OFFICIAL IRELAND DOES not like inconvenient truths. Almost everybody from Pricewaterhouse Coopers (PwC) to An Taoiseach insisted last week that the effective rate of tax on profits earned by US multinationals is close to 12%.
Evidence from the US suggests the opposite. The best managed multinationals operating here pay close to zero per cent.
If you want to see in detail how it’s done, then read the fine print of a report produced by the US Senate Homeland Security and Government Affairs Committee issued on 21 May, 2013. The report is entitled ‘Offshore profit shifting and the US tax Code – Part 2.’
The report, co-sponsored by senators John McCain and Carl Levin, focuses on Apple Inc. which has $102bn in profit/cash stored outside the US.
It states that Apple “has told the Committee that since the early 1990s the Government of Ireland has calculated Apple’s income in such a way as to produce an effective tax rate in low single digits… the rate varies, but since 2003 has been 2% or less.”
An Apple subsidiary based in Ireland called ASI (Apple Sales International) paid $10m tax on $22bn profit in 2011-an effective tax rate of 0.05%.
In 2010 the rate was 0.06%, in 2009 it was 0.10%. These numbers were supplied by Apple itself to the Senate inquiry in a ‘sealed exhibit.’
ASI appears to have 250 Irish employees since 2012 and files a corporate tax return in Ireland.
The US senate report adds: “Ireland has essentially functioned as a tax haven for Apple, providing it with tax rates approaching zero. Since 2009 the rate has been consistently far below 1% and in 2011 was as low as five-hundredths of one per cent.”
These numbers back up claims by Trinity College’s Professor Jim Stewart whose own research published last week suggests that US firms here face an effective tax rate of 2.2%.
Finance Minister Michael Noonan is defensive. He has recently altered Irish tax law in an effort to prevent the operation of controlled foreign subsidiary companies (CFCs) in Ireland that are technically stateless.
But the precise effects of his most recent changes remain to be seen. Will they affect firms that are “managed and controlled” in jurisdictions with which we do not have a tax treaty?
The ‘double Irish’
Tax experts believe they will not affect the use of a technique known as the ‘double Irish’. This is a procedure whereby some multinational profits are transferred from Ireland to firms managed and controlled in countries like Bermuda.
The Senate report cited above also deals with another Irish-registered Apple company called AOI (Apple Operations International). AOI earned net profits of $30bn between 2009 and 2012 yet has paid no corporation tax to any known government in the past five years. It is not tax resident in any known jurisdiction and files no corporation tax returns. This company does appear to be stateless and is the parent of ASI.
AOI is registered in Ireland but “has no physical presence at (its Irish address) or any other address”. Apple Inc. was unable to provide historical records to show the business purpose for which AOI was formed. The company has no employees and has had none for thirty years.
Some 32 of the 33 AOI board meeting held by it between 2006 and 2012 were held at Cupertino in California. There are three directors: Californians Gene Levoff and Gary Wipfler and Irish resident Cathy Kearney. Kearney attended seven of the board meetings, six of them by telephone.
AOI has no bank accounts in Ireland but its assets are managed by a firm called Braeburn Capital in Nevada.
The importance of being physically non-existent
AOI’s non-existent physical presence here is important. The Republic of Ireland has traditionally used management and control tests to determine tax residency. And AOI though Irish registered is neither managed here nor controlled from here.
ASI (Apple Sales International), according to the US Senate Committee, is not tax resident in Ireland either but as an operating company does file a corporation tax return here. It is an indirect subsidiary of AOI and paid the 0.05% tax rate in 2011. ASI controls much of Apple’s business in Europe, Middle East, Asia and the Pacific.
From a tax planning perspective ASI’s purpose is to absorb the income and profit generated by Apple Inc. outside the US and to hold that money tax free or largely tax free until it can be sent somewhere else. The Senate Committee believes that it has successfully shifted $74bn in profits away from the US in this way over a four-year period. The nominal corporation tax rate in the US is 35% compared to12.5% in Ireland.
Much of Apple’s global production is done under licence by third party manufacturers in southern China. The title to this product is bought by ASI which then sells back the product to Apple retail companies across the globe at a huge surplus. They in turn sell the product to final customers. The physical products (such as iPhones) normally do not enter or leave Ireland.
Although 95% of Apple’s product development and R & D work is done in the US approximately 60% of its spending in this area is paid for by its Irish and global affiliates.
Apple Inc. in California retains legal rights to all its new products and intellectual property but it transfers the ‘economic rights’ associated with this intellectual property to ASI which is described as its ‘primary intellectual property recipient’.
The US tax code allows product development and R & D costs to be split ‘in proportion to each party’s share of reasonably anticipated benefit.’
Thus, in legal terms, ASI acts as the holder of economic rights to Apple’s intellectual property outside the Americas and is the recipient of much of its sales revenue and profit outside the US. But when ASI remits profit back to AOI (its Irish parent) the transaction does not trigger a tax liability in the US under what’s known as Subpart F of the US tax code. Subpart F is a general US tax law enacted in 1962 designed to allow the IRS tax the global income of multinationals.
US senators are very exercised by all of this for several reasons.
Firstly tax planning is reducing the federal government’s tax income. Corporation Tax yielded 32% of all federal taxes in 1952 compared to just 9% at present.
Apple is no isolated case
Secondly, Apple is no isolated case. Other multinationals have equally smart tax planning units though their tax planning techniques vary.
Thirdly, US legislators reckon that multinationals have close to $2 trillion in profits stored outside the US. They fear that the profit earned outside the Americas is ‘permanently reinvested’ overseas. Apple, for example, has $100bn in overseas cash but rather than bringing it home recently raised $17bn in bond capital to pay for its working capital requirements.
US multinationals need to look sharp if they are to continue to benefit from these tax arrangements, however. The EU is investigating Irish tax structures while in the UK the Cameron government has targeted firms like Amazon, Starbucks and Google which pay very little UK tax. The US Senate Committee has previously probed Microsoft and Hewlett Packard.
Beware the IRS
The IRS has vast powers. It could declare certain overseas subsidiaries of multinationals to be entities whose transactions should be disregarded when calculating a final tax liability.
It could describe some controlled foreign corporations or CFCs as mere ‘tools’ of tax planners, designed for the passive accumulation of untaxed profit and devoid of any other business relationships.
It could rip aside the corporate veil and declare that all transactions at subsidiary firms are really transactions of the parent.
It could insist that all R & D outlays be charged where they are incurred.
It could outlaw cost sharing arrangements.
Who will complain on either side of the Atlantic?
But has the Obama administration got the stomach for all of this? It is most unlikely. The Americans moan domestically about Ireland and its accommodating tax laws but it’s their money that escapes tax. In both 1997 and 2006 previous administrations introduced rule changes which blunted the power of the IRS in fundamental ways. These changes meant that US firms would continue to pay little or no tax in Ireland and in other tax havens. For most Irish politicians this is not a problem.
The relationship suits both sides.