Having read the Commission letter through it is clear that the game has moved to a different pitch. The key issue is not the 1991 transfer pricing arrangement or its subsequently revision in 2007. Yes, there was little objective basis for the 65/20 margins used and there was no reference to the arm’s length principle and the arrangement seemed to be reverse engineered, but there is nothing in the EC letter to say that the margins used were wrong and led to taxable income figures that were significantly out of line if a more careful and objective approach was taken in line with OECD standards (which weren’t introduced here until 2010).
There is no doubt the 1991 advance pricing arrangement (APA) was put together in a pretty arbitrary manner as indicated by the minutes and notes taken by the Revenue official but that was as much the nature of the regime at the time rather than any special or preferential treatment to Apple. The detailed nature of the records kept suggest it was not unusual.
Can it be argued that similar arrangements were not put in place for other companies? APAs on a cost-plus basis for entities that engage in the activities attributed to the Apple’s Irish operations are not unusual.
Apple Operations Europe:
– the "manufacture of a specialised line of personal computers."
- providing "shared services to Apple companies in Europe, the Middle East and Africa (EMEA) region, including payroll services, centralised purchasing and a customer call centre."
Apple Sales International:
– the "procurement of Apple finished goods from third-party manufacturers"
– the "onward sale of those products to Apple-affiliated companies and other customers"
– "logistics operations involved in supplying Apple products from the third party manufacturers to Apple-affiliated companies and other customers."
Manufacturing, shared services, procurement and logistics are not high-profit activities. The Commission can argue that the 65/20 cost-plus margins in the 1991 APA and the updated margins in the revised 2007 agreement were "wrong" but they are unlikely to result in a material difference to the amount of tax Apple would have had to pay in Ireland. In monetary terms, any finding here would be relatively insignificant.
It is pretty clear that the issue has moved on and that these transfer pricing arrangements are no longer central. The key issue is Apple’s intellectual property, or more precisely, the location of Apple’s intellectual property.
If we look at the five items requested by the Commission in June letter published this week none of them relates to the pricing agreements. The information requested was:
– Provide the financial accounts of ASI and AOE for the period 2004-2013, in particular the P&L accounts.
– In the case of ASI single out in the P&L the amount of passive income each year and specifying if such passive income comes from Ireland.
– Provide the number of full time equivalent employees (hereinafter “FTE”) of ASI and of AOE over the same period (each end of reporting period). Provide the FTE of the Irish branch of ASI and of AOE for the same period (each end of accounting period).
– Provide the cost sharing agreement between Apple Inc., ASI and AOE in all its variations since 1989 until the last modification.
– Describe in detail the type of intellectual property covered by the cost sharing agreement.
It is clear the Commission are focusing on the ASI subsidiary as a whole and not just its Irish branch. The key issue is whether any of the intellectual property rights held by ASI are located in Ireland. Last year’s US Senate report contained a good deal of information on ASI. The post continues below the fold with a a selection of quotes relating to ASI, and its parent AOE, in the Senate report.
The first is Apple Sales International (ASI), an entity that has acquired certain economic rights to Apple’s intellectual property.
Apple entered into a cost-sharing agreement with two of them, Apple Operations Europe (AOE) and its subsidiary, Apple Sales International (ASI). Under the terms of the cost-sharing agreement, Apple’s Irish affiliates shared Apple’s research and development costs, and in exchange, were granted the economic rights to use the resulting intellectual property.
Apple Inc. is the sole owner of the legal rights to Apple intellectual property. Through a cost-sharing arrangement, Apple Inc. owns the economic rights to Apple’s intellectual property for goods sold in the Americas, while Apple’s Irish affiliates, Apple Sales International (ASI) and its parent, Apple Operations Europe Inc. (AOE), own the economic rights to intellectual property for goods sold in Europe, the Middle East, Africa, India, and Asia (“offshore”).
The key roles played by ASI and AOE stem from the fact they are parties to a research and development cost-sharing agreement with Apple Inc., which also gives them joint ownership of the economic rights to Apple’s intellectual property offshore. Although AOE and ASI jointly participate in the cost-sharing agreement with Apple Inc., the bulk of Apple’s offshore earnings flow to ASI.
As part of its duties, ASI contracted with Apple’s third-party manufacturer in China to assemble Apple products and acted as the initial buyer of those finished goods. ASI then re-sold the finished products to ADI for sales in Europe, the Middle East, Africa, and India; and to Apple Singapore for sales in Asia and the Pacific region. When it re-sold the finished products, ASI charged the Apple affiliates a higher price than it paid for the goods and, as a result, became the recipient of substantial income, a portion of which ASI then distributed up the chain in the form of dividends to its parent, AOE. AOE, in turn, sent dividends to AOI .
the cost sharing agreement gives ASI the rights to the “entrepreneurial investment” profits that result from owning the intellectual property.
The cost-sharing agreement is structured as follows. In the agreement, Apple Inc. and ASI agree to share in the development of Apple’s products and to divide the resulting intellectual property economic rights. To calculate their respective costs, Apple Inc. first pools the costs of Apple’s worldwide research and development efforts. Apple Inc. and ASI then each pay a portion of the pooled costs based upon the portion of product sales that occur in their respective regions. For instance, in 2011, roughly 40 percent of Apple’s worldwide sales occurred in the Americas, with the remaining 60 percent occurring offshore. That same year, Apple’s worldwide research and development costs totaled $2.4 billion. Apple Inc. and ASI contributed to these shared expenses based on each entity’s percentage of worldwide sales. Apple Inc. paid 40 percent or $1.0 billion, while ASI paid the remaining 60 percent or $1.4 billion.
The figures disclose that Apple’s Irish subsidiary, ASI, profited more than twice as much as Apple Inc. itself from the intellectual property that was largely developed in the United States by Apple Inc. personnel.
When interviewed, Apple officials could not adequately explain why ASI needed to acquire the economic rights to Apple’s intellectual property in order for each to conduct its business. In fact, prior to Apple’s reorganization in 2012, ASI had no employees. All business decisions were made by ASI’s board of directors, which was composed primarily of Apple Inc. employees and held its meetings in Cupertino, California. Apple’s CEO, Tim Cook, told the Subcommittee staff that, during his time as Chief Operating Officer of Apple, he was unable to recall any instance where the ownership of intellectual property rights affected Apple’s business operations.
Technically, as a result of Apple’s cost-sharing agreement, Apple Inc. owns all of the intellectual property rights (both legal and economic rights) embedded in the CPUs used in the Americas, and ASI owns the intellectual property economic rights for the CPUs used in rest of the world.
The Commission don’t care about the transfer pricing; they are going after the intellectual property. ASI is a US-based company that has an Irish branch. [Yes, it is Irish-incorporated but that is not an important factor when determining tax liabilities.] There is nothing to indicate that it was the Irish branch that acquired ASI’s intellectual property but that is what the Commission is going for.
It is also looking at the cost-sharing agreement between three US-based companies: Apple Inc. and its subsidiaries ASI and AOE. It is not immediately clear what this has to do with the amount of tax Apple pays in Ireland. The agreement pays for R&D activity that takes place in the US which generates intellectual property assets that are held in the US.
There is an increasing resemblance to a fishing expedition. Have a look at the transfer pricing arrangements. They seem to be done on a fairly unsystematic basis but throw up nothing that is unusually preferential for Apple. Throw a blanket over intellectual property and make a request for further information and see if anything turns up there.
There is nothing to indicate that Apple moved any intellectual property to Ireland. On AOE and ASI the Commission letter says (pages 8 and 9):
No rights in relation to the IP concerned are attributed to the Irish branch of AOE.
No rights in relation to the Apple IP concerned are attributed to the Irish branch [of ASI].
So, if no IP rights are attributed to the Irish branches of AOE and ASI, and the Commission say as much, what are the fishing for? There is nothing to indicate the R&D was paid for from Ireland; there is nothing to indicate the resultant intellectual property was held in Ireland; there is nothing to indicate the income earned by the IP flowed to Ireland.
When talking about AOE, ASI (and also AOI) Sen. Carl Levin said:
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.
If these companies have IP assets in Ireland then we are really at the races (the billions) but there is no need for Apple to transfer these IP assets to Ireland with the resultant risk that the income earned by those assets could be subject to Irish tax [and note that this income could be subject to the 25% rate rather than the 12.5% rate]. All Apple needs to do to defer the US corporate income tax is to hold the IP in Irish-incorporated companies; it does not have to actually move the IP to Ireland.
Anyway, it is clear the game has moved on to the intellectual property, but similar to the transfer pricing arrangements it seems unlikely to catch much.
I wonder how Apple feels about the EU Commission rummaging through its US affairs. It would be interesting to know how the co-operation with this investigation has been since this request for the information about the IP was made in June. It would have been pretty easy for the Department of Finance to co-operate with the requests for information on the transfer pricing arrangements – that would mostly have been available from the Revenue Commissioners.
However, they won’t have had the financial accounts for AOI and ASI and they definitely don’t have all the cost-sharing agreements Apple Inc. has entered with its US-based subsidiaries or have the details of the US-held IP that resulted from them. The Irish government cannot give information that it does not have and we don’t know if Apple is willing to provide it.