Closed Apple grilled over tax avoidance

Apple chief executive officer Tim Cook takes the hot seat on Tuesday morning in Washington to answer questions about a tax planning strategy that has enabled it to avoid billions of dollars of taxes.

Carl Levin, chairman of the Senate investigations committee, set the tone with his opening remarks, noting that just in 2012, Apple had exploited tax loopholes allowing it to avoid $9bn in US taxes. Such practices, he said, did “real harm” to the US economy, disadvantaging domestic companies that don’t make use of “tax gimmicks”.

Mr Cook is due to testify later in the committee’s hearings on Tuesday morning. Join us here to see how he handles what has become a sensitive political issue for one of the US’s most successful companies.

You can watch the hearing here, read Mr Cook’s written testimony here and read the Senate committee’s report on Apple’s tax structure here.

It’s shaping up to be a hostile hearing for Cook. John McCain, in his opening comments, has just come out all guns firing, hitting out at what he called Apple’s “convoluted and pernicious strategies.” The American people, he says, will not tolerate it. This committee has taken aim at tax avoidance like this at other companies for some time – but with a high-profile target like Apple, members like McCain clearly feel they finally have chance to get some attention.

The Apple CEO won’t be up for a while. Two law professors are due to speak first – Richard Harvey of Villanova and Stephen Shay of Harvard. Meantime, Cook is getting some support from another Republican member of the committee, Rand Paul: he says instead of this “show trial” the committee should apologise to Apple and turn it’s attention to the real scandal – the US tax code.

Some half-hearted support for Apple from Prof Harvey: “I suspect that what Apple has done falls under the bounds of current international tax law.” He also says it isn’t as aggressive in its tax avoidance as some – it only shifted 64 per cent of its 2011 income into an Irish-incorporated entity that had no jurisdiction at all for tax purposes, whereas other companies might have gone even further.

Harvey has been explaining how Apple used its Irish subsidiaries to pay almost no tax on much of its international sales. “I think there will be some interesting publicity around the world to the lack of Irish taxes being paid,” says Harvey.

He’s right about that. The revelations about the Irish loophole that Apple’s profits slipped through have been making waves on the other side of the Atlantic today. This was UK Liberal Democrat MEP Sharon Bowles: “It is totally unacceptable that corporate tax avoidance is now the norm in Europe, aided and abetted by aggressive tax planning and tax consultancy firms.” She chairs the European Parliament’s economic and monetary affairs committee.

Chairman Levin is promising eight minutes of questions. Cook should be up soon after.

Prof Harvey sums up the issue the committee is grappling with: 39 per cent of Apple’s sales are in the US, but it books only 30 per cent of its profits there. But given that most of its R&D, design and other high-value work happens in the US, “the lion’s share” of the profits should really be recorded there.

Ahead of Cook’s appearance, the discussion in the committee has turned to the perennial questions: Why not just lower the US corporation tax rate, plug the loopholes, widen the tax base and adopt a territorial tax system more like those used by other countries? If they head down this road it could be a long morning.

John McCain: “Apple has violated the spirit of the law, if not the letter of the law.”

Rand Paul jumps back to Apple’s defence. On why there’s nothing wrong with tax avoidance: “If you say to your chief financial officer, Please maximise our tax burden, I don’t think that is anything shareholders would accept.”

The eight-minute Q&A period we were promised 48 minutes ago is still going on and we haven’t even got to the main dish yet. An unusually formal looking Tim Cook is waiting in the first row in a dark suit, white shirt and blue tie.

Right, that’s it. Cook is up. He’s accompanied by Peter Oppenheimer, Apple’s chief financial officer, and Phillip Bullock, head of tax operations.

Cook gives his opening statement. “We are proud to be an American company.” It’s a paean to the entrepreneurial spirit, beginning with an evocation of Steve Jobs starting out in a garage.

“Apple is responsible for creating or supporting 600,000 jobs,” says Cook

“Apple has real operations in real places, with Apple employees selling real products to real customers. We pay all the taxes we owe, every single dollar.”
He’s going over the same material as in the testimony filed yesterday, saying that the US tax system has not kept up with the digital age.
“The tax system handicaps American corporations in relation to our foreign competitors who don’t have such constraints on the free movement of capital.”

“Apple has always believed in the simple, and not the complex,” insists Cook. He recommends a “dramatic simplification of the corporate tax code”: lower corporate income tax rates and a reasonable tax on foreign earnings.
This would likely result in an increase in Apple’s US taxes, he says, but would keep America globally competitive.

Now Apple’s CFO, Peter Oppenheimer, is making his opening remarks. He’s talking about Apple’s subsidiaries.

Irish subsidiaries were established in the 1980s, Oppenheimer says. A cost sharing agreement with Irish subsidiaries was put in place when Apple was 5 years old. Today the substance of the agreement is largely unchanged, he says. The cost sharing agreement is common in the industry and completely legal.

More than half of our ongoing R&D costs are funded by Apple Ireland. When Apple lost money in the 1990s, so too did its Irish subsidiary. He’s talking about Apple’s dark days in 1997. A big part of the turnaround was to streamline and simplify to survive, making it as simple as efficient. Consolidated post-tax income into 2 subsidiaries. The consolidation eliminated enormous complexity in handling foreign bank accounts and manage currency risk.

For many years ASI has had thousands of employees in Ireland. “The face that AOI and ASI are not tax resident in Ireland does not reduce Apple’s US taxes at all,” says Oppenheimer. Apple could manage its after-tax profits with lots of other subsidiaries but it would still make no difference to tax paid in the US, and would be less efficient, he says.

He says that the decision to raise debt to fund the buyback, rather than repatriate offshore cash, was in the best interest of shareholders, given low interest rates.
And that concludes Apple’s opening remarks.

Chairman Levin is digging into the structure of Apple’s Irish subsidiaries, asking where they are controlled and incorporated. We know where he’s going with this: How did it manage to come up vehicles that weren’t tax resident in any nation?

“AOI does not have a tax residency. That does not mean that it does not pay taxes,” says Phillip Bullock, Apple’s head of tax operations. US taxes are paid in full on its interest, which runs into tens of billions of dollars, he says.
The income earned by ASI and AOE has been subject to Irish tax in accordance with the agreement that we have with Ireland, where the rate is 2 per cent.
In the last 5 years it has received dividends from its operating subsidiaries of around $30bn, Bullock says.
But it has not filed a corporate income tax return, is that correct? asks Levin.
That is correct, says Bullock, because it’s not subject to US tax. Levin now asking about where the IP resides.

Now Senator McCain is questioning Mr Cook.
He says that Cook is a smart but tough guy, which he says is a compliment. Do you feel bullied by this committee? McCain asks.
I feel good to be participating in this. I’d like for comprehensive tax reform to be passed this year, says Cook. I think it’s important that people hear our story directly from me. “I wasn’t dragged here.”

McCain asks: Couldn’t one draw the conclusion that you and Apple have an unfair advantage over smaller, domestic based companies that don’t have the same ability to locate overseas?
That’s not the way that I see it, says Cook.
Apple pays 30.5% of its profits in the US. We do have a low tax rate outside the US, but this tax rate is for products that we sell outside the US, not within. “There is no shifting going on that I see at all.”

Why does AOI exist, asks McCain. 4000 employees is impressive but not next to Apple’s overall workforce.
Cook says AOI was created in 1980 – before even the Mac was announced. Apple wanted to distribute its products outside the US.
Is that still operative today, McCain asks.
Yes, says Cook. We built up a significant skills base there, to serve the European market. AOI is nothing more than a holding company – a concept many companies use, not an operating company. The dividends that go into this holding company have already been taxed appropriately in their local jurisdiction.
McCain asks: “To a great advantage to Apple, wouldn’t you agree?”
Cook replies that it’s just about an efficient way to manage cash. “AOI does not reduce our US taxes at all,” he insists, again.

Cook is pitching this entirely to a Washington audience. He’s brushing off the Irish structure as something that is only about lowering taxes elsewhere. Wonder how that’s playing in Europe.

McCain: When you look at that avoidance or relief of 30.5% tax burden – you said the purpose of AOI was to ease administrative burdens. But isn’t it obvious that you aren’t bearing the same tax burden that you are bearing in the US? I’m not saying that’s wrongdoing but it gives Apple a significant advantage.
Cook: I see this differently. Apple’s earning these profits outside the US.
McCain ends on a light note, saying that what he really wanted to ask was why he has to keep updating his iPhone apps all the time?
Cook smiles and says he’s working on it.
With that friendly banter, they’re off for a short recess.

Cook has handled it well so far. He faced down McCain, who went in hard at the outset. And his very direct, buck-stops-here statement that he wanted people to hear it from him direct was well judged, it seemed to take a lot of the sting out of the questioning.

The Committee is reconvening now after the break. Senator McCaskill leads off by saying that any good American business does tax planning. “But I do hope that I can understand better why the structure you’ve used has been embraced so we make it simpler and support international growth,” she says.

McCaskill: Clearly you made a decision that it was going to be cheaper to service debt and use the cash to pay dividends rather than bring the cash back from offshore. How much cheaper?
Cook: our weighted average cost for the borrowing we just did was less than 2 per cent – versus 35 per cent to repatriate.

Apple keeps coming back to this line that it was a small company when it started up its Irish operations – and now it has 4,000, skilled employees.
McCaskill: if you got a good deal from Ireland in 1980, how do we simplify the US tax code, without letting another country in emerging markets undercut us like Ireland did?
Cook: the barrier is repatriating cash at 35 per cent level. My proposal is that we eliminate all corporate tax expenditures and get to a reasonable tax on bringing money back. He doesn’t want a zero tax rate, which he says is different to his peers.

McCaskill: What keeps Apple from moving out of California?
Cook: We are proud to be an American company. We are there because we love it there, and this is where we can create things.
McCaskill: So it’s an intangible?
Cook: it’s who we are as people. We are an American company whether we are selling in China or Egypt. It has never entered my mind, honestly senator, of moving our California HQ to another country. It’s beyond my imagination – I have a pretty wild imagination, but it’s beyond it.

McCaskill: Should you be able to deduct the interest on the debt?
Cook: It could be one of the corporate expenditures to do away with. It would be a very small percentage of the tax we pay overall. But it’s certainly one of the things I think this group should talk about.

Cook: Today everything we sell in the US is taxed in the US. For a foreign country, generally speaking, it’s taxed in the local market and then if it’s one of the countries that are being served from Ireland, those units are generally sold by an Irish subsidiary. That income is taxed to the degree it needs to be in the local jurisdiction, then proceeds moved to an Irish sub, AOI, which then invests Apple’s earnings – which are in turn then taxed in the US.

McCaskill: Are any proceeds parked in Ireland under the aegis of intellectual property?
Apple’s Bullock: No – 100 per cent of any sale is fully taxed in the US, there is no outbound payments going offshore.

Senator Johnson is asking about the disparity between US sales and income.
Cook says that the Mac business is a larger percentage of sales in the US than internationally. IPhone became a larger percentage of international business than US business. Generally the iPhone has higher gross margins than Macs – so the international business carries higher margins than our domestic business.

Johnson: You have full time IRS agents doing a full time audit nonstop?
Bullock: That’s correct.
Johnson: they look at the corporate structure and transfer prices and ensure you’re following tax law?
Bullock agrees.
Johnson now asks who Apple’s shareholders are, since they are benefiting from this.
Oppenheimer: Our top 50 shareholders own about half the company – these include mutual funds, public employee retirement funds and individual “retail” shareholders.
Johnson: so those folks benefit by not paying out taxes to foreign governments. What other taxes does Apple generate – what could you take credit for?
Oppenheimer: $325m paid in federal employment taxes and $100m over the last couple of years in property taxes. Last year Apple collected, remitted and paid approx $1.3bn in sales tax.

Bullock says Apple paid $900m in international income taxes around the world last year, and that will be larger this year. That includes employee payroll tax, VAT and GST that is collected and remitted around the world.
Apple has 50,000 of its 75,000 employees in the US – an imbalance to its 60 per cent overseas sales, mainly due to its retail stores.

Cook says that to incent a huge number of companies to bring back their cash from overseas it would need to be a taxed at a single-digit percentage rate. Apple would bring back a lot of its cash, he says, and help to stimulate US growth.

How important is it to change the tax code, asks Senator Ayotte.
Cook says: It’s vital to do, it’s great for America to do. We would have a much stronger economy if we did that – it would create jobs and increase investment.

Cook: The US is advantaged if more capital moves into the country – it would strengthen our economy. It has to be a reasonable tax on doing so. “Apple does not support a temporary tax holiday.” The tax code needs to be reformed for a long time… “It’s important for business to be predictable.”

Senator Ayotte goes off topic for a second: the advantages of being based in the US are the intellectual property protections. Apple has faced challenges in China – can you tell us what those are? How do we address this IP protection with our international partners?
Cook says: We’ve faced more significant issues in other countries than China. I think that the US court system is currently structured in such a way that it’s very difficult to get the protection a technology company needs because our cycles are very fast and the court system is very long. Foreign or US competitors can quickly take certain IP and ship products with it before the court rules.
We require much more work on IP in this country as well, Cook continues. For us, our IP is so important to our company, I would love the system to be strengthened in order to protect it.

Senator Portman now takes the mic.
He wants to reform the code to make American companies more competitive. “The international tax code is a relic of the 1960s,” he says. Almost all of the US’s industrial competitors have moved to a territorial tax system, he says, including the UK. I think that’s the right way to go.
$1.5-2 trillion is locked up overseas, he says.

Meanwhile, Microsoft is unveiling its new games console, “Xbox One”.

Samsung is one of Apple’s biggest competitors, Mr Cook agrees.
South Korea has a much lower tax rate than the US, says Sen Portman, but it appears Apple and Samsung pay about the same global tax rates.
Portman says it’s worse for Apple because it can’t bring its cash home, a problem which Samsung does not face.

Apple has about 36 people working on its taxes. “The tax return I sign each year is two feet tall or greater,” CFO Oppenheimer says.

Chairman Levin: You bring the profits home from South America don’t you?
Cook: I would guess there is some cash in South America, I don’t know sir.
Levin: you shifted IP to three companies in Ireland that don’t exist for tax purposes. That’s your choice – you did that in a transfer price agreement. But you didn’t shift it for sales in the Americas, isn’t that right?
Bullock: the economic rights for IP for distribution in America is owned by Apple Inc. In Europe it is owned by the Irish subsidiaries.
Levin: so the profits in the Americas outside the US are paid here, right?
Bullock: any residual profit is subject to US tax in full.
Levin: So you’re bringing those profits home? in Canada, Mexico.
Bullock: Those profits are generated by the US company, I would argue.
Levin: But it doesn’t in Europe? Is there any doubt that Apple could write its agreement with its subsidiaries in any way it liked?
Bullock argues it’s an arm-length agreement. Levin is challenging him: but both signatories are Apple employees?
They all work for Apple Inc, Bullock concedes.
Cook objects to the way Levin is characterising this. But the chairman is continuing – three Apple employees signed away the “crown jewels” of Apple’s IP to an Irish company. He’s really going after Apple now.
“You shifted the most valuable thing you have – the economic rights to your IP. The thing that produces your profits.”

Apple brings home profits from Mexico and Canada and South America, says Levin – so it can bring home the profits from Ireland. It’s Apple’s decision.

Cook wants to respond to the chairman’s comments but Levin is pressing him.
“I have no current plans to bring the profits back at the current tax rates,” says Cook. “Your comment sounds like it’s forever. I’m not saying it’s forever – I have no idea how the world made change.”

Levin: you have a right to shift the IP in the same way that you have a right not to shift it in the Americas.
“OK here’s where we’re at – you’ve got $100bn in profits that are sitting there – you say it’s your current intent you are not going to pay your taxes on them, because you don’t need to pay your taxes on those – the economic value has been shifted.”
Bullock says Apple disagrees with Levin’s characterisation.

Apple: “It began in 1980.”
Levin: “We’ve been through the history. You signed that agreement in 2008 – it continued to shift the economic rights to Irish companies under your control.”
Oppenheimer: I respectfully disagree.
Levin: in 2008, totally under Apple’s control – “let’s not kid ourselves about that” – that agreement could have been changed. “You are in control – it’s your company. You had a right to make a decision. let’s not kid ourselves as to the implications of what this means in terms of America’s revenue. I’m not saying it’s illegal. I’m not saying it’s legal. I’m saying you made a decision… to continue that arrangement.”

Oppenheimer continues to insist that this is just the way Apple has done business for 30 years. “Customers love the iPhone and the iPad,” he says.
Levin: “We love the iPhone and the iPad – people in Mexico and Canada love the iPhone. I have one here. My granddaughter even knows how to use it.
“But those IP were not transferred there. The continuation of that system means most of your profits worldwide are sitting in Irish companies that don’t pay taxes. You can defend it but that’s the result.
“There is a huge drain as a result – 95 per cent of the creativity is in California but two thirds of the profits is in Ireland,” Levin continunes.

Levin continues his tirade:

We’re proud you are an American company. We are glad you’re where your at. But the result of these arrangements are that most of your profit are in Ireland – these companies that don’t exist anywhere except on the water. Of course we’ve got to change this system – but in order we have got to change it, not deny it. What is going on is a huge loss of revenue to the US because these corporations – and you are the biggest one – can shift profits to where American companies don’t pay tax on it.

We can’t continue a system where a successful company can make a decision in 2008/9 as to where the profits are going to flow.

Levin continues:

Folks, it’s not right – that decision, the way it is decided so unilaterally, that a company can shift its value to a tax haven, which is what Ireland is.

I applaud you for your constructive view. It’s not easy to come under a spotlight. It’s important for us, who have to rewrite these laws, to change it in a sensible way.

And that’s the end of the Apple execs panel.
Levin thanks Cook and his colleagues.
Cook says “Thank you Mr Chairman” and exits.

Levin finished with a long harangue over transfer pricing that had Apple’s tax official looking uncomfortable. After a pretty muted hearing, it looked like a deliberate piece of political theatre to put Apple on the spot and justify Levin’s decision to run this session. But Tim Cook and his colleagues should still feel they got away well from what could have been a far more damaging hearing.

Bullock was rattled at times on the details, but Cook looked pretty clam throughout. An impressive display of statesmanship. Although the chairman did not allow him to defend Apple after his closing condemnation.

That concludes our liveblog for today. Thanks for tuning in. More analysis on Apple and US tax reform coming soon to