As we’ve seen previously, Apple has a cash problem. Not the kind of problem you and I have, where we wish we had more of it. No, Apple’s problem is too much cash.
Apple’s excess cash problem has been caused by three things. First and foremost, it was caused by Apple’s amazing profitability as it brought out product after product that customers loved. Second, it was caused by Apple suddenly running out of ideas for new products after the iPad in 2010, meaning that Apple wasn’t reinvesting its money in any major new products. Third – and this is what I want to address today – it was caused by Apple’s aggressive avoidance of tax on its global earnings.
Apple is Global
While Apple is the leading cell phone manufacturer in the USA, with about 40% of the market, in the rest of the world it is just one of the many vendors, with 15-17% of the market. However, that share of the global market is very lucrative for Apple.
Apple Revenue by Region (2015)
The chart shows that although the US is Apple's biggest market, 60% of Apple's sales actually come from outside the Americas. What makes these “foreign” contributions to profit particularly important is that they give Apple the opportunity to play shell games with its earnings. While Apple has stopped investing in major new products, it has invested heavily in schemes to avoid paying taxes in foreign countries.
Apple is not the only large company doing this. Google, McDonald’s and Ikea are three other big firms who play fast and loose with tax regulations. I’m going to talk about Apple, though, because we are now familiar with its balance sheet, but also because Apple is arguably the worst offender.
Apple has made a lot of money in foreign countries, but it hasn’t always reported its earnings in the country where it made its sales. Apple has deliberately structured its sales transactions in order to attribute its income to shell companies in countries with ridiculously low tax rates.
During the 1990s, Ireland enjoyed a high-tech boom, fueled by corporate tax rates as low as 10%, low wages, and government incentives for tech companies. (In comparison, the corporate income tax rate in the US is 35%.) That boom ended when Ireland began to bring its tax policies into line with the rest of the world.
Double Irish with a Dutch Sandwich
However, it was not until 2015 that Ireland removed its most eagerly exploited tax loophole, dubbed the double Irish by tax exploiters and critics alike. The scheme requires a company like Apple to create two Irish subsidiaries. One of these will have its head office in a tax haven like the Cayman Islands. Despite being registered in Ireland, the Irish government does not tax it because Ireland, unlike the rest of the world, assesses taxes based on where the head office is, not where the company is registered.
You can see where this is going. Other countries don’t tax the company because it is registered in Ireland. Ireland doesn’t tax it because its (nominal) head office is in the Caymans.
The scheme is more complicated than this, and involves creating a Dutch subsidiary, too, to act as an intermediary. With two Irish companies and a Dutch one in the middle, the scheme is also referred to as a Dutch sandwich. Advantageous tax laws in the Netherlands certainly contribute to the problem.
Apple is one of the companies that takes advantage of this arrangement. Google is another. So is Facebook. But Apple has taken things a step further. It has arranged some of its transactions so that earnings are attributed to three shell companies that are not based in any country. You read that correctly. Apple has some of its profits going through subsidiaries that don’t have a home and therefore doesn’t pay tax to anyone. This it tax dodging in the extreme.
Investigated by the US Senate
But don’t take my word on this. According to the US Senate’s Permanent Subcommittee on Investigations, in a report to Senate in May 2013:
“Apple has established and directed tens of billions of dollars to at least two Irish affiliates, while claiming neither is a tax resident of any jurisdiction, including its primary offshore holding company, Apple Operations International (AOI), and its primary intellectual property rights recipient, Apple Sales International (ASI). AOI, which has no employees, has no physical presence, is managed and controlled in the United States, and received $30 billion of income between 2009 and 2012, has paid no corporate income tax to any national government for the past five years.”
What this is saying is that Apple has set up separate subsidiaries for its operations and its sales:
- The operations company (AOI) has no physical presence anywhere, which is decidedly strange for an operations company.
- The sales company (ASI), purchases goods from suppliers in China and elsewhere, and resells them at a steep markup to Apple’s retail subsidiaries around the world.
This means the retail subsidiaries make very little profit when they sell the products to customers, and therefore have little tax to pay. The sales company earns the profit. The sales company, however, is registered in Ireland, which unlike the rest of the world does not tax income transferred to Irish companies from foreign operations.
The Moral of the Story
Tax avoidance schemes like the one outlined above are particularly attractive to high tech firms because they can be very profitable and because it is easier to attribute earnings on intangible assets and services to shell companies, compared to earnings on things like car sales. Regulators can tell where a vehicle assembly plant is located, but it is hard to tell where distributed services like iCloud, for instance, are provided.
The ingenuity and drive that it takes to come up with large scale tax avoidance schemes is extraordinary. They are the accounting equivalent of coming up with the next iPhone or iPad. The accountants working at Apple probably got huge bonuses. I hope they took them in cash rather than in Apple shares.
Accountants at Ernst & Young have also been earning large amounts for helping Apple figure out how to avoid taxes. Together with KPMG, PwC and other large international accounting firms, they repeat the trick for clients like Google and Facebook.
The world’s largest and most profitable companies are now beyond the control of individual nation states. Accounting firms help keep them out of reach.
Photo of the Cliffs of Moher, County Clare, Ireland, with O'Brien's Tower in the distance, taken in 2013.
Photo of a dodgy shell taken in Tobago in 2012. Sorry, I've never been to the Caymans so I have no pictures from there.
Market share data based on my reviews of recent Forbes and Gartner Group data in July 2016.
Regional sales data obtained from Apples 2015 annual report.
For more on the role of major accounting firms in tax scandals, follow my UK colleague, Prof. Prem Sikka, on Twitter (@premnsikka).