Apple’s profits in Ireland are “a fraud,” said Nobel Prize-winning economist Joseph Stiglitz in an interview with Bloomberg Television’s Tom Keene. True it is, but almost every tech company uses the same loophole for which Stiglitz blamed the U.S. tax system.
Stiglitz said: “Our current tax system encourages companies to keep their money abroad, opens up a vast loophole through what is called the transfer-pricing system that allows them not only to keep their money abroad but, effectively, to escape taxation.”
How it works
In international markets, companies manipulate higher costs, reducing taxes by using easily understood transfer-pricing. In this simplified example below, a product sells for $1,000 and costs $500 to produce. The taxes in the U.S. would be $175. But if the cost to produce it can be inflated to $600 and recognition of the sale and the cost transferred to a lower-tax country such as Ireland, $175 in taxes are saved.
More than 700 American companies site international headquarters in Ireland because it has a 12.5 percent tax rate compared to much higher rates in the U.S. and Europe, according to the Guardian.
Tech company tax avoidance structure
Setting up operations like this is included in the standard playbook of every large law firm; no magic or rocket science needed. First, the U.S. company incorporates an Irish subsidiary. Stiglitz’s claim of fraud seems disproportionate compared to Ireland’s small economy amounting to less than 2 percent of the European economy. Still, Stiglitz is accurate because using a special corporate structure, the Irish subsidiary shields most European profits.
Next, representative companies are established in each country: Apple Italia S.R.L, Apple (UK) Limited, Apple France, etc. The representative companies usually operate in countries that have much higher tax rates, managing product sales and distribution under agreement with Apple Ireland. Apple Ireland sells products to each higher-taxed representative company at the highest price possible to expose as little profit as possible in the higher-taxed country.
The difference between Apple Ireland’s selling prices to the representative companies and the prices sold within the country boarders is enough to cover the operating cost of the representative country and not much more. Government tax agencies may negotiate with the representative companies, producing a small increase in taxation.
Research tax shelters
Research expenses are also used to reduce taxes in the U.S. After the research is patented and approaches the point of development, the patents are transferred at a low cost to a subsidiary located in an off-shore tax haven that has much lower tax rates than the U.S. The patents and related intellectual property are then licensed back to the U.S. parent at a greater cost. Licensing fees paid to the off-shore entity inflate the product costs on the parent company’s profit-and-loss statement, decreasing U.S. profits and U.S. taxes. The profit flows to the off-shore entity, and it is taxed at a low rate.
This isn’t a Panama Papers exposé of illegal activity. It’s all legal—supported by legislation, tax code and court case precedent. Every CEO would defend the use of this tax scheme, not just Apple CEO Tim Cook.