Tuesday, April 18, 2023

The last insight into Apple’s use of capital allowances?

As is well known Apple revised its international structure in 2015.  Since then we have been tracking the impact of this via the annual publication of the consolidated accounts for the group of subsidiaries headed by Apple’s central international holding subsidiary, Apple Operations International (AOI).

As will be set out here, we may now have reached the last insight into Apple’s use of capital allowances.  The full picture is provided across by combining the previous posts as there are some elements in each that are not repeated here.

Where in the world is AOI?

One we will repeat is the location of AOI. As noted in the opening paragraph, the analysis deals with the consolidated accounts for the group of subsidiaries headed by AOI.  The accounts show that this group contains close to 80 subsidiaries, across Europe, Africa, the Middle East, Asia and Oceania. The accounts essentially cover all of Apple’s activities outside the Americas.

AOI is sometimes referred to as Apple’s main Irish subsidiary. AOI is at the top of the group of Apple’s subsidiaries outside the Americas.  And AOI is a company that was established in Ireland. But that does not mean that it is resident here.

We know from the 2012 US Senate investigation that under Apple’s previous structure, that though AOI’s functions were all carried out in the US, AOI itself was “stateless”; it did not have a tax residency.  Apple achieved this because AOI was not registered in the US where it was managed and controlled, and it was not managed and controlled in Ireland where it was registered.

When Apple revised it’s structure it eliminated AOI’s stateless nature.  Document leaks subsequently shows that AOI became a resident of Jersey in the Channel Island. See reporting here.  Jersey has a corporate income tax.  But the rate of that tax is zero percent.  Obviously, this is from a few years ago. But there has been nothing to indicate that AOI residency has changed since.

We know that Ireland is central to Apple’s current structure, but this happens in subsidiaries beneath AOI and not necessarily in AOI itself. AOI is the holding company for those, and, as noted, other worldwide subsidiaries.  The accounts show that the group headed by AOI had an average of 56,000 employees in 2022.  We would have to remove the first digit to get close to the number of those who are in Ireland.  So, all of the subsequent analysis refers to the overall performance of AOI and the group of nearly 80 worldwide subsidiaries beneath it.

How is the AOI group doing?

The AOI group is hugely profitable.  This is due to the cost-share agreement the group has with the US parent, Apple Inc, which grants the AOI group the rights to sell Apple’s products in markets outside the Americas.  The AOI groups gets this right by paying around half of Apple’s total R&D expense. In 2022, the AOI group had an R&D expense of $15.5bn most of which would have been paid to Apple Inc. which oversees the R&D the bulk of which is carried out in the US.

AOI Income Statement 2017-2022

From that cost-share payment, the AOI group had sales of over $220 billion and generated an operating profit of close to $70 billion.  There is no way Apple Inc. would enter into a similar arrangement with a third party. 

How much tax does the AOI group pay?

We can see that the provision for income taxes has been around $11.0 to $11.5 billion in each of the past two years.  To repeat another point from the earlier posts, a company making a provision for taxes is not the same as a company paying taxes.  We can get a better indication of how much tax the AOI group pays from the cash flow statement.

AOI Cash Flow Statement 2017-2022

In 2022, the AOI group made $7.7 billion of cash tax payments in the countries in which it operated.  That is lower than the provision for income taxes in the income statement but is a huge increase on the $1.4 billion of cash tax payments made in 2017. [We do not have access to AOI’s accounts for earlier years.]

Why are cash tax payments lower than the tax provision?

The earlier posts have gone through this. It is due to the AOI group having large amounts of deferred tax assets.  A significant amount of the tax provision does not result in a charge on cash it results in a charge on the deferred tax asset.

AOI Balance Sheet 2016-2022

In the above, we can deferred tax assets reducing from $25.7 billion at the end of 2016 to $5.0 billion at the of 2022.

How much tax does the AOI group pay in Ireland?

As with the previous posts, there is no direct way of establishing this from the presentation of the accounts.  The likelihood is a lot but firm conclusions are difficult to reach.  Here is the tax reconciliation statement from the consolidated accounts for the AOI group.

AOI Tax Reconcilliation 2017-2022

First, we note that the reference rate used is 12.5 per cent, which suggests that AOI is the main tax jurisdiction for the group. But it is not the only one.  The largest item in this table is now the “difference in effective tax rates on overseas earnings”.  It is not clear how significant it is but in the latest accounts this item has become “effect of different tax rates”.  The $2,335m figure for 2021 is used with both descriptions.

This description shown above would imply that a significant portion of the group’s profit is taxed at higher rates in other countries, though this depends on the interpretation of “overseas earnings” (words which are now dropped).

For 2022, the adjustment was $3.3 billion above whatever would be in the baseline tax charge at the 12.5 per cent reference rate.  If the effective tax rate on the relevant was 25 per cent then there would have been around $6.5 billion of tax on $25 billion of profit.  But that depends on the actual effective tax rate on those profits.

As we did last year we can pick up this thread in the overall accounts for Apple in its 10K filing with the SEC.  Here is the breakdown of the company’s entire tax provision in its latest annual report.

Apple 10K Provision for Income Tax 2022 - 2

In broad terms, the foreign (i.e. non-US) pre-tax earnings and the provision for foreign taxes align with those we see in the consolidated statements of the AOI group.  In the 10K accounts, foreign would also include activities in countries in the Americas excluding the US, whereas the AOI group covers Apple’s activities outside the Americas.

Anyway, reflecting what is in the AOI group’s accounts, we can see a large increase in the provision for foreign taxes in Apple’s overall taxes.  It rose from $6.5 billion in 2020 to around $12 billion in each of the last two years.  And this corresponds with the big jump in the adjustment for the “difference in effective tax rates on overseas earnings” or “the effect of different rates” in the AOI group’s accounts.

Something has happened in recent years that has led to a big jump in tax somewhere.  Looking at the 10K statement we can see that this is not the US: the increase shows there as an increase in the provision for foreign taxes.  While looking at the accounts for the AOI group suggests that this is not Ireland: the increase shows there as an increase in tax overseas earnings, assuming that “overseas” is outside Ireland.  We can really only be sure that it is outside the US.  We do not know what “overseas” means in the AOI group’s accounts.  And whatever has caused this seems to have gone under the radar.

We are now left with about $5 billion of the provision for taxes in the AOI group’s accounts that could be in Ireland.

What amount capital allowances are left?

The previous posts go through the 2015 acquisition of a now Irish-resident subsidiary in the AOI group that acquired the license to sell Apple’s products outside the Americas.  This huge acquisition, probably not far from $240 billion, resulted in a huge amount of expenditure that became eligible as a tax deduction. 

Under Section 291A of the Tax Consolidated Act this is achieved via capital allowances – the amount of the capital expenditure that can be deducted each year when taxable income is being determined.

A deferred tax asset of $30 billion ($240 billion of capital allowances multiplied by 12.5 per cent) was put on the balance sheet of a company in the AOI group when this transaction occurred.  Each year a large amount of the AOI group’s tax provision is charged against this deferred tax asset.  We can see the evolution of this in the following table.

AOI Deferred Tax Assets 2017-2022

We can’t go back to when the transaction occurred at the start of 2015, but we can see that at the end of the 2016 financial year, the AOI group had $22.6 billion of deferred tax assets from “Intra-Group Transactions” (which would describe one subsidiary buying a license from another subsidiary).

We can see that $4.4 billion were further used in 2017 and 2018 with $3.3 billion used in the four years since.  All told, the value of the capital allowances has declined from $30 billion with just $812 million remaining by the end of the 2022 financial year.  As this corresponds to around one-quarter of the recent annual usage, it will be the case that income generated in the first quarter of the 2023 financial year will fully exhaust the capital allowances.  This will expose all of the profit from the license held in Ireland to tax.

And we can already see evidence of this in Irish tax receipts.  Companies pay their Corporation Tax via preliminary payments made in months six and 11 of their financial year with their full tax return due nine months after the year ends.  For large companies these preliminary payments should correspond to 90 per cent of the final tax liability.  A company with a September year end will make its first preliminary payment in March with the second following in August.

Here are the month Corporation Tax receipts in March for recent years:

CT Revenues March 2009-2023 Bar

Prior to 2022, March was not a significant month for Corporation Tax revenues.  This has changed in the last two years and a link with Apple seems likely.  The increase in 2022 could be linked to the increase in the AOI group’s profits, with the profit of the Irish licensing subsidiary perhaps rising significantly above that which could be offset by capital allowances with the further increase in 2023 perhaps due to the exhaustion of those capital allowances now taking place. 

To date, there has been no evidence in Ireland of a significant Apple restructure. Absent that, we can expect to see strong August receipts in due course.  It is also possible we might see some changes in Ireland’s national accounts – due to the exhaustion of the capital allowances – and that is something we may return to.

Monday, April 17, 2023

What to do with €30 billion of savings?

To paraphrase a former Taoiseach, as a community we are living away within our means. This can be represented using the recently published Q4 2022 update of the Institutional Sector Accounts.  Here we show gross savings minus gross capital formation [S-I] for the government and household sectors – this is equivalent to a sector’s contribution to the current account of the balance of payments. Here they are on a four-quarter sum basis:

Savings minus Investment for HH and Gov

There was an expectation that household savings would decline as the pandemic eased but savings remain significantly above pre-pandemic levels.  For the government sector there has been an improvement due to the reduction of Covid-related income and business supports and the government’s position has been further boosted by soaring Corporation Tax receipts.

Although, the quarterly figures are only preliminary, summing over the four quarters of 2022 shows the household sector to have had a surplus of savings over investment of €20.5 billion with the government showing a surplus of €9.5 billion on the same measure.  Combined they sum to €30 billion.

The evolution of the line in the above chart, as well as the composition between household and government sectors is as good a starting point as any to discuss the performance of the economy since the year 2000.  But reaching an unprecedented position of +€30 billion is as worthy of examination as the developments that led to the deterioration to –€20 billion during the credit bubble.

Ireland’s Savings in Comparative Terms

But where do we stand relative to other countries? Here is a set of EU countries selected as those which have the necessary data available from Eurostat. The data are scaled by Net National Income which mitigates, but doesn’t completely eliminate, the need to adjust the figures for Ireland. Apart from the calculations done to get the [S-I] figures, no adjustment is made to the Eurostat data.

Savings minus Investment Selected EU Countries 2022

We see that Ireland is also high in comparative terms with other countries, though for the household sector there is a relatively small difference to Germany, Czechia, Sweden, The Netherlands and France.  With most EU countries running government deficits it is Ireland’s government surplus that leads to most of the gap. Still, for the household sector one can query whether we are at a sufficiently mature stage to be savings on a par with households in Sweden, The Netherlands and Germany.

The post is titled “what to do with €30 billion of savings” but we do know what has been done with it.  Households have put most of their surplus on deposit and the government has started contributing to a National Surplus Reserve Fund

The increase in household sector deposits has been noted for sometime.  Irish households have been deleveraging for around 15 years now. Post-2008 this was mainly via a reduction in debts. This has now switched to being an increase in deposits.

In the financial accounts of the Central Bank of Ireland, the household sector had just over €150 billion of currency and deposit assets at the end of 2019.  By the end of 2021 this had increased to €185 billion with a further rise to €195 billion by the third quarter of 2022.

Household Sector Loans and Deposits 2002-2022 Q3 CB Data

This increase in household sector deposits in Ireland has been one of the fastest in the EU14.

EU14 Household Deposits Change 2019-2021

However, the level does not stand out, whether using a ratio of deposits to income or using a balance sheet measures such as a ratio of deposits to loans.

EU14 Household Deposits to Income Ratio, 2021

EU14 Household Deposits to Loans Ratio, 2021

While there certainly is some interest in what households do with the near €200 billion of currency and deposits assets they now have (and knowing more about the distribution of those would be a useful step in that regard), a more pertinent issue is probably what happens to savings behaviour going forward. Will household saving continue at an elevated level? Should the government be running a budget surplus?

Macroeconomic Constraints: Real and Financial

The economy faces constraints but these are more real (resources) than financial (income).  The unemployment rate is below five percent while pressures in housing are well documented. But the domestic economy is running a very large balance of payments surplus – perhaps only second to Norway in European terms. Norway is benefitting from higher energy prices; Ireland from booming Corporation Tax revenues.

But in Ireland, it seems it is the household sector that is saving the largesse not the government sector.  Norway (population 5 million) added €100 billion to its sovereign wealth fund last year.

In response to the surge in inflation, the government introduced a large set of compensatory measures.  Some of these were targeted where they were needed but many were universal and seem only to have added to the burgeoning deposits of certain households.

If these measures are not repeated in 2023 then we may see some reduction in household savings. If not offset by spending elsewhere, this would see the government surplus rise (also aided by first quarter Corporation Tax receipts which have been particularly strong).

But what level of budget surplus is politically sustainable?  Should the government be increasing taxes aimed at households with elevated savings rates to recapture the benefits of the soaring Corporation Tax receipts or to ensure that those savings aren’t released into an economy already operating at close to capacity?  The need for increased housing supply is undeniable but should activity in other sectors be squeezed to try and create room for more construction activity? No solutions are offered here as we are merely pointing to the trade-offs faced.

The unusual position of the economy can be illustrated with a chart of the unemployment rate (representing an internal resource imbalance) and the current account of the balance of payments (representing an external income imbalance).  The two macroeconomic loops the Irish economy has experienced in the last 50 years are also highlighted (1975 to 1998 and 2003 to 2019).

Internal and External Imbalances 1975-2022

The imbalances experienced by the Irish economy have typically been in the top left quadrant: high unemployment and a large balance of payments deficit.  The economy is now in the opposite position: low unemployment and a large balance of payments surplus. 

The economy certainly has the income capacity to increases spending but it does not seem as if there is the resource capacity to do so.  Higher spending may push up domestic inflationary pressures which heretofore has largely been driven by external factors. 

There is also the sustainability of the income.  In the textbook descriptions, taxation is viewed as a withdrawal from the circular flow of income that would not be considered, at least directly, to lead to an increase in national income. 

Exchequer Corporation Tax 12-Month Rolling 2012-2023

Ireland’s Corporation Tax revenues do not fit with the textbook analysis.  Four-fifths is paid by foreign-owned companies and the bulk of that arises from (U.S.) companies that have a presence in Ireland to service international markets.  Corporation Tax is an injection to national income and that injection is reaching ever higher levels.  In the 12 months to the end of March, Corporation Tax receipts reached €24 billion.


Ireland is in a position of wanting to do things (such as build houses) and having the income to finance this activity but not the resource capacity to undertake it. With the unemployment rate close to four percent an increase in spending would likely lead to a rise in inflation.

We could view building houses as something we want to do all the time – which we should – and not just when Corporation Tax receipts are booming. To that end we could increase taxes to provide a sustainable revenue source to fund public capital spending on housing.  This could also create the resource space in the economy to accommodate that activity.

However, that is an economic argument not a political one.  Tax increases while the government is running surpluses are unlikely to get much traction.  But political myopia to the trade-offs we face does not mean that they do not exist. We should have something to show for the ongoing boost to national income: but that something should not be a surge in domestic inflation.