The Wrongologist

What’s
Wrong Today:

Yesterday,
we discussed the Deficit Hawks and the Republicans’ viewpoint that America
doesn’t need more tax revenues in order to reduce and eventually eliminate the
Deficit. Most who are not captured by corporate
lobbyists understand that lower corporate taxes have not provided
either more jobs, or more revenue to help support the commons.

Our
society works best if those who enjoy its benefits are also prepared to pay
their share of the costs. The chart below shows that individuals have
paid about the same percentage of total federal revenues since the 1930’s,
while corporations’ share has fallen dramatically:

This chart
shows that corporate tax receipts declined approximately 50% (as a percentage
of GDP) from roughly 4.8% in 1959 to 2.4% in 2011.

And the
chart below
shows the decline of corporate tax receipts (as a percentage of corporate
profits) from 77% in 1959 to roughly 25% in 2011.

Corporate tax avoidance has become an
epidemic in America. It is the result of allowing lobbyists to draft our
tax regulations. All taxpayers play by the rules as written. Aside from
outright tax evasion and money laundering, which is illegal, tax minimization
within legal boundaries is perfectly rational. Companies would not willingly
pay more taxes and earn a lower return on capital than they do today without a
fight.

What is
avoidance worth?

In July,
2012, the Tax Justice Network released an updated version of a report showing that $21 trillion
and possibly as much as $32 trillion have been siphoned out of the global economy
into tax shelters. According to The BBC,
the low-end
figure is equivalent to the size of the US and Japanese economies combined. The
Economist reports that: (emphasis by the
Wrongologist)

Yesterday,
we reported that Apple, Inc. represented $83 billion of that $21 trillion. Let’s
take a closer look at Apple’s tax avoidance strategies:

Apple’s
state tax avoidance

According
to the New York Times, Apple uses a
small office in Reno Nev. to avoid millions of dollars in state taxes in
California and 20 other states. Although Apple’s headquarters are in Cupertino,
CA, its Reno office, 200 miles away, collects and invests much of the company’s
profits, allowing Apple to avoid state income taxes. California’s corporate tax
rate is 8.84% while Nevada’s is 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. In 2006, Apple established
a Nevada subsidiary named Braeburn Capital to manage and invest the company’s
cash.

Braeburn
is a variety of apple that is simultaneously sweet and tart.

Whenever
someone in the United States buys an Apple product, a portion of the profits
from that sale is deposited into accounts controlled by Braeburn and then
invested in stocks, bonds or other financial instruments. Those profits are shielded
from tax authorities in California by virtue of Braeburn’s Nevada domicile. Nevada
has no state corporate income tax and no capital gains tax

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. What’s more,
Braeburn allows Apple to lower its taxes in 20 other states, because those
jurisdictions use formulas that reduce what is owed when a company’s financial
management occurs elsewhere.

Apple’s
global tax strategy

While
Apple’s Reno office helps the company avoid state taxes, its international
subsidiaries and the company’s assignment of sales and patent royalties to
other nations, help reduce taxes owed to the American and other governments.

For
instance, Apple’s subsidiary in Luxembourg, named iTunes S.à r.l., controls global
iTunes sales.

Luxembourg
has just half a million residents, but when customers across Europe, Africa or
the Middle East download a song, television show or app, the sale is recorded
in Luxembourg.

In 2011, iTunes S.à r.l.’s revenue exceeded
$1 billion, representing roughly 20% of iTunes’s worldwide sales.

The reason
is simple. Luxembourg taxes the payments collected by Apple and numerous other
tech corporations at very low rates if they route transactions through their
country. 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.

Downloadable
goods illustrate how government tax systems are increasingly ill equipped for tracking
sales in an economy dominated by electronic commerce.

In the
1980s, Apple was among the first major corporations to designate overseas
distributors as “commissionaires,” rather than retailers.  Since commissionaires never technically take
possession of inventory — which would require them to recognize taxes — the
structure allows a salesman in high-tax Germany, for example, to sell computers
on behalf of a subsidiary in low-tax Singapore.

Hence, those
profits would be taxed at Singaporean, rather than at German, rates.

The
“Double Irish”

In the
late 1980s, Apple used a tax structure, known as the “Double Irish” to move
profits into tax havens around the world. Apple created two Irish subsidiaries,
named Apple Operations International and Apple Sales International. 

The arrangement
allowed Apple to move ownership of patents developed in California to Ireland.
That allowed patent royalties due to move to the Irish subsidiary. As a result,
profits were taxed at the Irish rate of approximately 12.5%, rather than at the
American statutory rate of 35%. By 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 figures)

Moreover,
the second Irish subsidiary, the “Double”, allowed other profits to flow to
tax-free companies in the Caribbean. Apple assigned partial ownership of its
Irish subsidiaries to Baldwin Holdings
Unlimited in the British Virgin Islands, a tax haven.

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.

These
strategies help explain how Apple has managed to keep its international taxes
to 1.9% on its earnings outside the US in its last fiscal year, according to a
regulatory filing by the company. They had $713 million in tax on foreign
earnings of $36.8 billion in the fiscal year ended Sept. 29.

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 by a former Treasury Department economist,
Martin A. Sullivan. Mr. Sullivan said:

Apple isn’t the enemy here, Congress is.

Our tax
systems must be reformed. We need to take that job away from corporate lobbyists. We must make it harder for companies to use
internal (“transfer”) pricing to avoid tax. Companies should be made to book
activity where it actually takes place.

Any new
system needs to ensure that change results in corporations paying more in taxes
with less collection/compliance expenses. The new system must be simpler than
today’s.

Make it simple. More complexity creates
more avoidance opportunities.

If we can’t make our lawmakers reform the tax code and drastically reduce avoidance,
then we should just keep quiet, pay our taxes, accept the need for austerity,
help out our banks when they are in need, and most importantly, vote for the
Deficit Hawks in our next election and let them look after our best interests.