How Apple found a bigger tax loophole than the Double Irish

In May 2013 when Tim Cook, Apple CEO, told a US Senate panel that Apple does not transfer intellectual property to offshore tax havens to avoid US tax and does not hold money on a Caribbean island. He was drawing a sharp contrast with the likes of Google, Microsoft, Intel, Oracle and Facebook. In effect Apple was different to US companies that used well-known island tax havens using loopholes such as the Double Irish Dutch Sandwich.

Apple wants to make clear to the Subcommittee that the company does not use its Irish subsidiaries or any other entities to engage in the following tax practices that were the focus of the Subcommittee’s September 20, 2012 hearing [reference to hearings on Microsoft and Hewlett Packard], entitled Offshore Profit Shifting and the US Tax Code. Specifically, Apple does not move its intellectual property into offshore tax havens and use it to sell products back into the US to avoid US tax, nor does it use revolving loans from CFCs to fund its domestic operations. Apple does not hold money on a Caribbean island, does not have a bank account in the Cayman Islands, and does not move any taxable revenue from sales to US customers to other jurisdictions in order to avoid US taxation.

Cook also said that "Apple does not use tax gimmicks" — Senator Carl Levin, had used the word "gimmicks" at the September 2012 hearings.

In the period 1999-2002, US affiliates in Ireland reported a doubling of profits, making Ireland the most profitable location on earth for US overseas investment — profits in bigger markets plunged!

In 2005 The Wall Street Journal brought attention to the Double Irish loophole in Ireland and elsewhere. It reported that a four-year-old subsidiary, Round Island One Limited, was one of two of Microsoft's Irish subsidiaries, with addresses at a Dublin law firm, Matheson Ormsby Prentice (Matheson) and tax-resident in Bermuda. Round Island One controlled more than $16bn in Microsoft assets. "Virtually unknown in Ireland, on paper it has quickly become one of the country's biggest companies, with gross profits of nearly $9bn in 2004."

Through another Irish shell firm, Flat Island Co., Round Island licensed rights to Microsoft software throughout Europe, the Middle East and Africa. "Thus, Microsoft routes the license sales through Ireland and Round Island pays a total of just under $17m in taxes to about 20 other governments that represent more than 300m people."

Apple had a similar model to Microsoft's.

Both transferred the economic rights of some of their intellectual property (IP) to their Irish units and Apple had a shell firm subsidiary in the British Virgin Islands besides Irish non-resident subsidiaries with addresses at its Cork campus. Apple also had a company in the Cayman Islands, which was dormant by 2004.

Apple used commissionaire structures in markets across Europe where ownership of products would be retained by Apple subsidiaries and the sale wouldn't be typically booked in the country of sale but by an Irish unit.

Nevertheless, the consolidated accounts of Apple Computer Inc. Limited + subsidiaries for 2004 show earnings of $345m and a tax charge in Ireland of $21m after offsetting foreign taxes paid of $22m.

In 2006 the 2005 Wall Street Journal report triggered decisions to shield the accounts of Microsoft's Irish subsidiaries in Bermuda from public view by changing the status to unlimited.

Apple Computer Inc. Limited, the main overseas subsidiary of Apple, dated from 1980 when Apple opened its Irish facility in Cork — it was non-tax resident from the outset and had no employees.

The name was changed to Apple Operations International (AOI); it became "a trust and investment company" and was converted to unlimited status ending access to financial accounts.

One share in both AOI and in another subsidiary were also allotted to Baldwin Holdings Unlimited of the British Virgin Islands.

Also in 2006, Apple established Braeburn Capital in Reno, Nevada to manage its cash and investments. Nevada has no state corporate tax while the rate in California is 8.84% (baldwin and braeburn are breeds of apple).

Again in 2006, the CFC (controlled foreign corporation) look-through rule which was enacted in 2006 by Congress to allow US MNCs to re-characterize what would otherwise be subpart F income (e.g., dividends, interest, and royalties) by looking-through to the character of the income earned by the entity paying the dividend, interest, royalty, etc. may have helped Apple in its then evolving tax strategy.

Apple decided that AOI and its key subsidiary (Apple Sales International) were not tax resident anywhere. While the Senate Permanent Subcommittee on Investigations report of May 2013 says "For more than thirty years, Apple has taken the position that AOI has no tax residency, and AOI has not filed a corporate tax return in the past 5 years."   

Apple has exploited a difference between Irish and US tax residency rules. Ireland uses a management and control test to determine tax residency, while the United States determines tax residency based upon the entity’s place of formation. Apple explained that, although AOI is incorporated in Ireland, it is not tax resident in Ireland, because AOI is neither managed nor controlled in Ireland. Apple also maintained that, because AOI was not incorporated in the United States, AOI is not a US tax resident under US tax law either. When asked whether AOI was instead managed and controlled in the United States, where the majority of its directors, assets, and records are located, Apple responded that it had not determined the answer to that question. Apple noted in a submission to the Subcommittee: “Since its inception, Apple determined that AOI was not a tax resident of Ireland. Apple made this determination based on the application of the central management and control tests under Irish law.” Further, Apple informed the Subcommittee that it does not believe that “AOI qualifies as a tax resident of any other country under the applicable local laws.” For more than thirty years, Apple has taken the position that AOI has no tax residency, and AOI has not filed a corporate tax return in the past 5 years. Although the United States generally determines tax residency based upon the place of incorporation, a shell entity incorporated in a foreign tax jurisdiction could be disregarded for US tax purposes if that entity is controlled by its parent to such a degree that the shell entity is nothing more than an instrumentality of its parent. While the IRS and the courts have shown reluctance to apply that test, disregard the corporate form, and attribute the income of one corporation to another, the facts here warrant examination.

With revenues and profits surging, Apple was able to reduce its foreign tax rate on about thirds of its profit in 2012 to 1.9% whereas foreign headline corporate tax rates in its main markets typically were above 20%.

Some  American companies had shifted their headquarters/ tax residencies from Bermuda to Ireland from 2007 because of the negative publicity about companies incorporated in island tax havens and Apple had succeeded for five years in dramatically cutting its current tax bills without the taint of the Double Irish association while transferring cash directly to onshore US banks. 

Apple's overall tax rate was 14% in 2012 compared with a rate of 25% reported in Apple's accounts.

In 2013 Jesse Drucker of Bloomberg News in a report on Feargal O'Rourke, then head of PwC's tax practice and now senior partner, referred to a 2007 meeting on the Double Irish and having to route billions in royalty transfers (effectively accounting transactions) via the Netherlands to shell firms in places like Bermuda and the Cayman Islands, to avoid a 20% Irish withholding tax:

In October 2007, he met at Google’s Dublin headquarters on Barrow Street with Tadhg O’Connell, the head of the Irish Revenue division that audits tech companies, according to a person familiar with the meeting. O’Connell rejected O’Rourke’s request that royalties like Google’s should be able to flow directly to units in Bermuda and Cayman without being taxed.

In 2010 the Irish Government withdrew the withholding tax requirement.

Apple reported earnings/ net profit of $72.5bn in 2015 but it allocated 47.6bn or 65%, to overseas activities. The foreign tax rate was 6% in fiscal 2015.

In an extended interview published this week by The Washington Post, Tim Cook is reported to have said:

The way tax law works is the place you create value is the place where you are taxed. And so because we develop products largely in the United States, the tax accrues to the United States.

In effect allocating 65% of earnings as foreign is a fiddle and no tax is paid on most (or deferred long-term) of it because it is booked through fake Irish firms.

Tim Cook was asked by The Washington Post about comments by Joseph Stiglitz, the Columbia University economist, made on Bloomberg [television], where the latter called Apple’s profit reporting in Ireland a “fraud:”

The money that’s in Ireland that he’s probably referring to is money that is subject to US taxes. The tax law right now says we can keep that in Ireland or we can bring it back. And when we bring it back, we will pay 35% federal tax and then a weighted average across the states that we’re in, which is about 5%, so think of it as 40%. We’ve said at 40%, we’re not going to bring it back until there’s a fair rate. There’s no debate about it. Is that legal to do or not legal to do? It is legal to do. It is the current tax law. It’s not a matter of being patriotic or not patriotic. It doesn’t go that the more you pay, the more patriotic you are.

Steve Wozniak, Apple co-founder, told the BBC last April that all companies, including Apple, should pay a 50% corporate tax rate!

In September 2015 Apple had cash or near equivalents of $206bn on its balance sheet and about $181bn was apparently held overseas — mainly in Ireland.

There is no big cash hoard in Ireland and it's a fiction that it is held overseas.

It is either in onshore US banks or invested in US Treasuries.

“We pay all the taxes we owe, every single dollar,” Cook had told the Senate Permanent Subcommittee on Investigations May 2013 hearings.

We not only comply with the laws, but we comply with the spirit of the laws. We don’t depend on tax gimmicks.

Poetic license or lies?

Cathy Kearney, Apple's vice-president for operations based in Cork, last March told members of the European Parliament that Apple “does not operate a Double Irish structure” and Tony King, Apple's managing director in Australia, a year before told Australian senators the same.

That Double Irish claim was correct in respect of recent times but Tim Cook's claim of complying with "the spirit of the laws" is a lie.

To argue that most profit relates to the US while Apple then shifts most of the earnings to Irish shell companies to artificially defer or never pay US tax, is not compliance with the intention of the laws.

To achieve a foreign tax rate of 1.9% in 2011 and 6.0% in 2015 compared with 12% in 2002,  when headline corporate tax rates in main foreign markets typically are over 20%, takes a brazen disregard for the spirits of the laws.

Besides Apple decided itself that its Irish non-resident shell companies had no tax residence anywhere.

Ireland recently jailed former bankers on charges of false accounting and it doesn't take much imagination to see that a small firm in Ireland or the United States would not stand a chance in defending fraud charges before courts of law relating to the use of similar shenanigans to the ones used by Apple,

Apple directly employs 76,000 in the US. Globally, Apple had 110,000 full-time equivalent employees in 2015 — about 30,000 work in Apple's retail stores in the US and pay isn't great.