as can be seen in the search results for each

• News stories in past twelve months for “Microsoft Ireland Research” and tax
• News stories in past twelve months for “Round Island One” and tax

There has been some coverage of the outturns for Microsoft Ireland Research.  This May 2019 piece focused on a dividend payment it made.  There are a few mentions in pieces on The Currency including this April 2021 piece that went though some possible implications for Microsoft’s operations in Ireland of the Biden administration proposals for taxing US MNCs. And while this piece also from April 2021 again focused on dividend payments it did set out the financial outturns for the company:

The firm recorded $33.4 billion in turnover in 2020, up from $25.7 billion. Profit at the firm stood at $15.7 billion, down from $21.2 billion in 2018.

Microsoft Research Ireland employed an average of 524 staff per month in 2020, the vast majority of whom worked in localisation and product development. The average wage at the firm was more than €130,000.

But there is one thing absent from them: a sentence setting out the tax outcomes for the company.  This April 2020 piece from The Currency got tantalizingly close when it said the following about Microsoft Ireland Research: 

Its pre-tax profit nearly doubled to $22.5 billion, largely as a result of a $17 billion gain on the absorption of a liquidated Dutch subsidiary. Its corporation tax charge, by contrast, dropped by $200 million as a result of a $1.4 billion “decrease from effect of expenses not deductible in determining taxable profit”.

The $200 million drop in the tax charge made the cut but that this was a drop from $1.4 billion in 2018 to €1.2 billion in 2019.  And a subsequent piece featuring the company did not squeeze in the $600 million rise in 2020.  The tax charges across the last three years for Microsoft Ireland Research sum to almost $4.5 billion but they remain hidden from the reader in the few pieces that actually examine the company.

For a country that has seen a trebling of corporate tax revenues since 2014, is the third-largest recipient in the world of corporate taxes from US MNCs and with payments so concentrated that last year just ten companies were the source of half of all payments there has been very little interest in setting out who is actually making those payments.  Indeed, one could say there have been efforts to avoid doing so.

Could one company have paid €1.6 billion in tax in 2020?  The degree of concentration in the payments suggests that is possible.  Could that company have been Microsoft Ireland Research? The company’s financial accounts would suggest it was.  And if it was there is unlikely to be have a company with a larger tax payment. 

And that itself is not the end of Microsoft’s tax payments in Ireland.  Another Irish-resident subsidiary, Microsoft Ireland Operations Limited, had a 2020 tax charge of $342 million and a similar analysis to the above would indicate that pretty much all of that was also paid to Ireland.

Does Microsoft even pay $2 billion of tax in total, never mind only to Ireland?  Here is the consolidated income statement of Microsoft Corporation for the past five years.

Certainly, plenty of scope for $2 billion of tax payments there.  Indeed in 2020, Microsoft had a provision for income taxes of $8.6 billion (16.5 per cent of its $53 billion pre-tax profit) and cash paid for income taxes was $12.5 billion.  Timing differences mean provisions and payments don’t always coincide.

But maybe all this tax was paid to the US. It wasn’t.  Here’s a table taken from Microsoft’s annual 10K report for 2020 showing the split of its tax provision into domestic (i.e., US federal, state and local taxes) and foreign taxes.

The one-off distortions caused by the Tax Cuts and Jobs Act and other factors seem to have been worked out for the 2020 tax provision.  The table shows that the $8.8 billion tax provision for 2020 was almost equally divided between domestic and foreign taxes.  Indeed, for the three years shown, Microsoft had a provision for foreign taxes exceeding $4 billion in each year – so a $2 billion tax bill in Ireland cannot be ruled out. 

So, a definitive case that Microsoft Ireland Research is Ireland’s largest taxpayer has not been laid out.  But the evidence is clearly pointing in that direction.