Public discussions often frame the question as “How does Apple not pay income tax?” The technically accurate framing is different: Apple does pay income taxes, but historically it has achieved very low effective tax rates on certain portions of its global profits through lawful international tax planning. The distinction matters. The issue is not nonpayment, but rather the strategic use of corporate structuring, intellectual property (IP) migration, transfer pricing, and deferral rules that—until recent reforms—allowed substantial profit shifting.
Essentially, Apple games the system by aggressively manipulating the Internal Revenue Code and tax treaties to save billions of dollars in taxes. 9 Billion and counting to date. The Apple plan may work for any company whose assets can be sold anywhere in the world because the nature of the business allows for forming the necessary subsidiaries in tax havens (countries that have no income tax) while still maintaining the ability to conduct computer-generated sales.
For example: if Apple sells IPhone or IPad app in the United States, the sale produces federally taxable gross revenue. However, if the same IPhone or app is sold through an offshore haven, no federal revenue is generated for US tax purposes. Therefore, Apple is not taxed on the income generated from the sale of the IPhone or app until it is repatriated to the US, if ever.
Apple takes advantage of the laws of Ireland. Ireland has recently enacted numerous laws to attract foreign investors. Apple uses a technique known as the “Irish-Dutch Sandwich.” For tax planning reasons it is known as a sandwich because it involves more than one different countries, much like Hungary, Lichtenstein, and Switzerland are used to practically eliminate capital gains taxes that foreign investors would normally be paid on capital gains to the US for gains in real property or securities.
Apple’s “Irish-Dutch Sandwich”
Intellectual property is transferred from the U.S. corporation to a subsidiary established in Ireland. The subsidiary is managed by individuals residing in a Caribbean tax haven country such as the Cayman Islands, Nevis, Bermuda, or the British Virgin Islands. A sale is generated in Ireland. However, the gross proceeds of the sale are quickly transferred to an offshore tax haven in order to avoid taxation in Ireland. Under Irish law, the company established in that jurisdiction is not taxed due to the fact that the manager resides outside of that jurisdiction. (Typically, a corporation is a tax resident of the country where it is incorporated. This is not the case under Irish law. Under Irish law, a corporation is a tax resident where its manager resides.)
Therefore, an entity can incorporate and conduct business in Ireland. However, if its management is located in a tax haven jurisdiction such as the ones discussed above, the corporation is considered incorporated in the tax haven jurisdiction, not Ireland.
However, by virtue of the corporation maintaining its domicile in Ireland, it can utilize tax friendly agreements amongst European Union members. For instance, Apple next takes the sales revenues which were generated in Ireland, transferred to a non-Irish country, and finally diverted to the Netherlands. The Netherlands charges only a small tax on royalty income from the sale of ITunes or apps and since it is within the European Union, there is no tax withholding or tax between Ireland and it. It should be noted that rock groups such as the Rolling Stones and U2 have transferred sales from worldwide record sales to the Netherlands to avoid paying taxes in their home countries.
Pre-2017 U.S. Deferral Rules
Before the enactment of the Tax Cuts and Jobs Act (TCJA), U.S. corporations generally were not taxed on foreign subsidiary earnings until those earnings were repatriated to the United States. This created a powerful incentive:
- Retain profits offshore;
- Avoid triggering U.S. tax on repatriation.
Apple accumulated substantial overseas earnings under the Trump regime. This was entirely legal under the Internal Revenue Code at the time.
As the result of favorable world-wide income tax treaties, foreign investors in the U.S. may be able to arrange their business transactions in the U.S. without realizing any U.S. tax liability. Further, corporations of really any size can potentially utilize this system because it is relatively inexpensive. Particular attention must be paid to both the tax treaties of different countries and also the additional tax savings in planning the use of multiple tax treaties and multiple entities to legally avoid the taxes that would otherwise be paid.
Post-Tax Cuts and Jobs Act Landscape: GILTI and Global Minimum Tax
The TCJA significantly curtailed offshore deferral through mechanisms such as:
- GILTI (Global Intangible Low-Taxed Income);
- Mandatory repatriation tax (the “transition tax”);
- Reduced corporate rate from 35% to 21%.
Additionally, global developments such as the OECD Pillar Two framework introduce a 15% global minimum tax, limiting the effectiveness of purely jurisdictional arbitrage.
As a result, Apple’s effective tax strategy today operates in a more constrained global environment than it did a decade ago.
To better understand this intricate area of tax law, consult with a Los Angeles tax attorney at Moskowitz, LLP by calling 213-320-1880 or via our contact form.
Moskowitz LLP Disclaimer: Because of the generality of this blog post, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Prior results do not guarantee a similar outcome. Furthermore, in accordance with Treasury Regulation Circular 230, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purposes of (i) avoiding tax related penalties under the Internal Revenue Code, or (ii.) promoting, marketing, or recommending to another party any tax related matter addressed herein.
