EC Tax Ruling Stuns Apple
Imagine a situation where a regulatory authority rules that a corporation owes billions of dollars in back taxes to a government, and the government takes the side of the corporation and fights against the ruling. Welcome to the strange intersection of the European Union (EU), Apple (NASDAQ: AAPL), and international tax law.
The European Commission (EC) recently concluded that Apple's previous taxation arrangement with Ireland violated the rules of European state aid to corporations, and ruled that Apple must pay back taxes in Ireland from the years 2003-2014. The total tax bill could reach 13 billion euros (approximately $14.5 billion). Ireland would certainly enjoy an extra $14.5 billion in the coffers, but to accept the ruling is to agree that Ireland's dealings with Apple crossed the boundaries of legal tax benefits that any EU member state could offer to a corporation.
Irish officials are concerned that the EC ruling will undermine their low corporate tax structure and various incentives that have brought numerous corporations to Irish shores — especially given the retroactive nature of the action. According to the American Chamber of Commerce in Ireland, over 700 US companies have units in Ireland, employing some 140,000 workers. Apple accounts for 6,000 of those Irish jobs, with a large percentage of them well-paying, according to global outplacement consultant, Challenger, Gray & Christmas.
Apple obviously disagrees with the ruling, with CEO Tim Cook calling it "total political crap" in a recent interview. Cook asserted that his company has paid its fair share of taxes and that Apple did not receive any special deals from the Irish government. The real argument may be on the definition of a special deal. Meanwhile, Cook sought to reassure his Irish workforce, when he told CNBC last week that Apple "remains committed" to investing in the Emerald Isle.
Enforce your Existing Rules
Cook charges that the EC is effectively replacing the Irish tax laws with its own interpretation of what those laws should be. From the EC point of view, the issue is with loopholes in Irish tax law that allowed Apple to render large amounts of their income stateless and effectively not taxable by anyone. In other words, it's fine to have an overall low tax rate — 12.5% in Ireland compared to the 35% rate in the US — but that specific loopholes should not permit individual corporations to gain unfair advantage.
In the EC press release announcing the action against Apple, Commissioner Margrethe Vestager laid out the case against Apple. Favorable tax rulings from Ireland to Apple began in 1991 that legally allowed Apple to create tax-reducing structures, resulting in an effective tax rate that reached a low of 0.005% in 2014.
Two Ireland-based Apple subsidiaries, Apple Sales International and Apple Operations Europe, are at the center of the controversy. Their structure allowed sizable worldwide sales and profits to be recorded within Ireland, where the majority of the profits were assigned to a head office that resided inside Apple Sales International. This head office was not based in any country; therefore, no country could claim that income as taxable. It also had no employees or physical presence.
Over time, the discrepancy in taxable income increased as the amount of profits taxable in Ireland remained static while profits for Apple Sales International grew. Thus, by the final year under this structure, Ireland received only 50 euros in tax revenue for every million euros of collective Apple profit. In 2015, the structure was changed in both Irish subsidiaries, ending the favorable tax ruling.
The EC rules allow recovery for a ten-year period from the time information is first requested (2013 in the Apple case). However, the EU is not the only group interested in the taxation potential of these earnings.
Who Makes the Rules and Who Gets the Money?
Apple currently has over $230 billion in cash reserves, with an estimated $214 billion of that being held outside of the US — but they are not alone. There is approximately $2 trillion in collective corporate profits stashed overseas.
The US government has been debating the best way to bring this money back into America and keep more of it from leaving via tax inversions. Approaches range from the carrot (a one time "tax holiday" allowing corporate profits to be repatriated into the US at a lower rate) to the stick (Hillary Clinton's proposed "exit tax" and limits on "earnings stripping" that allows multinational corporations to shift profits).
However, one assumption underlies the entire debate — the money will eventually be returned to the US. If the EC action holds, that assumption in Apple's case is no longer true. The Treasury Department and Congress now face the possibility that inaction on tax reform will allow European authorities to claim a portion of the Apple money.
The EC noted that other countries could use their own tax laws to require that Apple pay more taxes over that same period, reducing the amount available to be claimed by Ireland. However, the US is choosing to focus on the EC action instead, claiming that the EC has no right to go after Apple in this way. American authorities are afraid that the EC action will set a precedent and that their own tax collection efforts (to the extent there are any) will be undermined.
It's hard to argue that Apple's approach doesn't stretch the boundaries of tax avoidance, and arguably, some entity should be receiving more of Apple's tax money. Yet the issue here has as much to do with sovereignty as it does money. The European Commission may be correct in their assessment of basic fairness, but where is the boundary on allowable tax incentives by member countries, and what is the potential impact of the EC enforcing these boundaries? Companies like Amazon (NASDAQ: AMZN), Microsoft (NASDAQ: MSFT), Google (NASDAQ: GOOGL), and Facebook (NASDAQ: FB) will be closely watching the Apple case for clues.
Corporations are likely to rethink locating in Ireland, or anywhere within the EU, if they are uncertain about the rules and whether legal agreements with individual member countries may be overturned by future EC actions. Further, in a post-Brexit world, the EC ruling runs the risk of feeding a similar movement in Ireland to leave the EU.
Congressional action in the short term to address tax reform seems unlikely. Theoretically, the US could take retaliatory tax action against the EU, according to Forbes. Such action is highly unlikely to be proposed and may well be struck down by courts if it were enacted — but who knows what President Trump might do?
As for Apple, $14.5 billion is not pocket change, but Apple can readily absorb the penalty given its stockpile of cash. The greater challenge for Apple today is to regain the "wow" factor with the sort of innovative products that defined Apple during the Steve Jobs era. Apple is scheduled to announce the new iPhone and Apple Watch versions on September 7th, with expectations mixed at this point.
Should Apple's announcement fail to impress consumers, perhaps Apple should sink even more of their available cash into productive research ventures — wherever they happen to be located and however they happen to be taxed — or their tax bill will be overshadowed by more pressing problems.
[Editor's Note: The editor is long on Apple]