Dealing at arms-length: sinking dubious tax havens
The global reputation of many behemoth multinationals has been tarnished by their dubious international tax arrangements. Among the worst offenders are Apple, Google and Starbucks. From 2009 to 2011 Apple alone managed to avoid taxes on $44 billion of its global profits. An Australian Financial Review investigation reveals since 2002 Apple has only paid $193 million in Australian tax, whilst recording $27 billion of sales over that period. It begs the question: how can such a well-known multinational, like Apple, engage in blatant tax avoidance within Australia’s sophisticated tax system?
The two key entities driving Apple’s tax avoidance are Apple Inc and Apple Sales International. Apple Inc (US) is responsible for sales in the US, and importantly has legal ownership of the majority of Apple’s intellectual property in the US. Apple Sales International (ASI) is based in Ireland and is responsible for engaging third party manufactures, namely China, to produce its products. ASI then supplies the Apple products to its In Country Distributors who then sell the products to various vendors.
Australia’s tax jurisdiction
Australia has adopted the common worldwide (residency-based) rules to define the jurisdictional limits of its tax laws. Accordingly, Australia taxes residents on both its domestic and foreign sources of income, whilst it taxes foreign residents on their domestic source income (being their income derived within Australia). This then means that Apple’s Australian distributor will be liable for the tax on all of its sales derived from within Australia.
To get around this, Apple engages in transfer pricing practices to reduce its distributor’s tax liabilities. This primarily involves ASI imposing a mark-up for the right of its distributors to use its intellectual property. For example Apple’s Australian distributor may purchase a Macbook from ASI for $1000 and sell it to vendors for $1100 (where the true cost may only be a fraction of this price). Consequently, the mark-up reduces the arbitrage on the sale price and cost price of an Apple product, which reduces the distributor’s profits and ultimately its tax liability.
Apple’s tax haven
This transfer pricing effectively syphons its Australian profits, untaxed, to ASI. As ASI is not a tax resident in Australia and doesn’t derive income from Australia, it does not pay taxes on its taxable income in Australia. However, ASI must pay tax somewhere. Right? The answer is ASI still manages to next to nothing in tax on its profits.
ASI takes advantage of a loophole in Irish and US tax laws which enable it to avoid paying tax in either country. In Ireland a company is a resident for tax purposes if its central management is based in that country. Conversely, in the US a company is a resident for tax purposes if it is incorporated in the US. ASI is incorporated in Ireland and its central management is in the US, therefore it is not liable to pay tax in either country. This enables ASI to reroute its Australian profits to Singapore, where it pays a withholding tax, and then to Ireland where it pays no tax.
Australia’s arm-length transfer pricing rules
The most obvious way to put an end to Apple’s profit shifting is for legislative co-operation between Ireland and the US to close the tax jurisdiction loophole. However, this loophole greatly benefits Apple, and any change would face fierce opposition from its lobbyists.
Australia has a transfer pricing regime in subdivision 815 of the Income Tax Assessment Act (Cth) 1997 which can address the profit shifting arrangement between ASI and its Australian distributor. The rules enable the Commissioner of Taxation to treat transactions between related parties as reflecting arms-length conditions (i.e. transactions on commercial terms). The transactions between ASI and its distributors are clearly not at arms-length as ASI is charging an exorbitant amount (being an uncommercial rate) for the right to use Apple’s intellectual property. Therefore, subdivision 815 could enable the Commissioner to compel Apple’s Australian distributor to report profits that would exist if ASI charged a commercial rate for its IP.
However, there are various problems with Australia’s transfer pricing rules, and more generally around the world, that enable Apple to avoid them. First, Apple is not obliged to report its intra-group transactions (i.e. transactions between ASI and its distributors), and therefore an information asymmetry exists between companies and tax authorities. As a result, the Commissioner of Taxation has difficulty identifying transactions that should be treated at arms-length.
Secondly, Australia’s arms-length rules under subdivision 815 focuses on transactions relating to ‘functions performed, assets used and risks assumed’. However, Apple is able to circumvent the rules by shifting part of its R&D costs from Apple Inc to Apple Sales International. This is done to show ASI has assumed the risk of developing its products, and therefore permits ASI to impose an IP mark-up. In reality, the risks relating to R&D never leave the company as ASI and Apple Inc belong to the same corporate group.
Fortunately, the OECD is in the process of developing new rules that prevent companies receiving income from intangibles, such as IP assets, simply by shifting the costs of R&D between intra-entity groups. Given the global nature of Apple’s corporate structure, an international body such as the OECD is best suited to co-ordinate the development of new transfer pricing rules. Hopefully these rules will see the addressing of the shortfalls in current transfer price regimes. Ultimately, Apple should be brought to bear the full extent of its tax burden.
Antony Ting, ‘itax – Apple’s International Tax Structure and the Double Non-Taxation Issue’,  British Tax Review No 1
Katie Walsh, Transfer pricing ruling core issue in Apple’s profit shifting, Australian Financial Review at http://www.afr.com/p/technology/transfer_pricing_rules_core_issue_OvzcB7ybbCrkvwOTBkjEINn
OECD, Discussion Draft—Revision of the Special considerations for Intangibles in Chapter VI of the OECD Transfer Pricing Guide lines and Related Provisions (2012) (the Discussion Draft), 12
Stephen Barkoczy, Foundations of Tax Law, (6th ed)
Antony Ting, itax – Apple’s International Tax Structure and the Double Non-Taxation Issue,  British Tax Review No 1, 43
Image: ‘Protesting Against Apple’s Tax Policy – Dublin Street Art’ by William Murphy, https://flic.kr/p/nhLhoz. Licence at https://creativecommons.org/licenses/by-sa/2.0/.