How Apple sidesteps billions in taxes

Apple, the world’s most profitable technology company, doesn’t design iPhones here. It doesn’t run AppleCare customer service from this city. And it doesn’t manufacture MacBooks or iPads anywhere nearby.

Yet, with a handful of employees in a small office in Reno, Nevada, Apple has done something central to its corporate strategy: it has avoided millions of dollars in taxes in California and 20 other states. Apple’s headquarters are in Cupertino, California. By putting an office in Reno, just 200 miles away, to collect and invest the company’s profits, Apple sidesteps state income taxes on some of those gains.

California’s corporate tax rate is 8.84 per cent. Nevada’s? Zero. Setting up an office in Reno is just one of many legal methods Apple uses to reduce its worldwide tax bill by billions of dollars each year. As it has in Nevada, Apple has created subsidiaries in low-tax places like Ireland, the Netherlands, Luxembourg and the British Virgin Islands — some little more than a letterbox or an anonymous office — that help cut the taxes it pays around the world.

Almost every major corporation tries to minimise its taxes, of course. For Apple, the savings are especially alluring because the company’s profits are so high.

Apple serves as a window on how technology giants have taken advantage of tax codes written for an industrial age and ill suited to today’s digital economy. Some profits at companies like Apple, Google, Amazon, Hewlett-Packard and Microsoft derive not from physical goods but from royalties on intellectual property, like the patents on software that makes devices work.

Other times, the products themselves are digital, like downloaded songs. It is much easier for businesses with royalties and digital products to move profits to low-tax countries than it is, say, for grocery stores or automakers. A downloaded application, unlike a car, can be sold from anywhere.

The growing digital economy presents a conundrum for lawmakers overseeing corporate taxation: although technology is now one of the nation’s largest and most valued industries, many tech companies are among the least taxed, according to government and corporate data.

Over the last two years, the 71 technology companies in the Standard & Poor’s 500-stock index — including Apple, Google, Yahoo and Dell — reported paying worldwide cash taxes at a rate that, on average, was a third less than other S&P companies’. (Cash taxes may include payments for multiple years.)

Even among tech companies, Apple’s rates are low. And while the company has remade industries, ignited economic growth and delighted customers, it has also devised corporate strategies that take advantage of gaps in the tax code, according to former executives who helped create those strategies.

Apple, for instance, was among the first tech companies to designate overseas salespeople in high-tax countries in a manner that allowed them to sell on behalf of low-tax subsidiaries on other continents, sidestepping income taxes, according to former executives. Apple was a pioneer of an accounting technique known as “Double Irish With a Dutch Sandwich,” which reduces taxes by routing profits through Irish subsidiaries and the Netherlands and then to the Caribbean. Today, that tactic is used by hundreds of other corporations — some of which directly imitated Apple’s methods, say accountants at those companies.

Without such tactics, Apple’s federal tax bill in the US most likely would have been $2.4 billion higher last year, according to a recent study by a former Treasury Department economist, Martin A Sullivan. As it stands, the company paid cash taxes of $3.3 billion around the world on its reported profits of $34.2 billion last year, a tax rate of 9.8 per cent. By comparison, Wal-Mart last year paid worldwide cash taxes of $5.9 billion on its booked profits of $24.4 billion, a tax rate of 24 per cent, which is about average for non-tech companies. Apple’s domestic tax bill has piqued curiosity among corporate tax experts because although the company is based in the US, its profits — on paper, at least — are largely foreign. While Apple contracts out much of the manufacturing and assembly of its products to other companies overseas, the majority of Apple’s executives, product designers, marketers, employees, research and development, and retail stores are in the US. 

Apple’s accountants have found legal ways to allocate about 70 per cent of its profits overseas, where tax rates are often much lower, according to corporate filings. Neither the government nor corporations make tax returns public, and a company’s taxable income often differs from the profits disclosed in annual reports. In Apple’s last annual disclosure, the company listed its worldwide taxes — which includes cash taxes paid as well as deferred taxes and other charges — at $8.3 billion, an effective tax rate of almost a quarter of profits.

However, tax analysts and scholars said that figure most likely overstated how much the company would hand to governments because it included sums that might never be paid. Apple, in a statement, said it “has conducted all of its business with the highest of ethical standards, complying with applicable laws and accounting rules.” It added, “We are incredibly proud of all of Apple’s contributions.”  Apple “pays an enormous amount of taxes, which help our local, state and federal governments,” the statement said. “In the first half of fiscal year 2012, our US operations have generated almost $5 billion in federal and state income taxes, including income taxes withheld on employee stock gains, making us among the top payers of US income tax.”

The statement did not specify how it arrived at $5 billion, nor did it address the issue of deferred taxes, which the company may pay in future years or decide to defer indefinitely. The $5 billion figure appears to include taxes ultimately owed by Apple employees. The sums paid by Apple and other tech corporations is a point of contention in the company’s backyard.

In 2006, as Apple’s bank accounts and stock price were rising, company executives came here to Reno and established a subsidiary named Braeburn Capital to manage and invest the company’s cash.

When someone in the US buys an iPhone, iPad or other Apple product, a portion of the profits from that sale is often deposited into accounts controlled by Braeburn, and then invested in stocks, bonds or other financial instruments, say company executives.

Then, when those investments turn a profit, some of it is shielded from tax authorities in California by virtue of Braeburn’s Nevada address. Since founding Braeburn, Apple has earned more than $2.5 billion in interest and dividend income on its cash reserves and investments around the globe. If Braeburn were located in Cupertino, where Apple’s top executives work, a portion of the domestic income would be taxed at California’s 8.84 per cent corporate income tax rate.

But in Nevada there is no state corporate income tax and no capital gains tax. What’s more, Braeburn allows Apple to lower its taxes in other states — including Florida, New Jersey and New Mexico — because many of those jurisdictions use formulas that reduce what is owed when a company’s financial management occurs elsewhere. Dozens of other companies, including Cisco, Harley-Davidson and Microsoft, have also set up Nevada subsidiaries that bypass taxes in other states. Hundreds of other corporations reap similar savings by locating offices in Delaware.