Bloomberg News

Apple Seen Using Loopholes to Avoid $9 Billion in Taxes

May 21, 2013

Apple Used Tax Loopholes to Evade $9 Billion, Senators Say

Tim Cook, chief executive officer of Apple Inc., during an event in San Francisco, California. Photographer: David Paul Morris/Bloomberg

Apple Inc. used “loopholes” to avoid paying $9 billion in U.S. taxes in 2012, U.S. Senator Carl Levin said at a hearing that brought the company’s chief executive officer, Tim Cook, to Washington to defend the strategies.

“Apple executives want the public to focus on the U.S. taxes the company has paid, but the real issue is the billions in taxes it has not paid,” said Levin, a Michigan Democrat. Apple employs “offshore tax strategies whose purpose is tax avoidance, pure and simple,” he said.

Today’s hearing was called to air accusations the iPhone maker has created a web of offshore entities to avoid paying billions of dollars in U.S. taxes.

Apple, in written testimony, denied any wrongdoing and said the company was one of the largest taxpayers in the U.S., having paid $6 billion last year.

Cook and two other executives -- including Chief Financial Officer Peter Oppenheimer -- were to appear before the Permanent Subcommittee on Investigations. The panel, led by Levin, in a report yesterday said Apple’s subsidiaries include three entities that have no home country for tax purposes.

In the last four years, Apple has avoided paying taxes on $44 billion in income, said Senator John McCain of Arizona, the panel’s top Republican. He called the company “one of the biggest tax avoiders in America.”

Senate Dissent

Three entities set up in Ireland hold 60 percent of Apple’s profits and claim to be tax residents “nowhere in the world,” McCain said. “It’s completely outrageous.”

Not all lawmakers supported summoning Apple executives to the hearing. Senator Rand Paul, a Kentucky Republican, said Apple was dealing with an “awful” tax code.

“I’m offended by the tone and tenor of this hearing,” Paul said. “I’m offended by a $4 trillion government bullying, berating and badgering one of America’s greatest success stories.”

“I’m offended by the spectacle of dragging in executives from a company that is not doing anything illegal,” Paul said. “If anyone should be on trial hear it should be Congress. I frankly think the committee should apologize to Apple.”

Company Response

Apple’s cash is largely held in U.S. banks in dollar-denominated assets, segregated into a portion that can be used for domestic operations and a portion that can be used only for international investments, the company said. The company doesn’t use foreign subsidiaries or gimmicks to avoid U.S. taxes, said the testimony.

The company also said the Irish subsidiaries, which are cost-sharing arrangements, have helped fund Apple’s research and development activities and taken on risks, leading to bigger profits and higher-paying jobs in the U.S.

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The company also said it supports a broader overhaul of the U.S. tax system.

Ireland has a corporate tax rate that applies to all companies, Irish Deputy Prime Minister Eamon Gilmore told reporters in Brussels today.

“Ireland has a very strong, very transparent tax regime,” Gilmore said. “There are problems in other jurisdictions. Those problems are going to have to be addressed. Any international loopholes that exist have to be closed off.”

Apple shares were down $3.48 or 0.8 percent, to $439.45, at 11 a.m. New York time.

‘Ghost Companies’

The world’s most-valuable technology company has $102 billion in offshore accounts and shifted billions in profits out of the U.S. into affiliates based in Ireland, where it negotiated a tax rate of less than 2 percent, according to a report by the panel. Levin today labeled them “ghost companies.”

The offshore entities of the Cupertino, California-based company have paid little or no tax in recent years, the congressional report said.

One affiliate -- Apple Operations International --generated net income of $30 billion between 2009 and 2012. It declined to declare a tax residence, filed no corporate tax return and paid no income taxes to any nation, the report said. AOI is Apple’s principal offshore holding company.

Cook’s appearance is unprecedented for Apple, whose co-founder and former CEO Steve Jobs never testified before Congress. In addition to Oppenheimer, Phillip Bullock, Apple’s head of tax operations, also was to appear.

Microsoft, Hewlett-Packard

The committee has been examining companies that use various maneuvers to reduce their tax bills, including Microsoft Corp. (MSFT) and Hewlett-Packard Co (HPQ).

Apple has said in filings with the U.S. Securities and Exchange Commission that it has $40.4 billion in earnings outside the U.S. on which it hasn’t paid U.S. taxes. If Apple brought that money back to the U.S., the company would owe $13.8 billion, according to the filings.

The panel’s report is designed to be a “case study” of how a company is able to pay an effective tax rate much lower than the 35 percent U.S. corporate rate, according to staff members on the subcommittee.

The bipartisan probe found Apple, through cost-sharing arrangements, has transferred offshore the profits powered by economic rights to its patents and other intellectual property - - aspects like licensing and sales. At the same time, the legal rights to its patents remain in the U.S., the panel found.

Apple’s relationship with the offshore affiliates isn’t arms’ length, the probe found.

Irish Entities

One of the Irish entities, Apple Sales International, before 2012 had no employees, and two of its three directors are Apple Inc. (AAPL:US) employees located at its California headquarters. All 33 ASI board meetings between May 2006 and March 2012 took place in Cupertino, the report found.

ASI buys Apple’s finished products from a Chinese manufacturer, resells them at a higher price to Apple affiliates and retains the profits, the report said.

From 2009 to 2012, the ASI arrangement facilitated a shift of about $74 billion in global profits away from the U.S., the report said, and the entity paid little in taxes worldwide. In 2011, ASI’s pretax earnings were $22 billion, and it paid $10 million in taxes -- a tax rate of 0.05 percent.

The report said Apple benefits from part of the so-called “check-the-box” tax regulations. Those rules allow dividends, royalties and other fees of lower-tiered subsidiaries to avoid IRS scrutiny because they can be marked as “disregarded” and no longer considered separate entities. The “passive income” paid by the subsidiaries to a higher-tiered parent company effectively disappears, the report said.

$9 Billion

Using this method, Apple avoided paying $9 billion in U.S. taxes in 2012, the report found.

Lawmakers in both parties are seeking a bipartisan agreement on how to tax income that U.S.-based corporations earn outside the country. Democrats and Republicans on the panel say Apple’s tax maneuverings, while not illegal, will help frame the debate about how to make the corporate tax system more fair.

McCain said he and Levin are seeking to craft a bipartisan proposal that would end some of the tax benefits, although the timing of an agreement isn’t clear. He said both parties in Congress should seek to address the matter, even if it isn’t in the context of a broad rewrite of the tax code.

“When you see egregious behavior like this, why wait?” McCain said.

To contact the reporters on this story: Laura Litvan in Washington at llitvan@bloomberg.net; Todd Shields in Washington at tshields3@bloomberg.net

To contact the editor responsible for this story: Bernard Kohn at bkohn2@bloomberg.net


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