Apple’s Irish tax dodge

The outrageous part about Apple Inc. (AAPL)’s audacious tax strategies isn’t whether they are legal. They may well be. More upsetting are the ruses and contrivances that Apple used to pull them off.

Consider an Apple subsidiary called Apple Operations International, which was spotlighted at a U.S. Senate hearing this week. Its net income accounted for 30 percent of Apple’s worldwide profit from 2009 to 2011. Apple Operations is incorporated in Ireland. It is managed and controlled in the U.S. Yet Apple says the unit isn’t a resident of either country - or any country. So it paid no corporate-income taxes.

The structure is a farce, regardless of whether there’s a loophole that may have been threaded. The Internal Revenue Service has the authority to label it a sham and attribute the income to the parent company, according to a Senate investigative report released at this week’s hearing. However, the IRS has been hesitant to use its power this way out of concern it would lose in the courts, which have tended not to take action against foreign shell corporations.

The tax code isn’t working, and so far authorities haven’t tried to fix it. What Apple did was legitimate, you might say. Apple has a duty to maximize returns for shareholders. Tax planning is part of that. Except, this smacks of abuse.

When I watched Apple executives testify on May 21 before the Senate Permanent Subcommittee on Investigations, it was with sadness. Here we had the top people from one of the country’s greatest, most-beloved companies.

Apple avoided $9 billion in U.S. taxes in 2012 through one chink in the tax code alone, the panel’s report said. Timothy Cook, Apple’s chief executive officer, explained that the company paid $6 billion in U.S. taxes, which was beside the point. He objected to the senators’ use of the words “gimmicks” and “shifting” (as in shifting profits to tax havens), but not the panel’s findings, most of which came from information that Apple provided itself.

“We pay all the taxes we owe, every single dollar,” Cook said. “We don’t stash money on some Caribbean island.”

That’s true, of course. Apple used a different island tax haven - Ireland.

This isn’t how I want to think of Apple’s executives. I don’t want to imagine them as scheming to invent and maintain specious legal fictions to reduce the company’s tax bill while government budget deficits balloon. Yet the tax code begs companies to connive and dissemble to lower their payments.

Take another example that the senators pointed to: Apple, as do many other multinational companies, uses a technique called transfer pricing. This lets it move income away from the U.S. to Ireland, where it has negotiated a 2 percent tax rate with the country’s government.

When Apple transfers intellectual-property rights to an Irish unit, it uses a so-called cost-sharing agreement. None of the transactions under the agreement is done at arm’s length. All the money going back and forth belongs to Apple.

The rules say companies are supposed to be honest about the numbers they assign to these transactions between subsidiaries. But the tax authorities have a hard time challenging them because there are rarely correct answers when it comes to valuing intellectual property or allocating research-and-development costs. So companies can get away with pretty much anything, making it easy to move profits to low-tax countries while recording costs in high-tax jurisdictions.

The Senate report said Apple shifted $74 billion in income to Ireland from the U.S. through its cost-sharing agreement from 2009 to 2012. This helps explain why $102 billion of Apple’s $145 billion of cash and marketable securities was assigned to offshore subsidiaries, as of March 30. Even that comes with a twist: Most of the “offshore” funds are kept at U.S. banks.

Beyond the questions of tax fairness, or how best to simplify and reduce rates, we should ask ourselves: Is this the kind of culture that our laws should be fostering? The people running Apple - whose board includes former U.S. Vice President Al Gore - aren’t being dodgy for tax purposes because they are evil. The law encourages them to behave this way, which leads to other uncomfortable questions.

If a company’s managers are willing to devise bizarre structures and stratagems to reduce corporate taxes, would they resort to creative accounting to boost the earnings they show investors on their financial statements? What other sorts of liberties might they be willing to take? Where does it stop?

Levin and McCain deserve credit. Rarely does the public get a deep-dive report like the one they just released. They made several concrete recommendations, including strengthening the tax-code section on transfer pricing and using the IRS’s current authority to disqualify sham entities.

It’s easy to be jaded, though. The IRS is in constant turmoil, most recently over singling out Tea Party groups for extra scrutiny. It’s doubtful that Congress will respond. Congress is the main reason the tax code is a mess.

At least the public is better informed about how corporate taxes work. We should take progress where we can get it.

*The author is a Bloomberg View columnist.

By Jonathan Weil