Barking up the wrong Apple tree

There is lots of excitement this morning about a story in the Financial Times about the European Commission state-aid investigation into Apple’s tax arrangements in Ireland. The story first appeared online under the headline “Apple hit by Brussels finding over illegal Irish tax deals”. When put on the front page of today’s print edition the headline was “Apple hit by Brussels findings over Irish backroom tax deals”. The story begins:

Apple will be accused of prospering from illegal tax deals with the Irish government for more than two decades when Brussels this week unveils details of a probe that could leave the iPhone maker with a record fine of as much as several billions of euros.

Preliminary findings from the European Commission’s investigation into Apple’s tax affairs in Ireland, where it has had a rate of less than 2 per cent, claim the Silicon Valley company benefited from illicit state aid after striking backroom deals with Ireland’s authorities, according to people involved in the case.

The headline and story resulted in widespread opprobrium from the usual sources being directed at Ireland. The reality is that the headline is nonsense and the presentation of the story in the text was misleading (at best). Anyone with even a summary understanding of the issue would immediately see that, but there are plenty who love jumping to and jumping on adverse conclusions about Ireland’s corporation tax regime.

The errors include:

  • there are no “fines” in state-aid cases
  • the case does not involve “billions of euros”
  • there are no “preliminary findings”
  • there is no “rate of less than 2 per cent”

And that’s just the first two paragraphs!

At present Apple pays very little corporate income tax on its profit earned on sales made outside the US. These profits will be taxed based on the source-location of the risks, assets and functions from which the profits are derived. The risks, assets and functions that generate Apple’s profits are mainly in the US and under current rules the US is granted the taxing right for the bulk of Apple’s profits. The fact that the US allows Apple to defer the payment of this tax until the profits are transferred to a US-incorporated company is a matter for the US.

Sometimes we tend to use the word “repatriate” when it comes to these profits. But Apple’s non-US profits don’t have to be repatriated to the US; they go there directly and there is no stop-off in Ireland. Yes, Apple’s non-US profits are accumulated in Irish-incorporated companies but almost everything about these companies happens in the US.  Using US rules, Apple was able to create this situation and maintain that these companies did not have a taxable presence in the US.  The EC investigation will examine none of the headline issues about these companies highlighted in the US Senate Report last May.

The EC can only investigate the taxing of activity that happens in Ireland and decisions that are made in Ireland. In its June announcement, the EC said the Irish element of its investigation relates to:

the individual rulings issued by the Irish tax authorities on the calculation of the taxable profit allocated to the Irish branches of Apple Sales International and of Apple Operations Europe;

It is the profit attributed to just the Irish branches of the companies that is in question not the entire profits of these companies. In his opening statement to the US Senate hearing last May, Sen. Carl Levin (D) said:

ASI, as we’ll explore in a bit, holds the economic rights to Apple’s valuable intellectual property in Europe, the Middle East, Africa, India, and Asia. From 2009 to 2012, its sales income amounted to $74 billion. … Unlike AOI, ASI has paid a small amount of tax, to Ireland. In 2011, for example, it paid $10 million in taxes on $22 billion in income. That’s a tax rate of five-hundreds of one percent. It appears that this tiny tax payment may be related to activity unrelated to ASI’s main purpose, which is to serve as the receptacle for profits generated by Apple’s intellectual property in much of the world.

Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in California.

In short, these companies’ decision-makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States.

When ASI receives income for the intangible assets it holds it receives it in the US. If the assets were held in Ireland the income flows should appear in the Irish balance of payments. They do not. [Note: The income flows from “double-irish” type structures do appear in the Irish balance of payments because some of the functions are based in Ireland, mainly low-profit sales and administrative support services. None of the risks, functions and assets in Apple’s global tax structure are located in Ireland.]

According to the Sen. Levin’s statement ASI received $22 billion in income in 2011. From the balance of payments we can see that the total amount of income flows into Ireland from royalties/licenses in 2011 was less than €4 billion. ASI might have received $22 billion of income from the intangible assets it holds but it didn’t do so in Ireland.

On RTE’s Morning Ireland today, it was said that:

Apple claim all their intellectual property is located in Ireland and hence their large profits come from the location of the intellectual property.

That is not true. Apple clearly state that their intellectual property is located in the US. The income and profits go to the US. That the US chooses not to tax them until they are transferred to a US-incorporated entity within Apple’s structure is a matter for the US authorities. This deferral provision in the US tax code is of no concern to the European Commission. The fact that the companies at the heart of the structure are Irish-incorporated is equally irrelevant. What matters is the source-location of the risks, assets and functions that generate the profits, not the country of incorporation.  [Incorporation can matter for residence but that is a different issue and is not subject to EC investigation.]

What will be of concern to the EC investigation is the activities that resulted in ASI paying $10 million of corporate income tax in Ireland in 2011 (and varying amounts in all years from 1991). The question is whether the right amount of profit was attributed under a transfer pricing agreement to the risks, assets and functions in Cork. It is not clear what activity this precisely relates to but it is obviously small in the scheme of Apple’s overall income flows.

Even if the $10 million from 2011 related fully to the activities covered by the transfer pricing agreement under investigation by the EC an underpayment by a factor of six (say because of a two per per cent rate rather than the 12.5 per cent rate) would mean that the amount of additional tax would be around $50 million.

Apple is a US company that owes US taxes because the risks, functions and assets that generate its profit are located in the US. The notion that Apple could owe “several billions of euros” of Corporation Tax in Ireland, as per the FT piece, is absurd, but persists. Apple designs products in the US, manufactures them in China and sells them around the world. On what possible basis would it owe 12.5 per cent of the profits from those activities to Ireland?

I don’t know if the $10 million of Irish Corporation Tax paid by ASI in 2011 was correct. My guess is that it was probably pretty close to what any other company would have paid if it carried out the same activities in Cork, i.e. not state aid, but as long as the investigation is ongoing insidious leaks attracting front-page attention seem likely to continue.

Comments

comments

29 thoughts on “Barking up the wrong Apple tree”

  1. It would be wrong to think that this was an innocent error on the part of the FT, BBC and GroanyAd. It is simply part of the ‘black propaganda’ against Ireland by British nationalism (both of the right-wing and left-wing varieties), which reached fever pitch during Scotland’s freedom referendum. Quite simply, ‘successful Ireland’ = ‘end of UK’. Most of the apocalyptic forecasts for the Irish economy in recent years (now shown to be as big a hoax as this one) were inspired by the same motive. Expect a lot more of this in coming years since the referendum has clearly not the put the issue of Scotland’s freedom to bed, resistance to London rule is growing, and another referendum is likely within 5 years. There will also probably be a referendum in N. Ireland as well later this decade. With both these in the offing, today’s hoax is only the tip of the iceberg of what is to come.

  2. Seamus, the article was crap by past FT standards and I’m surprised it got onto the front page even at the weekend.

    Apple and Ireland have though got to the point on corporate taxation where nobody is listening any more to the details. Minds have been made up.

    The EU is really expressing the fact that the rather generous past mood music on tax advantages for small EU states is different. They want everyone to understand that, loud and clear.

    The story won’t impress analysts, but people will trade on stories like this.

  3. Bottom line
    this sort of stuff has got to stop. Ireland has got to get out ahead of it. We need to not just be clean (Which we seem, mostly, kinda to be) but to be seen to be clean.

  4. fyi

    Europe’s Austerity Disaster

    29/09/2014 by Joseph Stiglitz

    ‘Austerity has failed. But its defenders are willing to claim victory on the basis of the weakest possible evidence: the economy is no longer collapsing, so austerity must be working! But if that is the benchmark, we could say that jumping off a cliff is the best way to get down from a mountain; after all, the descent has been stopped.

    But every downturn comes to an end. Success should not be measured by the fact that recovery eventually occurs, but by how quickly it takes hold and how extensive the damage caused by the slump.

    Viewed in these terms, austerity has been an utter and unmitigated disaster, which has become increasingly apparent as European Union economies once again face stagnation, if not a triple-dip recession, with unemployment persisting at record highs and per capita real (inflation-adjusted) GDP in many countries remaining below pre-recession levels.’

    http://www.social-europe.eu/2014/09/europes-austerity-disaster/

  5. @SC

    Thanks. Great explanation. Amazing the level of spoofing around this issue. There’s definitely journalistic incompetence there but it’s hard not to see it as something more sinister. I mean, front page of the FT!!

  6. In my eyes the Financial Times is a Union Jack uber Irland waver without a shred of credibility.
    Read Le Monde, Figaro, Die Welt, Austrian and Swiss newspapers for something based on reality sans blinkers. They will all be looking at it through their own lens filters but nothing as prejudiced as the British Press excepting the Guardian and New Statesman with the Economist improving in recent years. Hopefully they will not pile on and I will not have to cancel my Economist subscription.

  7. It’s a big bad world out there alright! Luckily, the EU is governed by the rule of law (a unique situation in the history of international cooperation which is mostly overlooked by those critical of it, the EU that is).

    It may be worth while to refer back to the Commission’s June press release.

    http://europa.eu/rapid/press-release_IP-14-663_en.htm

    “Tax rulings are used in particular to confirm transfer pricing arrangements. Transfer pricing refers to the prices charged for commercial transactions between various parts of the same group of companies, in particular prices set for goods sold or services provided by one subsidiary of a corporate group to another subsidiary of the same group. Transfer pricing influences the allocation of taxable profit between subsidiaries of a group located in different countries.

    If tax authorities, when accepting the calculation of the taxable basis proposed by a company, insist on a remuneration of a subsidiary or a branch on market terms, reflecting normal conditions of competition, this would exclude the presence of state aid. However, if the calculation is not based on remuneration on market terms, it could imply a more favourable treatment of the company compared to the treatment other taxpayers would normally receive under the Member States’ tax rules. This may constitute state aid.

    The Commission will examine if the three transfer pricing arrangements validated in the following tax rulings involve state aid to the benefit of the beneficiary companies:

    the individual rulings issued by the Irish tax authorities on the calculation of the taxable profit allocated to the Irish branches of Apple Sales International and of Apple Operations Europe;

    the individual ruling issued by the Dutch tax authorities on the calculation of the taxable basis in the Netherlands for manufacturing activities of Starbucks Manufacturing EMEA BV;

    the individual ruling issued by the Luxembourgish tax authorities on the calculation of the taxable basis in Luxembourg for the financing activities of Fiat Finance and Trade.

    The Commission has reviewed the calculations used to set the taxable basis in those rulings and, based on a preliminary analysis, has concerns that they could underestimate the taxable profit and thereby grant an advantage to the respective companies by allowing them to pay less tax. The Commission notes that the three rulings concern only arrangements about the taxable basis; they do not relate to the applicable tax rate itself.”

    The key words, it seems to me, are “other taxpayers” and “advantage”. As there is no EU-wide system of corporation taxation, one must assume that the reference is to other Irish, Dutch or Luxembourg companies. (Ireland, although some will find this hard to believe, is not the only country involved).

    P.S. To be fair to the journalist who wrote the FT piece, one also assumes that he was not responsible for the misleading headline.

  8. TL,
    Why would you expect a higher level of expertise from the FT over say our own paper of record or even over a red top. The journos especially the commentariat are c..p.

  9. Seamus

    I don’t suppose there’s a graphic representation of the set-up? I’m struggling with this a bit…

    Great job with Dobbo this evening!

    s

  10. @ Tull

    “Why would you expect a higher level of expertise from the FT over say our own paper of record or even over a red top.”

    Selection. Doesn’t mean they are not sometimes political but the attention to detail at the FT goes a good bit beyond the IT. And they do know their financials. Quite weak on climate however

    I remember Simon Carswell admitting that there were big gaps in his knowledge when he started as finance corr for the IT at the height of the panic.

  11. one more thing…

    http://www.irishtimes.com/business/economy/q-a-ireland-s-tax-battle-with-the-european-commission-1.1945413

    In this Mark says…

    “If it is eventually established that Ireland did indeed give illegal State aid to Apple, then it is possible the EC could order the country to recover the aid – the tax foregone – between 2004 and 2014.
    This could potentially amount to several billion euro. Between 2004 and 2008 alone, Apple avoided more than €850 million in tax here.”

    So is that where the confusion is when you say

    “Even if the $10 million from 2011 related fully to the activities covered by the transfer pricing agreement under investigation by the EC an underpayment by a factor of six (say because of a two per per cent rate rather than the 12.5 per cent rate) would mean that the amount of additional tax would be around $50 million.”

  12. The interview on RTE was a curious affair in that “Dobbo” asked the pertinent question at the start of the interview i.e. “was there a special deal for Apple?” but the Q & A veered away from the issue until the end where it emerged from Seamus Coffey’s replies that the fundamental issue was, indeed, whether Apple had been in receipt of discriminatory treatment relative to other – presumably Irish – companies i.e. had it enjoyed the “advantage” referred to in the Commission’s press release. Establishing that this has been the case – if necessary before the ECJ – is the only role that the Commission can play under present EU rules.

    Putting a figure on that “advantage” is a question, rather self-evidently, for a later date.

    It is doubtful if the Irish public will be any wiser from today’s media coverage. What it will know with certainty, however, is that Apple, with other US corporations, is involved in tax avoidance with the participation of Ireland, whether wittingly or unwittingly being beside the point, and that there is a growing, and understandable, level of international dissatisfaction with this situation. This almost certainly explains the decision by the – outgoing – Commission to initiate the proceedings under discussion.

    The knee-jerk reactions in Ireland to the very mention of MNC tax matters also suggests that there is a subliminal fear that basing an industrial strategy on such Irish participation, creating a tax advantage that could possibly be removed at a stroke by a decision of US lawmakers, may not be the wisest.

  13. “We were simply trying to understand what was the right amount of taxes that we would have to pay in Ireland,” Luca Maestri, Apple’s new CFO, said of the agreements, describing Apple’s approach as “very responsible, transparent and prudent”.

    The answer apparently was none as Apple’s main Irish subsidiary Apple Operations International (AOI) ceased paying taxes in Ireland in 2007 – it could in effect operate as an onshore company with the Dublin branch of Bank of America as its bankers and also be stateless when it suited.

    It paid the Irish Revenue $21m in 2005 and when it then paid nothing, officials must have known why – and hardly were later surprised by the stateless disclosure. 😳

    As to whether Apple got special treatment, when related to peers, likely not.

    However, in the UK, Ireland and elsewhere, the law is applied differently to big MNCs and most companies.

    The House of Commons Public Accounts Committe has criticised the access the Big 4 firms have to the Revenue & Customs (HMRC) and as in financial regulation, conflicts of interest can arise where a senior official aspires to a job with a Big 4 firm or a post retirement nixer. 😯

    “We comply with all laws” is the mantra – there wouldn’t be much of a society if we all just complied with legislated law while legislative action or inaction can be bought. When the Clinton Administration inadvertently opened a huge loophole with its ‘check-the-box’ rule, it couldn’t later get Congress to close it as business ‘induced’ enough members to retain it.

    The directors of an SME firm would risk imprisonment if they engaged in activities using letter-box companies etc that are common for big MNCs.

    I show here how Apple’s foreign tax rate has fallen over the past decade.

    http://www.finfacts.ie/irishfinancenews/article_1028235.shtml

    The revelations in recent years may in the long-term help to bring more balance to Irish enterprise policy

    Prof John Kay, the FT columnist, wrote last year:

    “It is disingenuous for companies to claim they pay the tax legally due when their assessments are based on accounts that defy economic and business realities.

    In the main, however, tax authorities have preferred to cut deals with big corporations rather than pursue costly legal action. They will not do the same for you and me. It makes no sense for a small company to pay an accountant to do anything but calculate the amount of tax that is properly due, or to incur legal fees resisting a challenge. The unacceptable outcome is an entirely correct perception that there is one law for the little guy and another for the big battalions. The potential effect of that perception on tax compliance is one that it is well worth spending millions of pounds to avoid.

    A serious reform agenda would involve a principled reappraisal of the basis for taxing corporations both nationally and globally, and a strategy for effective enforcement of existing rules. Such a strategy would make clear that executives of companies which present accounts to tax authorities that are essentially false, and the accountants who support them, will in future run serious risks. The door they hear closing behind them might be the door of a prison cell rather than the door of 10 Downing Street.”

  14. I don’t see any correction from the FT this morning nor any comment from this side of the pond. Pity.

  15. @Michael

    Nár laga Dia thú.

    The Big 4 are a HUGE part of the problem. Death by MBA. Hollowing out capitalism. One company can do it but when they all do the system is severely weakened

    http://www.ft.com/cms/s/0/7fb43b0a-3ead-11e4-adef-00144feabdc0.html

    “The combination of share buybacks, dividend increases and M&A activity has resulted in deterioration in corporate leverage,” says Steven Ricchuito, chief US economist at Mizuho Securities. “Net debt-to-sales is already back above its pre-crisis high even though corporates are levered long and are running with exceptionally low debt burdens.”

    You can add tax avoidance, zero investment and stupid C suite incentives to that . Very little value is generated. And the Big 4 are advising, auditing and lobbying at every stage.

    Anyone who says “they are breaking no laws” ignores the pernicious role they play in writing the tax laws.

    And that’s before mentioning Hong Kong.

    http://www.ft.com/cms/s/0/574791ee-fdc1-11e3-acf8-00144feab7de.html
    ” The big four global accounting companies have taken out press advertisements in Hong Kong stating they are “opposed” to the territory’s democracy movement, warning that their multinational clients may quit the city if activists carry out threats to disrupt business with street protests.”

  16. Its all obviously been coordinated by the UK Government with the Tory Party Conference in mind. Cameron thinks that, having crushed Scotland, he can now move on to Ireland. Those who said I was a ‘conspiracy theorist’ for suggesting that the UK Establishment/MI5/City of London axis was behind the apocalyptic forecasts (now proven hopelessly wrong) for the Irish Economy in 2009-2011 are very naïve and need to think again.

    http://www.rte.ie/news/2014/0930/648865-ireland-tax-apple/

  17. http://www.ft.com/cms/s/0/f098df90-3fef-11e4-936b-00144feabdc0.html

    “Will Apple still be at the cutting edge a decade from now? Not if you judge by what it does with its cash. The company keeps tens of billions of dollars offshore to avoid paying US corporate taxes. Yet it borrows at home – including a record $17bn bond issue last year – to fund a massive share buyback spree (Apple spends more on equity repurchases than any other US company). The roots of the problem lie with poor governance regulations and a badly outdated tax system. Unless these are fixed, boardrooms will keep on draining their treasuries at the expense of other stakeholders.”

  18. @seafood et al

    The current position with regards to the determination of residency for the purposes of corporation tax in Ireland is to figure out where the critical management decisions are made. Normally this involves looking at where the directors reside and where the top corporate structure board meetings are held etc. If it can be shown that these day to day and strategic decisions are made in Ireland then the company is deemed to reside here and as a consequence is subject to Irish corporate taxes. Repatriation makes no difference in the case of Ireland. If Ireland has a double tax agreement with the country in question then a credit is allowed in Ireland for taxes paid in the foreign country – but the entirety of the worldwide profits made by the company are taxed in Ireland. That’s the way it works here.

    The basic question for US legislators is why they don’t simply invoke such laws on US resident companies (where it can be shown that the companies are in fact resident in the US). All this ducking and diving on corporate tax avoidance would go away as the top decision making corporate in the structure would be deemed to be US and as a consequence it pays US taxes irrespective of the fact that the monies were repatriated back to the US or not.

    Reading the post above it seems pretty clear in relation to the AOI company that its residency is US when viewed using the Irish definition of corporate residency. As a result, as SC has indicated many times, the problem here is not an Irish one but a US one.

    I think we all know why US legislators don’t want to press the nuclear button on this one – perhaps the lobbying fraternity might have something to do with it ? Only suggesting like.

  19. WRT, did Apple get an advantage?
    Dealing with Irish Governments’ post Dev it is a given that to gain advantage you have to make “campaign contributions”. To get 2% corporate tax rate the price must have been high, loss of 4,000 jobs, plus “campaign contributions” would do it.
    Our governments have been guilty of short sighted tax policies that accelerated the race to the bottom and invited retaliation from more responsible govts cheered on by the British business press claque.
    Even today as France gives tax relief to the poor and claws it back from the well off which as every shopkeeper (and economist) in Ireland knows is good for business and the poor. Our Gov’t is still on the downward tax spiral for business and the better off.
    This is the kind of thinking that kept Ireland in poverty for half a century post independence.
    De ja vu all over again. A glacial unavoidable train wreck right before our eyes. Our only excuse is the EZ led by Germany is doing a brisk march into a concrete wall. Instead of forming allies within the EZ to address the problems, Kenny makes pilgrimages to Berlin to get a “good boy” pat on the head the same as Antonis Samaris of Greece, Mariano Rajoy of Spain, Pedro Passos Coelho of Portugal and other PIIGS including Francois Hollande who has to go on bended knee to Berlin to apologise personally for implementing orthodox economic solutions to stimulate demand domestically. As for labour force rigidity, in Ireland it is rife in the professions while the labouring classes have the privilege of going toe to toe with the Chinese. I am sure that Ryanair would rejoice if the Irish gov’t flew patients to Warsaw for 2/3rd off on most non time critical surgeries. Would that break up the cosy consulting cartels.?

  20. @Mickey Hickey
    ”..As for labour force rigidity, in Ireland it is rife in the professions while the labouring classes have the privilege of going toe to toe with the Chinese…”

    Very true. MNC’s are stocked with professional immigrants who require accomodation unlike many Irish youngsters who can live at home .Rents are driven up in Dublin as a consequence .For those outside the inner circle of politicians,liberals,landlords and MNC’s that sanctity mass immigration ,this premium in rents is effectively a tax on the Irish grunts.

    Anything that drives MNC’s out of Ireland is good in my book.There is little evidence showing its a universal good with little downside. It is more likely a factor in maintaining control over Irish society by those who rule over us.
    When was the last time you heard an argument in favour of maintaining Corporation taxes for MNC’s from the average Joe.? Its almost always someone from the inner circle of power mentioned above who makes the case.

  21. Is the US the only place in the world that imposes more tax obligations on its citizens resident abroad than it does on its corporations based in the US?

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