Apple, Outsourcing and Tax Law

At a May 21 hearing, the Senate Permanent Subcommittee on Investigations singled out Apple Inc. for scrutiny. (An earlier hearing last September focused on Microsoft and HP.)

The Senate investigation produced the startling information that three wholly owned Apple subsidiaries, accounting for tens of billions of dollars in annual income for Apple, do not actually exist for tax purposes. The subsidiaries are incorporated in Ireland, but run out of Apple’s headquarters in Cupertino, CA. Since they are not incorporated in the United States, they are not considered American companies for tax purposes. Ireland, on the other hand, decides the tax nationality of corporations according to the country where management resides. So the “Irish” corporation run by Apple out of its U.S. headquarters owes tax in neither country. In fact, those corporations don’t even bother preparing tax returns. They have achieved the remarkable status of stateless corporations.

The only problem for Apple is that the roughly $100 billion sitting in these sheltered accounts would be subject to U.S. corporate tax of 35 percent if those stateless subsidiaries transfer those funds to the parent company. But until Apple decides that shareholders should get their hands on the accrued earnings, the money sits untaxed and can be invested in any manner. In fact, it seems the money is currently sitting in New York banks even though, in tax terms, it doesn’t exist.

Other corporations use similar financial shell games to avoid paying taxes to the U.S. government, but Apple seems to have mastered the science. Indeed, Apple is so opposed to paying U.S. taxes that it has borrowed $17 billion to distribute to its shareholders rather than bringing its retained earnings “home” (that is, moving the money from one U.S. bank account to another).

“We pay all the taxes we owe, every single dollar,” testified Apple CEO Tim Cook during the hearing. Also, Cook argued, Apple doesn’t rely on tax “gimmicks.” Apparently, stateless subsidiaries are just the way everyday business should operate. And Apple doesn’t “stash money on some Caribbean island,” he said, as if that would be sleazier than parking the tax-free money in New York banks. Amazingly, many of the senators seemed to think this makes perfect sense for American taxpayers.

You might well think that Apple’s shareholders would want to get their hands on this money eventually. And they do. But Apple’s lobbyists are working overtime to coerce the Senate to pass a greatly reduced tax rate on repatriated earnings. How greatly reduced? Cook suggested in the hearing that a single-digit rate would be acceptable. Just try convincing the IRS that you should be able to knock 75 percent or more off your personal tax rate, the equivalent of what Cook thinks is reasonable.

The multinationals with money parked offshore are led by John T. Chambers, CEO of Cisco. Chambers claims that a tax holiday for repatriated earnings would be good for the country because the multinational corporations would put their lightly taxed money to work in R&D, additional plants and new equipment that would expand U.S. manufacturing. But it’s a phony argument. First, money spent on R&D, plant and equipment is already tax deductible; there would be no tax on repatriated profits actually used to expand the company. And, second, the money won’t be used to expand U.S. operations. The last time a tax giveaway for bringing money home was tried (in 2004), $300 billion was repatriated at a tax rate of just 5.25 percent and the National Bureau of Economic Research concluded that 92 cents of every repatriated dollar went to dividends, stock buybacks and executive bonuses. In other words, a tax discount is just another way to help people who already pay a lower tax rate than workers.

What does this have to do with promotion of offshore production? Here’s how the tax avoidance scheme based on offshore production works: First, set up a subsidiary in a low-tax country—Ireland, for example—to buy from an Asian manufacturer at low prices. Then sell the same items to the American parent company at a much higher price for resale in the United States. The parent company shows a low profit margin that is taxed at normal U.S. corporate rates. The difference remains with the subsidiary until such time as the U.S. government provides another tax giveaway for repatriated earnings.

There isn’t any evidence that Apple uses this scheme. Instead, it gives its intellectual property patents to the stateless subsidiaries incorporated in Ireland and then pays royalties to the Irish company. But, many multinational companies are using Irish and other tax haven corporations to reduce profits of the American parent in precisely this way.

This scheme can’t work for goods produced and sold in the United States. So those U.S. companies that decide to produce here rather than gaming the tax system via offshore subsidiaries are penalized. If Cook and his multinational corporate friends get their single-digit tax rate on repatriated money, the 100 percent American company would pay at least 300 percent higher taxes than the multinationals and, at the 5.25 percent rate provided in 2004, the difference would be 566 percent!

The system is insane. It kills jobs here and deprives the government of billions of dollars in taxes—revenue that must be covered by individual income taxes and the corporate taxes paid by the American companies that don’t employ the tax avoidance schemes. And it’s all perfectly legal.

That’s my opinion. What’s yours? Should Apple be applauded for creating hundreds of thousands of jobs and paying $6 billion in federal taxes last year? Or should the company be reviled for stashing a hoard of cash overseas so it could legally skirt an additional $15 billion in taxes over four years? How would you fix the corporate tax system? Should the federal government provide a tax break for repatriated earnings? Share your thoughts.

Editor’s note: Before “Shipulski on Design,” “Leading Lean,” and “Uncommon Sense,” there was ASSEMBLY magazine’s longest running and most controversial back-of-the-book column, “Unconventional Wisdom” by Jim Smith. A nationally known expert on electronics assembly, Smith never hesitates to question the sacred cows of manufacturing and economics. You can read more from him at his “Science of Soldering” blog.