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Threat of fines against Irish government and corporate partners like Apple prods Irish officials to take action

Ireland is expected to announce Tuesday, alongside a 2015 budget hearing, plans to close the tax loophole that allowed U.S. companies the opportunity to dodge taxes in many of the regions in which they do business.  A report in Reuters cites inside sources as saying the announcement is highly like for tomorrow.
 
I. How Apple Saved Billions
 
The move comes after the European Union's (EU) competition regulation body, the European Commission (EC), delivered a preliminary finding of guilt against Ireland and American gadget maker Apple, Inc. (AAPL).  While many U.S. tech firms, including Google, Inc. (GOOG) also leveraged the loophole to escape billions in taxes, the EC singled out Apple because it was the biggest offender, dodging up to $9B USD in taxes.
 
International tax law typically operates on the premise of incorporation.  A company like Apple or Google may engineer the product being sold, but if it's being distributed by local offices or sold at local retail stores, typically the company is required to incorporate locally and pay taxes on the profits it makes in the region.

Apple Money
Apple reportedly used the scheme to evade $9B USD in taxes per year. [Image Source: Today's iPhone]

A basic tax reduction scheme would be to focus business on lower tax regions.  For example, even without the loophole, it might be desirable to sell to the Irish market, which has a relatively low 12.5 percent corporate tax rate (versus the U.S. where the corporate tax rate can be as high as 35 percent).
 
This scheme could be mildly "gamed" if the parent company in a higher tax region like the U.S. established local business in a low tax region and transferred intellectual property rights to it, then charging royalties to shift the majority of profits to the lower effective tax rate.
 
The Ireland scheme was far more audacious and relied on an odd loophole.  As mentioned, most companies base taxation on the location of incorporation and require local companies to incorporate.  Ireland, presumably in a bid to lure local corporate outposts, instead opted for a more rare taxation view, in which it only levied taxes based on ownership.  Hence foreign firms were exempt from foreign ownership.
 
So if a company like Apple established a subsidiary in Ireland it could transfer regional royalties to that subsidiary and be charged no taxes locally.  But it would still be taxed when those profits returned to the U.S.
 
But there was a way around this.  A handful of regions like Bermuda offered basically tax-free money transfers to local corporate outposts.  And the Netherlands had a deal with Ireland that allows Irish companies to freely transfer funds to their Dutch parent without being taxed.

Double Irish scheme
[Image Source: The New York Times]

Hence a company like Apple would first establish an outpost in Ireland, and then establish another outpost in the Netherlands that becomes the "owner" of the first subsidiary.  IP rights would be transferred to the Irish subsidiary, which would then hoard regional profits.  It would pay no taxes on those profits in Ireland, as the Irish government would view it as owned by the Netherlands branch.  It would then transfer the money to the Netherlands, tax-free.  There, too it would pay no taxes, as the Netherlands would view the local Dutch branch as incorporated in the Netherlands.
 
In the confusion, the money would finally be transferred back to a tax-free region like Bermuda or the Cayman Islands.  There it would await repatriation in the U.S., when local tax loopholes allowed for the bare minimum on taxes to be paid on money transfers.
 
The scheme was typically termed "double Irish with a Dutch sandwich."
 
This sort of bewildering shell game is one of several tricks companies used to effectively pay no taxes, even as these companies regional profited from EU buyers.  The companies involved contend they did nothing wrong and were not "evading" taxes, despite the fact that their convoluted scheme led to effectively no taxation in some regions.  Instead, they contend local tax systems like Ireland and the Netherlands were to blame.
 
The scheme has been around for a few decades.  Apple, in fact, is believed to have helped pioneer the tax loophole in the 1980s, establishing a close relationship with the then cash-strapped Irish government, according to an April 2012 piece in The New York Times which highlighted the issue in-depth.
 
Pressure against the scheme mounted in the EU and U.S. after a series of high-profile follow-ups to that initial exposé.  Things reached a boil last May when the U.S. Senate held a special hearing grilling Apple CEO Timothy Cook.
 
II. The Loophole May be Closing
 
Following that hearing, Ireland agreed to not allow companies to transfer money out if they had no domicile (residence) in Ireland.  But critics say this provision had little effect and was mostly self-serving as it only served to create small local outposts like the one Apple maintains in Cork, Ireland.
 
Now Irish Finance Minister Michael Noonan is being pressed to make bigger efforts to close the loophole.
 
Under the tentative plan, Ireland would give foreign-owned branches, like the local Apple subsidiary a "phase out" period, where the tax-free status was grandfathered for a time.  But after some finite period -- perhaps 5 years -- Ireland's view of that company would shift to the widely accepted international definition -- ownership by incorporation.
 
In some regards Ireland had to make a move.  If it refused to change its policy, it risk billions in EU fines and its partners like Apple might still get a cold shoulder anyways if they were smacked with similar fines, as well.
 
Ireland has a lot to lose if U.S. companies sour to the arrangement.  Currently over 1,000 foreign companies, mostly U.S. firms, have leveraged the currently open loopholes to maximize their profits.  That may be bad for America's federal budget, but it's paying off for Ireland where these firms created 160,000 jobs.  That's roughly 1 in 10 jobs in the country.
 
Without the loophole some companies may have no reason to stay.  But Ireland may have a trick or two up its sleeve.  It's rumored to be "improving" its intellectual property tax rate in such a way as to perhaps soften the blow, perhaps allowing firms like Apple to achieve a slightly higher tax rate like 5 to 10 percent, which is still well below standard international taxes.  It also is hoping that American firms appreciate its growing legion of technical savvy workers and the fact that these workers are native English speakers.
 
There's cause for hope. Dell, the U.S. computer maker, recently announced plans to expand its Dublin subsidiary, making it Dell's regional research and development center.  Intel Corp. (INTC) also remains committed to Cork, Ireland, where it has a major processor fabrication plant.
 
The EC's competition Commissioner Joaquin Almunia made it clear he wasn't only targeting Apple and the Netherlands.  Last week he launched a probe of Amazon.com, Inc. (AMZN) and its relationship with Luxembourg, another tax haven.  Luxembourg is suspected of providing Amazon with "corporate tax aid", the same general offense that Apple/Ireland were found guilty of.
 
But there's some question as to whether Commissioner Almunia's efforts to crackdown on local tax loopholes will be sustained, as he's stepping down on Oct. 31.  That said, companies like Apple and Amazon shouldn't be too hopeful for a new relaxed era of loophole allowance; Commissioner Almunia's replacement, Denmark's finance minister Margrethe Vestager is rumored to be even more of a hardliner on cracking down on tax avoidance.

Source: Reuters





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