The Homeland Security & Governmental Affairs Permanent Subcommittee on Investigations, which previously “studied” Microsoft and Hewlett Packard, now has its eyes on Apple. A hearing, held this morning in Washington, D.C., focused specifically on the tech giant, to determine how U.S. based multi-national corporations use “loopholes” to move profits offshore to avoid paying taxes.
“Apple is an American success story,” said Chair Carl Levin (D-MI) in his opening statement, adding that he personally carries an iPhone. However, he noted, the company also has a “highly developed tax avoidance system.” The strategy is in two parts, he said – the company executes a shift in profit generating power (derived from intellectual property) to offshore tax havens. Once income is offshore, it remains shielded from U.S. taxes.
“I’m often asked if Apple still considers itself an American company,” said Tim Cook, CEO, Apple. “My answer has always been an emphatic yes.” The company has no intention of leaving its headquarters in Cupertino, CA. Rather, Apple is building a new, three million square-foot campus.
Apple is a bit larger today than the company Steve Jobs created in his parents’ garage 40 years ago, but the same entrepreneurial spirit drives everything they do, Cook said. Employees come to work with the goal to “capture the world’s imagination” with the “very best products on earth.” Innovation largely takes place in one zip code: 95014.
“Mobile apps are one of the hottest things in technology today,” he said. Apps have made software development the fastest growing job segment in the U.S. The apps store, a multi-billion dollar marketplace, has generated 300K new jobs, with no sign of slowing down.
While jobs in general stagnated, Apple’s workforce grew by fivefold, Cook said. The company has employees in all 50 states. It has invested $100 million in manufacturing its Mac lines domestically. In addition, iPhone components are made in Texas, with glass coming from Kentucky. A large data center has also been constructed in North Carolina, with others on the way - in Oregon and Nevada.
The company, which Cook called a “champion of human rights, education and the environment,” has “real operations in real places, with employees selling real products to real customers. We pay all the taxes we owe – every single dollar.” Apple does not depend on tax gimmicks, or moving intellectual property offshore or stashing money on some Caribbean island, he said. In fact, the company paid $6 billion in income taxes – or $16 million per day. Unfortunately, he said, “It would be very expensive to bring the offshore funds back into the United States, under the current tax system.”
Offering suggestions on how to reform the current corporate tax system, Cook said Apple supports a system that is revenue neutral, that eliminates all tax expenditures, lowers tax rates and implements a reasonable tax on foreign earnings that allows free flow of capital back to the US. “We make this recommendation with our eyes wide open,” he said, knowing that such reform will result in higher taxes for the company. “We believe such comprehensive reform would be fair to all taxpayers,” Cook said.
Cost Sharing Agreement
A cost sharing agreement involves a U.S. parent company assigned a designated amount of funds, dedicated to developing new products. Apple has agreements with the Ireland-based Apple Sales International (ASI), which, along with Apple Operations International (AOI), a holding company, Levin believes are “ghost companies.”
The senator noted that 95% of Apple’s R&D is conducted in the United States, yet over a four-year period (2009-2012) ASI paid $5 billion for its shares of the R&D costs, and received profits of $74 billion. In comparison, Apple, Inc. paid $4 billion under the agreement, and $38 billion in profits. Its Irish subsidiary received almost twice the profits from property developed by Apple in the U.S., Levin concluded.
Like ASI and AOI, Apple Operations Europe (AOE), has no tax home, he said. (U.S. tax law is based on where a company is incorporated, not where it is managed.) AOI has no physical presence, he added. In 30 years of existence, it never had any employees. Its ledger is managed in Austin, TX, with assets in a bank in New York. AOI also held 33 board meetings, with all but one in Cupertino.
“Apple is exploiting an absurdity,” Levin said. The company has also quietly negotiated with Ireland government of a 2% tax rate, well under the standards of statutory rates, he added.
In his testimony, J. Richard Harvey, a professor at Villanova University School of Law, said Apple allocated 64% of its 2011 global income into Ireland. His issue was not whether it was aggressive, but whether it makes sense to have them be able to record so much income in an entity with no employees and no real activity. When he heard Apple’s assertion that it does not use tax gimmicks, he said he almost “fell off my chair.” However, he does not recommend that worldwide income be taxed, at least not at the full rate. Instead, foreign, tax haven earnings should be taxed at 15%.
“Frankly, I am offended by the tone and tenor of this hearing. I am offended by a four trillion dollar government bullying, berating and badgering one of America’s greatest success stories,” said Sen. Rand Paul (R-KY). “Tell me one of these politicians up here that doesn’t minimize their taxes. Tell me a chief financial officer that you would hire if he didn’t try to minimize your taxes legally. Tell me what Apple has done that is illegal.”
“If anyone should be on trial here, it should be Congress,” Paul continued, suggesting they should apologize to Apple for hauling the company before a “show trial.” Going further, the senator said Congress should have brought in a giant mirror to see who created the “mess of a tax code” that sends U.S. companies running overseas in the first place. Apple created 600K American jobs, he said. “We want to drag them before this committee to chastise them? I find it abominable.”
“This subcommittee is NOT going to apologize to Apple,” Levin replied, angrily.
“If you want the capital to come home, don’t double tax it,” Paul said, adding the rate should be 5%, not 35%. “Why do you think people are frustrated with Congress?” he asked. “Because we don’t do the right thing.”
Apple In Action
Peter Oppenheimer, Senior Vice President & Chief Financial Officer, Apple, discussed operational structure. In the U.S., Apple sells through retail and online stores, and channel partners. Taxes are paid to federal, state and local government on the full profits of these sales. With iPhones and iPads sold in more than 100 countries, Apple has to physically establish a presence in the region where they wish to sell products and services, he said.
He explained that cost sharing agreements with the Irish subsidiaries were put in place decades before the iPhone, when Apple was a young, five-year-old company that wanted to sell products overseas. Despite investments and attempts at expansion though, Apple came very close to going out of business. In 1997, on the brink of bankruptcy, (after losing $2 billion over the two previous years.) the company restructured its finances and made a dramatic turnaround.
“The fact that AOI and ASI are not tax resident in Ireland does not reduce our U.S. taxes, at all,” Oppenheimer said. In addition, managing large pools of cash centrally, rather than in many places around the world, reduces complexity, better protects the asset, and helps the company earn higher returns on the economies of scale.
Oppenheimer conceded that many have questioned Apple’s decision to issue $17 billion debt rather than repatriate, in order to return capital to shareholders. “This decision was in the best interest of our shareholders.” If Apple used foreign earnings to return capital,” he explained, “funds would have been diminished by the very high 35% tax rate.” The cost of issuing debt, in contrast, was less than 2%.
Regarding tax shelters, Cook noted he does not consider deferral a sham or abuse in any way. The barrier to repatriation is the 35% level, he said. “I’m not proposing zero. My proposal is we eliminate all corporate tax expenditures, get to a very simple system and have a reasonable tax on bringing money back from overseas. I think if we did that, many, many companies would bring back capital to invest in the United States and it would be great for the economy.”
Agree to Disagree
Politely debating with Sen. John McCain (R-AZ) about why AOI still exists, “There is no shifting going on,” Cook insisted, referring to the differences between domestic and overseas tax rates. In the U.S., Apple pays taxes on profits at the top tier, he said. The low rate outside the country is for products sold outside the U.S., not within.
Yes, the three subsidiaries are not tax-resident anywhere, Cook agreed. “Does that sound logical?” McCain asked. Cook replied that ASI and AOE do pay Irish taxes, while AOI’s investment income is taxed in the U.S., at the highest level.
“Isn’t it obvious that you are not bearing the same tax burden as if you were bearing in the United States?” McCain asked, adding this gives Apple a significant advantage over smaller corporations which are strictly located in the country.
“Apple is earning these profits outside the United States,” Cook replied. “By law and regulation, these profits are not taxable in the U.S.”
What about the perception of unfair advantage? McCain pressed. “I see this as a very complex topic,” Cook said. “I’m glad that we’re having the discussion. But honestly speaking, I don’t see it as unfair. I’m not an unfair person and that is not who we are as a company or who I am as an individual.”