Tax shelter may have helped Apple pocket $20B USD in profit over the past four years alone, according to previous U.S. Senate hearing

Thanks to its violation of local antitrust laws, Microsoft Corp. (MSFT) has been struck with fines totalling $2.2B+ USD in the last decade, courtesy of the European Union.  Likewise, Intel Corp.'s (INTC) anticompetitive efforts to fix CPU prices cost the silicon giant $1.4B+ USD in Europe.  And most recently, Google Inc. (GOOG) has been forced to make major changes to its internet business model in Europe in an effort to placate competition regulators with the European Commissioner (EC).  Google is trying desperately to avoid becoming the latest posterchild of the EU's tough brand of antitrust law.

Now he EU is turning its attention to Apple, Inc. (AAPL) by bringing charges of illegal state aid against The company. 

European Commission on Ireland State Aid by Mikey Campbell

At the crux of the issue are deals Apple cut with Ireland via subsidies; deals the EU and U.S. have alleged allowed it to dodge billions in yearly taxes.  Apple, Inc. owns "Apple Operations International", which in turn owns five subsidiaries.  Of these, the EU believes four of the five were used to funnel money through Ireland to avoid taxes on products sold in the EU.  The subsidiaries in the crosshairs are:
  • Apple Operations
  • Apple Distribution International
  • Apple Sales Ireland
  • Apple Retail Europe Holding
Apple's Irish structure

Technically most of the products in question are designed by Apple in the U.S., made in China via third party suppliers, and then shipped around the world. Traditionally, when selling in a foreign market, you owe the local government some cut of the taxes, and often you would owe a portion to your home country as well.

But in recent years Ireland has advertised itself as an escape route for the world's richest corporations looking to dodge taxes.  The scheme is cornered on the curious Irish law which states that if a company is wholly (100 percent owned) by a company from a foreign country, than any income on profits are exempt from Irish taxes.  Ultimately, Ireland does make some amount of the profit, as the company must set up local offices in Ireland and is taxed at the modest 12.5 percent rate.  But as the majority of profits pass through a tax exempt subsidiary, companies can enjoy low single-digit effective tax rates in Ireland.

Double Irish w/ a Dutch Sandwich
Apple uses the "Double Irish w/ a Dutch Sandwich" strategy to lower its overseas taxrates to as low as 2 percent, allegedly. [Image Source: The New York Times]

From there the money passes through one of two routes.  One exploits an arrangement between the Netherlands and Ireland that mandates tax-free exchanges.  Using this so-called "Double Irish Dutch Sandwich" strategy, a company like Apple or Google:
  1. Sets up an office in Ireland
  2. Launches a subsidiary of the local Irish office
  3. Transfers intellectual property rights from the U.S. to the second subsidiary
  4. Grants ownership of the subsidiary to a Netherlands subsidiary
  5. Second Irish subsidiary charges local subsidiaries in other EU states "royalties", draining them of most of their profit
  6. Secondary Irish subsidiary transfers the profit to the Netherlands, exempt of taxes.
  7. The primary Irish subsidiary grants a further intellectual property licensing rights, and receives the money back from the Netherlands.
  8. Often this primary is subsidiary is wholly owned by virtually tax-free island nation such as Jersey or Bermuda.  It is then transferred to that island nation
  9. The money is later repatrioted back to the U.S. or Europe via loopholes in the local tax code, which allow it slowly trickle back to the U.S., mostly untaxed.
Both Google and Apple exploited this strategy to dramatically lower their effective tax rates over the years.  

Google, for example, claimed a 22 percent effective tax rate on its annual earnings report in 2010.  However, the overseas portion of its earnings saw an incredibly low 2.4 percent tax rate.  That allowed Google to rake in an annual earnings of roughly $5.5B USD overseas, with only a little over $135M USD paid in taxes.  Hence while overseas revenue accounted for a little over half of Google's revenue (52 percent), it accounted for roughly 65 percent of its profit.

Apple, meanwhile managed even bigger profits and even more aggressive global tax evasion.  While Google had a 17 percent effective global tax rate between 2007 and 2012, Apple managed an even more tight-fisted 14 percent.  

Google and Apple
While Google dodged as much as $1.5B USD via Ireland's tax loopholes, that figure pales in comparison to the $9B USD that Apple pocketed. [Image Source: The New York Times]

And Apple made much more profit than Google.  While Google's scheme may have allowed it to avoid around $1.5B USD in a good year (based on the 2010 figures and the UK's effective tax rate of 28 percent), the EC alleges that Apple managed nearly six times that -- roughly $9B USD in escaped taxes per year.  In fact, the EC claims Apple paid as little as 2.0 percent in taxes.

Tax evasion of this manner is estimated to cost the EU and U.S. over $2T USD annually, at current rates.

Pressure has been building for some time now.  Last May the U.S. Senate grilled Apple CEO Timothy Donald "Tim" Cook in a hearing over its Irish taxation strategy.  Italy led the charge last year, accusing Apple of tax fraud for shuffling its local profits out of the country.  And in June the EU began to investigate the electronics giant for violating the laws of the EU charter.

Apple CEO whining
Apple CEO Tim Cook claims his company has done nothing wrong as is being unfairly targeted. [Image Source: Reuters]

Indeed, in at least one regard Apple is a victim of its own success; given its astronomical profits, its tax evasions strategies have been very apparent.  Even compared to companies as profitable as Google or Microsoft, Apple stands in a league of its own.  But that's a double-edged dagger as with success comes scrutiny.

In its preliminary findings, the EC finds Ireland and Apple guilty of violating laws in the EU charter that prohibit giving state aid to private corporations without a consensus.  The EC writes:

In the light of the foregoing considerations, the Commission's preliminary view is that the tax ruling of 1990 (effectively agreed in 1991) and of 2007 in favour of the Apple group constitute State aid according to Article 107(1) TFEU [Treaty on the Functioning of the European Union]. The Commission has doubts about the compatibility of such State aid with the internal market. The Commission has therefore decided to initiate the procedure laid down in Article 108(2) TFEU with respect to the measures in question.

At this point the preliminary finding does not carry any fines.  But depending on Apple's response, it could soon find itself owing the EC billions in fines.  Apple has one month to plead its case, including offering details of its corporate orginizational structure, European employees, and various financial documents.

Apple did not directly deny that it was tax dodging in Ireland.  In a statement released to Business Insider, the devicemaker argued, in effect, that it was only doing what Google and its other rivals were doing.  It also echoed the same tired argument that it was facing an ever increasing tax burden in a global context.  Apple states:

Apple is proud of its long history in Ireland and the 4,000 people we employ in Cork. They serve our customers through manufacturing, tech support and other important functions. Our success in Europe and around the world is the result of hard work and innovation by our employees, not any special arrangements with the government. Apple has received no selective treatment from Irish officials over the years. We're subject to the same tax laws as the countless other companies who do business in Ireland.

Since the iPhone launched in 2007, our tax payments in Ireland and around the world have increased tenfold. To continue that growth and the benefits it brings to the communities where we work and live, we believe comprehensive corporate tax reform is badly needed.

Such an argument ignores the fact that to whatever extreme Apple faces "unfair" corporate taxrates in the U.S., it's countering those higher rates with seemingly overtly abusive tactics overseas.

Apple office in Cork
Apple employs roughly 4,000 people, mostly Irish citizens, at its office in Cork, Ireland. [Image Source: Reuters]

While many feel the U.S.'s official corporate tax rate of 35 percent is too high, few would agree with corporations like Apple and Google paying as little as 2 or 3 pennies on the dollar, when working citizens have to pay 15 to 25 cents on the dollar, at minimum.

Don't expect any sudden conclusions to the Apple-EC standoff, but suffice it to say things have gotten serious.  The ball is now in Apple's court.  But if it fails to convince the fine-friendly EU that it did not violate the charter's state aid laws, it could cost Apple directly billions in fines, and billions more in lost profits if the EU manages to force Apple to abandon its Irish/Dutch tax escape.

Sources: Europa [PDF; preliminary finding], via AppleInsider

"A politician stumbles over himself... Then they pick it out. They edit it. He runs the clip, and then he makes a funny face, and the whole audience has a Pavlovian response." -- Joe Scarborough on John Stewart over Jim Cramer

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