On Dec. 16, 1773, demonstrators boarded ships in Boston Harbor and threw chests of tea into the water. This was the culmination of the resistance movement against the taxation of the colonists imposed by the British Parliament. Their rallying cry was “No taxation without representation.” In the recent budget discussions in Washington, we have heard the members of the modern day Tea Party protest about the evils of taxation and about the negative effects of high taxes on our economic recovery. In particular, they complain about the 35 percent corporate income tax.
In July 2008 the U.S. Government Accountability Office published a report on the tax liabilities reported by U.S.-controlled corporations. They studied the tax returns of more than 1,250,000 U.S. corporations for the years 1998 through 2005. During those eight years, between 60 percent and 70 percent of those companies paid no U.S. taxes. A further study prepared in September 2012 for the U.S. Senate Permanent Subcommittee on Investigations looked at the contribution of corporate taxes to the U.S. budget since 1952. In 1952 corporate tax generated 32 percent of all federal tax revenue, while individuals contributed 42 percent. In 2010 corporations contributed 9 percent and individuals still contributed 42 percent.
A casual study of this data might prompt one to ask whether high corporate taxation is really a major cause of our budget problems, or whether the ingenious methods that corporations have found to avoid taxation are not also contributing factors. The Senate Permanent Subcommittee studied this question further in hearings in September 2012 and May 2013. In particular they looked at Apple, Microsoft, and Hewlett Packard — not because these companies were especially egregious, but because they illustrated some of the more creative ways in which corporations avoid U.S. taxation. It must be emphasized that these tax avoidance measures are perfectly legal, and the corporations spend millions of dollars on lawyers, accountants, lobbyists, and political contributions to make sure that they stay legal.
A look at Apple might illustrate how the game is played. Apple has about 80,000 employees, of which 52,000 are in the United States. Almost all of Apple’s research activity is conducted in California, where the vast majority of the engineers, designers and technical experts reside. Many of the components of Apple’s new products are designed in the United States and then manufactured by third parties elsewhere. Most of the finished products are assembled in China.
In 1980 Apple created Apple Operations International (AOI) as its primary offshore holding company. AOI is registered in Ireland but has no employees, no physical presence, and declares no tax residency anywhere. AOI has three directors, two of whom are located in California and one in Ireland. From May 2006 through December 2012 it held 33 board meetings, of which 32 were held in Cupertino. The one Irish director failed to participate in about half of the board meetings. AOI’s assets are held in bank accounts in New York, and its accounting records are maintained by Apple in the United States. AOI received $30 billion in profits from 2009 through 2012, and accounts for about 30 percent of Apple’s worldwide net profits on which it has paid no tax to any government.
Apple Sales International (ASI) is another Irish company, which is a subsidiary of Apple Operations Europe (AOE), which is in turn a subsidiary of AOI. As with AOI the majority of directors of ASI reside in California and all board meetings for a six-year period were held in Cupertino. In 2010 and 2011, ASI paid $17 million in global taxes on $34 billion of income (about .05 percent). ASI contracts with Apple’s third party manufacturers in China to assemble products and acts as the initial buyer of those finished goods. ASI then re-sells the finished product to other Apple entities for sale in Europe, the Middle East, Africa, India, and the Asia-Pacific region. ASI charges the other affiliates a higher price than it paid for the goods, thus effectively shifting profit from the country where the product is sold to ASI, some of which ASI passes as a dividend to its parent AOE, which in turn passes as a dividend to AOI.
If the reader is confused by all of this, then the tax lawyers have achieved their objective. The harder it is for the IRS to understand, the less likely they are to question it. Techniques such as acquiring finished goods through an offshore subsidiary located in a tax haven and then reselling them to the wholly owned sales subsidiaries at much higher prices are not unique to Apple and are widely used to shift profit from high tax countries to lower tax countries. Similarly, assigning intellectual property rights (such as patents and trademarks) to subsidiaries in tax havens, so that sales subsidiaries must pay a “royalty” to the tax haven upon sale of the product, is also used by companies other than Apple to shift profits to lower tax countries.
It should also be emphasized that Apple is not a “bad apple” and is not one of the 60 percent to 70 percent of companies mentioned above that have paid no U.S. taxes for several years. In fact, for the three fiscal years 2009, 2010 and 2011, Apple paid a total of $5.3 billion in U.S. corporate income tax. Apple’s total sales for the three years were over $216 billion – for an effective tax rate of less than 2.5 percent.
So when you next hear someone complaining that the 35 percent corporate tax rate is strangling our economy, think of all the lawyers, accountants and lobbyists who are kept employed helping corporations avoid those taxes. Also think of those poor countries such as Bermuda or the Cayman Islands where the tax-sheltered profits of U.S. companies are parked, and where those profits amount to more than 500 percent of the country’s GDP. Think also of the hard-working owners of the Michelin 3-star restaurants in Washington, D.C., who would have to close if lobbyists were not to invite politicians to dinner.
A few years after the Boston Tea Party, when the framers of the Constitution included in the preamble “in order to create a more perfect union,” little could they have thought of the day when American ingenuity would almost reverse the British Parliament and produce an almost perfect union yielding “representation without taxation.”
