Apple’s in the Hot Seat
On May 21, 2013, the Senate Permanent Committee on Investigations held a hearing on how individual and corporate taxpayers are shifting billions of dollars offshore to avoid U.S. taxes. This year’s focus is on the tax strategies of Apple Inc. and their efforts to escape the U.S. tax on worldwide income.
Chief Executive Officer Tim Cook provided a figure to Congress on Tuesday showing that Apple paid $6 billion last year -- a rate of 30.5 percent, which amounts to 1 out of every 40 dollars in corporate income taxes collected by the U.S. government. Needless to say, Apple officials were not pleased to be on the Committee’s front burner.
This was not the Committee’s first foray into a corporation’s effective use of the tax code. Back in 2010, the focus was on Google, Inc’s tax avoidance strategies. In that case, tax attorneys used techniques known as the “Double Irish” and “Dutch Sandwich” to avoid U.S. taxes. The Double Irish strategy is popular among companies with intellectual property and has been used by Facebook and Microsoft as well.
The Double Irish
After three years of negotiations, Google received approval from the IRS in 2006 for a transfer pricing arrangement which allowed it to license the rights to its search and advertising technology and other intangible property for Europe, the Middle East and Africa to a unit called Google Ireland Holdings, which in turn owned Google Ireland Ltd., to which Google attributed 88% of its non-U.S. sales in 2009. Google Ireland Ltd. then paid those amounts back to Google Ireland Holdings in the form of royalties, erasing their tax liability in Ireland.
The Dutch sandwich
The second part of the strategy was known as the Dutch Sandwich because the royalty income of Google Ireland Holdings was funneled through the Netherlands before being distributed to a pair of Google subsidiaries in Bermuda. This was done to avoid a withholding tax in Ireland. Once the profits hit Bermuda, they became difficult to track because disclosure is not required by the Irish holding company. This strategy does not permanently avoid U.S. taxation, it merely defers tax until the earnings are brought back to the United States.
Over the past several years, the amount of permanently reinvested foreign earnings reported by U.S. multinationals has increased dramatically. One study has calculated that undistributed foreign earnings for companies in the S&P 500 have increased by more than 400%. Another 2012 study by the U.S. Department of Treasury found that the foreign share of worldwide income of U.S. multinational corporations increased by 14% from 1996 to 2004, due largely to a shift in profit margins rather than a shift in sales.
Apple, Inc. maintains more than $102 billion in offshore cash, cash equivalents and marketable securities. Apple executives have testified that they have no intention of returning those funds to the United States unless and until there is a more favorable environment, emphasizing a lower corporate tax rate and a simplified tax code.
Like Google, Apple used the “Double Irish” technique to transfer its profits away from the United States to Ireland. Apple also used the “check-the box” rules to treat all of their foreign subsidiaries as disregarded entities for U.S. tax purposes, effectively avoiding the Subpart F rules, which were designed to prevent multinational corporations from shifting profits to tax havens to avoid U.S. tax. Even without using the “check-the box” rules, Subpart F contains exemptions for manufacturing activities and royalties paid between subsidiaries located in the same country that Apple could have taken advantage of.
Unlike Google’s case though, in which the profits were funneled through the Netherlands to Bermuda, Apple’s offshore entities are not declared tax residents of any jurisdiction, thus avoiding the payment of taxes to any national government.
The Senate Subcommittee Recommendations
Based upon the Subcommittee’s investigation, the Memorandum makes the following recommendations:
- Strengthen Section 482. Strengthen Section 482 of the tax code governing transfer pricing by implementing more restrictive transfer pricing rules concerning intellectual property.
- Reform Check-the-Box and Look Through Rules so that they do not undermine the intent of Subpart F of the Internal Revenue Code
- Tax CFCs Under U.S. Management and Control.
- Use the current authority of the IRS to restrict the “same country exception” so that the exception to Subpart F cannot be used to shield from taxation passive income.
- Use the current authority of the IRS to restrict the “manufacturing exception” unless substantial manufacturing activities are taking place in the jurisdiction where the intermediary CFC is located.
As with the Apple and Google cases, Congress has from time to time attempted to critically examine a taxpayer’s navigation of the tax code. Perhaps one day they will enact reform of the “loopholes” they created. In the meantime, it seems appropriate to conduct business affairs in accordance with the direction of the landmark tax case Helvering v. Commissioner, 309 U.S. 106 (1940), in which the court directed taxpayers to do all that they could to legally reduce their tax liabilities.
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