Apple and the EU

Apple and the EU:  Summary of the EU's latest ruling against Apple and the EU's proposed reforms of corporate taxation.

As previously covered in this blog, the EU ruled against Ireland granting tax benefits of up to €13 billion to Apple in violation of the State aid rules.  In their law review article, "Apple State Aid Ruling: A Wrong Way to Enforce the Benefits Principle?", Professor Reuven S. Avi-Yonah (Michigan Law) and Gianluca Mazzoni (SJD Candidate, Michigan) detail how Apple was able to utilize Ireland in reducing its tax liabilities.  The most notable facts of Apple's Irish arrangement as uncovered by the article are:

• Apple's market capitalization as of October 7, 2016 was $614.61 billion dollars (or $612.66 billion as of the third quarter of 2016)
• Apple used cost sharing agreements to shift profits from U.S. Developed intangibles to its Irish subsidiaries.
  • The article briefly discusses how cost sharing agreements (as used in pharmaceutical companies) should deter transfer pricing/revenue shifting because in pharmaceutical companies it is a gamble as to whether a particular drug will be a blockbuster drug and the pharmaceutical companies would risk losing R&D costs shifted to its offshore subsidiary if the drug didn't have profits generated in the offshore subsidiary.
  • The article states that this is not the case in technology companies, like Apple, because of Apple's track record of producing blockbuster technological products.
• Apple utilized licenses of Apple's brand and intellectual property by its Irish subsidiary's (Apple Sales International, ASI's) subsidiary retail locations throughout Europe to shift royalty payments from the retail locations to ASI instead of paying taxes on the income in the European countries.
  • The article notes that the profits from other EU nations are paid to the Irish subsidiary as royalty fees for licensing Apple's logo and branding to the EU subsidiaries.

The article also discusses the reason why Apple was able to utilize its Irish structure to shield income from taxation.  The primary reason for Apple's ability to set up this structure are as follows:

• Ireland and EU's lack of withholding tax on receipts fro EU member states.
  • The article highlights that the commentary regarding EU's position to not implement a withholding tax on receipts from EU member states could create a tax haven for EU profits to be shielded from tax because the countries where the profits are earned do not impose a withholding tax on the profits leaving that country and coupling that with certain countries (Ireland and Cyprus) that do not tax money not directly earned in that country's borders allows a sophisticated company to avoid tax on profits made in EU countries.
• In 1997 U.S. adoption of Check the Box regulations.
  • The article points out that in 1997 under the direction of the U.S. Treasury and the Clinton Administration, Congress adopted the "check the box" regulations.  Check the box regulations allowed U.S. multinational corporations to treat (for US tax purposes) foreign subsidiary corporations as transparent and not separate taxable entities.  This also allowed the foreign subsidiaries to transfer royalties and interest payments between each other without generating tax (called Subpart F) on the transfers.
  • The article also makes the point that at the adoption of the check the box rules, the U.K. and Germany objected to this position because it would allow U.S. multinational corporations to utilize earnings stripping to reduce taxable income in their respective countries.  Congress at the urging of the U.S. multinational companies (namely the argument that reducing the taxable income in foreign countries would lead to larger amounts of tax paid in the U.S.) enacted the check the box regulations.
  • The article also, with the advantage of hindsight, makes the argument that the check the box regulation over time has shown that the U.K. and German objections were warranted because U.S. multinational corporations have stripped earnings from EU countries and have not resulted in more U.S. taxes paid by the sameU.S. multinational corporations.
  • The article points out that the check the box regulations created such a huge loophole (estimated $86.5 billion over a ten year period) that early on President Obama and the U.S. Treasury advocated for the reformation of the check the box regulation.  However, after intense lobbying by business associations, the Obama administration has since abandoned the check the box regulation reforms and extended the check the box regulation treatment for another 5 years.
• Exploitation of difference between Irish and U.S. tax residency rules
  • As stated in the article, Irish laws taxes corporations for only income earned in Ireland.  U.S. law taxes income earned worldwide for companies that are resident in the United States.  This creates a gap in taxation for an Irish company with income earned outside Ireland, which as the article points out was exploited by Apple by also negotiating a corporate rate of less than 2% for its Irish income.

Finally, the article discusses how the EU Commission reached its determination that Ireland provided improper state aid by granting Apple such a sweetheart deal. The article summarizes the EU Commission position as follows:

• Was there state aid provided by Ireland to Apple?
  • The EU Commission concluded yes, because a benefit was conferred on Apple, and was not conferred on all other companies.
• The article states that the EU Commission found fault with the Irish determination because it was a result of a negotiation and not merely a summary of the comparable transactions.
• The article also stated that the EU Commission questioned the methodology (Transactional Net Margin Method) chosen to determine the appropriate transfer price because the terms were not defined.
• The article then stated that the EU Commission questioned the inconsistencies in the transfer methodology selected by Apple; and
• The article stated that the EU Commission challenged the open ended duration of the ruling in Apple's favor.

Note: Apple has utilized this structure since the 1980s and as Tax Justice discusses, Apple continues to use this structure in 2016 to shield income from taxation in the U.S. based on Apple's most recent quarterly earnings report.

However, there might be a change to this structure starting in 2020, as Ireland has passed legislation in 2013, which took effect in 2015 for newly incorporated companies and in 2020 for existing companies, that in order to incorporate in Ireland the company must also be a resident of Ireland (meaning that the income received by Apple's Irish subsidiaries from its EU subsidiaries would be taxed in Ireland at 12.5%). See this Guardian article.

Additionally, the EU Commission has also proposed corporate tax reforms to address continued tax avoidance by multi-national corporations.  The EU Commission's proposals are as follows:

• Common Consolidated Corporate Tax Base
  • The EU Commission is proposing to treat all profits earned in EU countries as one taxable base, so that multi-national won't be taxed separately by each EU member nation.  This proposal purportedly allows a corporation to offset losses in one EU country with profits in another EU country and provides one joint tax on the profits. This proposal also attempts to address profit shifting from one EU country to another in an effort to seek a lower or advantageous tax rate.
• Improved Mechanisms to resolve double taxation disputes
  • Currently the EU has a double taxation dispute resolution only addressing transfer pricing.  This proposal by the EU Commission hopes to provide a timely response to companies seeking relief from EU members double taxing the same income in both EU member nations.
• Measures to tackle tax loopholes with non-EU countries.
  • EU Commission proposes to address tax gaps between EU nations and non-EU nations which have been exploited by companies to reduce tax.  One key example is the Irish-US tax gap implemented by Apple to avoid taxation on its EU revenues.

Whether these proposals will curb aggressive tax avoidance by multi-national corporations is questionable. But the real question is: What are Congress and the IRS/U.S. Treasury proposing to address the existing tax gap (much of which is due to U.S. multinational corporations and their profit shifting (earnings striping)/transfer pricing/base erosion/inversions practices)?

If you have specific and credible evidence of a corporation's use of transfer pricing to avoid paying its tax liabilities you should consider filing a tax whistleblower claim.  Contact us to see if your information would permit you to receive a 15-30% award of the amount of taxes, penalties and interest collected by the IRS on your transfer pricing tax whistleblower claim.

Taxing the Individual vs. Taxing Corporations: History shows the burden is on Individuals and not Corporations

As discussed in the TaxProfBlog the Joint Committee on Taxation has released its overview of the federal tax system.  Noteworthy in the JCT’s finding is in table A-1 on pg. 23, the corporate income tax revenues received by the IRS has steadily declined since 1950, while individual income taxes and social security taxes continue to rise.  See the chart below:

One possible explanation for the decline in the corporate tax receipts may be the erosion of the corporate tax base by U.S. multinational corporations (“USMNCs”) and their profits shifting from the United States.  See TaxProfBlog and Kimberly A. Clausing (Reed College), Profit Shifting and U.S. Corporate Tax Policy Reform.

Clausing argues that the U.S. is losing over $100 billion dollars a year due to profit shifting efforts of USMNCs.  See Chart below.

Ms. Clausing states that 98% of the profit shifting occurs by USMNCs to jurisdictions that taxes the USMNCs at less than 15%.  Finally, she states that the revenue decrease has grown 5 times over the past decade due to increase profit shifting by USMNCs. 

To combat the erosion of profits to offshore jurisdictions, Ms. Clausing proposes the following small changes to the current taxing regime:

1. Repeal the check the box regulations that facilitates income shifting [for more information on check the box regulations and use in international tax planning, see this Wikipedia article];
2. Tougher earnings stripping laws [Treasury has already instituted additional regulations to curb earnings stripping, see my blog]; and
3. Anti-inversions rules such as an exit tax [See my earlier blog about imposing an exit tax to dissuade corporate inversions]. 

Ms. Clausing also advocates for the following fundamental changes to the existing taxing regime:

1. Worldwide consolidation of corporate returns for tax purposes
2. Formulary apportionment of international corporate income, using a method similar to that used by U.S. states in taxing national income.

Ms. Clausing’s proposal suggests that the U.S. should move to a territorial tax system.  While some have advocated the territorial tax systems would create jobs and raise wages for U.S. workers, see this article by Curtis S. Dubay and the Heritage Foundation, others (Center on Budget and Policy Priorities) have advocated that such a transition would: 1) create greater incentives for USMNCs to invest and book profits offshore, 2) reduce wages in the U.S., 3) would cause larger budget deficits by draining corporate tax revenues, and 4) would shift the tax burden to domestic businesses and small businesses.

Regardless of the solution proposed by either side, the simple fact still remains that individuals in the U.S. continue to bear the brunt of the tax burden, while corporations continue to avoid paying taxes.

If you have specific/credible information about corporations avoiding the payment of tax through transfer pricing, inversions and earnings stripping, you can get involved in preventing/limiting the tax avoidance by filing an IRS tax whistleblower claim.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower with specific and credible information about a corporate taxpayer’s avoidance of tax (through transfer pricing, inversions and earnings stripping).   Contact us if you want to file a tax whistleblower claim.

Pfizer and the Inversion Debate.

As everyone is aware, America will lose another company in 2016 to Ireland with the closing of the Pfizer – Allergan inversion.  See Bloomberg article.  With the inversion (See this Fortune article for more information about inversions), Pfizer will relocate its corporate headquarters to Ireland and continue its long standing policy of transferring profits from the U.S. to a lower tax jurisdiction.  Pfizer’s move will continue a trend of U.S. companies playing the shell game with its U.S. sourced profits through transfer pricing.  See these Bloomberg articles regarding profit shifting to avoid taxes and  the U.S. corporate tax-dodge

The obvious question about such a move is: What happened to President Obama’s and Treasury Secretary’s, Jacob J. Lew, position that the US would try and prevent future inversions (See Forbes article for more information of the Treasury Regulations) in response to Pfizer’s first failed attempt to invert by purchasing Astra Zeneca?  (Note: see Bloomberg article about Pfizer’s attempt to acquire Astra Zeneca).  As stated by the Wall Street Journal, the Treasury’s efforts failed to prevent US inversions or foreign corporations from acquiring US corporations. 

So how does the U.S. solve the problem given the ineffectiveness of the changes to the Treasury Regulations?  Possible solutions could be: 1. To lower the corporate tax rate in the United States; or 2. A Tax Holiday.  See Congressional Research Service’s article: Corporate Expatriation, Inversion and Mergers: Tax Issues for a discussion of the solutions proposed to solve the inversion problem.

The first solution would be to de-incentivize corporations from changing their home jurisdiction by matching the corporate rates in other countries.  However, that might not stop the mass exodus of corporations or generate job in the U.S.  See Sam Becker’s article about Kansas’ attempt to lower tax rates for businesses and the negative impact on jobs in Kansas.

The second solution might be to declare a tax holiday and allow the companies to bring back money to the United States at a reduced rate or without paying tax.  As stated in Jaimie Woo’s Huffington Post article this might not be the best idea, because it is rewarding the companies that shifted its profits offshore through transfer pricing by allowing them to bring the profits home at a much lower rate.  Also, the tax holiday would not address the problem of inversions, because the reason the companies are inverting is to avoid all U.S. taxation, not just at a reduced rate.

Another possibility, but rarely discussed is an expatriation tax.  This solution wouldn’t solve the corporate inversion problem, but would provide a huge incentive to not invert. What is an expatriation tax?  If you are a U.S. Citizen and want to renounce your citizenship (or are ordered to renounce your U.S. citizenship), the IRS treats that situation as an expatriation and imposes a tax on all your assets.  See Internal Revenue Code Section 877A.  As stated by the IRS, the Expatriation Tax would treat the individual as having sold all of his/her assets the day before expatriating their citizenship, and would impose a tax on the sale of those assets (with a sizable exemption).

The Expatriation Tax Model could be implemented to include Corporations and not just U.S. individuals.  This would require the U.S. Corporations to pay the tax on the deferred earnings of their offshore subsidiaries, and all other assets prior to inverting to the foreign jurisdiction.  This would make sure the company pays its fair share of U.S. taxes before utilizing the foreign jurisdictions tax benefits.

Could this unique solution work?  It might not stop the inversions, but it would at least cause the corporations to pay their fair share of taxes for choosing to relocate (on paper) its corporate headquarters in another jurisdiction.  Unfortunately, as with the proposed legislation (changing the tax rate and a tax holiday) it is unlikely that Congress will implement this solution to prevent corporations from avoiding U.S. taxes.

If you feel strongly about inversions and have specific/credible information about corporations avoiding the payment of tax, something that you can do now to limit the tax avoidance is to utilize the IRS tax whistleblower program.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower with specific and credible information about a corporate taxpayer’s avoidance of tax (either through an inversion or other methods, such as transfer pricing, or sham transactions).   Contact us if you want to file a tax whistleblower claim.