[Vision2020] How Apple Sidesteps Billions in Taxes

[Art Deco]

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April 28, 2012
How Apple Sidesteps Billions in Taxes By CHARLES
DUHIGG<http://topics.nytimes.com/top/reference/timestopics/people/d/charles_duhigg/index.html?inline=nyt-per>and
DAVID
KOCIENIEWSKI<http://topics.nytimes.com/top/reference/timestopics/people/k/david_kocieniewski/index.html?inline=nyt-per>

RENO, Nev. — Apple<http://topics.nytimes.com/top/news/business/companies/apple_computer_inc/index.html?inline=nyt-org>,
the world’s most profitable technology company, doesn’t design iPhones
here. It doesn’t run AppleCare customer service from this city. And it
doesn’t manufacture MacBooks or iPads anywhere nearby.

Yet, with a handful of employees in a small office here in Reno, Apple has
done something central to its corporate strategy: it has avoided millions
of dollars in taxes in California and 20 other states.

Apple’s headquarters are in Cupertino, Calif. By putting an office in Reno,
just 200 miles away, to collect and invest the company’s profits, Apple
sidesteps state income taxes on some of those gains.

California’s corporate tax rate is 8.84 percent. Nevada’s? Zero.

Setting up an office in Reno is just one of many legal methods Apple uses
to reduce its worldwide tax bill by billions of dollars each year. As it
has in Nevada, Apple has created subsidiaries in low-tax places like
Ireland, the Netherlands, Luxembourg and the British Virgin Islands — some
little more than a letterbox or an anonymous office — that help cut the
taxes it pays around the world.

Almost every major corporation tries to minimize its taxes, of course. For
Apple, the savings are especially alluring because the company’s profits
are so high. Wall Street analysts predict Apple could earn up to $45.6
billion in its current fiscal year — which would be a record for any
American business.

Apple serves as a window on how technology giants have taken advantage of
tax codes written for an industrial age and ill suited to today’s digital
economy. Some profits at companies like Apple, Google, Amazon,
Hewlett-Packard and Microsoft derive not from physical goods but from
royalties on intellectual property, like the patents on software that makes
devices work. Other times, the products themselves are digital, like
downloaded songs. It is much easier for businesses with royalties and
digital products to move profits to low-tax countries than it is, say, for
grocery stores or automakers. A downloaded application, unlike a car, can
be sold from anywhere.

The growing digital economy presents a conundrum for lawmakers overseeing
corporate taxation: although technology is now one of the nation’s largest
and most valued industries, many tech companies are among the least taxed,
according to government and corporate data. Over the last two years, the 71
technology companies in the Standard & Poor’s 500-stock index — including
Apple, Google, Yahoo and Dell — reported paying worldwide cash taxes at a
rate that, on average, was a third less than other S.& P. companies’. (Cash
taxes may include payments for multiple years.)

Even among tech companies, Apple’s rates are low. And while the company has
remade industries, ignited economic growth and delighted customers, it has
also devised corporate strategies that take advantage of gaps in the tax
code, according to former executives who helped create those strategies.

Apple, for instance, was among the first tech companies to designate
overseas salespeople in high-tax countries in a manner that allowed them to
sell on behalf of low-tax subsidiaries on other continents, sidestepping
income taxes, according to former executives. Apple was a pioneer of an
accounting technique known as the “Double Irish With a Dutch Sandwich,”
which reduces taxes by routing profits through Irish subsidiaries and the
Netherlands and then to the Caribbean. Today, that tactic is used by
hundreds of other corporations — some of which directly imitated Apple’s
methods, say accountants at those companies.

Without such tactics, Apple’s federal tax bill in the United States most
likely would have been $2.4 billion higher last year, according to a recent
study <http://taxprof.typepad.com/files/134tn0777.pdf> by a former Treasury
Department economist, Martin A. Sullivan. As it stands, the company paid
cash taxes of $3.3 billion around the world on its reported profits of
$34.2 billion last year, a tax rate of 9.8 percent. (Apple does not
disclose what portion of those payments was in the United States, or what
portion is assigned to previous or future years.)

By comparison, Wal-Mart<http://investors.walmartstores.com/phoenix.zhtml?c=112761&p=irol-sec>last
year paid worldwide cash taxes of $5.9 billion on its booked profits
of $24.4 billion, a tax rate of 24 percent, which is about average for
non-tech companies.

Apple’s domestic tax bill has piqued particular curiosity among corporate
tax experts because although the company is based in the United States, its
profits — on paper, at least — are largely foreign. While Apple contracts
out much of the manufacturing and assembly of its products to other
companies overseas, the majority of Apple’s executives, product designers,
marketers, employees, research and development, and retail stores are in
the United States. Tax experts say it is therefore reasonable to expect
that most of Apple’s profits would be American as well. The nation’s tax
code is based on the concept that a company “earns” income where value is
created, rather than where products are sold.

However, Apple’s accountants have found legal ways to allocate about 70
percent of its profits overseas, where tax rates are often much lower,
according to corporate
filings<http://files.shareholder.com/downloads/AAPL/1826229879x0xS1193125-11-282113/320193/filing.pdf>.


Neither the government nor corporations make tax returns public, and a
company’s taxable income often differs from the profits disclosed in annual
reports. Companies report their cash outlays for income taxes in their
annual Form 10-K, but it is impossible from those numbers to determine
precisely how much, in total, corporations pay to governments. In Apple’s
last annual disclosure, the company listed its worldwide taxes — which
includes cash taxes paid as well as deferred taxes and other charges — at
$8.3 billion, an effective tax rate of almost a quarter of profits.

However, tax analysts and scholars said that figure most likely overstated
how much the company would hand to governments because it included sums
that might never be paid. “The information on 10-Ks is fiction for most
companies,” said Kimberly Clausing, an economist at Reed College who
specializes in multinational taxation. “But for tech companies it goes from
fiction to farcical.”

Apple, in a statement, said it “has conducted all of its business with the
highest of ethical standards, complying with applicable laws and accounting
rules.” It added, “We are incredibly proud of all of Apple’s
contributions.”

Apple “pays an enormous amount of taxes, which help our local, state and
federal governments,” the statement also said. “In the first half of fiscal
year 2012, our U.S. operations have generated almost $5 billion in federal
and state income taxes, including income taxes withheld on employee stock
gains, making us among the top payers of U.S. income tax.”

The statement did not specify how it arrived at $5 billion, nor did it
address the issue of deferred taxes, which the company may pay in future
years or decide to defer indefinitely. The $5 billion figure appears to
include taxes ultimately owed by Apple employees.

The sums paid by Apple and other tech corporations is a point of contention
in the company’s backyard.

A mile and a half from Apple’s Cupertino headquarters is De Anza College, a
community college that Steve
Wozniak<http://topics.nytimes.com/top/reference/timestopics/people/w/stephen_wozniak/index.html?inline=nyt-per>,
one of Apple’s founders, attended from 1969 to 1974. Because of
California’s state budget crisis, De Anza has cut more than a thousand
courses and 8 percent of its faculty since 2008.

Now, De Anza faces a budget gap so large that it is confronting a “death
spiral,” the school’s president, Brian Murphy, wrote to the
faculty<http://www.deanza.edu/budgetinfo/announcements/News01_23_12.html>in
January. Apple, of course, is not responsible for the state’s
financial
shortfall, which has numerous causes. But the company’s tax policies are
seen by officials like Mr. Murphy as symptomatic of why the crisis exists.

“I just don’t understand it,” he said in an interview. “I’ll bet every
person at Apple has a connection to De Anza. Their kids swim in our pool.
Their cousins take classes here. They drive past it every day, for Pete’s
sake.

“But then they do everything they can to pay as few taxes as possible.”

*Escaping State Taxes*

In 2006, as Apple’s bank accounts and stock price were rising, company
executives came here to Reno and established a subsidiary named Braeburn
Capital to manage and invest the company’s cash. Braeburn is a variety of
apple that is simultaneously sweet and tart.

Today, Braeburn’s offices are down a narrow hallway inside a bland building
that sits across from an abandoned restaurant. Inside, there are posters of
candy-colored iPods and a large Apple insignia, as well as a handful of
desks and computer terminals.

When someone in the United States buys an
iPhone<http://topics.nytimes.com/top/reference/timestopics/subjects/i/iphone/index.html?inline=nyt-classifier>,
iPad<http://topics.nytimes.com/top/reference/timestopics/subjects/i/ipad/index.html?inline=nyt-classifier>or
other Apple product, a portion of the profits from that sale is often
deposited into accounts controlled by Braeburn, and then invested in
stocks, bonds or other financial instruments, say company executives. Then,
when those investments turn a profit, some of it is shielded from tax
authorities in California by virtue of Braeburn’s Nevada address.

Since founding Braeburn, Apple has earned more than $2.5 billion in
interest and dividend income on its cash reserves and investments around
the globe. If Braeburn were located in Cupertino, where Apple’s top
executives work, a portion of the domestic income would be taxed at
California’s 8.84 percent corporate income tax rate.

But in Nevada there is no state corporate income tax and no capital gains
tax.

What’s more, Braeburn allows Apple to lower its taxes in other states —
including Florida, New Jersey and New Mexico — because many of those
jurisdictions use formulas that reduce what is owed when a company’s
financial management occurs elsewhere. Apple does not disclose what portion
of cash taxes is paid to states, but the company reported that it owed $762
million in state income taxes nationwide last year. That effective state
tax rate is higher than the rate of many other tech companies, but as Ms.
Clausing and other tax analysts have noted, such figures are often not
reliable guides to what is actually paid.

Dozens of other companies, including Cisco, Harley-Davidson and Microsoft,
have also set up Nevada subsidiaries that bypass taxes in other states.
Hundreds of other corporations reap similar savings by locating offices in
Delaware.

But some in California are unhappy that Apple and other California-based
companies have moved financial operations to tax-free states — particularly
since lawmakers have offered them tax breaks to keep them in the state.

In 1996, 1999 and 2000, for instance, the California Legislature increased
the state’s research and development tax credit, permitting hundreds of
companies, including Apple, to avoid billions in state taxes, according to
legislative analysts<http://www.lao.ca.gov/2003/randd_credit/113003_research_development.html>.
Apple has reported tax savings of $412 million from research and
development credits of all sorts since 1996.

Then, in 2009, after an intense lobbying campaign led by Apple, Cisco,
Oracle, Intel and other companies, the California Legislature reduced taxes
for corporations based in California but operating in other states or
nations. Legislative analysts
say<http://www.leginfo.ca.gov/pub/09-10/bill/asm/ab_0001-0050/abx3_15_cfa_20090215_133520_asm_floor.html>the
change will eventually cost the state government about $1.5 billion a
year.

Such lost revenue is one reason California now faces a budget
crisis<http://www.lao.ca.gov/analysis/2012/update/economic-revenue-update-022712.pdf>,
with a shortfall of more than $9.2 billion in the coming fiscal year alone.
The state has cut some health care programs, significantly raised tuition
at state universities, cut services to the disabled and proposed a $4.8
billion reduction in spending on kindergarten and other grades.

Apple declined to comment on its Nevada operations. Privately, some
executives said it was unfair to criticize the company for reducing its tax
bill when thousands of other companies acted similarly. If Apple
volunteered to pay more in taxes, it would put itself at a competitive
disadvantage, they argued, and do a disservice to its shareholders.

Indeed, Apple’s decisions have yielded benefits. After
announcing<http://files.shareholder.com/downloads/AAPL/1826229879x0xS1193125-12-182321/320193/filing.pdf>one
of the best quarters in its history last week, the company said it had
net profits of $24.7 billion on revenues of $85.5 billion in the first half
of the fiscal year, and more than $110 billion in the bank, according to
company filings.

*A Global Tax Strategy*

Every second of every hour, millions of times each day, in living rooms and
at cash registers, consumers click the “Buy” button on iTunes or hand over
payment for an Apple product.

And with that, an international financial engine kicks into gear, moving
money across continents in the blink of an eye. While Apple’s Reno office
helps the company avoid state taxes, its international subsidiaries —
particularly the company’s assignment of sales and patent royalties to
other nations — help reduce taxes owed to the American and other
governments.

For instance, one of Apple’s subsidiaries in Luxembourg, named iTunes S.à
r.l., has just a few dozen employees, according to corporate documents
filed in that nation and a current executive. The only indication of the
subsidiary’s presence outside is a letterbox with a lopsided slip of paper
reading “ITUNES SARL.”

Luxembourg has just half a million residents. But when customers across
Europe, Africa or the Middle East — and potentially elsewhere — download a
song, television show or app, the sale is recorded in this small country,
according to current and former executives. In 2011, iTunes S.à r.l.’s
revenue exceeded $1 billion, according to an Apple executive, representing
roughly 20 percent of iTunes’s worldwide sales.

The advantages of Luxembourg are simple, say Apple executives. The country
has promised to tax the payments collected by Apple and numerous other tech
corporations at low rates if they route transactions through Luxembourg.
Taxes that would have otherwise gone to the governments of Britain, France,
the United States and dozens of other nations go to Luxembourg instead, at
discounted rates.

“We set up in Luxembourg because of the favorable taxes,” said Robert
Hatta, who helped oversee Apple’s iTunes retail marketing and sales for
European markets until 2007. “Downloads are different from tractors or
steel because there’s nothing you can touch, so it doesn’t matter if your
computer is in France or England. If you’re buying from Luxembourg, it’s a
relationship with Luxembourg.”

An Apple spokesman declined to comment on the Luxembourg operations.

Downloadable goods illustrate how modern tax systems have become
increasingly ill equipped for an economy dominated by electronic commerce.
Apple, say former executives, has been particularly talented at identifying
legal tax loopholes and hiring accountants who, as much as iPhone
designers, are known for their innovation. In the 1980s, for instance,
Apple was among the first major corporations to designate overseas
distributors as “commissionaires,” rather than retailers, said Michael
Rashkin, Apple’s first director of tax policy, who helped set up the system
before leaving in 1999.

To customers the designation was virtually unnoticeable. But because
commissionaires never technically take possession of inventory — which
would require them to recognize taxes — the structure allowed a salesman in
high-tax Germany, for example, to sell computers on behalf of a subsidiary
in low-tax Singapore. Hence, most of those profits would be taxed at
Singaporean, rather than German, rates.

*The Double Irish*

In the late 1980s, Apple was among the pioneers in creating a tax structure
— known as the Double Irish — that allowed the company to move profits into
tax havens around the world, said Tim Jenkins, who helped set up the system
as an Apple European finance manager until 1994.

Apple created two Irish subsidiaries — today named Apple Operations
International and Apple Sales International — and built a glass-encased
factory amid the green fields of Cork. The Irish government offered Apple
tax breaks in exchange for jobs, according to former executives with
knowledge of the relationship.

But the bigger advantage was that the arrangement allowed Apple to send
royalties on patents developed in California to Ireland. The transfer was
internal, and simply moved funds from one part of the company to a
subsidiary overseas. But as a result, some profits were taxed at the Irish
rate of approximately 12.5 percent, rather than at the American statutory
rate of 35 percent. In 2004, Ireland, a nation of less than 5 million, was
home to more than one-third of Apple’s worldwide revenues, according to
company filings. (Apple has not released more recent estimates.)

Moreover, the second Irish subsidiary — the “Double” — allowed other
profits to flow to tax-free companies in the Caribbean. Apple has assigned
partial ownership of its Irish subsidiaries to Baldwin Holdings Unlimited
in the British Virgin Islands, a tax haven, according to documents filed
there and in Ireland. Baldwin Holdings has no listed offices or telephone
number, and its only listed director is Peter Oppenheimer, Apple’s chief
financial officer, who lives and works in Cupertino. Baldwin apples are
known for their hardiness while traveling.

Finally, because of Ireland’s treaties with European nations, some of
Apple’s profits could travel virtually tax-free through the Netherlands —
the Dutch Sandwich — which made them essentially invisible to outside
observers and tax authorities.

Robert Promm, Apple’s controller in the mid-1990s, called the strategy “the
worst-kept secret in Europe.”

It is unclear precisely how Apple’s overseas finances now function. In
2006, the company reorganized its Irish divisions as unlimited
corporations, which have few requirements to disclose financial
information.

However, tax experts say that strategies like the Double Irish help explain
how Apple has managed to keep its international taxes to 3.2 percent of
foreign profits last year, to 2.2 percent in 2010, and in the single digits
for the last half-decade, according to the company’s corporate filings.

Apple declined to comment on its operations in Ireland, the Netherlands and
the British Virgin Islands.

Apple reported in its last annual disclosures that $24 billion — or 70
percent — of its total $34.2 billion in pretax profits were earned abroad,
and 30 percent were earned in the United States. But Mr. Sullivan, the
former Treasury Department economist who today writes for the trade
publication Tax Analysts, said that “given that all of the marketing and
products are designed here, and the patents were created in California,
that number should probably be at least 50 percent.”

If profits were evenly divided between the United States and foreign
countries, Apple’s federal tax bill would have increased by about $2.4
billion last year, he said, because a larger amount of its profits would
have been subject to the United States’ higher corporate income tax rate.

“Apple, like many other multinationals, is using perfectly legal methods to
keep a significant portion of their profits out of the hands of the
I.R.S.,” Mr. Sullivan said. “And when America’s most profitable companies
pay less, the general public has to pay more.”

Other tax experts, like Edward D.
Kleinbard<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1791769>,
former chief of staff of the Congressional Joint Committee on Taxation,
have reached similar conclusions.

“This tax avoidance strategy used by Apple and other multinationals doesn’t
just minimize the companies’ U.S. taxes,” said Mr. Kleinbard, now a
professor of tax law at the University of Southern California. “It’s German
tax and French tax and tax in the U.K. and elsewhere.”

One downside for companies using such strategies is that when money is sent
overseas, it cannot be returned to the United States without incurring a
new tax bill.

However, that might change. Apple, which holds $74 billion offshore, last
year aligned itself with more than four dozen companies and organizations
urging Congress for a “repatriation holiday” that would permit American
businesses to bring money home without owing large taxes. The
coalition<http://www.winamericacampaign.org/>,
which includes Google, Microsoft and Pfizer, has hired dozens of lobbyists
to push for the measure, which has not yet come up for vote. The tax break
would cost the federal government $79 billion over the next decade,
according to a Congressional report.

*Fallout in California*

In one of his last public appearances before his death, Steven P.
Jobs<http://topics.nytimes.com/top/reference/timestopics/people/j/steven_p_jobs/index.html?inline=nyt-per>,
Apple’s chief executive, addressed Cupertino’s City Council last June,
seeking approval to build a new headquarters.

Most of the Council was effusive in its praise of the proposal. But one
councilwoman, Kris Wang, had questions.

How will residents benefit? she asked. Perhaps Apple could provide free
wireless Internet to Cupertino, she suggested, something Google had done in
neighboring Mountain View.

“See, I’m a simpleton; I’ve always had this view that we pay taxes, and the
city should do those things,” Mr. Jobs replied, according to a video of the
meeting <http://www.youtube.com/watch?v=gtuz5OmOh_M>. “That’s why we pay
taxes. Now, if we can get out of paying taxes, I’ll be glad to put up
Wi-Fi.”

He suggested that, if the City Council were unhappy, perhaps Apple could
move. The company is Cupertino’s largest taxpayer, with more than $8
million in property taxes assessed by local officials last year.

Ms. Wang dropped her suggestion.

Cupertino, Ms. Wang said in an interview, has real financial problems.
“We’re proud to have Apple here,” said Ms. Wang, who has since left the
Council. “But how do you get them to feel more connected?”

Other residents argue that Apple does enough as Cupertino’s largest
employer and that tech companies, in general, have buoyed California’s
economy. Apple’s workers eat in local restaurants, serve on local boards
and donate to local causes. Silicon Valley’s many millionaires pay personal
state income taxes. In its statement, Apple said its “international growth
is creating jobs domestically, since we oversee most of our operations from
California.”

“The vast majority of our global work force remains in the U.S.,” the
statement continued, “with more than 47,000 full-time employees in all 50
states.”

Moreover, Apple has given nearby Stanford University more than $50 million
in the last two years. The company has also donated $50 million to an
African aid organization. In its statement, Apple said: “We have
contributed to many charitable causes but have never sought publicity for
doing so. Our focus has been on doing the right thing, not getting credit
for it. In 2011, we dramatically expanded the number of deserving
organizations we support by initiating a matching gift program for our
employees.”

Still, some, including De Anza College’s president, Mr. Murphy, say the
philanthropy and job creation do not offset Apple’s and other companies’
decisions to circumvent taxes. Within 20 minutes of the financially ailing
school are the global headquarters of Google, Facebook, Intel,
Hewlett-Packard and Cisco.

“When it comes time for all these companies — Google and Apple and Facebook
and the rest — to pay their fair share, there’s a knee-jerk resistance,”
Mr. Murphy said. “They’re philosophically antitax, and it’s decimating the
state.”

“But I’m not complaining,” he added. “We can’t afford to upset these guys.
We need every dollar we can get.”

Additional reporting was contributed by Keith Bradsher in Hong Kong, Siem
Eikelenboom in Amsterdam, Dean Greenaway in the British Virgin Islands,
Scott Sayare in Luxembourg and Jason Woodard in Singapore.


-- 
Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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