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Apple: An Example Of Why Corporate Tax 'Reform' Isn't Enough

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This article is more than 6 years old.

One of the main focuses of current congressional attempts to change the tax code is corporations. Lower the top rate from 35% to 20% and you unleash the ability to invest, make more money, create jobs, and pay workers better, so the argument goes.

Much of the rationale behind this is, from a business perspective, either wishful thinking or a smokescreen for making more money. Collective corporate profits in the U.S. sit at all-time highs, and that's not because there are suddenly so many more businesses in the country. Here's a graph from the Federal Reserve Bank of St. Louis that shows corporate profits after tax.

Federal Reserve Bank of St. Louis

All the complaints about federal income taxes putting companies at such a disadvantage seem hollow when you look at actual data. Look at the Forbes list of the 2000 largest public companies and you see that 12 of the top 20 call the U.S. home. Of the top 50, 21 are here.

There is no dearth of corporate profits or scale in the U.S. Although the top rate may be 35%, the effective tax rate of the most profitable large corporations runs about 16%. Compared to the pretax net income these corporations showed in their annual reports the rate was 14%.

Even though the numbers are far below the proposed 20%, lowering the top rate to that figure would be a fiscal disaster because of how large companies achieve the tax reductions. They transfer ownership of intangible property (things like copyrights, patents, business methods, production processes, and trademarks) to overseas shell subsidiaries in low- or no-tax regions created to own those properties and then license the use of what they developed back to the parent or to other subsidiaries that actually are doing business and making money.

Effectively, corporations take significant portions of their profits and send them as royalties or licensing fees to the other company, which they own, that will pay little or no tax. (The actual mechanisms may require multiple shifts, but the concept is the same.) Because the licensing fees are technically costs of doing business, the shift in profits becomes an expense, lowering the apparent profits of the main company and, as a result, reducing taxes.

The techniques are in wide use across many industries and companies. Let's look at Apple, which is a great example because of the Paradise Papers. That is the name for the latest release leak of law firm files that show how corporations and the wealthy move money across national boundaries to keep it hidden and to reduce and even avoid taxes.

In 2013, Apple was the target of heavy criticism over its tax strategies that kept payments low and eyebrows high. Here's a partial description from a Senate Permanent Subcommittee on Investigations document:

[In addition to other mechanisms], Apple established at the apex of its offshore network an offshore holding company that it says is not tax resident in any nation. That subsidiary, Apple Operations International, has no employees and no physical presence, but keeps its bank accounts and records in the United States and holds its board meetings in California. It was incorporated in Ireland in 1980, and is owned and controlled by the U.S. parent company, Apple Inc. Ireland asserts tax jurisdiction only over companies that are managed and controlled in Ireland, but the United States bases tax residency on where a company is incorporated. Exploiting the gap between the two nations’ tax laws, Apple Operations International has not filed an income tax return in either country, or any other country, for the past five years. From 2009 to 2012, it reported income totaling $30 billion.

A second Irish subsidiary claiming not to be a tax resident anywhere is Apple Sales International which, from 2009 to 2012, had sales revenue totaling $74 billion. The company appears to have paid taxes on only a tiny fraction of that income, resulting, for example, in an effective 2011 tax rate of only five hundreds of one percent. [According to the European Commission, the rate dropped even lower, to 0.005%, by 2014.] The third Irish subsidiary is Apple Operations Europe. In addition to creating non-tax resident affiliates, Apple Inc. has utilized U.S. tax loopholes to avoid U.S. taxes on $44 billion in otherwise taxable offshore income over the past four years, or about $10 billion in tax avoidance per year.

That gives a flavor of the complex machinations that go into slashing taxes. Apple faced a problem then, as the Irish government said that to keep the tax advantage, the company had to prove it was managed and directed from elsewhere. If Apple admitted this, the U.S. would then say that all the profits were actually domestic, and so subject to tax.

What the Paradise Papers show in Apple's case is that the company started shopping for a new subsidiary jurisdiction that would allow equivalent profit shifting, as The Guardian reported.

Noonan said any companies incorporated in Ireland before the end of 2014 that were being run from tax havens could continue with these arrangements until 31 December 2020 – a six-year period of grace known as “the grandfathering provisions”. This gave Apple two months to finalise a move to Jersey, a crown dependency of the UK, which makes its own laws and is not subject to most EU legislation, making it a popular tax haven.

The Paradise Papers show two of Apple’s Irish subsidiaries, AOI and ASI, in the process of changing tax residency to Jersey.

Apple refused to discuss the details. But the Guardian understands ASI is now a dormant company.

Here's a statement that Apple provided the Guardian:

The debate over Apple’s taxes is not about how much we owe but where we owe it. We’ve paid over $35bn in corporate income taxes over the past three years, plus billions of dollars more in property tax, payroll tax, sales tax and VAT.

The number is large, but the company's revenues are far larger. Over the last three years, they total almost $679 billion. Once you deduct expenses — including the shift of money to subsidiaries to artificially reduce profits — there is about $198 billion in before-tax income over the three years.

When you deduct the taxes for the US entity, the rate seems to be roughly 25%, but that doesn't reflect profits held in no- and low-tax jurisdictions. And even after the transfers, Apple paid considerably less than the top corporate rate of 35%. If Apple's income isn't large enough to warrant a top tax rate, which company's would be? And what will the effective rate be when the techniques are used on the lower cap?

Although there are some attempts in the GOP's tax plan to reduce the transfer activity, there will still be plenty of ability to do so. Some aspects of the plan, like moving to a territorial tax model like most of the rest of the world, rather than taxing all global profits, could increase interest in the strategies. The mechanism to avoid shifting profits, a 10% tax on money made overseas, will still look comparatively attractive compared to a 20% or higher amount.

In 1950, corporate income taxes were 26.5% of total federal receipts, according to the Tax Policy Center. By 2015, they were down to 10.6%. Individuals were responsible for 39.9% in 1950 and 47% in 2015. Why would tax "relief" for corporations mean increased tax revenue? The result will be even more responsibility to pay for government being shifted to individuals, and that will hurt those in the middle and at the bottom of the economic heap most of all.

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