Apple mired in a mess entirely of its own making

After the EU ordered Apple to pay billions in back taxes to Ireland this week Apple chief executive Tim Cook chose to indulge in populist rhetoric — "it's political crap" — and did not try to refute the detailed allegations levelled against the company by the European Commission.

Doubtless, Cook did what he thought was right; the media, at large, is on Apple's side and is not particularly inclined to meticulously examine things. More so in the US, where the American government is painting this as some kind of victimisation of US companies.

But Apple's corporate structure does merit some attention.

{loadposition sam08}The late Steve Jobs was the one who set up Apple's operations in Cork, Ireland, back in 1980. Apple has provided employment to thousands and the attractive corporate tax rate that Ireland offers — 12.5% — has resulted in a host of international companies setting up office there.

EU competition commissioner Margrethe Vestager. Courtesy the European Commission

But in Apple's case, the tax rate was much, much lower. According to the detailed European Commission statement, Apple paid corporate tax at the rate of 1% in 2003 and this declined to 0.005% in 2014.

One of its companies registered in Ireland is Apple Operations Europe.

Apple has another entity incorporated in Ireland: Apple Sales International. And where it starts to become really interesting is the fact that this entity has what is referred to as a "head office" in the EC statement that generated massive profits but paid no tax at all!

Under the setup in Ireland, Apple Sales International buys all Apple products from equipment manufacturers around the world and sells them in Europe, the Middle East, Africa and India.

Customers who buy these products in the geographical regions listed buy them contractually from Apple Sales International, and not from the sales outlets in these regions. As a result, all profits from these sales are recorded in Ireland.

Internal allocations of these profits were governed by two tax rulings issued by Ireland, one granted in 1991 and then replaced by one granted in 2007. The latter was terminated when Apple Sales International and Apple Operations Europe changed their structures last year.

Graphic courtesy the European Commission.

The two rulings allowed Apple to split its profits for tax purposes: most profits were directed to the "head office" within Apple Sales International.

Here it is pertinent to note that the US Congress inquired into Apple's tax gymnastics in 2013. And to borrow some material from but US Senator Carl Levin who was speaking at the inquiry, an unit called Apple Operations International, part of Apple's corporate setup, generated US$30 billion in profits between 2009 and 2012, but paid no corporate income at all.

And here is Levin again: "AOI's board minutes show that its board of directors consists of two Apple employees who live in California and one Irish employee of Apple Distribution International, an Irish company that AOI itself owns.

"Over the last six years, from May 2006 through the end of 2012, AOI held 33 board meetings, 32 of which took place in Cupertino, California. AOI's lone Irish-resident director participated in just seven of those meetings, six by telephone, and in none of the 18 board meetings between September 2006 and August 2012."

Phillip Bullock, the head of tax operations for Apple, told the US Senate committee in 2013 that "AOI is incorporated in Ireland; thus, under US law it is not tax resident in the US." But then his next sentence was: "AOI is also not tax resident in Ireland because it does not meet the fact-specific residency requirements of Irish law."

Curious is probably a mild way of describing such statements. Unsurprisingly, only Levin and Republican John McCain were somewhat forensic in their queries; the rest of the inquiry panel gave Cook, who appeared before them, an easy ride.

The EC statement had this to say about the "head office": "This 'head office' was not based in any country and did not have any employees or own premises. Its activities consisted solely of occasional board meetings. Only a fraction of the profits of Apple Sales International were allocated to its Irish branch and subject to tax in Ireland. The remaining vast majority of profits were allocated to the 'head office', where they remained untaxed."

Any company would kill for an arrangement like this.

And the amount of money that Apple saved through this complicated arrangement was huge. The EC statement again: "In 2011, for example (according to figures released at US Senate public hearings), Apple Sales International recorded profits of US$22 billion (€16 billion) but under the terms of the tax ruling only around €50 million were considered taxable in Ireland, leaving €15.95 billion of profits untaxed. As a result, Apple Sales International paid less than €10 million of corporate tax in Ireland in 2011 – an effective tax rate of about 0.05% on its overall annual profits."

But wait, there's more. Apple Operations Europe also had a "head office" to which most of its profits were diverted. The EC says: "The company was responsible for manufacturing certain lines of computers for the Apple group. The majority of the profits of this company were also allocated internally to its 'head office' and not taxed anywhere."

When Apple chief executive Tim Cook was interviewed after the EC order was issued, he wasn't asked about the nitty-gritty of these set-ups, which can only be described as devious.

He was asked general questions and thus was able to spin his way out of any troublespots. As the days go on, Apple will, no doubt, turn on the charm and try to paint itself as the innocent in this case.

It may well take years for the appeal by Apple to be heard. And while the Irish cabinet has decided to appeal as well, a motion for parliament to back its decision will come up only next Wednesday (6 September).

The gory details are likely to be only examined in court.