All you need to know about Apple’s tax evasion controversy

Apple headquarters

Apple was slapped with a European Commission ruling on August 30, ordering the tech giant to pay a whopping $14.5 billion bill for back taxes in reference to its business and sales in Europe in general, and in Ireland in particular. The subject of Apple’s taxes, and especially the over $230 billion in cash stored offshore, has a remained a tricky issue for this company for years now. How Apple found itself involved in such a mess and its record-breaking tax evasion case have become a hot topic.

The situation may seem vague and confusing at a first glance, and I will try to break down the nuts and bolts. The EC ruling says both Apple and the government of Ireland violated European Union rules in their mutual tax arrangements. This has resulted in Apple owing major money to Ireland, while Dublin actually disagrees and doesn’t want the money. Irish Finance Minister Michael Noonan issued a statement saying he “disagrees profoundly” with the recent EC ruling and will move forward to appeal, making most readers think what have they missed.

Apple, as generally expected, is also blueprinting a major appeal. The argument placed forward by CEO Tim Cook states his company followed regulations laid out by Irish tax authorities, and therefore Apple should face no penalties at all. To make this whole scandal even more interesting, Washington is backing Apple and accusing the EU of playing the role of a “supra-national tax authority,” a statement reads.

To make it simple, brace yourself for a serious brawl. In one corner we have a triple-tag team involving Apple, the U.S. Treasury Department – itself the largest corporation in the world—and the Irish government that is fiercely attempting to dodge a tax haven tag. Facing this lineup is the European Commission, a major international body enjoying the support of all EU bloc members—with the obvious exception of Ireland—who are sick and tired of Apple (and probably many other major international corporations) evading billions in tax sales.

The Apple tax plan

The ultimate row between the two sides is over the structure of Apple’s taxes using Ireland as an escape route. The truth is the method adopted by Apple is nothing new. In fact, hundreds of other major companies have similar perplex arrangements. Here’s how it works: Two Irish-registered companies by the names of Apples Sales International and Apple Operations Europe are in control of the intellectual property rights to all Apple brand names and property sold outside of the two American continents.

Taking advantage of legal tax mechanisms, all Apple products sales in Europe were wired to these two companies. This means the vast majority of Apple’s profits made in Europe found their place in Ireland. This practice, called transfer pricing aimed at funneling profits into a specific country, is considered legal and a common practice.

The actual problem began over how profits were actually taxed after landing in Ireland. Apple had come to an agreement with Dublin to impose a system channeling the majority of its profits outside of Ireland into what has been described as a “head office” inside Apple Sales International, as the EC explains. Investigation by the Commission, however, showed that Apple had at some points enjoyed a miniature tax rate of 0.005%. This is significantly lower than Ireland’s already-low 12.5% corporation tax rate. The whole point is that any Apple sale in Europe, being a product or service, are officially registered as taking place in Ireland with an extremely strange low tax rate. This is where everything gets interesting.

Did Apple violate any laws or break any rules?

What has made this particular case quite peculiar is the nature of the EU’s involvement. Tax evasion is normally plain and simple and down-to-earth: a country has and imposes tax laws, a company violates these laws, ending in the company being caught red-handed and forced to dig into its pockets. The difference in this case is that Apple was in fact in compliance with the laws of Ireland. The glitch is in Irish laws that fail to comply with EU tax regulations, which forbid member states to behave as tax havens.

The end result is Apple has been ordered to pay taxes to Ireland, at a time when Dublin doesn’t even want Apple’s money. But why? Wasting no time at all, the Irish Finance Minister issued a statement saying, “I disagree profoundly with the Commission’s decision.” He goes on to explain that Dublin will be taking this decision to European Courts as a necessary measure to “defend the integrity of our tax system; to provide tax certainty to business; and to challenge the encroachment of EU state aid rules into the sovereign Member State competence of taxation.”

In layman’s terms, Ireland has a major interest in maintaining Apple, and a long list of other major international corporations, active on its soil. As explained before, Ireland imposes a very low and tempting 12.5% corporate tax rate. The Apple office in Cork, located in the southern section of Ireland, currently has a staff of over 5,000.

The big story

Apple is only one chapter of a much bigger story worldwide. Facebook, for example, employs the famous “Double Irish” arrangement to minimize its tax exposure. Through such measures it moves from one Irish company to another $1 billion of IP royalty payments. The latter company is controlled from the Cayman Islands.

Google not only uses Double Irish but takes advantage of the “Dutch Sandwich” method, transferring through Amsterdam $10.8 billion in order to bypass Irish withholding taxes.

U.S. market rights were sold by Microsoft to a Puerto Rico-based subsidiary. That particular company goes on to copy and sell Redmond’s software to U.S. distributors, providing Microsoft a $6.3 billion discount.

Rest assured if inspectors dig into the files of the likes of Cisco, McDonald’s and Starbucks, it will be all more of the same. Apple’s taxes nosedived from 1% to 0.005% in Ireland, a country of 12.5% original corporate tax rate. For example, U.S. imposes a painful top corporate tax rate of 35%. Starbucks itself has been ordered by EC to pay the Netherlands up to $34 million; Google is in a mess in France and other EU states; Belgium is demanding money from Anheuser-Busch. Meanwhile Fiat, Amazon and McDonald’s are all facing windfall payments to tiny Luxembourg.

Apple’s position

Apple is obviously furious about the EC ruling. Tim Cook rushed to issue an open letter to Apple customers on the same day of the ruling, in an attempt to soothe worries and provide needed reassurance. He is seen restating Apple’s general justification of tax arrangements in Ireland, pointing out specifically that the company has for decades enjoyed a tangible presence in this country, beginning in 1980 with a 60-employee factory.

The final argument placed forward by Cook relies on taxation principles, that the profit made by a company should only be taxed in the country of value-origin. Apple should be taxed in California considering the fact that Apple’s R&D is based there, Cook argues.

While Apple enjoys a physical presence in Ireland with a long history, the low taxation rate it is taking advantage of relying on the existence of the currently phantom “head office” in the country that actually coordinates global sales. This head office of Apple currently exists only on paper, according to the EC investigation.

Another debatable subject is the fact that Apple was abiding by Irish tax laws or not. EC refuses to accept Ireland’s taxation policies, arguing they’re not in line with EU rules. The point becomes now obvious: If a country in a free trade zone such as the EU is able to manipulate its tax code to provide low rates to multinational companies, it’s utterly presenting all tax haven benefits while sitting inside the biggest single market in the world.

Where Washington stands

The party oddly vocal about this subject has been the U.S. Treasury Department after issuing a number of statements last week and following the ruling handed down on August 30th. The Department mostly objects retroactive taxation, arguing the practice is “unfair, contrary to well-established legal principles, and calls into question the tax rules of individual Member States.”

All in all

When all the dust settles, experts doubt Apple will simply pay up this massive tax bill without a long dispute. This goes despite the fact that the $14.5 billion back tax demand on Tim Cook’s desk is not even 10% of Apple’s tax holdings sitting offshore. Despite the commission decision sending shockwaves across the globe, it is to be repealed by Apple, facing huge revenue losses, and Ireland, facing huge job losses. This is a process most likely to take years to settle. Taking into consideration the fact that E.U. bureaucracy moves at a snail’s rate, and it took three years to conduct the initial investigation, a settlement soon is far from reality. There is no need to worry about Apple’s future, as the computer giant enjoys more than $231 billion in cash on its balance sheet, according to CNNMoney. The company is also valued at over $700 billion, nearly twice its first competitor.

There is a high probability, however, that Apple will in the end place forward a check to put an end to this unwanted episode. While Washington and Dublin may continue to disagree with the EC ruling, they face opposing, public opinion in other EU member states, all 27 others. As explained by The Wall Street Journal, this could literally be the start of a chain reaction of major international corporations being forced to succumb to major back bills taxes.

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