Apple Operations International and the European Commission

Math quiz. If you paid a 36% tax on one-third of your income and a 6% tax on the rest – what is your overall tax rate? If you are Stephen Moore, you might sum 36% and 6% but the rest of us would take a weighted average and get 16%. Which brings me to the latest from Jared Bernstein:

I’m talking about Apple, Ireland, and the European Union, of course. The EU’s tax authorities are accusing Ireland of providing special tax breaks to subsidiaries of the US multinational tech company. Such alleged state subsidies are considered anti-competitive by the EU, which is thus demanding that Ireland claw back $14.5 billion in ten years’ worth of upaid taxes.,, Perhaps surprisingly, given the extent to which the Obama administration has righteously denounced such extensive corporate tax avoidance (e.g., they’ve gone after corporate inversions as best they can without Congress), they’re not at all pleased by the EU’s move on Apple. As tax expert Steve Rosenthal interprets their thinking. “Apple may be a tax cheat, but Apple is our tax cheat.” Perhaps they’re worried that if Ireland succeeds in squeezing some juice out of the Apple, there won’t be any left for our Treasury

The White House thinking seems to be related to something called the foreign tax credit which would be relevant if Apple was repatriating all that foreign sourced income but guess what – it is repatriating none of it at least for now. Yet Apple is telling its shareholders that its effective tax rate is over 26%. Maybe this is not as bad as Stephen Moore arithmetic but does this make any sense? Last year, Apple told its shareholders it made $72.5 billion before taxes with $47.6 billion sourced abroad and a provision for foreign taxes around $2.9 billion. So OK, U.S. sourced income is actually 35% and the foreign tax provision is such over 6%. But how on earth does E&Y say their tax provision is over $19 billion? Are they providing for the repatriation tax even if they are not repatriating? How is this consistent with APB 23? Of course they did tell shareholders:

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of September 26, 2015 the Company is unable to estimate the impact.

But if this is without merit – why provide a tax provision for it? So much confusion, so little time. Speaking of confusion, let’s highlight some of the testimony from Tim Cook when he appeared before the Senate hearings back in 2013:

In accordance with US law, Apple pays US corporate income taxes on the profits earned from its sales in the US and on the investment income of its Controlled Foreign Corporations (“CFCs”), including the investment earnings of its Irish subsidiary, Apple Operations International (“AOI”). Apple does not use tax gimmicks. Apple does not move its intellectual property into offshore tax havens and use it to sell products back into the US in order to avoid US 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… Under US tax law, these foreign intercompany payments are not taxable.

Sufficiently confused? Most of Apple’s income ends up in this Apple Operations International (AOI). Cook seems to be saying its income is not subject to US taxation which would be consistent with no repatriation tax. That income turns out not be to be taxed anyway so when he claims there are not using tax havens – that is not true. OK, AOI is not located in the Caymans but that is not the only tax haven. Apple’s 10-K filing notes only three material affiliates – all in Ireland. Apple Sales International and Apple Operations Europe are taxed at the Irish rate of 12.5%. The European Commission’s position is that these entities get very little income with most of it sourced in AOI where it is not taxed. How does that work? Phillip Elmer DeWitt explains:

it’s in the southern Irish city of Cork that Apple pioneered its famous “double irish with a Dutch sandwich” — a tax avoidance technique designed to take advantage of a quirk in Ireland’s tax laws that allows foreign corporations to move money around the world tax free…AOI is incorporated in Ireland; thus, under US law, it is not tax resident in the US. AOI is also not tax resident in Ireland because it does not meet the fact-specific residency requirements of Irish law.

This last sentence is actually from Cook’s testimony. What it basically says is that AOI is located nowhere. It might as well be on Gilligan’s Island or even Mars. But how is this Double Irish Dutch Sandwich (doesn’t that make you hungry) not a tax gimmick? Wasn’t Tim Cook under oath when he testified? And how is lying to the Senate “perfectly legal”?