The European Union has ordered the government of Ireland to collect €13 billion in corporate taxes from Apple Inc. That’s roughly $14.5 billion given current exchange rates; one of the largest tax bills in human history. The determination comes as part of Brussels’ ongoing investigation of state subsidies that take the form of advance tax rulings. You can read the EU press release here. There are several aspects to this story that leave Americans scratching their head. Let’s review them.
1. Ireland Doesn’t Want the Money
It’s the obligation of governments to impose tax and collect revenue. So you’d think Ireland would be happy about this. Except you’d be wrong.
Ireland vigorously opposes the EU state-aid probe and the findings related to Apple, released August 30 by European Commissioner Margrethe Vestager. Ireland does not want to collect the taxes in question. In fact, it plans to appeal the decision on the grounds that these taxes were never due in the first place. I’m sure Ireland has a few roads that need paving, or a few teachers who could use raises. But Ireland doesn’t want the money.
When’s the last time you heard of a sovereign nation insisting that it must not collect a boatload of tax revenue? Strange but true.
Why would a country turn away such a large economic windfall? In the case of Ireland, it’s the fear of losing foreign direct investment. What if other multinational corporations start to worry their tax incentives are also in jeopardy? They might take their business (and their jobs) elsewhere.
2. What’s Up with the EU’s State-Aid Rules?
The European Commission says Ireland violated EU law when it gave Apple two advance tax rulings in 1991 and 2007. The advance rulings dictate how Apple’s various affiliates conduct their transfer pricing program (i.e., the prices a multinational firm charges itself on related-party transactions).
Ireland’s corporate tax rate is very favorable, at a mere 12.5 percent. (By contrast the U.S. corporate tax rate is 35 percent and abnormally high by global standards.) Yet Ireland’s low tax rate wasn’t sufficient to attract foreign capital. Companies wanted an even better deal.
The two advance rulings allowed Apple to achieve an effective tax rate that was much lower than Ireland’s statutory rate. According to the Commission, Apple’s effective tax rate dropped 1 percent in 2003, and a scant 0.005 percent in 2014. That’s as close to zero taxation as you’re going to find outside of a pure tax haven like the Cayman Islands (which doesn’t bother to impose a corporate tax).
The Commission examined those ridiculously low rates – as well as the secretive process by which the tax rulings were obtained – and determined that Ireland granted Apple a selective benefit that was not generally available to other taxpayers. Apple and the Irish government maintain that the favorable terms permitted by the advance rulings were not necessarily unavailable to other taxpayers. The eventual fate of the appeal is likely to hinge on what exactly constitutes a “selective” tax benefit.
Prohibiting state aid makes sense, especially in the case of the EU which struggles to maintain competitive balances within its expansive single market. EU member states shouldn’t be selecting winners and losers in the private marketplace. Granting special tax breaks to some firms, but not others, is blatantly unfair and distorts commerce. It also opens the door to the worst kind of crony capitalism, which all nations would do well to avoid.
Most economists would agree that curtailing state aid is the correct policy. Yet we live in a world that’s awash in state subsidies of dubious merit. That’s true for America as well. U.S. state governments are rather skillful at wasting public funds on questionable tax incentives, but that’s a story for another day.
3. A Portrait of Profit Shifting
So, if Ireland’s corporate tax rate is 12.5 percent, how did Apple get its effective rate down to almost zero? That’s the magic of transfer pricing. One of the Commission’s key findings is that a significant share of Apple’s European profits were never taxed anywhere. Not in Ireland, and not in the source country where the income was generated.
Most of the profits from Apple’s European operations were crammed into a wholly owned affiliate: Apple Sales International (ASI). ASI held the rights to commercially exploit Apple’s high-value intellectual property via a cost-sharing agreement with Apple’s parent company back in Silicon Valley. That means lucrative royalty payments from across Europe were funneled into ASI.
According to the Commission, ASI has no employees, no premises, and engages in no genuine economic activities. Its head office is not based in any country. It seems to exist solely for the purpose of sheltering income, but that’s perfectly legal. Such is the nature of transfer pricing.
According to U.S. congressional hearings, global profits in excess of $22 billion were shifted to ASI. Only a small fraction of those earnings were booked in Ireland; the rest were apparently never booked anywhere. That is what’s known as “stateless income” because no government gets to tax it. Stateless income is the holy grail of modern corporate tax planning. U.S.-based multinationals are very adept at this practice. They have every reason to be, given the way our tax code treats foreign-source income combined with our high marginal rate.
This gives rise to complaints that EU officials – and Vestager in particular – are unfairly targeting U.S. companies. In 2014 the Commission went after Starbucks, which was found to have received illegal state-aid from the Netherlands to the tune of roughly €30 million. Cases against Amazon and McDonalds are pending. Some politicians in Washington are complaining that the EU is picking on American firms. I prefer to think the EU is simply pursuing those taxpayers most proficient at crossborder profit shifting … and they happen to have American parent companies.
But let’s be clear. The occurrence of stateless income does not necessarily mean the taxpayer in question has failed to comply with its legal obligations. Apple goes to some length to explain that it has done nothing wrong. You can read the company’s press release here.
Strictly speaking, Apple is faultless. That’s true even if we accept the Commission’s conclusion regarding state aid. Remember, it’s the EU member state that erred in authorizing the illegal state aid, not the taxpayer that erred in accepting the favorable treatment. That said, it’s the taxpayer who gets stuck with the bill and the government that gains billions of euros in tax revenues.
In other words, the ‘wrongdoer’ is excessively rewarded. You’re not alone if that strikes you as a bizarre outcome.
4. Apple Doesn’t Care
Apple contested the Commission’s determination, and will support Ireland in its expected appeal. But don’t be too surprised if the company’s tax department, at least privately, is ambivalent over the outcome. That’s because the company won’t bear the economic cost of the tax bill. Instead, it will be the U.S. federal government that will ultimately pay Apple’s Irish tax bill. People outside the narrow community of tax professionals find this perplexing.
The U.S. tax code allows businesses to offset taxes paid to foreign governments by claiming a dollar-for-dollar credit against their domestic tax burden. The foreign tax credit is not a controversial idea in tax policy circles; it’s how we alleviate double taxation. The credit has been around for many decades.
Thus far I haven’t encountered any academics or tax policy wonks who think Apple’s Irish tax payments won’t be creditable under applicable U.S. law. That means when Tim Cook writes a check to the Irish government, the company will be able to offset its future U.S. tax liability by an identical amount. Economically it’s a wash from Apple’s perspective.
Given how the foreign tax credit operates, you can understand why Apple wouldn’t care all that much about the outcome of the dispute – apart from any reputational damage that might result from adverse headlines. And there will be plenty of those.
The popular media is already botching their reporting, suggesting Apple failed to pay “back taxes.” Not so. You owe back taxes only where the government assesses a tax and you fail to pay it. As far as these EU state-aid cases are concerned, there is no deficiency to speak of. The governments maintain that the companies in question are fully compliant.
Who does care about the outcome? That would be U.S. Treasury Secretary Jacob Lew. He understands that Uncle Sam picks up the tab (all $14.5 billion of it) if the Commission’s determination isn’t reversed. That’s why his staff released a detailed White Paper on August 24 – just days before the Commission’s determination was released – explaining why Brussels should refrain from proceeding against Apple or other U.S. multinationals that obtain similar advance rulings.
The White Paper reads like an advocacy piece, which is exactly what it is. You can read it here. This is a huge issue for Treasury. Remember, Apple is just the tip of the iceberg. Legions of other U.S. multinationals obtained similar advance rulings from Ireland, Luxembourg, the Netherlands, and other EU member states. This could get really expensive, even by Washington standards.
5. Are Tax Incentives Worth the Trouble?
There’s little doubt the Irish government wants to attract foreign capital. Who can blame them? But Apple wasn’t going to invest in the Irish economy just because management happens to enjoy a pint or two of Guinness. There has to be financial incentives on offer; the more generous the better.
Call me cynical, but Ireland’s protocols for obtaining advance tax rulings are best understood as a delivery mechanism for distributing those subsidies in an orderly manner. I get all that, although the purist in me would prefer it if the process were more transparent. In Europe, these advance rulings are kept secret; in America they’re made public. (Note: Tax Analysts brought the FOIA lawsuit that resulted in IRS private letter rulings being publicly disclosed, and the country is better off for it.)
Still, there’s one burning question that tends to get lost in the discussion: Are corporate tax incentives an appropriate use of public funds? Stated differently, what kind of bang for the buck did Ireland get by foregoing all that tax revenue? NYU law professor Daniel Shaviro recently took a stab at trying to answer that question. His analysis is noteworthy.
Apple brags about having 6,000 jobs in Ireland. That translates to 60,000 job-years (an annualized concept) for the 10-year period at issue in the Commission’s report. Let’s assume the Commission’s determination ($14.5 billion) is accurate regarding the net under-taxation of Apple’s profits for the same time period. Divide the revenue figure by the employment figure and you get … wait for it … $240,000 per job, per year. That eye-popping figure is a reasonable approximation of how much Ireland paid (per job) to stimulate the local economy. That’s a rotten deal by any objective standard.
I encourage other interested parties to attempt their own calculations, but I think you’ll find Shaviro’s calculations reliable, given his assumptions. (His blog “Start Making Sense” can be found online at http://danshaviro.blogspot.com/)
Don’t feel bad for Ireland. Their revenue agency will soon be able to collect an enormous sum from Apple. Don’t feel bad for Apple, either. The company shall be made whole via the foreign tax credit. When the dust settles, you’ll find that the U.S. government picked up the tab, and in so doing subsidized employment in the Irish tech sector to the tune of $240,000 per job, per year. Money well spent? I don’t think so.
For more tax talk, follow me on Twitter @RobertGoulder