Apple and its European Commission Troubles: hype or real transfer pricing liability for Apple

Since June 2014, The European Commission (“EC”) (European Union's politically independent executive arm, made up of 1 commissioner from each EU country) has investigated Apple, and more specifically the tax authorities in Ireland, to determine if the Irish tax authorities followed the EU rules on state aid in issuing favorable tax rulings to Apple.

As explained in the Permanent Subcommittee on Investigations (PSI) report on Apple, Apple utilizes “key offshore subsidiaries incorporated in Ireland.”  The reason Apple has utilized the Irish subsidiaries is that “Ireland has provided Apple affiliates with a special tax rate that is substantially below its already relatively low statutory rate of 12 percent,” generally negotiated with the Irish government to be at rates at 2% or less. See pg. 20.

Apple CEO Tim Cook, in his 60 minutes interview, has called the investigation “political crap” and has stated that “there is no truth behind it.”  Mr. Cook has also stated in the same interview that “Apple pays every tax dollar we owe.” 

Some news outlets (Bloomberg, Guardian) have stated that Apple could “be on hook for $8 billion in taxes”.  Bloomberg calculated this figure by stating that if the EC terminates the Irish rulings for Apple, and requires Ireland to seek recourse tax payments from 2004-2012 on profits of $64.1 billion at a 12.5% rate, that would generate $8 billion in taxes owed by Apple to Ireland.

While other news outlets (Forbes and in a recent opinion piece in Forbes) has stated that Apple isn’t on the hook for $8 billion, but that the Irish government is being investigated and that the true amounts Ireland may request from Apple, assuming the EC rules against Ireland’s rulings favoring Apple, would be more in the $200 million range, and not the $8 billion figure used by Bloomberg.  Mr. Worstall in the Forbes opinion piece states explains that the reason behind the lower figure is due to the structure employed by Apple, the Double Irish structure.  He states that some profits can be taxable in Ireland and some profits are not taxable in Ireland, so the Bloomberg calculation, which treats the entire amount of profits ($64 billion) as taxable in Ireland is incorrect.  Mr. Worstall explains that Bloomberg’s figure is wrong because it fails to account for transfer pricing even between Apple’s Irish entities, which might shield the non-Irish resident income from being taxed in Ireland.

Two noteworthy observations regarding Apple’s EC investigation are:

1. If as Mr. Worstall states, the game is transfer pricing and the prices allocable between the various Irish entities, then what about the transfer price between Apple Inc. (the U.S. entity) and AOI (Apple’s primary Irish entity identified in the PSI hearings)?  If the EC is examining whether the proper transfer pricing and applicable tax rates are at play, why isn’t the IRS examining Apple to determine if Apple used the proper transfer prices to shift the U.S. developed technologies and intellectual property to its offshore operations to pool an estimated $181 billion dollars offshore through the Irish entities instead of being taxed in the United States.
2. Panama Papers part 2.  Previously I blogged about the Panama Papers and whether U.S. corporations and individuals would be exposed.  Give the exposure Apple has gotten over its use of Irish entities, and the knowledge that other companies and individuals have utilized offshore entities to grow their wealth, why hasn’t there been more disclosures of companies and individuals in the U.S. that have taken advantage of offshore entities.  If PSI can expose Apple’s offshore structure, why couldn’t the IRS expose other companies’ offshore transfer pricing structure?

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.

Partnership Audit Technique Revisions: a big hullabaloo or fundamental changes?

With the recent Bipartisan Budget Act of 2015, the IRS changed the way it would audit and assess taxes of partnerships.  Since the passage of the act, there have been numerous articles and blogs explaining the changes to the partnership audit procedures including: Forbes article and McDermott, Will & Emery’s blog

For an explanation of partnership audit rules under Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, see Auditing Large Partnerships and TEFRA; and Navigating TEFRA Partnership Audits in Multi-Tiered Entity Structures.

New Partnership Audit Rules from:

1. All partnerships are subject to the new rules regardless of size.
1. There is an exception to this rule, a partnership can elect out of the new audit rules, if the partnership has fewer than 100 partners and if the partnership only has: individuals, C corporations, foreign entities (treated as C corporations if domestic) S corporations or estates of deceased partners.
1. To Elect Out the partnership must follow the following rules:
1. The partnership must elect the opt-out on its partnership return each year.
2. The partnership must inform each of its partners of the election.
3. The partnership must submit the names and taxpayer identification numbers of each of its partners, including S corporation shareholders treated as partners for purposes of the 100-partner test.
2. Entity Level Tax
1. At the conclusion of the partnership audit, IRS will be assessing the partnership the imputed underpayment at the individual or corporate rates, instead of assessing individual partners.
2. IRS assess the partnership in the year in which the audit is concluded [present year], instead of the tax year which is under audit [past year(s)].
3. Exception 1: If a partner pays the partnership level adjustment, the partnership’s imputed underpayment is reduced. Partners must file amended returns reporting their share of partnership adjustment and pay all taxes within 270 days of receiving notice of the proposed adjustment.
4. Exception 2: Within 45 days of the Final Notice of Partnership Adjustment, partnership can elect to issue statement to partners who were partners during the years to under audit [past year] to reflect their share of the partnership adjustments, but the partners pay the liability for their share of the partnership adjustments in the year in which the audit is concluded [present year] at an interest rate 2% higher than the current rate, instead of interest running since the year under audit [past year].
3. Partnership Representative.
1. a. Similar to a Tax Matters Partner in Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, the new law requires that a partnership designate a representative to act on behalf of the partnership. If one is not appointed, the IRS can appoint the partnership.

The IRS sought these changes because the prior system (TEFRA) often delayed the assessment of tax on partners for several years after the partnership adjustments were determined at the partnership level.  This was especially true for large partnerships or multi-tiered partnerships.  The new changes now permit the IRS to assess the tax at the partnership level and leave it up to the partnership and/or its partners to determine whether they want to pay the tax in the year the partnership audit has concluded [present year] or in the years under audit [past years]. 

While the new rules present additional issues for partners and partnerships to work through and amend their partnership agreements, the new assessment rules appear to streamline the collection of taxes from partnerships and/or their partners, especially in large/multi-tiered partnerships.

However, like TEFRA (the prior partnership audit rules regime), it will take time before IRS, partnerships and partners understand the effects of the new rules.

If you know of a partnership or multi-tiered partnership that has committed tax violations and you have specific and credible evidence of the alleged tax violations, you should consider filing a tax whistleblower claim to report the alleged violations.  Contact us to assist you in preparing your tax whistleblower claim.

Pfizer Inversion Derailed by New U.S. Treasury Regulations

Pfizer Allergan inversion derailed by new regulations

The U.S. Treasury, in conjunction with the White House, released an update to their framework for Business Tax Reforms.  According to the U.S. Treasury press release, these reforms are geared toward stopping U.S. corporations from inverting to more tax favorable jurisdictions and then utilizing earnings stripping to reduce taxable U.S. income.

As previously discussed in this blog, there are three ways a U.S. corporation can shift profits from the U.S. to an offshore tax favorable jurisdiction: 1) Transfer Pricing; 2) Inversion; and 3) earnings stripping. 

2016 update vs. 2012 proposed business tax reforms:  The White House and U.S. Treasury’s update outlines the following reforms:

1. Minimum tax (≥19%) on foreign earnings in year the profits are earned;
2. One-time tax on unrepatriated earnings at 14%;
3. Restrict deductions for excessive interest to curb earnings stripping;
4. Limit inversions by preventing firms form acquiring smaller foreign firms and changing their tax residence unless the change in tax residency in the new foreign jurisdiction has substantial economic activities and the operations in the foreign jurisdiction are more valuable than the U.S.
5. Tighten rules for cross-border transfers of intangible property
6. Close loopholes by expanding Subpart F rules.

These reforms are an update of the 2012 reforms suggested by the White House and Treasury.

Based on a comparison of the reforms, the 2016 reforms focuses more on the profit shifting/inversion/earnings stripping activities of large U.S. multinational corporations, and less on the incentives towards small business and clean energy.  The latest reforms are in addition to 2014 and 2015 rules to limit inversion transactions and earnings stripping.

2015 Rule Changes:  In Notice 2015-79, the US Treasury attacks inversions by imposing an 80% test and a substantial business test.  The 80% test states that the shareholders of the U.S. company must receive less than 80% of the resulting inverted company.  The substantial business test requires that the foreign company have substantial business activities in the jurisdiction in which it is incorporated.  If both tests are met, then a third test, the 60% rule, would also prevent inversions.  The 60% rule implies post inversion restrictions if the shareholders of the U.S. company receive 60% or more of the resulting company.

Notice 2015-79 also seeks to limit inversions by preventing the foreign company and U.S. company from setting up a new foreign holding company in a third unrelated jurisdiction which the U.S. company and foreign company would then be merged into the new foreign holding company.  Notice 2015-79 restricts this third country inversion by disregarding the new foreign holding company. 

Notice 2015-79 further limits inversions by taxing transfers of property (including intellectual property) or licensing of property from the U.S. company to its new foreign subsidiary or parent.  Prior to this change, transfers of property and/or licenses of property were not taxable to the U.S. corporation.  The new rule also has a similar provision for indirect transfers or licenses through partnerships by the U.S. company.

Finally Notice 2015-79 prevents certain shifting of former Controlled Foreign Corporation (“CFCs”) of the U.S. company without incurring taxation. 

2014 Rule Changes:  In Notice 2014-52, the U.S. Treasury imposed restrictions to inversions.  The 2014 Notice imposes new penalties for violating the 60% test in addition to 80% test (the existing prohibition of ownership of 80% of the new company by the shareholders of U.S. company).  Notice 2014-52 also restricts the transfer of assets between the U.S. company and the Foreign Company to meet the 60% and 80% tests.

Notice 2014-52 also limits the inverted company from utilizing cash of a CFC of the U.S. company without incurring tax.  Prior to the rule changes, the cash trapped in the CFC of the U.S. company could be loaned to the new inverted foreign company or any subsidiary of the new inverted foreign company without incurring tax.  With the rule changes, the trapped cash loaned to any inverted foreign company or subsidiary foreign company will be treated as a dividend to the U.S. company, regardless of whether the cash is ultimately used in the U.S.

Notice 2014-52 does not address earnings stripping, but merely notifies the public that additional rules may be adopted in the future.

Conclusion:  Together the new Treasury rules contained in Notice 2014-52, Notice 2015-79 and the 2016 reform updates (when enacted) appear to provide the antidote to the recent rash of U.S. multinational corporations inverting to more favorable tax jurisdictions.  Whether these changes are an effective approach to address inversions and earning stripping will depend on whether U.S. companies now have a disincentive to invert and strip the U.S. entities of its future earnings. 

Apparently, the changes have already blocked one previously announced inversion between Pfizer and Allergan. According to Forbes, the recent merger cancellation has also impacted the stock of both companies. 

What is noteworthy is that the U.S. Treasury has not attacked transfer pricing in the bulk of its 2014, 2015 and 2016 rule changes.  Does this mean the U.S. Treasury is leaving the battle of transfer pricing to the IRS with its cases against Microsoft, Amazon, Zimmer and Medtronic?

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.