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.