How Apple got its 2% tax rate in Ireland

Obsession
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Obsession
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Wouldn’t it be nice if you could tell the government what you’d pay in taxes, not the other way around? Apple did it in Ireland, and might now be in trouble for it.

Since last year’s US investigation, we’ve known that Apple has an unusual tax situation in Ireland. The European Union has been investigating, and in a June decision publicly released today (pdf), the EU came to the “preliminary view” that Ireland’s relationship with Apple is a state subsidy could be incompatible with EU rules.

Ireland was asked to turn over numerous details documents about Apple’s finances and corporate structure, and if they confirm investigators’ initial assessment that the tax deal broke the rules, a multi-billion fine for Apple could follow.

How it works is fairly simple: Apple’s subsidiaries in Ireland are the global hub for its worldwide business, and its corporate structure allows the company to make sure that its tax-deductible costs are kept in high-tax countries while profits pass through the low-tax Ireland. For instance, Apple’s retail subsidiaries in Germany or France would purchase an iPhone from an Apple manufacturing subsidiary, while also paying fees to another subsidiary in Ireland as part of an intellectual property cost-sharing agreement.

But what happens to all that money in Ireland? Two deals made between Apple and Ireland, one in 1991 and another in 2007, governed the company’s tax treatment, and it’s those deals that are at the heart of this case. Accountants are supposed treat economic exchanges between related subsidiaries as though they were “arms length” transactions between unrelated business; it appears to investigators that the treatment of Apple’s various payments was, at best, simply pulled out of the air, and at worst, designed to avoid taxes in other European countries.

Notes from a 1990 negotiation between an Apple tax adviser and Irish officials help bear this out (emphasis added):

[The tax advisor’s employee representing Apple] mentioned by way of background information that Apple was now the largest employer in the Cork area with 1,000 direct employees and 500 persons engaged on a sub-contract basis. It was stated that the company is at present reviewing it’s worldwide operations and wishes to establish a profit margin on it’s Irish operations. [The tax advisor’s employee representing Apple] produced the accounts prepared for the Irish branch for the accounting period ended […] 1989 which showed a net profit of $270m on a turnover of $751m. It was submitted that no quoted Irish company produced a similar net profit ratio. In [the [tax advisor’s] employee representing Apple]’s view the profit is derived from three sources-technology, marketing and manufacturing. Only the manufacturing element relates to the Irish branch.

[The representative of Irish Revenue] pointed out that in the proposed scheme the level of fee charged would be critical. [The tax advisor’s employee representing Apple] stated that the company would be prepared to accept a profit of $30-40m assuming that Apple Computer Ltd. will make such a profit. (The computer industry is subject to cyclical variations). Assuming that Apple makes a profit of £100m it will be accepted that $30-40m (or whatever figure is negotiated) will be attributable to the manufacturing activity. However if the company suffered a downturn and had profits of less than $30-40m then all profits would be attribitable [sic] to the manufacturing activity. The proposal essentially is that all profits subject to a ceiling of $30-40m will be attributable to the manufacturing activity.

[The representative of Irish Revenue] asked [the tax advisor’s employee representing Apple] to state if was there any basis for the figure of $30-40m and he confessed that there was no scientific basis for the figure. However the figure was of such magnitude that he hoped it would be seen to be a bona-fide proposal.

Translation: The Apple tax adviser tells the Irish official that Apple’s subsidiary is a big employer and more profitable than any Irish company, but that only part of those profits should are really related to things going on in Ireland, so it should only pay taxes on a limited share of profits even if it makes more money, and that there’s no obvious reason for choosing that share.

And whether it relates to the 1991 deal or the 2007 deal, which also put a cap on the company’s taxable profits in Ireland, EU investigators haven’t seen an analysis explaining how those caps were reached, but they suspect that the justification isn’t related to the actual economic value produced by the subsidiary.

Ireland told the commission that it is confident it is taxing Apple’s Irish subsidiaries appropriately, and isn’t giving the company selective treatment despite the two special deals to reduce their taxes. Apple said in a statement that the company “has received no selective treatment from Irish officials over the years,” and emphasized the need for corporate tax reform to reduce the incentives companies have to move cash and intellectual property overseas.

If after further investigation the commission finds that there is no justification for the tax subsidy, there could be repercussions in the US as well. In particular, the examination of the company’s intellectual property cost-sharing agreement will be interest to US investigators, since it is the mechanism that Senate investigators suspect is used to move US taxable profits to Ireland. That’s one way to think different.

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