The European Commission’s “state aid” investigation of Apple revealed that in 2014 Apple’s aggregate tax rate on its European business was $50 per $1 million of profit. At that rate Apple is not only the world’s largest for-profit corporation, but also the world’s largest tax-exempt one. Put to one side the false claims that the European Commission exceeded its authority in this case by intervening in domestic Irish tax affairs. Focus instead on the extraordinary fact that Apple, which earns about 2/3 of its revenue outside the United States, paid tax on its European operations at a rate of 0.005 percent. What lessons can we draw from this?
First, Apple’s near tax-exempt status demonstrates (as if more proof were required) that U.S. and international tax norms are irredeemably broken, but not in the ways claimed by some. The U.S. international tax system is not “uncompetitive.” To the contrary, the United States aids and abets U.S. multinationals in their stateless income tax gaming, whose object is to skim profits from countries where income actually is earned, and then to deposit those profits in a zero or near zero tax receptacle. That is the source of Apple’s offshore cash hoard totaling more than $200 billion.
For the United States, the game is different, but just as artificial. Apple’s plan, authorized in broad outline by IRS regulations, was to create an Irish subsidiary, stuff it with seed money, and to pretend that the subsidiary had its own independent business agenda. Apple Cupertino and Apple Ireland then entered into an “arm’s length cost sharing agreement” of the sort that two independent drug companies might employ to jointly develop a new drug.
In the deal, Apple Ireland got the ownership and exploitation rights to all of Apple’s patents and other intellectual property for all European jurisdictions, in return for paying Europe’s share of global R&D costs.
Ireland pays this mostly to Cupertino, which conducts the R&D in the United States, and Apple Ireland keeps all the profits above those costs as returns on valuable IP “owned” by it. Cupertino no doubt was secretly thrilled to let Apple Ireland get the better of it in these “arm’s length” negotiations.
Third, these aggressive schemes distort competition and hurt individual taxpayers all over the world. Domestic firms cannot play these stateless income games, and so cannot compete fairly with multinationals. Moreover, the missing corporate tax revenues must be made up elsewhere, which invariably means from you and me, as we are not able to be so nimble with our incomes or our citizenship as Apple and other multinationals are.
Fourth, despite claims to the contrary, under current law Apple need never pay U.S. tax on its offshore hoard of nearly tax-exempt income. In fact, when Apple borrows money in U.S. capital markets, as it has done in recent years to the tune of billions of dollars, those borrowings operate in substance as tax free repatriations of its offshore income.
The ultimate lesson here is that we need real business tax reform, immediately. The first step, already underway, is comprehensive tax transparency to global tax authorities — a uniform template of information that gives authorities a clearer picture of where a firm generates real economic value, and where its tax income is booked.
The second step should be comprehensive reform of U.S. financial accounting standards, which create as much misinformation as useful insights. Apple for example is highly unusual in recording a financial accounting charge for residual U.S. tax on much of its almost untaxed foreign income. Apple could trigger such a tax, but has no tax reason to, and to date has not done so. This non-cash charge has obfuscated the trivial tax bills Apple actually has incurred in Europe, thereby forestalling until now the firestorm of criticism Apple so richly deserves.
Apple’s tax ingenuity proves that the new international business tax order must be simple and robust to gaming. The only approach that satisfies these criteria while maintaining a level tax playing field for global competition is true worldwide tax consolidation, which means that all of Apple’s worldwide income (or loss) would be reflected immediately on its U.S. tax return. This comports with the economic reality that Apple is one global enterprise, not hundreds of independent actors employing a common name. It also comports with Apple’s public financial statements, which are the windows through which Apple’s owners and others see Apple.
In return, the U.S. corporate tax rate must come down to something in the range of 25 percent, and the United States must continue to give a tax offset for income taxes paid to those foreign countries where income arises. A rate in this range is in the middle of the pack of world norms, so U.S. companies will be competitive in this respect with domestic German companies, for example. The system vitiates tax gaming, because income siphoned from Germany will just be taxed currently at 25 percent by the United States.
Apple does not need or deserve a 0.005 percent tax burden, and we as individuals do not deserve being required to make up the missing tax revenues. Apple can compete and thrive in a world where it pays the same tax rates as those imposed today on any mid-sized domestic Business.
Kleinbard if former chief of staff for the U.S. Congress Joint Committee on Taxation. He is currently a professor at USC Gould School of Law in Los Angeles, and author of We Are Better Than This: How Government Should Spend Our Money. Follow him and more USC Gould School of Law professors @USCGouldLaw
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