Apple’s Irish Tax Strategy Explained

Tim Cook, Apple’s chief executive, and Peter Oppenheimer, chief financial officer, are expected to testify before the U.S. Senate Permanent Subcommittee today to dispute the findings of a new Senate report on its tax strategies.

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A new Senate report alleges that Apple (NASDAQ:AAPL) blows through a loophole that capitalizes on the difference between U.S. and Irish rules regarding tax residency to avoid paying corporate income taxes.

The report says the move let Apple shift at least $74 billion away from the Internal Revenue Service between 2009 and 2012. The report also alleges that Apple uses shell operations in Ireland to avoid U.S. taxes.

But Apple hotly disputes that characterization. Apple says its Irish units are not “offshore operations,” but instead run a huge chunk of Apple’s global business, which the Senate report also indicates.

Apple says its international headquarters in Cork, Ireland, employs 4,000 workers. These workers are responsible for selling Apple products to consumers and businesses in Europe, the Middle East, Africa, India, Asia and the Pacific, information that is noted, too, in the Senate report.

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The 4,000 workers at Apple’s base in Ireland “are engaged in manufacturing, customer service, sales support, supply chain and risk management operations and finance support services,” Apple’s testimony says.

Apple says 61% of its sales come from overseas, which is why two-thirds of its $144.7 billion in cash and equivalents is parked overseas, cash which supports growth, including things like acquisitions or opening new stores.

The Apple units in question are located at the same address in Cork. Apple incorporated the Apple Sales International unit in Ireland to hold Apple’s offshore intellectual property rights.

That unit is the recipient of a big chunk of Apple’s global sales. Apple has negotiated with the Irish government just a 2% tax rate (or less) on profits from that unit, more than ten percentage points lower than Ireland’s corporate tax rate.

“Apple Sales International buys Apple’s finished products from a manufacturer in China, re-sells them at a substantial markup to other Apple affiliates, and retains the resulting profits,” the Senate report says.

Apple also incorporated Apple Operations International in Ireland more than three decades ago, the parent of Apple Sales International which is controlled by Apple executives in Cupertino, Calif.

The units share members of their boards of directors. No bank accounts or management personnel are located in Ireland, the Senate report says.

But the Senate report alleges Apple Operations International is a shell company that has no workers. “AOI is a thirty-year-old company that has operated since its inception without a physical presence or its own employees,” the report says.

However, Apple hotly disputes that characterization, saying the Senate report is incorrect.

It says its 4,000 workers in Ireland perform “important business functions that facilitate and enhance  Apple’s success in international markets.”

The Irish headquarters are “not a shell company,” Apple’s testimony says, and that the offices contributed more than half of Apple's R&D costs in 2012.  Apple says it launched its Irish operation in 1980, that its tax moves have been regularly audited by the IRS and are authorized under U.S. law.

The strategies Apple uses are legal, the Senate report notes.

Here’s the tax move: Ireland uses a management and control test to determine tax residency. In Ireland, a company must be managed and controlled in the country to be a tax resident. The U.S. determines tax residency based upon place of formation. Under U.S. law, a company is a tax resident of the country in which it was established.

Therefore, since Apple has not declared an Irish tax residency for these units, and because it controls these companies in Ireland, they are not tax residents of Ireland.

But since these Irish units were not incorporated in the U.S. and reside in Ireland, they are not tax residents of the U.S., either.

The units have no tax residency, the Senate report says.

That helped Apple avoid paying U.S. taxes on its profits, the Senate report says, which helped Apple continue to build up offshore cash holdings now topping $102 billion, two-thirds of its total cash pile, the Senate report says.

But Apple not only says the Senate report falls short of understanding its structure, but that U.S. law, reiterated in the health reform bill, says U.S. companies “are free to use” foreign operations “for purposes of conducting their foreign affairs.”

Apple’s Irish affiliates own the economic rights to intellectual property for goods sold in Europe, the Middle East, Africa, India, and Asia. Overall, Apple Inc. in the U.S. is the sole owner of the legal rights to Apple’s intellectual property.

Apple says its Irish units have rights to distribute Apple products in territories outside the Americas “in exchange for contributing to jointly-financed R&D efforts in the US.”

That arrangement “supports the funding of the company’s high-paying R&D jobs in the US, promoting domestic job growth and generating significant tax revenue for federal and state governments.” Apple says it has created or supported 600,000 U.S. jobs.

Apple has also joined other companies in petitioning Congress to lower the 35% corporate tax rate, one of the highest corporate rates in the world, though U.S. companies use moves to make their effective rate lower. Apple disclosed in its filings that its effective tax rate was 25% in fiscal 2012, about the international average.

The Senate report cites a GAO study that found 83 of the 100 largest publicly traded U.S. companies have units in tax havens or financial privacy jurisdictions.

Apple says it pays "an extraordinary amount" in U.S. taxes, adding it is one of the biggest corporate taxpayers in the U.S. It cites the roughly $6 billion it paid in fiscal 2012, or an estimated $1 for every $40 paid to the U.S.

Apple “complies fully with both the laws and the spirit of the laws,” Apple’s testimony says. “And Apple pays all its required taxes, both in this country and abroad."

Apple insists it does not use tax gimmicks.

“Apple does not move its intellectual property into offshore tax havens, or use offshore havens to sell products back into the U.S. in order to avoid U.S. tax,” its testimony says. “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.”

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