Apple, the iconic producer of iPhones and iPads, has been front and center of recent headlines resulting from the European Commission’s investigation of Ireland for providing the company with tax breaks that allegedly should be considered anti-trust violations. Like any other major multinational, Apple has received its fair share of criticism for its tax planning strategies. In this instance, it is being accused of using countries such as Ireland for attaining tax treatment that is more favorable than what’s available to other firms. According to the EU, Ireland was allegedly providing “state aid” to Apple through these low tax deals, and now the EU is demanding Apple pay Ireland up to 13 billion euros (roughly $14.6 billion) in back taxes, interest included.
This is part of a broader anti-tax avoidance crusade spearheaded by supranational entities with corporations serving as the perfect scapegoats. On the surface, these moves by the European Commission might be standard corporation-bashing grandstanding, but there is a much larger endgame at play – global taxation rules. The immediate victim in this discussion is Ireland and its sovereignty in matters of taxation. But the implications go much farther. This Apple case is the perfect storm for the European Commission, which is hoping it can ignite anti-corporate sentiments, while at the same time advancing its global taxation agenda.
For a better understanding of the context of the Apple controversy, this article will seek to analyze the following:
- The business practices of Apple and tax laws of Ireland that were deemed irregular by the European Commission
- The international players involved in this case
- The real agenda pursued by the EU
- Potential solutions to this controversy
Apple’s tax practices
Apple and many other multinational firms have expanded their operations across the globe through the establishment of subsidiary companies outside of their country of domicile. Such moves are economically logical in an increasingly globalized world that requires more localized knowledge in running global operations. Additionally, such incentives to establish subsidiaries abroad have been propelled by tax policies that make it uneconomical for companies to maintain the bulk of their operations in their country of origin.
From a practical perspective, this means that companies often engage in substantial transactions between the parent company and foreign subsidiaries, as well as between those subsidiaries. Pricing these intra-company transactions (a.k.a., transfer pricing) is a very important issue in the field of global tax policy since governments are paranoid that firms understandably will attempt to minimize profits in high-tax nations and maximize their earnings in low-tax jurisdictions.
The practice of transfer pricing has earned many corporations, especially Apple, great criticism from self-styled tax justice advocates and international authorities alike. Essentially, transfer pricing involves the exchange of goods or services between two or more divisions of the same company. Large firms with subsidiary divisions that are treated as separate entities are closely watched by national tax authorities as they use transfer pricing to conduct internal transactions.
Transfer pricing and similar tax planning strategies are nothing new in the realm of international business. It is the logical response to increasingly complex tax regimes that make it harder for businesses to maintain their operations in their country of origin.
Companies have a fiduciary obligation to their workers and shareholders, so opting for a low-tax environment is an optimal and understandable strategy for promoting the welfare of the aforementioned parties.
This nuance is overlooked by activist bureaucrats and political figures, both of whom are constantly looking for ways to collect as much tax revenue as possible to finance their extravagant welfare states. As already noted, the popular perception is that multinationals are under-stating profits in high-tax nations and booking profits in lower-tax nations. While the desire for tax transparency is laudable, the complex situations that both businesses and nations find themselves in are largely the fault of misguided fiscal policy.
Globalizing a domestic problem
Globalization has brought unprecedented degrees of economic prosperity to individuals worldwide through the voluntary exchange of goods, services and ideas. Sadly, onerous tax policy has effectively become internationalized, as entities such as the EU and OECD are working to take the complex tax policies of some of their member countries and turn them into international standards (a.k.a., so-called “best practices”) for all nations to follow.
The latest Apple probe is not just confined to the EU; it has also drawn the U.S. into the mix. At first glance, the U.S. Treasury correctly points out that the EU is targeting American companies like Apple in a way that could undermine global tax policy in the future. However, close analysis past actions of the U.S. in matters of international taxation paint another picture – one that is based on national self-interest as opposed to genuine tax reform.
The U.S. sees the EU’s action as more of a move to take away the American government’s ability to collect tax revenue. Even though the U.S. may have reasonable fiscal policies in certain areas when compared to the EU, it is not exempt from the desire to get their hands on as much tax revenue as possible, be it through its high levels of corporate taxation, its aggressive system of worldwide taxation, or its enthusiastic quest to establish a global tax collecting apparatus through laws such as the Foreign Account Tax Compliance Act (FATCA).
What is really at stake
The logic behind the EU’s classification of Ireland’s tax policy as a “subsidy” is rather strange when one contemplates the meaning of the word. Generally speaking, subsidies are a form of financial payment or special favor given to individuals or industries at the expense of taxpayers and/or consumers. These money transfers are generally for the sole benefit of a narrow sector of society – politically connected industries in these instances – in the name of the public good. And there are plenty of unambiguous examples of government subsidies for companies, including the Export-Import Bank in the United States.
What Ireland offered Apple and countless other corporations, however, are by no means subsidies. Competitive policies of low taxation and wholesale reductions of government involvement in the economy are the complete opposite of subsidies. Subsidies involve the government literally aiding industries through taxpayer-funded transfers, but that’s not the case with Ireland and Apple. Ireland has built a solid reputation for its low corporate tax policies, most notably a corporate tax rate of 12.5 percent (and even lower when Irish-based subsidiaries have non-Irish-source income), that have allowed it to become an attractive hub for multinational corporations.
Unfortunately, in the eyes of Brussels, Ireland’s low corporate taxes are viewed as unfair competitive advantages. When Ireland provides tax rates below the EU bureaucrat’s desired targets, it is immediately branded as country that is providing unfair state aid, and thus must be punished.
Beyond questions of the appropriate rate of taxation, EU bureaucrats ultimately want control over their member countries’ fiscal decision-making. Such a supranational vision of how tax policy is conducted has the potential of undermining the sovereignty of EU member states while also threatening to create a system that will facilitate ever-rising tax burdens.
The EU Commission’s proposal involves a retroactive replacement of present Irish tax law with a vision of what the original law should have been its eyes. If the EU has its way, retroactive rulings of this kind will generate increased degrees of legal uncertainty for corporations. This could potentially compel corporate prospects to look elsewhere in search of more institutionally sound environments. Consumers and everyday people ultimately end up losing out from the loss of valuable services provided by corporations – cheap goods, investment, and jobs – once these businesses have no choice but to take their operations elsewhere.
Resolving the tax conundrum
It would behoove Western governments to reconsider their current approach to taxation. In his letter to European Apple customers, current Apple CEO Tim Cook offered the more rational suggestion of taxing company profits where economic value is actually created. The best approach to handling tax disputes is to effectively “de-globalize” the situation and pursue more territorial means of taxation. Once fiscal issues become globalized, international bureaucracies will only magnify the degree of red-tape and bureaucracy that is involved, consequently leading to polices that not only are bad for shareholders, but also consumers and workers.
Tax policy is already complicated at the domestic level, and internationalizing the issue with global bureaucracy in the mix will add more problems. If EU countries are concerned with transfer pricing policies, they already have mechanisms in place that can make transfer pricing policies conform with arms-length standards. There is no need for top-down decrees that deprive countries of their ability to set their own fiscal policies.
What the Apple case is indicative of is the need for countries – U.S. and EU countries alike – to simplify their tax codes and lower their tax rates. Supranational organizations such as the EU and the OECD have a knack for turning simple matters into bureaucratic boondoggles.
The overarching trend of tax competition between jurisdictions has been a fixture of the world economy for the past few decades, and with very positive results. Tax rates have become more reasonable, and competition has allowed corporations to freely move their operations to locations where they face less burdensome taxation and regulations. In turn, countless citizens benefit from the increased investment and productive activity that these businesses provide.
While it may be troubling that corporations that would otherwise keep their operations domestically end up going abroad, policymakers would be wise to not pursue punitive measures against these corporations. This would only create a vicious cycle of interventions that may actually aggravate current economic problems, instead of actually striking at the very root of the problem – the flawed system of taxation. Hopefully, cooler heads will prevail and more territorial-based alternatives to taxation are put forward by policymakers in the near future.
In the meantime, perhaps Ireland should respond to the current tax attack in the same way it reacted to an EU-instigated attack on its tax system almost 20 years ago. Back in the 1990s, Ireland had a 30 percent tax rate for some companies, but a 10 percent tax rate for manufacturers and financial companies. The EU asserted this was unfair, obviously hoping to force Ireland to impose a 30 percent rate on all firms. Ireland turned lemons into lemonade, however, by instead adopting its iconic 12.5 percent rate.
Today, the EU has ruled that Ireland’s tax system is unfair because Irish companies (or, in this case, the Irish subsidiaries of foreign companies) sometimes pay lower tax rates on income earned outside of Ireland than they pay on their Irish-source income. Why that’s an antitrust violation is a mystery, but Ireland should once again snatch victory from the jaws of defeat by adopting a tax rate – perhaps 5 percent – that is universally applicable.
One suspects the EU bureaucrats will rue the day they launched another fiscal attack on Ireland.