Tax avoided by Apple is due to the US Treasury

‘Bizarre’ finding says the US animal is alive, Irish, worth ¤13bn and living in the basement of Apple’s Cork HQ , writes Colm McCarthy

IN 1935 Albert Einstein and two co-authors published an article in an academic journal called the Physical Review about the problem of quantum superposition, the idea that a subatomic particle exists in a combination of several alternative states. The act of observation affects the particle making it select just one of these states. The Austrian physicist Erwin Schrodinger concocted a thought experiment to illustrate the point. A cat is enclosed in a lead box with a device which might or might not have released a fatal dose. When the box is opened, the cat will prove to be either dead or alive: prior to the act of observation it must be deemed both dead and alive simultaneously.

If you find subatomic physics hard to follow, stay away from international tax accounting. There has been a Schrodinger cat residing in the basement of Apple’s Hollyhill headquarters in Cork since 1991. It is called Apple Sales International and is a very large animal indeed. It has few employees but has assets in the hundreds of billions.

Viewed from the headquarters of the US Internal Revenue Service in Washington it appears to be an Irish cat, free from US taxation until the billions get remitted to the Land of the Free. But viewed from the office of the Irish Revenue Commissioners it is (or was) a Bermudan cat, exempt from taxes in Ireland and happily there are none in Bermuda. The tax accountants had apparently been able to strip the beast of any nationality whatsoever and hence this particular very large unit of Apple of any liability to corporation taxes.

The company points out that it pays significant corporation taxes around the world, including in Ireland, through its other units and it is not correct to allege that Apple pays no taxes. But Apple avoided a large part of its potential tax liability through adroit use of corporate tax structures deemed within the Irish tax laws. The rules permitting the tax alchemy in Cork were changed last year, accounting for the extraordinary once-off 26pc jump in Ireland’s 2015 GDP reported some weeks back, as well as a boost to Ireland’s corporation tax receipts.

Since the changes last year, Irish-registered companies can no longer claim to be stateless. The European Commission opened Schrodinger’s box last Tuesday and declared the cat to have been both alive and Irish for the 10 years up to 2014. It therefore owes the Irish Government €13bn in back taxes, plus interest. The European Court of Justice will eventually determine whether the Commission has decided the animal’s nationality correctly and might even conclude that the competition directorate has strayed into areas where it lacks competence.

But the economic reality of the matter is clear. This cat is American, always has been American and the tax avoided by Apple is logically due to the US Treasury, if it is due to anybody at all. In economic substance, the Commission’s decision is ‘bizarre’, the description chosen by Finance Minister Michael Noonan. But in legal terms, the Commission could prevail: the connection between international tax law and economic reality is not close.

In its press release last Tuesday, the Commission invited the treasuries of the other EU member states to help themselves to a share of the spoils, potentially endowing the once-stateless cat with an embarrassment of nationalities. The full 150-page report on which the Commission’s decision was based has not been released. A crucial issue, since the Commission’s case rests on its powers under state-aid rules, is whether the arrangements availed of by Apple constitute a special deal or were available to other multinationals operating here. If they were available to all, the Commission could lose its case at the European Court, since there will have been no distortion of competition. Until the full report, which presumably contains the evidential basis for the Commission’s decision, is released, it will be impossible to say much more — the Irish Revenue people insist that there was no special deal.

The European Commission has been supportive of efforts, led by the OECD club of developed countries, to agree a new basis called BEPS for the taxation of multinationals which would curtail the opportunities for tax-dodging. Tax would be payable in the country in which the substantive economic activity actually occurred, in Apple’s case largely in the USA. The decision announced last Tuesday to make Apple retrospectively liable for €13bn plus interest, and designating the Irish Exchequer as the lucky recipient, is not consistent with this interpretation.

The Commission must believe that it has found evidence of some failure, amounting to special treatment, in the Irish deal with Apple.

Writing in last Friday’s Irish Times, Cliff Taylor appears to have identified where the problem could lie: Apple was not using a manoeuvre called the ‘Double Irish’, a tax-friendly corporate structure popular with multinationals based here and in the process of being phased out. The corporate structure at Apple may have been unique and the Commission seems confident that there was thus some special treatment, hence potentially a breach of state-aid rules.

Since both Apple and the Government are committed to appealing the decision through to the European Court, the matter will take several years to resolve. In the meantime, the European Commission is in the incongruous position of supporting the OECD’s plans for a rational distribution of corporate tax to the appropriate jurisdiction while awarding Ireland a slice of enormous profits earned outside Ireland by one of America’s largest companies.

There is a deeper issue for Irish policy, whatever the outcome of this extraordinary case. The long-established strategy of encouraging foreign direct investment through a low corporate tax rate has acquired an ugly sister-policy.

This consists of facilitating multinationals based here to dodge taxes logically due elsewhere, through deft manipulation of corporate structures and double tax treaties. It is this sister-policy which has caused the rift with the Commission. The beneficiary companies have been mainly American, reflecting both their preponderance in Ireland and weaknesses in the system of corporate taxation in the US. The apparent impatience with Ireland in some continental European countries is not readily explained — the tax being dodged in Ireland would not be heading their way under the more rational system that is emerging.

Ireland’s favourable regime, stripped back to its original content of the 12.5pc tax rate, is also becoming less attractive as corporate tax rates around the world are reducing rapidly. Fifteen of the EU’s 28 current members have rates at 20pc or below and several of those with higher rates manage to dilute the impact with various cunning loopholes. The United Kingdom rate is 20pc and the government’s stated intention is to reduce it further. Ireland’s competitors are heading, with encouragement from the OECD, towards the kind of tax code we thought we had initially, a low rate without loopholes.

This poses a challenge to fashion a policy for the future which will support Irish as well as foreign companies through the development of non-tax competitiveness. It is regularly asserted that multinationals come here for the skilled workforce and business-friendly policies, not just for tax breaks. That contention is likely to be tested in the years ahead.

‘The apparent impatience with Ireland in some continental countries is not readily explained’