The voices of Tax Policy Center's researchers and staff
U.S. lawmakers are not alone in their frustration over Apple’s success at avoiding corporate income taxes by shifting reported profits to other countries. News organizations in Australia report that since 2002 Apple has paid only $193 million of Australia corporate income tax on domestic revenues of $27 billion – an income tax equal to just 0.7 percent of gross receipts.
If the analysis is correct, does Australia have a legitimate beef? Should Apple be paying Australia more? And, if not, where should Apple report its income?
The simple story is as follows: Apple licenses its technology to a contract manufacturer in China that produces iPads sold in Australia. Apple engages in marketing activities in Australia but its patents and other intellectual property (IP) are owned by an Apple subsidiary in Ireland, which receives a significant share of Apple’s worldwide profits. Apple pays only a 12.5 percent corporate tax rate in Ireland and avoids even some of this tax by shifting its reported profits to Bermuda, which has no income tax. This is perfectly legal.
Under current rules for taxing multinational companies, the country where the income is generated (the source country) gets the first bite. The United States (along with a few other countries) taxes the worldwide income of resident corporations, but allows firms to both take a credit for foreign income taxes they pay and defer tax on the active profits of their controlled foreign subsidiaries until the profits are repatriated back to the U.S. parent. Thus, Apple pays no U.S. corporate income tax on its active foreign-source profits as long as these profits remain overseas.
The value of iPads sold in Australia is generated from three sources: 1) Apple’s IP, 2) manufacturing of the tablets, and 3) marketing activities. The source of the income from manufacturing and local marketing is clearly China and Australia. Australia’s income tax collections reflect the return from local marketing activities, which are a very small share of the total value of Apple sales. But who should get the IP profits?
Is it Ireland, home of an Apple subsidiary that is treated as an independent firm even though it is owned by the U.S. parent? Or perhaps it is Bermuda, if Apple can shift the income there? The current rules allow this, but the idea that an Irish or Bermuda company, with little more than an office and a handful of employees, is generating a large share of Apple’s profits doesn’t meet a smell test, even if it is legal.
It is just this type of arrangement, combined with competitive and political pressures for countries to protect their home-based multinationals, that has led the OECD, at the request of the G20, to establish its Base Erosion and Profit Sharing (BEPS) process aimed at preventing profit shifting to low-tax countries.
If Apple is barred from reporting IP profits in Ireland, where should it report them? The income could be allocated to the United States, where most of the IP assets were originally developed. The Camp tax reform plan moves in that direction by requiring U.S.-based multinationals to report more of their low-taxed IP profits as current U.S. taxable income, albeit at a reduced rate for non-U.S. sales. This solution makes sense for profits from the iPad, which was developed in California.
But this answer is not always so clear-cut. An increasing number of companies are decentralizing their R&D operations. And because IP assets support production wherever it occurs, they don’t really have a single home.
Another solution would copy a model used by U.S. states: allocate worldwide profits based on some combination of tangible assets, employment, and sales. But with Apple using an independent contract manufacturer in China, its employees and factories would escape this allocation method. The Chinese company is taxable in China on its manufacturing profits, but these profits do not reflect the value of Apple’s IP.
That takes us back to Australia. No current theory of international corporate taxation – whether based on the source of profits or the residence of the corporation – supports the Aussies claim that they should tax a bigger share of Apple’s profits based on sales of iPads there. The Apple corporate group is not resident in Australia and very little of the value from Australian sales is generated there. However, some tax experts would allocate IP profits by sales of the multinational group, on the theory that firms would not forgo sales in a country to lower the tax rate on their worldwide profits. Under this type of destination-based tax, Australia might have a larger claim to the revenue after all.
There is no obvious answer to this conundrum. Those profits should be reported somewhere. The $64 billion question is: Where? A lot of countries would like a chunk of all that potential tax revenue.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.