Friday, June 14, 2013

Levin and Hodge on Apple and Google

The MNC tax debate continues.  It is due to be on the agenda for the upcoming G8 Summit in Fermanagh but there is little prospect of anything substantive emerging next week, though some changes over the coming years are likely, possible through the OECD.

At present, the focus remains on domestic tax systems to respond to the problem of taxing large MNCs whose profits are based on mobile intellectual property.  The recent investigations into Apple and Google have received significant attention here with a lot of comment on how Ireland is perceived.  What sometimes gets overlooked is what the leaders of the debate in the US and UK actually want to happen.  The changes they recommend are to their domestic tax regimes.

First, here is Sen. Carl Levin on Apple:

Apple is exploiting an absurdity, one that we have not seen other companies use. The absurdity need not continue. Although the United States generally looks to where an entity is incorporated to determine its tax residency, it is possible to penetrate an entity’s corporate structure for tax purposes, and collect U.S. taxes on its income, if the entity is controlled by its U.S. parent to such a degree that the shell entity is nothing more than an “instrumentality” of its parent, a sham that should be treated as the parent itself rather than as a separate legal entity. AOI, AOE and ASI all sure seem to fit that description.

Take AOI. AOI has no owner but Apple. AOI has no physical presence at any address. In thirty years of existence, AOI has never had any employees. AOI’s general ledger, its major accounting record, is maintained at Apple’s U.S. shared service center in Austin, Texas. AOI’s finances are managed by Braeburn Capital, an Apple Inc. subsidiary in Nevada. Its assets are held in a bank account in New York. 

AOI’s board minutes show that its board of directors consists of two Apple Inc. 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 7 of those meetings, six by telephone, and in none of the 18 board meetings between September 2006 and August 2012.

ASI’s circumstances are similar. Prior to 2012, ASI, like AOI, had no employees and carried out its operations through the action of a U.S.-based board of directors, most of whom were Apple Inc. employees in California. Of ASI’s 33 board meetings from May 2006 to March 2012, all 33 took place in Cupertino.

In short, these companies’ decision makers, board meetings, assets, asset managers, and key accounting records are all in the United States. Their activities are entirely controlled by Apple Inc. in the United States. Apple’s tax director acknowledged to the Subcommittee staff that it was his opinion that AOI is functionally managed and controlled in the United States. The circumstances with ASI and AOE appear to be similar.

Our legal system has a preference to respect the corporate form. But the facts here present this issue:  Are these offshore corporations so totally controlled by Apple Inc. that their identity as separate companies is a sham and a mere instrumentality of the parent, and if so, whether Apple’s claim that AOI and ASI owe no U.S. taxes is a sham as well?

Second, here is Margaret Hodge MP on Google:

Google generates enormous profits in the UK. But despite an $18 billion turnover between 2006 and 2011 it paid the equivalent of just $16 million in taxes to the UK government.

Google brazenly argued before this committee that its tax arrangements in the UK are defensible and lawful. It claimed that its advertising sales take place in Ireland, not in the UK.

This argument is deeply unconvincing and has been undermined by information from whistleblowers, including ex-employees of Google, who told us that UK based staff are engaged in selling. The staff in Ireland simply process the bills. Google also conceded at this second hearing that its engineers in the UK are contributing to product development.

The company’s highly contrived tax arrangement has no purpose other than to enable the company to avoid UK corporation tax.

Confidence in HMRC has also been weakened. It is extraordinary that the department did not challenge Google over the complete mismatch between the company’s supposed structure and the substance of its activities.

In the conclusions and recommendations of the report from the committee (page 5) it states:

Any common sense reading of HMRC’s own guidance and tests suggests HMRC should vigorously question Google’s claim that it is acting lawfully. In contrast to evidence given to us previously, Google has also conceded that its engineers in the UK are contributing to product development and creating economic value in the UK We note that HMRC has never challenged an internet-based company in the Courts on the question of its permanent establishment.

The key issues in both cases refer to the interpretation and implementation of domestic tax law rather than tax avoidance loopholes provided by the Irish tax system (though Ireland clearly facilitates the use of these strategies by the MNCs).

Sen. Carl Levin is clear that the holding companies used by Apple should be judged to be an “instrumentality” of the US parent and thus subject to US tax law. Margaret Hodge MP is clear that the activities of Google should be judged as a “permanent establishment” in the UK and thus subject to UK tax law.  Ireland has nothing to do with these domestic concerns.

Would the changes that Levin and Hodge propose end the tax avoidance strategies of Apple and Google?  No. 

If the Apple holding companies were deemed by the IRS to be resident in the US for tax purposes, Apple could simply move the companies to Bermuda and use the “Double-Irish” loophole to continue to defer its US corporate tax liabilities. 

If Google’s operations were deemed by HMRC to be a permanent establishment, Google UK could enter a “cost-sharing agreement” with Google Ireland and continue to transfer its profits to Ireland (and subsequently to Bermuda) via royalty payments on its intellectual property.

The chase to tax MNC profits may have begun but there will be a huge number of twists and turns before they are caught, if ever.

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