Apple CEO Tim Cook displays an iPad Mini after it was unveiled in San Jose… (Kevork Djansezian / Getty…)
Apple found itself in the uncomfortable position Monday of being labeled a corporate bad guy, drawing fire from senior senators in both parties for using subsidiaries in Ireland to reduce its tax bill.
But if Apple has its way, its bitter rival Google will be back in the spotlight Tuesday for its own tax-avoidance strategies. And maybe Apple's example -- as well as its support for an unusually thorough rewriting of corporate tax law -- will push Congress to eliminate loopholes, broaden the base and lower rates.
As my colleagues Jim Puzzanghera and Chris O'Brien reported, a new report by congressional investigators asserts that Apple used accounting maneuvers to credit $30 billion in revenue to a unit incorporated in Ireland but operated out of the United States. The company, Apple Operations International, has not only paid no taxes over the last five years, it hasn't even filed a tax return -- anywhere. A second unit incorporated in Ireland, Apple Sales International, had $74 billion in sales income from North and South America from 2009 to 2012 but paid less than 1% in taxes to that country.
As their story notes, Apple is not accused of breaking any laws. It didn't break any new ground either; other U.S. companies have long found ways to route earnings through foreign subsidiaries with lower tax rates. For example, Google has for years used subsidiaries incorporated in Ireland and other offshore havens to cut its tax liabilities to the bone.
The challenge for Apple is to distinguish its tactics from its rivals'. In testimony prepared for a hearing Tuesday before the Senate Permanent Subcommittee on Investigations, Apple argues that it isn't using "tax gimmicks." It then goes on to list a number of, umm, less-than-admirable tactics that it isn't using, without having to mention that Google and other rivals are.
"Apple does not move its intellectual property into offshore tax havens and use it to sell products back into the U.S. in order to avoid U.S. tax; it does not use revolving loans from foreign subsidiaries to fund its domestic operations; it does not hold money on a Caribbean island; and it does not have a bank account in the Cayman Islands. Apple has substantial foreign cash because it sells the majority of its products outside the U.S. International operations accounted for 61% of Apple’s revenue last year and two-thirds of its revenue last quarter. These foreign earnings are taxed in the jurisdiction where they are earned," the company states in its testimony.
What it has done, Apple said, is enter a cost-sharing arrangement with its Irish subsidiaries to help fund research and development in the United States. Under the terms of that arrangement, the profits stemming from the intellectual property Apple develops are split with the subsidiaries. "After paying their share of R&D expenses and bearing losses during some very lean years in the 1990s," the company said, "Apple’s Irish subsidiaries are now profiting from the cost-sharing arrangement established three decades ago."
Yes they are. But even if Apple is observing both the letter and the spirit of the law, as it asserts, its arrangements highlight how outdated the tax code has become. It's out of sync with the global nature of commerce.
U.S. law treats all revenue an American company earns anywhere in the world as taxable revenue, but it allows them to defer paying taxes on that revenue until they use it in the United States. That gives companies such as Apple an incentive to keep their overseas earnings parked in low-tax foreign countries, such as Ireland, rather than putting it back to work here.
Meanwhile, as more profits are derived from intellectual property, such as copyrighted software and patented search algorithms, companies are finding it relatively easy to attribute the revenue they earn to havens such as the Cayman Islands. They do so by selling their intellectual property to subsidiaries in those low-tax enclaves at a price that's supposed to reflect the market value -- except that it doesn't.
Apple insists that it's not doing anything of the kind, and that the 1986 Tax Reform Act blessed the sort of cost-sharing arrangement the company has with its Irish units. Put another way, though, it's taking advantage of a tax provision that predates the World Wide Web to assign to a foreign subsidiary a share of the profits that would otherwise be taxable in the United States. The details may be distinguishable from what Google has been doing, but it still smacks of bad tax policy.
Among the country's tech giants, Apple may hold whatever moral high ground remains for no other reason than it pays a boatload of taxes to Washington every year -- nearly $6 billion in fiscal 2012, or about 2.5% of all corporate taxes paid. It expects its U.S. tax bill to be more than $7 billion in fiscal 2013.