Apple: Tax Dodgers or Smart Managers?

Apple may have surpassed Levis as the most globally recognizable American brand. Its products are everywhere. Its iconic logo is instantly recognized, as is the distinctively stylish design of its iPods, iPads, iPhones, MacBooks, and iMacs. After a period of struggle in the 1990s, Apples founder Steve Jobs returned to head the company. It has since achieved incredible financial success. With a stock price of $530 in October of 2013, its market capitalization was more than $480 billion. In 2012 it surpassed Exxon-Mobil to become the most highly valued publicly traded company in history. Apples profits in 2012 were $41.7 billion on sales of $165.5 billion. Earnings per share that year were $44.15.

The company is headquartered in the United States, where it employs 52,000 of its approximately 80,000 worldwide workforce. Most of these workers, both in the United States and globally, are not involved in the manufacture of Apple products. Apple has outsourced the manufacture and assembly of much of its production, notably to Chinese factories. (The Foxcomm facility in China has been the subject of ongoing complaints about labor practices, especially involving work hours and production schedules.) Although products are often developed in Apples U.S. facilities, they have primarily been produced elsewhere since the late 1990s. Most of Apples engineers, technical specialists, and designers are employees of Apple in California, and almost all of Apples research and development occurs in the United States.

Since the 1980s, Apple has had a number of subsidiaries incorporated in Ireland. Apple created an arrangement in which the Irish subsidiaries share proportional costs for product development but also proportionally split the revenue from the intellectual property rights derived from that product development. Locating subsidiaries in Ireland is attractive for U.S. firms because of the relatively lower Irish corporate tax rate. Many U.S. companies have taken advantage of this lower tax rate and the relatively educated Irish workforce. However, Apples arrangement has been especially lucrative for the company. Apple successfully negotiated a tax rate of approximately 2% with the Irish government, well below the already low 12% nominal Irish corporate tax rate.

Apples Irish subsidiaries are responsible for sales of Apple products throughout the world, with the exception of the Americas. Those non-American sales represent about 60% of Apples worldwide sales. That means the Irish subsidiaries pay 60% of the development costs and reap 60% of the sales of Apple products.

Apple products produced by third-party manufacturers and assemblers in China are sold to either Apple in the United States or Apple Sales International in Ireland. Apple Sales International takes only legal title, not physical possession of the products. It sells those products to Apple distributers across the globe for a premium on what was paid to the manufacturer and distributes its profit to its ultimate Irish parent, Apple Operations International. In the four years from 2009 to 2012, Apple Sales International registered income of $74 billion, almost twice the amount of the U.S. business. Apple Operations International, in turn, accounts for about 30% of Apples worldwide profits.

Interestingly, both Apple Operations International and Apple Sales International are skeletal operations. Apple Operations International has no employees. Its two directors and one corporate officer are employees of other Apple firms. Apple Sales International only recently acquired employees of its own. Its workforce now totals about 250.

Even more interesting is the fact that the Irish subsidiaries are not residents of any country for tax purposes. U.S. law taxes businesses based on their country of incorporation. Irish law, on the other hand, taxes businesses based on the location of management and control. This effectively means that 60% of Apples sales are credited to subsidiaries that have next to no tax liability in any country because the Irish companies are incorporated in Ireland but their operations are managed from California. Apple Operations International paid no tax to any government during the period 20092011. Its Irish subsidiary, Apple Sales International, reported paying $21 million on sales of $38 billion for an effective tax rate of 0.06%.

As a result of its structuring of subsidiaries in Ireland, Apple has been able to attribute significant amounts of its sales and profits to organizations that have no or few employees, that have minor roles in the development of Apple Products, and that manufacture exceedingly small percentages of Apple products. It is no wonder, then, that the U.S. Senate initiated hearings in the spring of 2013 into whether Apple was inappropriately structuring operations to avoid paying U.S. taxes. In a rare show of bipartisanship, Senators Carl Levin and John McCain chastised Apple CEO Tim Cook for establishing offshore operations that had no apparent business purpose other than tax avoidance. Although the Senate hearings were an uncomfortable experience for Apple, it received good news from the SEC in October of 2013. The SEC ruled that Apples strategy was perfectly acceptable under the law.

Apples tax strategy is legal according to the SEC. Is it sometimes the case that legal actions fail to live up to moral obligations? When and Why?

What responsibility do you believe a corporation has to support the communities in which it operates and from which it derives benefits?

Should businesses be required to establish a clear business purpose, other than tax avoidance, before the law permits a subsidiary structure such as Apple employs?

Are Apples executive strategists merely exhibiting an intelligent approach to maximizing profits? Or is this a case in which the goal of maximizing profits has crossed a line of corporate responsibility?