How To Close The Loopholes That Made Apple’s Tax-Dodging Completely Legal

Apple CEO Tim Cook testified Tuesday before the Senate Permanent Subcommittee on Investigations, following that panel’s report that Apple has avoided tens of billions of dollars in U.S. tax liability through complex, lawful multinational structures. Cook was the latest head of a major technology company to face Senate scrutiny for its corporate tax behavior, after the same panel summoned Microsoft and Hewlett-Packard executives in September 2012.

Just as his competitors did before the same Senate panel last fall, Cook defended his company’s tax strategies as both legal and in his shareholders’ interests. Cook’s endorsement of corporate tax reform was more specific than the broad support Microsoft executive Bill Sample offered last year. But his support for lowered rates, closed loopholes, and doctrinaire reforms is unlikely to take the heat off the eye-popping tax behavior that inspired the hearing.

The panel’s investigation found, with Apple’s cooperation, that the company’s three Ireland-based subsidiaries “have no tax jurisdiction at all,” as The Guardian explains, allowing it to shelter tens of billions in sales from not just U.S. but all taxation.

The complex arrangement includes three subsidiaries, based ostensibly in Ireland, which appear not to be designated as tax resident anywhere, the committee said. A source on the committee called them “iCompanies – I for imaginary, invisible”.

The commitee said that the arrangement, described by one senator as “the epitome” of tax-avoidance schemes, allowed Apple to pay only very small amounts of tax on much of its overseas profits, thanks to the Irish companies that exist “nowhere” for tax purposes. […]

One of those Irish affiliates, Apple Sales International (ASI), reported sales income of $74bn over four years but paid hardly any tax. In 2011 ASI had pre-tax earnings of $22bn but paid just $10m in tax, a rate of 0.05%.

Citizens for Tax Justice says Apple is holding fully $102 billion in untaxed offshore cash. The Financial Times notes Apple is careful to maintain appearances, however. It’s reported tax rate of 25.2 percent for 2012 “is an accounting entry and has no effect on the actual amount of taxes paid,” which amount to more like a 15 percent effective tax rate.

Throughout the hearing, both senators and witnesses repeatedly acknowledged that Cook and his fellow executives are indeed operating within the law. The dispute is over how policymakers should respond to a corporate tax code so riddled with loopholes and bad incentives that Apple and other multinationals behave in this way. As corporations have manipulated the flaws in that tax code and payroll taxes have increased, working people have replaced companies as a primary source of tax revenue:

One response to the flawed corporate code, supported by many businesses, would be to offer a tax holiday on repatriated profits currently sheltered overseas. Congress tried such a holiday before, and it was a massive failure. Cook’s rejection of this approach was heartening, but the rote ‘simplification’ of the system he repeatedly endorsed amounts to what’s known as a territorial approach, whereby loopholes are closed and the tax code is rewritten such that companies pay U.S. taxes on U.S. revenues.

For all their simplicity, such territorial systems encourage an international race to the bottom on corporate taxation, as Europe has discovered. Last week, Bloomberg’s Jesse Drucker detailed the perverse corporate tax outcomes created by European policymakers who talk about making it harder to dodge taxes but whose policies actually make it easier.

Threading the policy needle between race-to-the-bottom territorial policy, tax holiday giveaways, and the current ineffective legal web is quite difficult. But economist Alan Auerbach has one idea, explained in a paper jointly published by the Center for American Progress and the Hamilton Project, that would seem to balance both government and corporate interests. Auerbach suggests that multinational companies pay their taxes only in the countries that use their products, so that moving money across borders doesn’t alter the taxes they owe in any given country. Tim Fernholz of Quartz explains that Auerbach’s idea strips “the ability to move US profits overseas” artificially, as present law has encouraged Apple to do. With a few other tweaks, this could make it more attractive to invest in the U.S.

So far, today’s hearing has not entertained this notion of destination-based taxation on multinational activity. But it’s the sort of Gordian Knot approach to a longstanding, costly policy tangle that might appeal to the head of a company that once made “Think Different” its global slogan.