[Senate Hearing 113-90]
[From the U.S. Government Publishing Office]
S. Hrg. 113-90
OFFSHORE PROFIT SHIFTING AND THE
U.S TAX CODE--PART 2 (APPLE INC.)
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HEARING
before the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
MAY 21, 2013
__________
Available via the World Wide Web: http://www.fdsys.gov
Printed for the use of the
Committee on Homeland Security and Governmental Affairs
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81-657 WASHINGTON : 2013
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20402-0001
COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
THOMAS R. CARPER, Delaware Chairman
CARL LEVIN, Michigan TOM COBURN, Oklahoma
MARK L. PRYOR, Arkansas JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri ROB PORTMAN, Ohio
JON TESTER, Montana RAND PAUL, Kentucky
MARK BEGICH, Alaska MICHAEL B. ENZI, Wyoming
TAMMY BALDWIN, Wisconsin KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota
Ricard J. Kessler, Staff Director
Keith B. Ashdown, Minority Staff Director
Trina D. Shiffman, Chief Clerk
Laura W. Kilbride, Hearing Clerk
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
CARL LEVIN, Michigan Chairman
MARK L. PRYOR, Arkansas JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri ROB PORTMAN, Ohio
JON TESTER, Montana RAND PAUL, Kentucky
TAMMY BALDWIN, Wisconsin KELLY AYOTTE, New Hampshire
HEIDI HEITKAMP, North Dakota
Elise J. Bean, Staff Director and Chief Counsel
Robert L. Roach, Counsel and Chief Investigator
David H. Katz, Senior Counsel
Daniel J. Goshorn, Counsel
Henry J. Kerner, Minority Staff Director and Chief Counsel
Staphanie Hall, Counsel to the Minority
Brad M. Patout, Senior Advisor to the Minority
Scott D. Wittman, Research Assistant to the Minority
Mary D. Robertson, Chief Clerk
C O N T E N T S
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Opening statements:
Page
Senator Levin................................................ 1
Senator McCain............................................... 8
Senator Paul................................................. 10
Senator Carper............................................... 26
Senator McCaskill............................................ 34
Senator Portman.............................................. 53
WITNESSES
Tuesday, May 21, 2013
J. Richard Harvey, Professor, Villanova University School of Law,
Villanova, Pennsylvania; and................................... 13
Stephen E. Shay, Professor, Harvard Law Cambridge, Massachusetts. 17
Timothy D. Cook, Chief Executive Officer, Apple Inc., Cupertino,
California..................................................... 35
Peter Oppenheimer, Senior Vice President and Chief Financial
Officer, Apple, Inc., Cupertino, California; accompanied by
Phillip A. Bullock, Head of Tax Operations, Apple Inc.,
Cupertino, California.......................................... 38
Mark J. Mazur, Assistant Secretary for Tax Policy, U.S.
Department of the Treasury, Washington, D.C.................... 65
Samuel M. Maruca, Director, Transfer Pricing Operations, Large
Business & International (LB&I) Division, Internal Revenue
Service, Washington, DC........................................ 68
Alphabetical List of Witnesses
Bullock, Phillip A.:
Prepared statement........................................... 121
Cook, Timothy D.:
Testimony.................................................... 35
Prepared statement........................................... 121
Harvey, J. Richard:
Testimony.................................................... 13
Prepared statement........................................... 81
Maruca, Samuel M.:
Testimony.................................................... 68
Prepared statement........................................... 146
Mazur, Mark J.:
Testimony.................................................... 65
Prepared statement........................................... 139
Oppenheimer, Peter:
Testimony.................................................... 38
Prepared statement........................................... 121
Shay, Stephen E.:
Testimony.................................................... 17
Prepared statement........................................... 107
EXHIBIT LIST
1. a. GMemorandum from Permanent Subcommittee on Investigations 152
b. GApple's Offshore Organization Structure, chart prepared
by the Permanent Subcommittee on Investigations, Source:
Materials received from Apple Inc.............................. 192
c. GEffect of Check the Box, chart prepared by the Permanent
Subcommittee on Investigations, Source: Materials received from
Apple Inc...................................................... 193
d. GApple's Current Operating Structure. Source: Apple Inc... 194
e. GCost Sharing Payments and Earnings of Apple Sales
International (Ireland) and Cost Sharing Payments and Earnings
of Apple Inc. (United States), chart prepared by the Permanent
Subcommittee on Investigations, Source: Materials received from
Apple Inc...................................................... 195
f. GApple's Offshore Distribution Structure, chart prepared
by the Permanent Subcommittee on Investigations................ 196
g. GGlobal Distribution of Apple's Earnings, chart prepared
by the Permanent Subcommittee on Investigations, Source:
Materials received from Apple.................................. 197
h. GApple Operations International's Profits as a Share of
Worldwide Profits, chart prepared by the Permanent Subcommittee
on Investigations, Source: Materials received from Apple....... 198
i. GGlobal Taxes Paid by Apples Sales International, 2009-
2011, chart prepared by the Permanent Subcommittee on
Investigations, Source: Materials received from Apple.......... 199
j. GTaxes Avoided by Apple Using Check The Box, chart
prepared by the Permanent Subcommittee on Investigations,
Source: Materials received from Apple.......................... 200
k. GApples' Non-Tax Resident Entities, chart prepared by the
Permanent Subcommittee on Investigations, Source: Materials
received from Apple Inc........................................ 201
l. GApple: Avoiding Billions in U.S. Taxes, chart prepared by
the Permanent Subcommittee on Investigations, Source: Materials
received from Apple Inc........................................ 202
2. GExcerpt (cover and signature page) from Amended & Restated
Cost Sharing Agreement Between Apple Inc., Apple Operations
Europe & Apple Sales International, May 2008. [APL-PSI-000020,
034] 203
3. GExcerpt (page 1 and signature page) from Amended & Restated
Agreement To Share Costs and Risks of Intangibles Development
(Grandfathered Cost Sharing Arrangement), June 2009. [APL-PSI-
000035, 053]................................................... 205
4. GCorrespondence between Ernst & Young and Cork, Ireland
Office of the Revenue Commissioners, dated September 2004,
regarding Apple Computer Inc Ltd, The company is a non-resident
holding company and is non-trading. In the circumstances there
is nothing to return from the corporation tax standpoint. [APL-
PSI-000336-337]................................................ 207
5. GApple Operations International--2009-2012 Shareholder
Meetings [APL-PSI-000340]...................................... 209
6. GExcerpt from June 22, 2012 information supplied by Apple to
the Permanent Subcommittee on Investigations, . . . table
identifies the Board Members and Corporate Officers of Apple's
Irish entities . . .; Since the early 1990s, the Government of
Ireland has calculated Apple's taxable income in such a way as
to produce an effective rate in the low single digits. . . .
The rate has varied from year to year, but since 2003 has been
2% or less. [PSI-Apple-02-0002-005]............................ 210
7. GExcerpt from July 6, 2012 information supplied by Apple to
the Permanent Subcommittee on Investigations, . . . its
principal offshore trading activities take place in Ireland and
through Apple Distribution International and in Singapore
through Apple South Asia Pte, Ltd.; What percentage amount of
your company's world-wide revenues were: booked or recorded in
the U.S.?; Cash Reserves and Amounts Paid to Top 5 non-U.S.
Subsidiaries. [APL-PSI-000081, 098-108, 120]................... 214
8. GExcerpt from September 10, 2012 and January 11, 2013
information supplied by Apple to the Permanent Subcommittee on
Investigations, Apple Inc., Apples Sales International
(``ASI''), and Apple Operations Europe (``AOE'') participate in
a long-standing R&D cost sharing arrangement. . . . [APL-PSI-
000129, 233]................................................... 226
9. GExcerpt from September 12, 2012 information supplied by
Apple to the Permanent Subcommittee on Investigations, Apple
Operations International--2009-2011 Minutes. [APL-PSI-000323].. 228
10. GExcerpt from January 11, 2013 and 18, 2013 information
supplied by Apple to the Permanent Subcommittee on
Investigations, Since its inception, Apple determined that AOI
was not a tax resident of Ireland.; Apple does not believe that
AOI qualifies as a tax resident of any other country under the
applicable local laws.; For the past three fiscal years, AOI
has not filed any corporate income taxes with any national
government. [APL-PSI-000236, 239-240].......................... 229
11. GExcerpt from March 11, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, To the best of
our knowledge, AOI does not meet any of the Irish central
management and control factors.; The conclusion that AOI is not
managed and controlled in Ireland does not require a
determination where AOI is managed and controlled. [APL-PSI-
000241-248].................................................... 232
12. GExcerpt from March 11, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, MINUTES OF A
MEETING OF THE BOARD OF DIRECTORS OF APPLE OPERATIONS EUROPE;
IT WAS NOTED that the Company was to receive on 18th November
2010 a dividend in the amount of US $1,750,000,000 from Apple
Sales International; . . . an interim dividend . . . be paid in
the total amount of US $1,750,000,000 on the 18th of November
2010, to Apple Operations International. . . . [APL-PSI-000288-
289]........................................................... 240
13. GExcerpt from April 26, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, Apple Operations
International--Board of Directors Meetings During Tim Cook
Directorship. [APL-PSI-000341-343]............................. 242
14. GExcerpt from May 3, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, Apple Operations
International--FY 08 and FY 12 Board of Directors Meeting
Information. [APL-PSI-000349].................................. 245
15. GExcerpt from May 12, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, AOE and ASI are
participants in a Cost Sharing Arrangement with Apple Inc
whereby AOE, ASI and Apple Inc have agreed to pool their
resources for purposes of undertaking intellectual property co-
development activities. . . . [APL-PSI-000351-353]............. 246
16. GExcerpt from May 16, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, IRC section
954(d) generally does not apply to income received by ASI or
any of Apple's other Irish entities during the period 2008 to
present because sales made to third parties are generally made
through disregarded entities.[APL-PSI-000381-383, 386]......... 249
17. GExcerpt from May 17, 2013 information supplied by Apple to
the Permanent Subcommittee on Investigations, The individual
who signed the relevant agreements for Apple Sales
International was a U.S.-based Apple Inc. employee who signed
the agreement in his capacity as Director of Apple Sales
International. [APL-PSI-000392, 396]........................... 253
18. GApple Inc. 10-K Select Figures, 2009-2012, with excerpts
from 10-K filings.............................................. 255
19. GForeign Indefinitely Reinvested Earnings: Balances Held By
The Russell 3000, A 5-Year Snapshot, May 2013, prepared by
Audit Analytics................................................ 284
20. GResponses to supplemental questions for the record from
Apple Inc...................................................... 290
OFFSHORE PROFIT SHIFTING AND THE
U.S. TAX CODE--PART 2 (APPLE INC.)
----------
TUESDAY, MAY 21, 2013
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 9:33 a.m., in
room SD-342, Dirksen Senate Office Building, Hon. Carl Levin,
Chairman of the Subcommittee, presiding.
Present: Senators Levin, Carper, McCaskill, McCain,
Johnson, Portman, Paul, and Ayotte.
Staff present: Elise J. Bean, Staff Director and Chief
Counsel; Mary D. Robertson, Chief Clerk; Robert L. Roach,
Counsel and Chief Investigator; David H. Katz, Senior Counsel;
Daniel J. Goshorn, Counsel; Allison F. Murphy, Counsel; Adam
Henderson, Professional Staff Member; Angela Messenger,
Detailee (GAO); Christopher Reed, Congressional Fellow; Michael
Avi-Yonah, Intern; Aaron Fanwick, Law Clerk; Alex Zerden, Law
Clerk; Ty Gellash (Senator Levin); Elizabeth Herman (Senator
McCaskill); Henry J. Kerner, Staff Director/Chief Counsel to
the Minority; Stephanie Hall, Counsel to the Minority; Brad M.
Patout, Senior Advisor to the Minority; Scott Wittman, Research
Assistant to the Minority; Megan Schneider, Intern to the
Minority; John Lawrence (Senator Ayotte); Ritika Rodrigues,
Rachael Weaver, (Senator Johnson); and Brandon Brooker (Senator
Paul).
OPENING STATEMENT OF SENATOR LEVIN
Senator Levin. Good morning, everybody. Before we begin, I
know that we are all heartbroken because of the tragedy in
Oklahoma, and we want those communities and all the families
and individuals who are affected to know that they are not
alone. They are not going to face this alone, and American
mourns with you and will help you rebuild.
The Subcommittee meets today to hold a second hearing to
examine how U.S.-based multinational corporations use loopholes
in the Tax Code to move profits to offshore tax havens and to
avoid paying U.S. taxes. In September, we examined two case
studies: a study of how Microsoft Corporation shifted profits
on U.S. sales to U.S. customers from the United States to an
offshore tax haven; and also a study on how Hewlett-Packard
devised a ``staggered foreign loan program'' to effectively
repatriate offshore profits to the United States without paying
the U.S. taxes that are supposed to follow repatriation.
Today the Subcommittee will focus on how Apple effectively
shifts billions of dollars in profits offshore, profits that
under one section of the Tax Code should nonetheless be subject
to U.S. taxes, but through a complex process avoids those
taxes.
Our purpose with these hearings is to shine a light on
practices that have allowed U.S.-based multinational
corporations to amass an estimated $1.9 trillion in profits in
offshore tax havens, shielded from U.S. taxes. One study has
estimated that offshore earnings stockpiled by S&P 500
companies using these techniques have increased 400 percent in
the last decade.
There is a direct relationship between this rapidly
accelerating shift of corporate profits offshore, on the one
hand; and on the other, a worrisome Federal deficit fed in part
by a decline in the contributions corporate taxes make to
Federal revenue. Corporate income tax revenue has accounted for
a smaller and smaller share of Federal receipts and today is
down to about 9 percent of Federal revenue. That decline is in
part due to the use and abuse of loopholes that so riddle our
Tax Code that the average U.S. corporation pays an effective
tax rate of 15 percent, less than the statutory rate of 35
percent. A recent study found that 30 of our largest U.S.
multinationals, with more than $160 billion in profits, paid
nothing in Federal income taxes over a recent 3-year period.
These corporations use multiple offshore loopholes that give
them significant control over how much U.S. income they will
report and how much tax, if any, they will pay.
Despite the immense impact of these offshore tax practices
that deepen the Federal deficit and increase the tax burden on
American families, few Americans see the problem because of its
complexity. The first step toward change is to acknowledge that
there is a problem. Today, we again spotlight corporate
offshore tax avoidance so that our colleagues, and the American
people, understand the depth of our offshore tax loophole
problem and the damage that it does to our fiscal and economic
health.
Apple is an American success story. Its products are
justifiably well known and used throughout the world. Just like
millions around the world, I carry an iPhone in my pocket. The
company's engineers and designers have a well-earned reputation
for creativity. What may not be so well known is that Apple
also has a highly developed tax avoidance system--a system
through which it has amassed more than $100 billion in offshore
cash in a tax haven.
Sending valuable intellectual property rights offshore
together with the profits that follow those rights is at the
heart of Apple's tax avoidance strategy. More and more,
intellectual property is the dominant source of value in the
global economy. It is also highly mobile. Unlike more tangible,
physical assets, its value can be transferred around the globe,
often with just a few keystrokes. The secret to Apple's
business success is not in the aluminum and steel and glass of
my iPhone and other Apple products. Its profits depend on the
ideas that bring those elements together in such an elegant
package. That intangible genius is intellectual property that
is nurtured and developed here in the United States. The key to
offshore tax avoidance is transferring the profit-generating
potential of that valuable intellectual property offshore so
that the profits are directed not to the United States, but to
an offshore tax haven.
Apple's tax avoidance strategy comes in two parts: first,
it executes a shift of the profit-generating power of its
intellectual property to an offshore tax haven, thus directing
the resulting income to the tax haven--and, of course, to its
wholly owned corporations in that tax haven. Next, it uses a
number of tactics to ensure that, once this income is offshore,
it remains shielded from U.S. taxes, despite provisions of the
U.S. tax law which are designed to capture that income as
taxable.
Some of Apple's techniques are staples of international tax
avoidance, such as its use of what is known as a ``cost-sharing
agreement'' between the parent company and its offshore
subsidiaries, and its use of so-called check-the-box
regulations. We will discuss those in a moment. But others are
unique. Apple has sought the Holy Grail of tax avoidance,
offshore corporations that it argues are not, for tax purposes,
resident anywhere in any nation. And here is how it works.
Apple Inc. has created three offshore corporations,
entities that receive tens of billions of dollars in income,
but which have no tax residence--not in Ireland, where they are
incorporated, and not in the United States, where the Apple
executives who run them are located. Apple has arranged matters
so that it can claim that these ghost companies, for tax
purposes, exist nowhere. One has paid no corporate income tax
to any nation for the last 5 years; another pays tax to Ireland
equivalent to a tiny fraction of 1 percent of its total income.
The first of these companies is Apple Operations
International (AOI), and this chart,\1\ which we will put up
over here, shows Apple's offshore corporate network. AOI is at
the top of the structure. Apple is its sole owner. AOI in turn
directly or indirectly owns most of Apple's other offshore
entities.
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\1\ See Exhibit No. 1b which appears in the Appendix on page 192.
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Under Irish law, only companies that are managed and
controlled in Ireland are considered Irish residents for tax
purposes. Apple says that although AOI is incorporated in
Ireland, the company is not managed and controlled in Ireland
and, therefore, is not a tax resident in Ireland. U.S. tax law,
on the other hand, generally turns on where a company is
incorporated, not on where it is managed and controlled. Apple
says that since AOI is not incorporated in the United States,
it is also not present in the United States for tax purposes.
Magically, it is neither here nor there.
The second corporate ghost is Apple Sales International
(ASI). ASI, as we will explore in a bit, holds the economic
rights to Apple's valuable intellectual property in Europe, the
Middle East, Africa, India, and Asia. From 2009 to 2012, its
sales income amounted to $74 billion. Apple has performed the
same alchemy with ASI as with AOI. It is incorporated in
Ireland, operated from the United States, but, Apple says, is a
tax resident in neither country. Unlike AOI, ASI has paid a
small amount of tax, to Ireland. In 2011, for example, it paid
$10 million in taxes on $22 billion in income. Now, that is a
tax rate of five-hundreds of 1 percent. It appears that this
tiny tax payment may be related to activity unrelated to ASI's
main purpose, which is to serve as a receptacle for profits
generated by Apple's intellectual property in much of the
world.
Apple has told the Subcommittee that a third subsidiary,
Apple Operations Europe (AOE), which sits between ASI and AOI
in Apple's corporate structure, also has no tax home, again
using the same claims about Irish and U.S. standards on tax
residency.
Now, Apple is exploiting an absurdity, one which 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 to 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 30 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 (ADI),
an Irish company that AOI itself owns. Over the last 6 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 seven
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
California.
In short, these companies' decisionmakers, 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.
Now, 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?
AOI sits at the apex of Apple's offshore tax avoidance
strategy. Apple's claim that AOI and these other subsidiaries
are not tax resident in any nation is a key element in its
strategy to avoid taxes on its offshore income. But how did
that income end up offshore to begin with? And that brings us
to a second, more common arrangement for shifting income away
from the United States to a low-tax jurisdiction through what
is called ``transfer pricing.''
Many U.S. companies, including Apple, use transfer pricing
to shift intellectual property rights to offshore affiliates
and then direct income associated with that intellectual
property--taxable income that would otherwise flow to the
United States where the intellectual property was developed--to
the affiliates' home jurisdiction, which is typically a tax
haven. Now, there are multiple ways to transfer intellectual
property rights offshore, but Apple's primary method is through
a so-called cost-sharing agreement.
Generally in a cost-sharing agreement, a U.S. parent and
one or more of its affiliates are assigned a designated
percentage of funds and resources to be applied to the
development of new products--products that in the case of Apple
are developed here in the United States. Apple retains legal
title to and all marketing rights to the developed property in
North and South America, and its offshore affiliates get
marketing rights for the rest of the world. And that is a key
part of the so-called cost-sharing agreement. It is more than
sharing the costs, but the offshore affiliates also gets the
marketing rights and the profits for the rest of the world.
Apple set up its cost-sharing agreement with its Irish
subsidiaries. Now, I use the term ``cost sharing'' with some
skepticism since it is obviously not an arm's-length
transaction, although it is called an agreement. All the money
supposedly changing hands belongs to Apple, and all the
signatories were Apple employees. The agreement on its face
allocates the costs to be shared among the Apple companies; but
since all of those costs ultimately come out of the same
pocket, in reality the agreement is about shifting profits. The
cost-sharing agreement enables Apple to shift profits generated
by its intellectual property away from the United States where
the intellectual property was developed and instead concentrate
the lion's share of profits from most of the world to Apple
subsidiaries in Ireland. Again, the intellectual property that
generates Apple's profits was created in the United States, but
most of the profits are assigned to Ireland.
Why Ireland? Another highly successful but, until now,
hidden tax strategy is that Apple has quietly negotiated with
the Irish Government an income tax rate of less than 2 percent,
well under the Irish statutory rate of 12 percent as well as
the tax rates of other European countries and the United
States, well below those statutory rates. And as we have seen,
in practice Apple is able to pay a rate far below even that low
figure. In 2012 alone, due to the cost-sharing agreement
essentially shifting profits from all Apple sales outside of
the Americas to Ireland, ASI received $36 billion in income in
a nation where it pays almost no income tax.
Additional facts make it even more clear how the cost-
sharing agreement functions as a conduit to shift Apple profits
offshore to avoid U.S. taxes.
First, Apple's transfer of intellectual property rights
through the cost-sharing agreement is not needed for Apple to
conduct its commercial operations. Apple Inc. operates in
numerous countries around the world without transferring
intellectual property rights to each region or country. When
interviewed, Apple officials could not explain why ASI needed
to acquire Apple intellectual property economic rights in order
to conduct business abroad. The interests of all the parties to
the agreement are identical, and what is more, Apple Inc.,
which has renewed the agreement several times, most recently in
2009, can modify the agreement at any time, further evidence
that this is not in any sense an arm's-length transaction.
Second, 95 percent of Apple's R&D, the engine behind the
success of Apple products, is conducted in the United States.
Yet figures provided by Apple show that, over a 4-year period
from 2009 to 2012, ASI paid approximately $5 billion to Apple
Inc. as its share of the R&D costs. Over that same period, ASI
received profits of $74 billion.\1\ The difference between
ASI's costs and the profits, almost $70 billion, is how much
taxable income, in the absence of Apple Inc.'s cost-sharing
agreement with its own subsidiaries and its use of other tax
loopholes, would otherwise have flowed to the United States. In
comparison, over the same 4 years, Apple Inc. paid $4 billion
under the cost-sharing agreement and declared profits of $38
billion from sales in the Americas. Its subsidiary, in other
words, ASI, its Irish subsidiary, received almost twice the
profits from property developed by Apple Inc. in the United
States.
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\1\ See Exhibit No. 1e, which appears in the Appendix on page 195.
---------------------------------------------------------------------------
Common sense says that Apple would never have offered such
a lucrative arrangement in an arm's-length deal with an
unrelated party. It is hard to imagine Apple offering such a
lucrative deal to an outside party at any price. The fact that
the Irish subsidiaries pay a share of the R&D costs is
irrelevant to the main goal, which is concentrating profits
offshore. Even if the Irish subsidiaries paid 100 percent of
the R&D costs, this arrangement would still result in massive
profit concentration in a tax haven and, therefore, massive tax
avoidance.
The cost-sharing agreement is where profits generated by
U.S. activity begin their offshore journey. Other loopholes
keep these profits shielded from U.S. taxes. Apple exploits tax
loopholes to protect its offshore income from being taxed under
a part of the Tax Code known as Subpart F, which was designed
to combat profit shifting by U.S. multinationals and to collect
taxes on some of their income even when held offshore.
Subpart F was a Kennedy-era attempt to combat rampant
offshore tax avoidance and evasion. It made certain types of
offshore income subject to U.S. income tax, even when that
income was not brought back to the United States, including,
for example, funds transferred between offshore affiliates in
the form of dividends, royalties, or interest.
But in the 1990s, the Treasury Department unwittingly
opened a massive loophole in Subpart F. It approved a
regulation known as ``check the box,'' which allows companies
to declare to the Internal Revenue Service (IRS) what type of
entity they are for tax purposes, simply by checking a box on a
form. Under check the box, multinationals began to declare
offshore subsidiaries as ``disregarded'' for tax purposes--
making it appear as if complex chains of offshore entities were
one big corporation. That made the funds being transferred
among those offshore entities nontaxable under Subpart F.
Circumvention of Subpart F became even easier in 2006 when
Congress passed what is known as the ``look-through rule,''
which similarly shields offshore income from taxation under
Subpart F.
Apple is one among many U.S. multinationals exploiting
these tax loopholes. Its strategies are complex and are
outlined more fully in the memo that we have issued. But the
net effect is huge. Apple argues that it is one of the biggest
corporate taxpayers in America, that in 2012 alone it paid $6
billion in taxes. What Apple does not say is that, also in
2012, it shifted $36 billion in worldwide sales income away
from the United States and paid no U.S. tax on any of it. In
fact, the data provided by Apple indicates that, through its
cost-sharing agreement and check the box, in 2012 alone, Apple
avoided the payment of $9 billion in U.S. taxes. That works out
to avoiding $25 million a day, more than $1 million an hour, in
taxes.
Now, Apple executives want the public to focus on the U.S.
taxes the company has paid, but the real issue is the billions
in taxes that it has not paid, thanks to offshore tax
strategies whose purpose is tax avoidance, pure and simple.
Today we will ask Apple executives, as well as tax experts
and Treasury and IRS officials, about these tax avoidance
strategies. And as we listen to their testimony, we should keep
in mind the context in which we meet today. The offshore tax
avoidance tactics spotlighted by the Subcommittee do real harm.
They disadvantage domestic U.S. companies that are not in a
position to reduce their tax bills using offshore tax gimmicks.
They offload Apple's tax burden onto other taxpayers--in
particular, onto working families and small businesses. The
lost tax revenue feeds a budget deficit that has reached
troubling proportions. It has helped lead to round after round
of budget slashing and the ill-advised sequestration that now
threatens our economic recovery.
Because of those cuts, children across the country are not
going to get early education from Head Start. Needy seniors are
going to go without meals. Fighter jets sit idle on tarmacs
because our military lacks the funding to keep pilots trained.
Apple and the other companies exploiting tax loopholes depend
on the safety, security, and stability provided by the U.S.
Government and by this Nation. Their economic existence depends
on the U.S. Government's energetic protection of their
intellectual property--property which they develop here and
keep under the protection of the U.S. legal system, while
shifting the income that it generates overseas.
Nearly 30 years ago, Ronald Reagan faced a tax system
similarly open to exploitation and loopholes. When President
Reagan's Treasury Secretary told him that dozens of America's
most profitable companies paid no income tax, President Reagan
was stunned. And armed with that information, he went before
the American people to decry ``individuals and corporations who
are not paying their fair share or, for that matter, any
share.'' And he said, ``These abuses cannot be tolerated.'' And
he did not tolerate them.
The question that each of us should ask today is: Shouldn't
we close unjustified tax loopholes and dedicate the revenue to
educating our children, protecting our Nation, building its
future, and reducing its deficit? Closing these kinds of
unjustified loopholes could provide hundreds of billions of
dollars to reduce the deficit and avert damaging budget cuts to
our defense, to our schools, our roads, the safety of our food
supply, and other important priorities. And we should close
these loopholes. They are unjustified. We should dedicate the
revenue that generates to these other important priorities,
whether or not we reform the overall Tax Code.
Senator McCain and his staff have made an extraordinary
contribution to this bipartisan effort, and I thank them for
their great work and for your partnership, Senator McCain, on
this Subcommittee. Thank you. Senator McCain.
OPENING STATEMENT OF SENATOR McCAIN
Senator McCain. Thank you very much, Mr. Chairman. I want
to thank our witnesses who are here today, our two expert
witnesses, Professor Harvey and Professor Shay.
I would also like to express my appreciation to both the
government witnesses and Mr. Cook and his two executives who
are here to defend their position, and we will obviously listen
very carefully to their testimony. And I think it is important
that all of us make it very clear the admiration that we hold
for Apple. The incredible changes that Apple has caused in our
lives and the spread of information and the capabilities to
share information and knowledge throughout the world have been
phenomenal, both by Mr. Cook and his predecessor, Mr. Jobs.
However, Apple's corporate tax strategy reflects a flawed
corporate tax system, and it is a system that allows large
multinational corporations to shift profits offshore to low-tax
jurisdictions. For years, Apple has opted to forgo fully
contributing to the U.S. Treasury and to American society by
shifting profits and circumventing U.S. taxes. In the last 4
years alone, Apple has avoided paying taxes on $44 billion in
income.
With over $145 billion in cash on hand, Apple ranks as one
of the wealthiest multinational corporations in the world.
Given its annual intake, Apple executives enjoy reminding the
public that the company is likely the largest corporate
taxpayer in the United States. However, these same executives
fail to mention another less attractive fact: Apple is also one
of the biggest tax avoiders in America.
Today Apple has over $100 billion, more than two-thirds of
its total profits, stashed away in an offshore account. That is
over $100 billion that are not currently subject to U.S.
corporate income taxes and, therefore, cannot be used to ease
the deficit or help invigorate the same American economy that
fostered the creation of this large corporation in the first
place. As the shadow of sequestration encroaches on hard-
working American families, it is unacceptable that corporations
like Apple are able to exploit tax loopholes to avoid paying
billions in taxes.
Apple's corporate tax strategy is fueled by the company's
fixation on reducing U.S. tax payments. Apple's scheme enables
the company to shift billions of dollars in global profits into
overseas subsidiaries without having to pay U.S. taxes.
Although Apple is by all accounts an American company, its
holding company in Ireland currently retains the bulk of its
profits. The Subcommittee's investigation has uncovered a
disturbing truth. Apple's three primary Irish entities hold 60
percent of the company's profits, but claim to be tax residents
nowhere in the world. It is completely outrageous that Apple
has not only dodged full payment of U.S. taxes, but it has
managed to evade paying taxes around the world through its
convoluted and pernicious strategies.
Specifically, from 2009 to 2012, Apple Operations
International received roughly $30 billion in dividends from
other Apple subsidiaries around the world. That made up 30
percent of Apple's total worldwide net profits over the last
few years. However, Apple Operations International did not pay
corporate income taxes to any national government. Furthermore,
Apple Operations International, a company with tens of billions
of dollars in cash, has never had any employees and appears to
be completely directed by Apple in California.
Perhaps sensing that it might need to maintain some
semblance of legitimacy, Apple Sales International, another
subsidiary with no tax residence and no employees through 2011,
began employing 250 people in 2012. However, with $22 billion
of income in 2011, Apple Sales International, only paid one-
twentieth of 1 percent in Irish taxes. As Apple funnels
billions of dollars through its numerous Irish entities, even
those entities that do pay taxes enjoy a negotiated tax rate of
less than 2 percent. Apple contends that none of its
subsidiaries in Ireland reduce its U.S. tax liability by one
cent. This statement is demonstrably false.
For one thing, the very method by which Apple divides the
world serves to deprive the United States of substantial
revenue. By centralizing worldwide profits outside of the
Americas in Ireland, Apple is able to shelter its profits from
the U.S. tax authorities. Furthermore, Apple has taken its most
valuable asset, its intellectual property, and divided it
between its legal and economic rights. The company left 100
percent of its legal rights in the United States, but
transferred a portion of these economic rights to its Irish
entities, thereby shifting billions of dollars in profit to
Ireland. Despite the fact that 95 percent of Apple's research
and development takes place right here in the United States of
America, the majority of its profits are elsewhere. Apple's
Irish subsidiary has profited in an amount far in excess of its
research and development contributions.
By engaging in these elusive corporate strategies aimed at
deferring and reducing tax payments, Apple's tax department has
given a new meaning to the company's old slogan, ``Think
different.'' In my view, loopholes like these, which
multinationals like Apple aggressively employ, are harmful in
that they provide large corporations huge competitive
advantages over smaller domestic companies. These domestic
companies pay a higher tax rate because they cannot use
overseas operations to lower their effective corporate tax
rate. It is problematic when small and emerging American
companies feel the full weight of corporate income taxes while
larger corporations maneuver around full tax payment.
Given the massive budget cuts under sequestration that have
impacted our Nation's most vital interests, U.S. corporations
cannot continue to avoid paying their appropriate share in
taxes. Our military cannot afford it, our economy cannot endure
it, and the American people will not tolerate it.
America's tax system is broken and uncompetitive, and I
have long supported efforts to modernize it. However, I will
not allow that position to be used as an excuse to turn a blind
eye to the highly questionable tax strategies used by Apple.
The general American public should not have to make up the
balance as corporations avoid paying billions in U.S. taxes.
The egregious loopholes that exist in the Tax Code must be
closed so that the nearly $1 trillion in untaxed overseas
profits can come back to the United States. It is past time for
American corporations like Apple to reorganize their tax
strategies to pay what they should and invest again in the
American economy.
When Tim Cook, an outstanding executive, CEO of Apple, met
with the Subcommittee, he said that though he has no immediate
intentions of repatriating Apple's foreign cash, the company
does have plans to grow manufacturing in the United States and
create more American jobs. This is a step in the right
direction, and we must have a tax system that encourages this
objective.
Mr. Chairman, finally, as Ronald Reagan used to say, facts
are stubborn things, and I would just like to repeat again the
following facts: 95 percent of the research and development of
Apple takes place in the United States, less than 1 percent in
Ireland. Apple's Irish subsidiaries, Apple Operations in
Europe, Apple Sales Incorporated, and Apple Operations
International, are tax resident--I repeat, are tax resident--
nowhere in the world. Apple has negotiated a tax rate in
Ireland of less than 2 percent. Apple used loopholes to defer
paying taxes on $44 billion in taxable offshore income. ASI
paid 0.05 percent in global taxes in 2011, $10 million in taxes
on $22 billion in earnings. ASI from 2009 to 2012 contributed a
little more than half of the cost-sharing payments to Apple
Incorporated but pocketed twice the earnings of Apple
Incorporated, $74 billion compared to $39 billion. Apple
Operations International received $30 billion in dividends from
2009 to 2012 and paid zero taxes; $102 billion of Apple's $145
billion in cash on hand is overseas.
I thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator McCain.
And we have Senator Johnson and Senator Paul. Do either of
you have an opening comment? We welcome you.
OPENING STATEMENT OF SENATOR PAUL
Senator Paul. Frankly, I am offended by the tone and tenor
of this hearing. I am offended by a $4 trillion government
bullying, berating, and badgering one of America's greatest
success stories.
Tell me one of these politicians up here who does not
minimize their taxes. Tell me a chief financial officer that
you would hire if he did not try to minimize your taxes
legally. Tell me what Apple has done that is illegal.
I am offended by a government that uses the IRS to bully
tea parties, but I am also offended by a government that
convenes a hearing to bully one of America's greatest success
stories. I am offended by the spectacle of dragging in
executives from an American company that is not doing anything
illegal. If anyone should be on trial here, it should be
Congress.
I frankly think the Committee should apologize to Apple. I
think that the Congress should be on trial here for creating a
bizarre and byzantine Tax Code that runs into the tens of
thousands of pages, for creating a Tax Code that simply does
not compete with the rest of the world.
This Committee will admit that Apple has not broken any
laws, yet we are forced to sit and Apple is force to sit
through a show trial at the whims of politicians, when, in
fact, Congress should be on trial for chasing the profits of
great American companies overseas.
We haul before this Committee one of America's greatest
success stories, and you want applause? I say instead of Apple
executives we should have brought in here today a giant mirror.
OK? So we could look at the reflection of Congress, because
this problem is solely and completely created by the awful Tax
Code.
If you want to assign blame, the Committee needs to look in
this mirror and see who created the mess, see who created this
Tax Code that is chasing American companies overseas.
Our corporate Tax Code is double Canada's I never thought I
would be complimenting Canada for their Tax Code. Ours is
double Canada, double a lot of Europe. Instead of complaining
that theirs is too low, why don't we set about to work that
ours is too high?
Apple has 600,000 jobs they have created, American jobs,
and we want to drag them before this Committee to chastise
them? I find it abominable.
Just in my State, we have $700 million in sales from Dow
Corning. They make the Gorilla Glass, and they were virtually
out of business. In the 1990s, Apple struggled. If I had to
guess--unfortunately, I did not guess enough to invest in
Apple, but the thing is that in the 1990s people were worried
they might go out of business. They had one computer that was
not doing well, and then all of a sudden, the innovation that
came about. And we want to bring them forward and chastise them
for their success?
A couple years ago, we did repatriation of foreign capital.
We want the capital to come home. Do not double tax it. We tax
it at 35 percent. Let us tax it at 5 percent. I have a bill
that would repatriate profits from foreign companies at 5
percent and put it into infrastructure. Our country is woefully
short of money for infrastructure. But you are not going to get
it at 35 percent. You are getting zero. Let us make it 5
percent and create an infrastructure fund. There are probably
70 votes for that bill in Congress, but nobody will bring it
up. Why? They say, oh, it is the sweetener for overall tax
reform, which is elusive and a hill too tall to climb and never
seems to get here. Why not tomorrow pass it?
Why do you think people are frustrated with Congress?
Because we do not do the right thing. Everybody admits, even
those who want to drag Apple before this Committee, they admit
that our Tax Code is part of the problem, that if we had
repatriation at 5 percent that they would bring money home. Why
don't we just pass it? Instead, it has to be revenue neutral,
scored by the Congressional Budget Office (CBO). Just pass it
if it is the right thing to do.
I would say that what we really need to do is apologize to
Apple, compliment them for the job creation they are doing, and
get about doing our job. Look in the mirror and let us make the
Tax Code better, fairer, and more competitive worldwide. Money
goes where it is welcome. Currently our Tax Code makes money
not welcome in this country.
Thank you, Mr. Chairman.
Senator Levin. Thank you, Senator Paul. You are, of course,
free to apologize if you wish. That is not what this
Subcommittee is about. This Subcommittee is about investigating
a Tax Code that is not working for the American people, is not
working for businesses in this country, where some businesses
decide how many taxes they are going to pay, how many they will
not, what they are going to leave offshore in terms of profits,
and cooking up all kinds of arrangements to avoid paying taxes.
Apple is a great company, but no company should be able to
determine how much it is going to pay in taxes, how many
profits they are going to keep offshore, how they are going to
bring them back home, using all kinds of gimmicks to avoid
paying the taxes that should be paid to this country. They make
use of this country. They use our legal system. They have the
right to lobby here for whatever they want to do, and they do
lobby here plenty. But they do not have a right to decide in my
book how many taxes they are going to pay and to whom they are
going to pay them. Avoiding paying taxes in this country to me
is not right. The American people know it is not right. And if
you want to hold up a mirror, you can hold up a mirror to
anybody you want. You can apologize to anyone you want. This
Subcommittee is not going to apologize to Apple. We did not
drag them in front of this Subcommittee. They have come here
willingly to explain their system. We intend to hear from them
as to what this system is that they use. We are also going to
hear from some experts, and those experts are now going to
testify in front of us.
I now would like to call our first panel of witnesses this
morning: Professor Richard Harvey of Villanova University
School of Law in Villanova, Pennsylvania; and Professor Stephen
Shay of Harvard Law School in Cambridge, Massachusetts. We
appreciate both of you being with us this morning. We look
forward to your testimony.
Professor Shay, I would like to welcome you back, having
testified at our previous hearing on this matter in September
of last year.
Professor Harvey, we welcome you to the Subcommittee. We
appreciate both of you sharing your legal and your tax
expertise today. We look forward to your testimony and your
perspective on offshore profit shifting.
Pursuant to Rule VI, all witnesses who testify before the
Subcommittee are required to be sworn. At this time I would ask
you both to please stand, raise your right hand. Do you swear
that the testimony you are about to give to this Subcommittee
will be the truth, the whole truth, and nothing but the truth,
so help you, God?
Mr. Harvey. I do.
Mr. Shay. I do.
Senator Levin. We will use a timing system today. Please be
aware that 1 minute before the red light comes on, you are
going to see the lights change from green to yellow, giving you
an opportunity to conclude your remarks. While your written
testimony will be printed in the record in its entirety, we ask
that you limit your oral testimony to no more than 10 minutes.
Professor Harvey, we are going to have you go first, and
after we have heard your testimony, all of the testimony from
both witnesses, we will then turn to questions. Professor
Harvey, you may proceed.
TESTIMONY OF J. RICHARD HARVEY,\1\ PROFESSOR, VILLANOVA
UNIVERSITY SCHOOL OF LAW, VILLANOVA, PENNSYLVANIA
Mr. Harvey. Thank you, Mr. Chairman. Also, thank you,
Ranking Member McCain, Members of the Subcommittee. Thank you
for the opportunity to speak this morning. The issues
surrounding transfer pricing and the shifting of profits by
multinationals offshore is a very important issue, and
specifically we are going to discuss the techniques that Apple
uses to accomplish that result.
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\1\ The prepared statement of Mr. Harvey appears in the appendix on
page 81.
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My professional background is described in my written
testimony, but in summary, I am currently a professor at
Villanova School of Law and Graduate Tax Program. I am a
retired managing partner at a Big Four accounting firm, a
former senior IRS official, and was also in the Treasury
Department Office of Tax Policy during the 1986 Tax Reform Act.
So, with the Chairman's permission, I want to submit my
written testimony for the record, and I will summarize my major
observations orally.
Senator Levin. It will be made part of the record, as will
all the prepared testimony.
Mr. Harvey. OK. I plan to make a few general remarks about
Apple's tax planning, and then I want to discuss briefly how
companies like Apple accomplish the shifting of income
offshore. And then I want to close with some tax policy
recommendations that hopefully the Committee will consider. So
let us start with my general comments.
I guess starting off--this is obviously going to be a
little bit of an Apple-bashing day, I suspect, but I would like
to start off with some good news for Apple. And the first good
news is after reviewing their structure, although I have not
done a detailed audit--I leave that to the IRS, I suspect that
what Apple has done is within the bounds of what is acceptable
under current international tax law.
Now, that in its own right raises issues, though, and I
will talk about them in a minute.
The second thing I want to mention is that Apple was able
to allocate 64 percent of its 2011 income into Ireland, a
company, as you folks have indicated, that basically had no
employees, and had no real activity. It was basically an entity
on paper.
Now, the scary thing is Apple allocated 64 percent of its
global income into that shell corporation. There are other
multinationals that probably would have allocated even more. So
to some extent, Apple is not as aggressive as others; but,
nevertheless, Apple is still shifting a substantial amount of
income, 64 percent of its 2011 income, into an entity with no
employees and with no real activity.
So, in my opinion, the issue today is not whether Apple's
current structures are legal. It is not whether they are the
most aggressive multinational company on the planet. But,
rather, the real question is whether it makes sense for Apple
and other companies like Apple--and I am talking about not only
U.S. multinationals. This is a global issue, so it is foreign
multinationals as well--whether it makes sense to have them
being able to record 64 percent of their profits in an entity
that has no employees and no real activity. That is the real
question that I think we need to focus on. And, again, I think
there is congressional action that can be taken if Congress so
chooses.
Now, let us turn to how Apple was able to record so much
income in an entity, Apple Sales International. And I focused
mostly on 2011 during my review. So in 2011, they recorded $22
billion of pre-tax income in Apple Sales International. And the
question is: How did they do that and accomplish a 0.05 percent
tax rate?
But before I go into that, I would like to directly address
a statement in Apple's testimony that they made public
yesterday. And, specifically, the testimony says, ``Apple does
not use tax gimmicks.''
Now, I about fell off my chair when I read that because,
when I think about tax gimmicks, certainly some of the
techniques that Apple uses could, in general usage of the word,
be considered ``gimmicks.'' But I will let the Committee decide
for themselves whether Apple used gimmicks that resulted in $74
billion of income over 4 years being recorded in an Irish
subsidiary with no employees for 3 of the 4 years and 250
employees in the last year and paying essentially no tax.
So I think as you listen to today's hearing, I would ask
you to think about whether these are gimmicks or maybe
techniques or tools, but I would also think about what we
should be doing about it.
Now, quickly, some critical factors that allowed Apple to
accomplish this result, and Chairman Levin and Ranking Member
McCain have already discussed some of them, so I will just
quickly summarize them.
The first critical factor is that the United States has
this concept of arm's-length pricing. So the idea is that two
affiliated entities can enter into a transaction, and as long
as it is at an arm's-length price, it will be respected for
international tax purposes.
Now, this is true whether the transaction is a relatively
simple, say, provision of service or whether it involves the
cure of cancer or the development of an iPad, an iPod, or an
iPhone.
As a result, because of this arm's-length pricing, what
Apple did is they entered into a cost-sharing agreement where
they transferred their development rights to operations outside
of the Americas to the Ireland subsidiary. Cost-sharing
agreements are legal under U.S. tax law. So I think one
question for Members of the Committee and ultimately Members of
Congress to consider is whether it makes sense for a company
like Apple to be able to enter into an agreement that transfers
its crown jewels to a foreign affiliate with no employees and
very little activity. So that was the first factor.
The second factor is the United States has so-called
Subpart F rules. Those Subpart F rules are designed to tax
passive income, and Apple was able to avoid those. Apple
avoided them mostly through check-the-box regulations and the
controlled foreign corporation (CFC) look-through rule.
Now, the check-the-box regulations allow Apple to make an
election to treat entities as though they do not exist, and as
a result, transactions disappear.
Now, when my children were younger--I have four adult boys,
but when they were younger, they were big into magic, and they
might characterize the check-the-box regs as making things go,
``Poof.'' Now, some of us in the tax trade refer to check-the-
box regulations as a tool for avoiding the Subpart F rules.
However, I suspect most others may view it as a gimmick in the
sense that you are able to make an election and just make
transactions disappear under the U.S. tax law.
The third critical factor in Apple's planning was they were
able to avoid paying any material Irish tax. It is not clear to
me whether they cut a specific deal with the Irish taxing
authorities. That was what I was led to believe by some of the
testimony they apparently gave to members of the staff. But at
the last minute, in the last 48 hours, we became aware that
Apple has entities in Ireland that are not managed and
controlled--in fact, all of their major entities in Ireland are
viewed as not managed and controlled and, therefore, not tax
resident in Ireland. But be that as it may, the bottom line is
that they had a substantial amount of income, $74 billion over
4 years, recorded in Ireland, and they paid essentially no tax.
The fourth critical factor--and this is really important
for the rest of the world--is that Apple has roughly 60 percent
of its global sales outside of the United States and outside of
Ireland, but they only allocate roughly 6 percent of their
profits to the rest of the world. And the way they accomplish
that is by having a very minimal sales commission being paid to
entities that operate in those countries. I am not suggesting
that that is in any way illegal, but that is the end result of
their planning. They pay a sales commission to sell into those
particular countries in the world, and $74 billion of income
can end up being retained in the Irish entity. Now, I suspect
there will be some interesting publicity around the world
surrounding the lack of Irish taxes being paid.
So let me move on because I am running out of time, but the
real question here is what to do about this. And I guess the
more important question is: Should anything be done? And if so,
what? And I would say that except for executives of
multinational companies, almost everyone I speak to would agree
that something needs to be done when so much income can be
allocated into an entity that has no substance of any
significant effect. So it seems kind of crazy to allow that
result.
Although there is general agreement that something needs to
be done, there is not general agreement as to exactly what
should be done, and there are different scenarios. One scenario
would say we will wait for some sort of global consensus to
arise. The Organization for Economic Co-Operation and
Development (OECD) is studying this particular issue and is due
to issue some thoughts within the next month or two. But
typically my experience is the OECD does not move very quickly.
Second, another alternative is for the United States to act
unilaterally, and unilateral action may be something that is
needed in this particular case, if only to jump-start what is
going on around the rest of the world.
So my basic recommendations are:
In the short run, Congress should consider tightening the
Subpart F rules by potentially restricting check-the-box
regulations for foreign entities, potentially limiting the CSC
look-through rule, and potentially limiting the contract
manufacturing regulations which I have not spoken about because
Apple really did not take advantage of those.
In addition, I think in the short term, Congress should be
thinking about increased transparency. There should be
additional reporting done by U.S. multinationals that shows
where they record their income for both accounting and tax
purposes, as well as where they record tax expense, where they
pay tax, and other factors that might be useful in allowing tax
administrators around the world to audit those companies.
In the longer term, there still needs to be a solution
because to the extent that there is an arm's-length pricing
model, you will always have companies having the opportunity to
shift income. So I would strongly suggest that in the long run
the United States continue to monitor what is going on in the
OECD. But assuming a global consensus cannot be reached, I
would not recommend that the United States adopt a worldwide
tax system unless the United States reduces its corporate rate
down to 15 percent. And since I do not think that is going to
happen anytime soon, we can probably reject that alternative.
But if the United States does keep the arm's-length standard, I
recommend imposing a minimum tax on foreign earnings,
especially those from tax havens. But this tax needs to be
designed so it is administrative. As a former tax adviser in
the private sector as well as a government official, it needs
to be administrable, and I make some specific recommendations
in my written testimony.
And then one other point that I have not mentioned is the
need to defer deductions with respect to activity overseas.
What oftentimes happens is U.S. multinationals will borrow in
the United States effectively on-lend that overseas, and they
will deduct the interest in the United States. but they will
not recognize any interest income in the United States. I think
that is an issue that also needs to be addressed.
Since I am over my time here, I am going to conclude my
testimony. Thank you for asking me to testify this morning, and
I would be pleased to answer any questions.
Senator Levin. Thank you, Professor Harvey.
TESTIMONY OF STEPHEN E. SHAY,\1\ PROFESSOR, HARVARD LAW SCHOOL,
CAMBRIDGE, MASSACHUSETTS
Mr. Shay. Chairman Levin, Ranking Member McCain, Members of
the Subcommittee, thank you for the opportunity to testify on
the important topic of shifting of profits offshore by U.S.
multinational corporations. I am a professor of Practice at
Harvard Law School. The views I am expressing are my own
personal views.
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\1\ The prepared statement of Mr. Shay appears in the Appendix on
page 107.
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I have also served in the Treasury Department and I have
practiced for over two decades at a large law firm as an
international tax partner.
The Subcommittee and its staff should be commended for
pursuing this important investigation. Protecting the existing
U.S. tax base is an important responsibility of those in
Congress and the Administration responsible for the fiscal
health of the country. The revenue lost to tax base erosion and
profit shifting is hard to estimate, but there is compelling
evidence that the amount is substantial. This revenue loss
exacerbates the deficit and undermines public confidence in the
tax system. Restoring revenue lost to base erosion and profit
shifting would support investing in job-creating growth in the
short term and reducing the deficit over the long term.
My written testimony provides background information on the
taxation of foreign income of U.S. multinationals earned
through a controlled foreign corporation and on transfer
pricing. I will review certain of the information developed by
the Subcommittee staff regarding Apple's international tax
planning and consider how current elements of U.S. tax law
contribute to key elements of that planning and make a limited
number of observations regarding the implications for tax law
changes.
Apple is a remarkable and a remarkably successful company.
I will refer to the information in Apple's fiscal year ending
2011 instead of the most recently ended year because separate
subsidiary information only was made available to the
Subcommittee staff for fiscal year 2011.
The Apple companies in Ireland included two participants in
the cost-sharing agreement that was of longstanding with Apple
for the rights to sell products outside North and South
America. Based on consolidating financials (without
eliminations for each of these companies), in 2011 Apple's
Irish companies earned approximately $22 billion in earnings
before tax (EBT), or approximately 64 percent of total global
EBT. Of that $22 billion, roughly $18 billion was operating
income. For reasons I mention in my testimony, I am going to
stick with EBT for most of my numbers.
Senator Levin. And, again, what is EBT?
Mr. Shay. Earnings before tax. Thank you, Mr. Chairman.
The Apple Irish companies' earnings before tax to sales
margin was 46 percent compared to 23 percent for Apple in the
United States.
The average effective book tax rate for the Irish companies
was well below 1 percent. Although Apple listed their
``location for tax purposes'' as Ireland in prior disclosures
to the Subcommittee, I was advised on Sunday night that the
principal companies in terms of earning income directly, Apple
Operations Europe and Apple Sales International, are not tax
resident in Ireland.
Apple Operations Europe and Apple Sales International as a
result only pay Irish tax on business carried out in Ireland.
Ireland does not make a claim to tax a non-resident Irish
company on non-Irish income.
It is not clear where the income attributable to the cost-
shared intangibles is treated as earned by Apple from the
information that we have been provided. It appears to be
allocated away from Ireland for tax purposes. Presumably, it is
what is fondly referred to by international tax planners as
``ocean income.'' It would be difficult to achieve a less than
2-percent Irish effective tax rate if that income were subject
to Irish tax at either its 12.5-percent rate for trading income
or a 20-percent rate otherwise.
Over the 3-year period 2009-11, Apple's Irish cost-sharing
participants paid approximately $3.3 billion in cost-sharing
payments to Apple US. While that is a very large number, over
the same period Apple's Irish affiliates has earnings before
tax after those payments of $29.3 billion. So would Apple have
entered into the cost-sharing arrangement if Apple's Irish
affiliates had been unrelated? To answer ``yes'' in my view
strains credulity.
The U.S. tax that was deferred on these earnings was likely
over $10 billion. The ability to reinvest those tax savings is
a valuable tax benefit.
The objective of the arm's-length principle in transfer
pricing is to achieve neutral treatment of related and
unrelated party transactions. The ability of multinational
businesses to take advantage of transfer pricing between
related persons in different countries--or possibly in this
case in no country--strongly favors structuring transactions
with affiliates to be able to shift income into low-tax
countries or no country. It is an advantage that is largely
unavailable to purely domestic businesses including almost all
small business enterprises. Yet small businesses and
individuals must make up the lost taxes.
The benefit of this income shifting is enhanced when
deductions are incurred in the United States to earn this low-
tax income that is deferred from U.S. tax. As described in my
testimony, it appears that Apple's general and administrative
and sales, marketing, and distribution expenses are incurred
disproportionately in the United States. By that, it is not
that they should not be incurred here, but they do not appear
to be charged against this low-taxed income in Ireland.
Allowing a current deduction for whatever portion of these
expenses is attributable to income booked in the Irish
companies effectively is a U.S. tax subsidy for those deferred
earnings. This is often referred to in exemption countries as
``deduction dumping''--in other words, you put your deductions
in the home country, and you try and achieve low tax exempt
income outside the home country.
Our system of deferral creates, and even more if it were an
exemption system, creates an irresistible incentive to shift
income to where it will be low taxed or not taxed. This was
understood when the Subpart F limits on deferral were first
adopted in 1962. They were intended to serve as a vital
backstop against transfer pricing abuse by reducing the
incentives that would arise if income could be shifted to low-
or zero-tax countries. Apple's international structure takes
full advantage of loopholes in existing anti-deferral rules.
Apple avoids the reach of the foreign base company sales
rules by contracting for manufacture of its products with third
parties and in most cases, for U.S. tax purposes, selling to
third parties. By using check-the-box disregarded entities,
intercompany transactions within the group of companies that
are classified as disregarded simply disappear.
With respect to payments of interest and dividends, the
look-through rule of 954(c)(6) accomplishes much the same
result except to the extent that deductible payments offset
income of the payor that would not be subject to current U.S.
tax.
If all of this works, our tax rules allow Apple to allocate
billions of dollars to nowhere when our rules presume that in
order to achieve deferral, some country has residence
jurisdiction to tax the income. That to me is the implication
of what we learned on Sunday night. No country is making a
claim, and yet we are allowing deferral of those earnings.
Our international tax rules are out of balance. They are
too generous to foreign income and not strong enough in
protecting against U.S. base erosion by foreign companies
investing in and carrying on business in the United States. The
losers are domestic businesses.
In the context of current law, if we are not going to go to
tax reform and in my view repeal deferral, changes still may be
made that would limit the scope for profit shifting. Most
promising is a minimum tax imposed on the U.S. shareholder of a
controlled foreign corporation in respect of low-tax foreign
income. This should not be a final tax in design. It should be
a deemed distribution, as under current Subpart F, but the
remaining U.S. tax should be collected when the earnings are
distributed or the stock is sold.
This should be accompanied by taking away the advantage of
tax havens for foreign companies that invest and carry on
business in the United States. The United States should protect
its source tax base by measures that include imposing
withholding tax on and/or restricting deductions for deductible
payments of income paid to or treated as beneficially owned by
related persons that are not ``effectively taxed'' on the
income. In doing this, the United States would take away a
substantial advantage that foreign-owned companies have in
structuring investments in the United States.
Third, the United States should strongly support and lead
efforts at the OECD to combat base erosion and profit shifting.
I have described elsewhere an approach that, if taken by the
United States, would provide the incentive for other countries
to adopt complementary rules.
Should Congress wait for tax reform to address income
shifting? The short answer is no.
I applaud the Committee for exposing--``exposing'' is
really the wrong word--for bringing to light international tax
practices that are not easily discernible from public financial
statements.
Thank you, and I would be pleased to answer any questions.
Senator Levin. Thank you both.
Let us have an 8-minute first round of questions for the
Members of the Subcommittee.
Professor Shay, as we have all said this morning, we have
learned that these three Irish subsidiaries of Apple are not
tax resident anywhere in the world, and the majority of Apple's
profits worldwide are not being taxed anywhere. The evidence
indicates that ASI, AOI, and AOE, the Irish subsidiaries, are
controlled out of the United States.
Let me start with you, Professor Shay. From a tax law
perspective, does it make sense to have Apple treat this income
as deferred when those entities have no tax residence? I think
you just testified to that, but if you could repeat your
conclusion.
Mr. Shay. When deferral was established, its premise was
that another country has asserted a tax claim or could
potentially assert a claim even if it chooses not to with
respect to that income. Ireland, by treating these companies as
non-resident, has affirmatively said it is asserting no tax
jurisdiction over the income that is not attributable to the
Irish business operation. It seems to me that is inconsistent
with the premise of deferral because the company has no tax
residence anywhere else that is making a tax claim. So, to me
that is incoherent. It is an incoherent tax system that permits
that to occur.
Senator Levin. Now, we have also seen that ASI, which is
Apple Sales International, signed a cost-sharing agreement with
Apple, that they have no tax residence anywhere in the world;
they had no employees at all until 2012; they currently claim
to Irish tax authorities that ASI is not managed or controlled
in Ireland; their board of directors is composed primarily of
Apple Inc. employees; they hold their meetings in California;
ASI's finances, including funds, are managed, controlled, and
invested by Apple employees in a Nevada subsidiary; their
business decisions are made by Apple executives in California.
Now, we also know that--I will leave it at that.
Now, Professors, from a policy perspective, does it make
sense for a company which is located in a foreign jurisdiction
in name only, while activities are controlled in the United
States, to be used as a tool to shift profits and to direct tax
liabilities away from the United States? Professor Shay.
Mr. Shay. Mr. Chairman, I do not think that makes sense.
But I also meant to put it in a broader perspective, we talk
about globalization. We are aware that we now have a digital
economy. We have different ways of earning income that no
longer have the kind of traditional physical nexus to a country
that they once did. It simply is important to rethink our
rules, and the premise that I would start with is that we
should no longer be oblivious to what happens in the other
countries. If another country is not taxing income, then, for
example, we should not give a deduction with respect to
payments to that country. That is subsidizing activity
unnecessarily.
I think we need to rethink our rules on the cross-border
context to be more aware of how other jurisdictions are taxing
the income.
Senator Levin. Professor Shay, has Apple in their cost-
sharing agreement effectively shifted profits overseas when
they shifted their economic value of their intellectual
property offshore?
Mr. Shay. Yes, by entering into an agreement that had its
origin long ago, although it has been renewed a couple of
times--or amended a couple of times, I should say, and agreeing
to pay a share of the research and development expenses, they
have then taken the fruits of that and possibly the fruits of
more than just those expenses--based on the numbers--and
located it outside the United States. And that clearly has the
result of shifting of profits.
Senator Levin. Overseas.
Mr. Shay. Overseas.
Senator Levin. Now, they deny that they shift profits
overseas, and your testimony is that they are shifting profits
overseas through this mechanism. The way to test the reality of
Apple's cost-sharing agreement is to ask, as you did, whether
or not it would have entered into the same agreement with an
independent, unrelated third party. And you, I believe,
testified, Professor Shay, that to say yes to that question
strains credulity.
Can you tell us why it would strain credulity to say that
they would enter into this kind of a cost-sharing and profit-
shifting agreement with an independent party?
Mr. Shay. I think it is important to look at outcomes. And
the law authorizes us to do that since 1986. One way of
thinking about this is if you were an investor in Apple and the
Apple management came to you and said, ``Look, we want to
partner with somebody who has few or no employees but has some
money, and they are going to pay a share of our R&D, and as a
result, we are going to give up the rest of the world outside
of North and South America profit for that amount, is that a
good deal?''
Another way of thinking of it is how would Mr. Einhorn
think about that deal. Would he be pleased with that
arrangement? Thinking about it that way, it does not seem
credible to me.
Now, Apple correctly says in their testimony this cost-
sharing agreement had its origins many years ago, and it did.
And that raises the question of should that ever have been
revisited, and at arm's-length would it ever have been
revisited?
When you look at the numbers that were up on the chart, $4
billion in exchange for $74 billion of earnings before tax--or
$72 billion, whatever it was, I think in that context you would
really question whether at arm's-length that deal would not
have been amended sometime between 1980 and now.
Senator Levin. So it was amended in the last few years. Is
that correct?
Mr. Shay. It was amended. It was amended for technical
reasons. I do not advise them. It appears clear that they
amended it in order to stay within a grandfather clause under
prior, much more relaxed, cost-sharing rules that have allowed
them to perpetuate the arrangement.
Senator Levin. All right. And in that arrangement, you are
saying that arrangement would never be entered into in the last
few years at an arm's-length with an independent party. It just
strains credulity, to use your word----
Mr. Shay. Yes, there are bad deals out there. This would be
a whopper. And I just doubt----
Senator Levin. A whopper against Apple.
Mr. Shay. Against Apple, and would you still own the stock
if somebody gave away that much of your income? That is a
simple way of asking the question.
Senator Levin. And if Apple can create companies with no
tax residence and create profits in those companies, and if
that is going to be tolerated, couldn't all U.S. multinationals
in effect do the same thing--eliminate the corporate tax for
our multinationals and allow them not only to become tax
freeloaders but also to offload their taxes on domestic
competitors, small business, and working people? I mean, if
they can do it, why couldn't every multinational do the same
thing?
Mr. Shay. I will point out, Apple points out in their
testimony, correctly, that they only did this for their
international sales. Now, their international sales are very
large----
Senator Levin. I mean, couldn't any multinational do it for
their international sales?
Mr. Shay. Any multinational could do it for their
international sales, but there is nothing preventing it from
being done, as we saw with Microsoft, for domestic sales. So,
again, this is not an Apple-bashing exercise to me. This is an
exercise in saying: Where are we? How can we possibly be in a
situation today where the law permits income to be allocated to
a company resident nowhere and not be taxed anywhere and the
United States just say, forget it, do not worry about it, that
is fine?
Senator Levin. Thank you.
One last question, Mr. Harvey. You said that you almost
fell off your chair when you read that Apple says that they do
not use gimmicks. Why did you almost fall off your chair?
Mr. Harvey. I think the check-the-box regulations,
certainly the practical effect of those regulations is a
gimmick to make transactions disappear.
Senator Levin. And how about creating corporations that do
not exist anywhere? Did you ever hear of that before?
Mr. Harvey. Certainly that is a goal of many tax planners.
The utopian goal that tax planners try to obtain is to create
an entity that is taxed nowhere. So Apple, through this
particular structure, was able to substantially accomplish that
result.
Senator Levin. Have you heard of that being done in other
cases?
Mr. Harvey. There are other situations where that situation
arises, yes.
Senator Levin. Where it is taxed nowhere?
Mr. Harvey. Correct.
Senator Levin. Okay. Thank you.
I think, Senator Johnson, probably you came in next. I am
not sure who was first.
Senator Johnson. I was here first.
Senator Levin. Thank you.
Senator Johnson. Thank you, Mr. Chairman.
Professor Harvey, in your testimony you stated that,
according to your calculations, Apple's overseas income was 64
percent of total income. Their sales were roughly 60 percent.
It would strike me that seems to be a somewhat fair allocation
of income to sales. What do you think would be a more fair
allocation between recognition of income?
Mr. Harvey. First of all, just to maybe clarify the
statistics, the 64 percent is the amount of income recorded in
Ireland. There is another 6 percent recorded in other foreign
countries. So in the aggregate, there is 70 percent of income
located overseas. So the statistics that I would look at would
be that there is 30 percent of the global income in the United
States and there are roughly 39 percent of global sales in the
United States.
Senator Johnson. Okay. My figures are about 39 percent
global sales and about 32 percent--I mean U.S. sales about 32
percent. So there is a greater allocation of income.
How should income be allocated?
Mr. Harvey. I think that is a question, and the key
question is for technology that is developed, say, in the
United States, how should that be taxed? Now, I think most
economists would tell you that if you develop the technology in
the United States then the United States would expect to get
the lion's share or substantially all of the income with
respect to that technology. But----
Senator Johnson. How is it handled between States in the
U.S.? If you develop the technology, let us say, in New York
but your manufacturing plant is in Texas, where is the income
tax, the State income tax allocated on that basis?
Mr. Harvey. Well, it depends on which State you are talking
about. There are some States that are separate company States,
and there are some States that are global apportionment----
Senator Johnson. But, generally, if you are manufacturing
in Texas, even though you might have produced a product in New
York, you are probably going to be taxed--well, Texas may be
wrong. Let us say Wisconsin. In Wisconsin, you would be taxed
in Wisconsin because you are manufacturing and selling out of
Wisconsin. Isn't that correct?
Mr. Harvey. Not necessarily. It depends on the particular
State rules. It depends where the technology is located. But
what I wanted to say, to finish up, which I think is important
for you to hear because it may support some of where you are
heading, is I think it is a legitimate question for Congress to
ask how should technology income be allocated. And if Congress
decides that it wants to provide some sort of incentive to have
technology income not taxed in the United States then I think
that is perfectly within Congress' right to do so, and they
should affirmatively do it, as opposed to leaving a regime that
is, in essence, a self-help regime that allows taxpayers to
really decide how much they are going to pay.
Senator Johnson. But in the end, Apple is selling a
product, and so you are really talking about where do you tax
the manufacturing income. I mean, we can split this baby 16
different ways, but at some point in time you have to figure
out where does the incidence of tax lie? I mean, how should
income be allocated between countries, between State, between
tax jurisdictions? That is a difficult question to answer,
isn't it?
Mr. Harvey. Absolutely. But what I would say is when you
have 64 percent of your income in a country like Ireland with
no employees and no real substance, that seems to be a serious
issue, and you have to decide where should that income be
taxed.
Senator Johnson. So let me ask, how long have we been
trying to solve this problem through the U.S. Tax Code?
Mr. Harvey. This problem has existed on and off--well,
basically continuously for decades.
Senator Johnson. So do you really think there is a fix to
it?
Mr. Harvey. Yes, I believe there are fixes to it that
Congress should take, because what has happened in the last 17
years is the passive income--or the Subpart F rules have been
so significantly relaxed that it is just open season for
taxpayers to go and do whatever they want.
Senator Johnson. If you are a business manager whose
primary fiduciary responsibility is to your shareholders, and
let us say the United States passed a law and said we are going
to claim all of your income and tax it at our corporate tax
rate of 35 percent, what would a rational business manager do
with his overseas operations?
Mr. Harvey. As I indicated in my testimony, I do not
recommend that we tax worldwide income, at least at the full
U.S. tax rate. I recommend that we only tax if we are going to
have a minimum tax on foreign earnings, that it only be with
respect to tax haven earnings, and at something less than the
full rate.
Senator Johnson. What would that be?
Mr. Harvey. I think the number that is thrown around by a
lot of folks is 15 percent, in that range.
Senator Johnson. But what if a business manager felt that
was too onerous and couldn't they just divest themselves of
those companies and then all of a sudden you have a smaller
U.S. company and you have a larger overseas company? I mean,
there are unintended consequences to try and do anything there?
Mr. Harvey. Well, you have the competitive issue, and are
you going to let U.S. multinationals then effectively have free
rein to move income offshore? And as Professor Shay indicated,
you can, if you want to, move almost all of your income
offshore. Now, Apple was not that aggressive. They were fairly
aggressive, but not that aggressive. So I think you have to
balance those issues and, admittedly, very difficult issues.
But I think Congress needs to face up to the issue and make
some tough policy calls.
Senator Johnson. Now, I understand the point that you might
have the disadvantage of a domestic competitor that does not
operate overseas when a multinational corporation's overall
effective tax rate is lowered because of some of the overseas
taxation issues. But, in general, who benefits from a lower tax
rate on a corporate structure such as Apple? Who is the
beneficiary?
Mr. Harvey. Certainly as a result of their tax planning,
their shareholders are the beneficiaries.
Senator Johnson. Who are the shareholders of Apple?
Mr. Harvey. Whoever owns the shares of stock.
Senator Johnson. Do you have any idea what the breakdown
is?
Mr. Harvey. I do not know what it is.
Senator Johnson. I will probably ask Apple management that.
But, in fact, the people that benefit really are those
owners, and a lot of those are probably union pension funds and
just individual shareholders, correct? In other words, there is
an assumption that because Apple made a really good deal with
the overseas taxing authorities that that is somehow bad for
America. In fact, would we be better off if Apple were paying
12 percent to Ireland or 25 percent to Germany? Would Americans
be better off?
Mr. Harvey. I think to the extent that you get a more fair
allocation of income, I think ultimately in the long term, yes,
Americans would be better off.
Senator Johnson. So it would be better if Apple were paying
more of its corporate profits to taxing authorities in Ireland
and Germany? That would be better for America?
Mr. Harvey. I think in the long run we need to come up with
what is the appropriate taxation of international income. As
indicated in my testimony, my written testimony, my preference
would be to see a reduction in the corporate tax rate in total
for both domestic and foreign companies down to 15 percent and
probably replace that with some sort of alternative funds,
whether it be a VAT or something else. I do not think that is
going to happen anytime soon, so if that is not theoretically
possible, then you have to address the very difficult issue
about competition between domestic companies and U.S.
multinationals and then U.S. multinationals versus foreign
multinationals. And I am sensitive to that.
There is an issue as far as competitiveness between the
United States and foreign multinationals, but do not forget
there is also an issue between competitiveness of U.S.
domestics versus U.S. multinationals.
Senator Johnson. If you are, let us say, a global
manufacturer that wants to manufacture for the U.S. market--
and, by the way, that is one of the things we have going for
us. We are still the world's largest market. If I am a
manufacturer, I would not dream of manufacturing for my
domestic customers anywhere other than the United States. But
if you are a global manufacturer, would you be more likely to
site a plant, let us say, in Toronto at 15 percent or Detroit
at 35 percent? What would be the rational thing to do?
Mr. Harvey. The rational thing from a corporate perspective
is to clearly locate in the lowest tax jurisdiction.
Senator Johnson. So we need to make sure that we are very
competitive globally, and when we are competing against tax
jurisdictions around the world that are willing to cut a deal,
should corporations take advantage of that? I mean, isn't that
the rational thing to do? And, quite honestly, when Apple is
responsible for 600,000 jobs in America, that is not just Apple
but all the application developers, you multiply that times
about a $50,000 median household income, that is about $30
billion worth of payroll at about a 20-percent tax rate. That
is a lot of taxes flowing into the Federal Government as well,
isn't it?
Mr. Harvey. It certainly is. But under that theory, why
don't we just eliminate taxes for Apple?
Senator Johnson. That was my next question. So one way
around this--one way of actually capturing that income--I just
want to posit this idea. My business was an LLC. It was a pass-
through income. Why not tax corporate income at the shareholder
level? We would eliminate all these problems, wouldn't we?
Mr. Harvey. Well, how would you propose to tax it for
pension funds and foreign shareholders? Would you tax that?
Senator Johnson. Well, it----
Mr. Harvey. Would the U.S. corporate tax be a withholding
tax?
Senator Johnson. If it passed through to the actual
taxpayer--if you are a tax-exempt organization, you will not
pay tax on that income. But if you are a high-taxed individual,
you will pay it at your high tax. You could eliminate all
dividend income, and you could capture all worldwide income,
and corporations would--you would eliminate the competitive
disadvantage of different taxing jurisdictions.
Mr. Harvey. Again, if that is what Congress decides to do
and wants to replace the $250 or $300 billion a year, it is
within your prerogative to do so.
Senator Johnson. But, again, that would eliminate the
inability--and that is basically what we have had. We have had
the inability for decades of trying to capture this income that
shifts around the world and reacts to different, very byzantine
tax structures.
Mr. Harvey. There is no question that the U.S. tax law is
extraordinarily complex. I guess one thing you did say, though,
is the issue of whether the U.S. tax law puts U.S.
multinationals at a competitive disadvantage, and there are
pros and cons on both sides of that. My personal view is that
the U.S. tax law in many cases actually favors U.S.
multinationals. Maybe we can talk about that separately at
some----
Senator Johnson. Okay. Thank you.
Thank you, Mr. Chairman.
Senator Levin. Thank you. Senator Carper.
OPENING STATEMENT OF SENATOR CARPER
Chairman Carper. Thanks very much. I have another competing
hearing going on over in the Finance Committee dealing with the
IRS, and I apologize for missing your testimony. But thank you
for joining us and welcome.
I would like to maybe put this hearing in context. Let me
just thank the Chairman and the Ranking Member for holding this
hearing and for all the witnesses coming. I want to put it in
some context, if I could.
The Congressional Budget Office reported earlier this month
that the budget deficit is coming down. About 3 or 4 years ago,
it peaked out, topped out at about $1.4 trillion. The estimate
as recently as a month ago was it was--this year our deficit is
going to be about $840 billion. CBO has now said it will be
probably closer to $650 billion--only $650 billion, and that is
an improvement, but we all know it is way too much.
One of our former colleagues, Kent Conrad, who for a number
of years was the Chairman of the Budget Committee, told his
colleagues last year that if you added up all the tax
expenditures, tax deductions, tax breaks, tax loopholes, tax
credits, that it added up for the next 10 years to something
like $15 trillion. And as I recall, what our friends Erskine
Bowles and Alan Simpson tried to do in leading the Deficit
Commission was to propose--in order to be able to bring down
the business corporate tax rate from 35 to about 25 to 28
percent, they proposed reducing significantly--not entirely but
significantly--the tax expenditures and argued that if we were
to do that, we would be more in line with the rest of the
world. And it also called for moving to a territorial tax
system.
Let me just either of you or both of you just to share with
us your views of the approach laid out by the Deficit
Commission, their recommendation, which a lot of people said,
well, that was dead on arrival. I think it still has a
heartbeat, and my hope is that it gives us a road map that will
still follow as this year carries on. But let me just ask you
to react to their recommendations.
Mr. Shay. You are referring to Simpson-Bowles.
Chairman Carper. You got it.
Mr. Shay. I think that was a very important start to the
discussion. There have been a variety of changes since, and I
think the realism of eliminating all tax expenditures, as I
referred to, is somewhat overstated. I do not think it is going
to happen.
Chairman Carper. I do not know of anyone suggesting we are
going to get rid of all of them--they did not suggest that
either--but enough to get us down to a rate between--our top
rate to about 25 to 28 percent. That was what they recommended.
Mr. Shay. Right. But I think some of the recommendations,
the reason I think this hearing and this issue is important is
because part of those recommendations included moving to a
fairly unspecified exemption system.
I think that is a source of great concern for the reasons
we have been discussing this morning. Under an exemption
system, there would be even fewer restrictions; it would even
be more beneficial to try and shift income abroad unless
significant protections are put in place or there is some form
of a minimum tax, something that is done of that nature.
Speaking more broadly, do I think the direction of tax
reform should be to broaden a base? My own view is we can use
more revenue, so I would not necessarily put it all into
lowering rates, but some mix, some balance. I think that is a
very sensible way forward.
I think we need to bring the discussion from the level of
broad generalities down to specifics. One of the reasons I
testified is I think that is going to take time. I actually
served in the Treasury Department from 1982 to 1987 during the
Reagan Administration. I served throughout tax reform. We
started before the election in 1984 to prepare the Treasury
proposals. They came out at the end of the year. We spent 1985
going through the House--well, before they went to the House,
they first were reviewed and because the President's proposals.
And that was a significant review, sort of a political screen,
but pretty light, frankly. Then they went through the House.
Then they went through the Senate.
That process is looked back on today with great affection
and seems to be viewed as a great process. It still came out
with a product that was far from perfect, even though it took 3
years. In order to do a tax reform that is going to be
responsible, we need the full involvement of the Treasury
Department; we need it to be done with the assistance of the
Office of Tax Analysis as well as the Joint Committee on
Taxation. This is difficult, complicated stuff, and doing it in
broad brush strokes or in a series of political compromises is
not going to get us where we want to be.
So while I admire what the Simpson-Bowles folks have done
at a high level and in the way they have contributed to the
debate, we have a tremendous amount of work in front of us if
we are going to have a genuinely effective tax reform.
In the meantime, we should not allow income shifting and
base erosion to continue. There are things we can do that would
help restore revenue that should be in the budget and that
could be contributed to purposes that on a bipartisan basis
probably Senator Levin and Senator McCain would agree on.
Chairman Carper. All right. Thank you.
Mr. Harvey. I guess what I would add just very quickly, I
would concur with pretty much all of what Professor Shay says.
The key is if we go to a territorial system, we need to have
very clear base erosion principles to prevent that. And I think
Chairman Camp from the Ways and Means Committee understands
that. In the proposals he has floated, there are base erosion
proposals.
Chairman Carper. All right. The Senate Finance Committee,
on which I serve, is going through a series of briefings,
basically member-only briefings to look particularly at
corporate tax reform and looking broadly at the exemptions that
exist and trying to decide where it might make sense to make
changes. I think sometimes folks in our jobs, we talk about
creating jobs. Mayors, Governors, Presidents talk about
creating jobs. We do not create jobs. What we do is help create
a nurturing environment for job creation, and that includes a
world-class workforce, access to capital, reasonably good
infrastructure, some certainty on the Tax Code, and a Tax Code
that incents, among other things, investment in the workforce
and investment in R&D that is going to lead to products and
goods and services that we can commercialize and sell around
the world.
We need to provide some certainty with respect to the Tax
Code, and I think we need some more revenues. I think one of
you mentioned that. The idea of taking the corporate rate down
to 15 percent and being able to supplement the lost revenue
with a VAT or a carbon tax, actually I do not think either of
those are going to happen, probably not on my watch.
And having said that, we do need to provide that certainty
and that predictability. We do need the revenues. The last 4
years in the Clinton Administration we had balanced budgets,
you will recall. Revenues were anywhere from 19.5 to 20.5
percent of GDP. That is when we had 4 years of balanced
budgets. We need to get closer to something along those lines.
Thanks, Mr. Chairman.
Senator Levin. Thank you very much, Senator Carper, who is
the Chairman of our full Committee. We very much appreciate
your being able to get here despite these other commitments
that you have. Senator McCain.
Senator McCain. Thank you, Mr. Chairman.
Professor Harvey and Professor Shay, thank you for being
here, and thank you for your very important and valuable
knowledge and expertise.
Isn't it just a fact that these tax advantages that Apple
has either taken advantage of or in some cases, in my view,
invented if you take a tax reduction in a country that you have
no employees, but doesn't this put domestic companies and
corporations at a distinct disadvantage?
Mr. Harvey. Yes.
Senator McCain. Professor Shay.
Mr. Shay. Yes. I think the objective of our tax rules
should be to try and achieve a balance, and in this particular
case, try to create in relation to transfer pricing and cross-
border activity neutrality between what would happen if you
were dealing with a third party and what happens when you are
dealing with an affiliate. Our rules today favor using
affiliates.
Now, coming back to something Senator Johnson referred to,
if I understand it correctly, most of Apple's manufacturing is
not done by Apple, and that is true of many companies today. It
is done, I believe, by Foxconn, or other contract
manufacturers, third parties. So companies today view
themselves, I believe--and I do not believe there is any
problem with it--as they are allocators of capital. They are
trying to allocate the capital to the highest after-tax use.
And that is fine.
Our job and your job as designers of tax systems is to try
and find a way that, while allowing business to do its
business, we are taxing income in a way that least disturbs the
pre-tax economic decisionmaking. And it seems to me very clear
today that we are off balance here. We have very substantial
amounts of income earned in a country where very little is
done. It is not in the United States where I think most of it
probably belongs, but it is also not in the market countries
where the customers are.
We need to come up with rules that achieve the outcome of
having it taxed fairly, our fair share in the United States
wherever else, whatever their claim is their fair share, that
is fine. But right now it seems to me clear we are not getting
our fair share.
The R&D is done here. It is supported with our educational
system. It is supported with an R&D tax credit. And that tax
credit applies just as much to the R&D that is cost-shared out
to the foreign location as it is here, so long as it was
performed in the United States. This is not in balance.
Senator McCain. Ninety-five percent of the R&D conducted by
Apple, and I would imagine every other high-tech corporation,
is conducted here in the United States. Thank God.
Professor Harvey, Apple has divided the world into two
sections--North and South America, and the rest of the world.
So if a customer in Sao Paulo, Brazil, purchases an iPhone,
Apple Incorporated receives the profit and the United States
the tax. However, if a similar customer purchases that same
iPhone in Copenhagen, Denmark, that profit goes to Apple
Ireland and no corporate tax accrues to any country.
How is it possible that no tax goes to any country?
Mr. Harvey. I believe some tax does go to the country that
the customers are located in, but it is a very small
commission.
Senator McCain. Like 0.005 or something like that, Ireland?
Mr. Harvey. That was the ultimate tax rate in Ireland. I
think the commission--I forget the exact commission, but it
might have been 5 percent of sales, maybe 8 percent of sales. I
am not sure.
Senator McCain. So the moral of the story, at least in my
view, is that Apple has violated the spirit of the law, if not
the letter of the law, and I agree that a great deal of
responsibility lies with Congress. And the last time, as you
mentioned, Professor Shay, that we did any meaningful reform
was way back in 1986, and it is long overdue. And perhaps this
testimony today will motivate the Congress of the United States
to enact a comprehensive reform and to bring him this $1
trillion or $1.5 trillion, I think it is, amount of money that
rests overseas which is not brought back because of the 35-
percent tax rate that would be imposed on it. And I guess my
question to you, to both of you, is: Should there be a
permanent incentive to bring that money home? Or should we have
just a one-shot deal to say you can have--if you bring it home
within the next year or two, you can have a 5-percent or a 10-
percent tax rate imposed on it?
Mr. Harvey. I guess I will respond first. I do not think
another temporary deal makes sense. There was a temporary deal
back in 2004-05. Studies done suggested that the vast majority
of those funds were used to pay off debt or make dividend
distributions.
So I think this really calls for a comprehensive tax reform
to address this issue, but also there are some issues that can
be addressed in the short term. If Congress decides it wants to
tighten up Subpart F, it can do so. If Congress decides it
wants to increase transparency, it can do so. So I think a one-
time tax holiday of the type that existed before would not be
the right policy answer.
Mr. Shay. Senator, I am not a fan of tax holidays. The fact
is quite a substantial portion of the income that is held
offshore should have been in the United States in the first
place if we were fully enforcing--or if we had transfer pricing
rules that made sense. What we are talking about today is there
is a portion of the offshore profits that should not have been
offshore. In a well-designed tax system, they would not have
been offshore.
When the decision was made to allocate income to the lower
tax environment, it was done under a law which was crystal
clear. It is deferral. It is not exemption. There are proposals
to use a holiday or a low rate as an inducement to bring back
money, which essentially is a windfall for the companies who
earned it overseas under a law that said it was deferral.
Now, I understand that Mr. Cook has indicated to the
Subcommittee that there would be no intention to bring back
money at the current rates. So it is true that one contributes
to pushing more income over there and keeping it there as long
as you hold out the prospect of exemption, lower tax rates, and
so on. That from a policy point of view does not make a lot of
sense to me.
There is a sound economic argument that I am not really
arguing for today but that says it is already there, if you tax
it, they will bring it home. I mean, their decision to bring it
home analytically should be independent of whether you tax it.
If you tax it, they will bring it home. If you do not tax it,
if you tax at a lower rate, maybe they will bring it home. Even
under an exemption system, there is no incentive to bring money
home if you are going to earn a higher after-tax return on
those funds abroad. The notion that exemption is the key to
having money come home, it reduces the transactional effect of
having a cost at the time of repatriation. If you had taxed it
at the time it was earned, that would have gone away. That is
equally an answer to repatriation, as is giving exemption. So--
--
Senator McCain. So permanent drastic reduction of the
corporate tax rate, it seems to me, following your argument,
would be the answer.
Mr. Shay. That would certainly be a windfall for the
earnings that are offshore. I think we generally agree a lower
corporate tax rate would be beneficial.
Senator McCain. Thank you, Mr. Chairman. I thank the
witnesses.
Senator Levin. Thank you very much, Senator McCain. Senator
Paul.
Senator Paul. I think we need to restate for the record and
be very clear here that neither this panel nor anyone on the
Committee has said that Apple broke any laws. So they are
brought before this Committee and harangued and bullied because
they tried to minimize their tax burden legally.
I would argue that it would probably be malpractice for
them not to do so. If you have a publicly held company and you
have shareholders and your mandate to your chief financial
officer is, ``Please maximize our taxes,'' I am guessing that
that would probably be something that shareholders would not
accept. I do not know of any taxpayers who really do that. I do
not know of anybody on this panel who tries to maximize their
tax burden.
My question for Mr. Harvey: Do you take any deductions on
your taxes?
Mr. Harvey. Obviously I do.
Senator Paul. Do you choose to maximize your tax burden or
minimize your tax burden?
Mr. Harvey. Minimize it.
Senator Paul. Do you think you are a bad person for doing
that?
Mr. Harvey. Absolutely not.
Senator Paul. If you were advising as an accountant and an
expert in the tax law, if you were advising a corporation and
your mandate was to do what is best for their shareholders,
would you advise them to count all their profit here at home at
35 percent or to try to do as much as they can legally to pay
their taxes at a lower rate elsewhere?
Mr. Harvey. Well, as I said in both my written and my oral
testimony, certainly what Apple did does not appear in any way
to be illegal. I think the question is a policy question as to
whether they should be allowed to do it in the future.
Senator Paul. Yes, and as a policy question, talking about
taxes I think is an appropriate thing for Congress. Bringing in
an individual company and vilifying them for doing something
that is in every business' mandate is objectionable, and that
is why I object to these entire hearings, because talking about
policy is one thing. For example, $1 trillion overseas, you
want to bring it home? We have examples. We did it for 1 year
at 5 percent. We brought in about $30 billion. We actually
limited how much could come in. I say make it permanent. But
make it permanent and make it low enough that people would do
it. If you permanently do this at 5 percent, the money will
come home. But money goes where it is welcome. If we want to
have high taxes, we are going to continue along this.
Everybody talks about tax reform. Just do it. Other
countries just do it. We have a 35-percent corporate income
tax. We are chasing people away from us.
If the outcome of this Committee's hearing is, ``Evil
Apple, let us go get them, let us go get companies like this,
and let us raise their taxes,'' guess what? Their headquarters
may no longer be in Cupertino. They may be in Dublin with all
their employees. They are the type of company, high-tech
companies that can relocate around the world. They are not
dependent on large manufacturing forces. So if you want to
chase them out, bring them here and vilify them. It is exactly
the wrong thing to do. We should be giving them an award today.
We should be congratulating them on being a great American
company and hiring people and not vilifying them for obeying
the law. I mean, they are obeying the law. No one is accusing
them of breaking the law. They are doing what their
shareholders ask, which is to maximize profit.
We have created this byzantine and bizarre Tax Code and
chased them overseas. But it has been going on a long time. But
just fix it. There are 70 votes right now in the Senate for
having a 5-percent repatriation tax. Those votes exist, but
everybody says, oh, that is the sweetener for overall tax
reform, because so many people agreed to it. Why not just pass
it tomorrow? The same with the corporate income tax. We have
made ourselves beholden to things like the CBO that are, like,
well, the CBO will score that as a loss of revenue. Well, one,
the CBO does not know a lot of times, I think, up from down in
the sense that you could change the corporate tax--there is
such a number that you can lower it to where you will get more
revenue. I do not know what that number is, but that number
does exist. We are at 35 percent. You have a couple trillion
dollars overseas. There is some number you lower it to where
less money goes overseas unless people set up their companies
to have their taxes overseas.
So there are many ways you can do this. Repatriation would
bring a lot home. But if we take it that this is a vendetta
against American companies for trying to maximize profit, I
think we really have missed the boat here. And really, I say
one again, there should be a giant mirror sitting there. We
should be looking at ourselves. We should be talking about what
we do. Overall tax reform, everybody wants to do it, but they
say, oh, it has to be revenue neutral. That to me is absurd as
well. That means we are just going to punish some more people
and punish some people less. Why don't we try to reward the
economy? Why don't we try to reward shareholders? Why don't we
try to reduce taxes as a stimulus to the economy? Leave it with
the people who earn it.
So I am very frustrated by the whole proceeding,
particularly because of all these accusations. They are simply
doing what every company does. In fact, if they are not, why
don't we have the next hearing of companies who come in and
their chief goal, their stated goal, is to maximize their tax
burden? I want to see one company come before here and tell us
that their goal is different than Apple's, that their goal is
to maximize their tax burden. Taxes are simply a cost, and they
try to minimize them legally. I do, too. I take a home mortgage
deduction. I take my kid deductions. I take all the deductions
I can legally take.
This kind of vilification has gone on before. FDR did it.
The President did it in his campaign. This is something that is
not good for the country. It pits one of us against another,
and I think Senator Johnson really put it well when he said,
``Who are these people? Is there a Mr. Apple out there?'' No.
It is us. If you have a mutual fund, you probably own some
Apple shares. If you are a teacher with a pension fund, you own
Apple shares. If you are a fireman with a pension fund, you
probably own Apple. Apple is a great American company, and I do
not even know if they will know the breakdown, but I think it
is interesting. Probably the vast majority--I would guess 70,
80 percent of their stock may be owned by Americans. And so who
are we doing when we want to punish Mr. Apple? Who are we
punishing? We are punishing ourselves. And if we want to grow
America, we want more companies to succeed in our country, make
money welcome. Money goes where it is welcome, and as much as
you want to stuff the genie back in the box and say you must do
this in America, companies can and will go everywhere. So let
us make it a good place to work. Let us not vilify our American
companies.
And so what I would say, let us keep in mind what we are
talking about today is not breaking of law. What we are talking
about is a company doing what every company in America does,
and that is, trying to minimize their tax burden.
Thank you.
Mr. Shay. Could I make one comment just to be sure the
record is correct? In my testimony--and I want to be crystal
clear--I said I take no position on the legal correctness or
strength of any tax position taken by Apple. I do not want that
construed as saying what they have done is also fine. I have no
idea. And that was not the point of the hearing. The
Subcommittee staff did not request tax returns. They have only
requested financial data, so far as I have seen.
What we are trying to do in the hearing, as I understand
it, is understand what happens under current U.S. law and ask
ourselves: Is this the place we want to be? We can come with
different answers, but nobody is trying to vilify Apple, nobody
is trying to say what they did is either wrong, but, frankly, I
am also not saying that there is no adjustment to be made to
their income. I simply do not know. I was not given the facts
to reach that conclusion, and I do not reach that conclusion.
Senator Levin. Thank you. I think you have put it very
clearly. There is no effort to vilify anybody. We are trying to
shine a spotlight on the practices of a big company. We have
done this with other companies. There is no other way to
illustrate the way our current system works. It is a perfectly
legitimate--not only legitimate function for Congress. We do
not do enough analysis of how the current system works. We do
not do enough oversight. And to attribute that to--or to
characterize that in the way that it has been characterized by
one Senator here as ``vilification'' misses totally the target
of what the function of the Subcommittee is and what Congress
is responsible to do and does too far little of, which is to
look at how the current practices of the government work, how
they fall short, how they misfire, how they reach absurd
results, which is the case here in the case of Apple paying a
zero tax. Their goal is a zero tax for three corporations? Is
that the goal, a zero tax? Now, it is not a matter of
maximizing tax. You can set up a straw man about no one wants
to maximize the tax. Of course, no one wants to maximize tax.
Senator McCain. Mr. Chairman, could I also make an
unnecessary comment here? I have had the honor of serving with
you for more than a quarter of a century. I know of no Member
of the U.S. Senate that has ever accused you of bullying or
harassing a witness in the thousands of hearings that you and I
have been part of over many years. And, frankly, it is
offensive to hear you accused of that behavior, which has never
characterized your conduct of this Committee or the Defense
Committee.
Thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator McCain. I very
much appreciate that. Senator McCaskill.
OPENING STATEMENT OF SENATOR McCASKILL
Senator McCaskill. I have two things to say. I really do
not have questions for this panel, and I am anxious to hear the
testimony of the next panel.
First is I love Apple. I love Apple. I am Apple. My
family--I made all my family--I harassed my husband until he
converted to a MacBook. And I use it. It is a huge part of my
life, from the way I consume media to the way I do my job. And
I am very proud of Apple as an American company. So I will say
that first.
Second, I will say that I had the opportunity coming in
when I did to witness the fact--and I let the word go out--that
we are capable of classy bipartisanship in the U.S. Senate, and
I do not think that Senator McCain sometimes gets enough credit
for being willing to go places and say things that re-establish
that we are capable of classy moments of bipartisanship. And
everyone just got to witness one of those, and I wanted to
publicly acknowledge Senator John McCain for that moment.
And, finally, I have questions about this, not because I
think Apple is the villain but, rather, Apple is utilizing the
Tax Code that we have given them. And if we have any hope of
changing that Tax Code to promote free enterprise and
capitalism and the success of the American entrepreneur, but at
the same time make sure that we are receiving enough taxes to
fix our roads and bridges, to help educate our kids, to remain
a country that is seen as the bright and shining light on the
hill because of our infrastructure and our educated workforce,
we have to make sure that we have a tax structure that supports
those goals. And I think we can do both without villainizing
any American companies, and I appreciate you for holding this
hearing, and thank you to both witnesses for being here, and I
would look forward to the next panel.
Senator Levin. Thank you very much, Senator McCaskill.
Professor Shay, you referred to ASI, the Irish company--I
will just be a couple minutes in a second round. Why don't we
have a 3-minute second round--as having ``ocean income.'' What
do you mean by that?
Mr. Shay. Again, we have not seen tax returns, and I tried
to be very careful in my testimony, but it would appear that
ASI, which has quite substantial sales but a very low tax rate
in Ireland, may well be allocating income attributable to the
cost-shared intangible not to its Irish business. Since ASI is
not resident anywhere else, that is something that tax planners
fondly refer to as ``ocean income.'' I have seen it occur in at
least one other case, but it did not come from having no tax
residence. It came from having one country view the income as
earned in the other country, and that other country viewed as
earned in the first country so it was not taxed anywhere. But
at least at that point, there were two countries, they were
parties to a treaty, they could have resolved the issue, and
the income would have been located somewhere. This structure is
``different,'' is the most polite way I will put it.
Senator Levin. Thank you. Unless there is an additional
question for this panel, we are going to excuse you with our
thanks, and we will move now to the second panel.
Thank you. Let me now call our next panel: Timothy Cook,
the Chief Executive Officer of Apple; Peter Oppenheimer, the
Senior Vice President and Chief Financial Officer of Apple; and
Phillip Bullock, Apple's head of tax operations. We thank you
for being with us this morning. We look forward to your
testimony.
Pursuant to Rule VI, all witnesses who testify before the
Subcommittee are required to be sworn, and at this time I would
ask you to please stand and raise your right hand. Do you swear
that the testimony you are about to give will be the truth, the
whole truth, and nothing but the truth, so help you, God?
Mr. Cook. I do.
Mr. Oppenheimer. I do.
Mr. Bullock. I do.
Senator Levin. We will use our traditional timing system
here today. About 1 minute before the red light comes on, you
are going to see lights change from green to yellow, giving you
an opportunity to conclude your remarks. Your written testimony
will be printed in the record in its entirety. We ask that you
limit your oral testimony to no more than 10 minutes.
Again, our thanks to you, Mr. Cook, and your colleagues for
being here today, and you may proceed.
I am sorry. We have changed that. It is a 15-minute
opportunity instead of 10 minutes.
TESTIMONY OF TIMOTHY D. COOK,\1\ CHIEF EXECUTIVE OFFICER, APPLE
INC., CUPERTINO, CALIFORNIA; ACCOMPANIED BY PETER OPPENHEIMER,
SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, APPLE INC.
AND PHILLIP A. BULLOCK, HEAD OF TAX OPERATIONS, APPLE INC.,
CUPERTINO, CALIFORNIA
Mr. Cook. Thank you. I appreciate that.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Cook appears in the Appendix on
page 121.
---------------------------------------------------------------------------
Good morning, Chairman Levin, Ranking Member McCain, and
Members of the Subcommittee. I am proud to represent Apple
before you today.
Apple has enjoyed unprecedented success over the past 10
years. The worldwide popularity of our products has soared, and
our international revenues are now twice as large as our
domestic revenues. As a result, I am often asked if Apple still
considers itself an American company.
My answer has always been an emphatic, ``Yes.'' We are
proud to be an American company and equally proud of our
contributions to the U.S. economy.
Apple is a bit larger today than the company created by
Steve Jobs in his parents' garage 40 years ago. But that same
entrepreneurial spirit drives everything that we do.
You can tell the story of Apple's success in just one word:
``innovation.'' It is what we are known for. Products like
iPhone and iPad, which created entirely new markets, these give
customers something so incredibly useful, they cannot imagine
their lives without them.
You might be surprised to learn that much of that
innovation takes place in a single U.S. Zip code--95014. That
is Cupertino, California, where we have built an amazing team,
the brightest, most creative people on the planet. They come to
work each day with just one mission: to make the very best
products on Earth. Their job is to dream up things that capture
the world's imagination.
One of those inventions is the App Store. If you have ever
used an iPhone or an iPad, that mobile apps are one of the
hottest things in technology today. Apps have made software
development one of the fastest growing job segments in the U.S.
today.
We estimate that the App Store has generated nearly 300,000
new jobs in the U.S. App developers have earned over $9 billion
from apps sold on the App Store, half in the last year alone.
None of that economic activity was there 5 years ago, but
Apple took a bold step in developing the App Store, and the app
economy was born. Today it is a multibillion-dollar
marketplace, and it shows no sign of slowing.
We have chosen to keep the design and development of those
revolutionary products right here in the United States. While
job growth stagnated across the country over the last decade,
Apple's U.S. workforce grew by five-fold. Today we have 50,000
employees, and we have employees in all 50 States.
Apple has created hundreds of thousands of jobs at small
and large businesses that support us, from people involved in
manufacturing to people involved in delivering the products to
our customers.
Components for iPhone and iPad, for example, are made in
Texas, and iPhone glass comes from Kentucky. In total, Apple is
responsible for creating or supporting 600,000 new jobs.
We have used our earnings growth to invest billions of
dollars in the United States to create even more American jobs.
We are investing $100 million to build a line of Macs in the
United States later this year. This product will be assembled
in Texas, include components from Illinois and Florida, and
rely on equipment produced in Kentucky and Michigan.
We have constructed one of the world's largest data centers
in North Carolina. Reflecting our commitment to the
environment, the data center is powered by the largest solar
farm and fuel cell of its kind in the United States. We are
building data centers in Oregon and Nevada, a new campus in
Texas, and a new headquarters in Cupertino.
With all this growth and investment, to the best of our
knowledge, Apple has become the largest corporate income
taxpayer in America. Last year, our U.S. Federal cash effective
tax rate was 30.5 percent, and we paid nearly $6 billion in
cash to the U.S. Treasury. That is more than $16 million each
day, and we expect to pay even more this year.
I would like to explain to the Subcommittee very clearly
how we view our responsibility with respect to taxes. 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. We not only comply with the laws, but we
comply with the spirit of the laws. We do not depend on tax
gimmicks. We do not move intellectual property offshore and use
it to sell our products back to the United States to avoid
taxes. We do not stash money on some Caribbean island. We do
not move our money from our foreign subsidiaries to fund our
U.S. business in order to skirt the repatriation tax.
Our foreign subsidiaries hold 70 percent of our cash
because of the very rapid growth of our international business.
We use these earnings to fund our foreign operations, such as
spending billions of dollars to acquire equipment to make Apple
products and to finance construction of Apple retail stores
around the world.
Under the current U.S. corporate tax system, it would be
very expensive to bring that cash back to the United States.
Unfortunately, the Tax Code has not kept up with the digital
age. The tax system handicaps American corporations in relation
to our foreign competitors who do not have such constraints on
the free movement of capital.
Apple is a company of strong values. We believe our
extraordinary success brings increased responsibilities to the
communities where we live, work, and sell our products. We
enthusiastically embrace the belief, as President Kennedy said,
``To whom much is given, much is required.''
In addition to creating hundreds of thousands of American
jobs and developing products that deeply enrich the lives of
millions, Apple is a champion of human rights, education, and
the environment. Our belief that innovation should serve
humanity's deepest values and highest aspirations is not going
to change.
Apple is also a company of strong opinions. While we have
never had a large presence in this town, we are deeply
committed to our country's welfare. We believe great public
policy can be a catalyst for a better society and a stronger
America.
Apple has always believed in the simple, not the complex.
You can see this in our products and in the way we conduct
ourselves. It is in this spirit that we recommend a dramatic
simplification of the corporate Tax Code. This reform should be
revenue neutral, eliminate all corporate tax expenditures,
lower corporate income tax rates, and implement a reasonable
tax on foreign earnings that allows the free flow of capital
back to the United States.
We make this recommendation with our eyes wide open, fully
recognizing that this would likely result in an increase in
Apple's U.S. taxes. But we strongly believe that such
comprehensive reform would be fair to all taxpayers, would keep
America globally competitive, and would promote U.S. economic
growth.
My colleague Peter Oppenheimer will now make a few opening
remarks, and then we will be happy to answer your questions.
Thank you very much.
Senator Levin. Thank you very much. Mr. Oppenheimer.
TESTIMONY OF PETER OPPENHEIMER,\1\ SENIOR VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER, APPLE INC., CUPERTINO, CALIFORNIA
Mr. Oppenheimer. Good morning, Chairman Levin, Ranking
Member McCain, Members of this Subcommittee. My name is Peter
Oppenheimer, and I am Apple's chief financial officer. I would
like to discuss the structure and management of Apple's global
business and financial operations.
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\1\ The prepared statement of Mr. Oppenheimer appears in the
Appendix on page 121.
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In the United States our operational structure is quite
simple: We sell to our customers through our retail stores,
online stores, and channel partners. We provide our award-
winning support to our customers through the Genius Bar and
AppleCare. We pay taxes to Federal, State, and local
governments on the full profits from these sales.
Outside the United States we seek to provide the same
industry-leading products, services, and support that our U.S.
customers have come to expect. We now sell the iPhone and iPad
in over 100 countries.
Like all multinational companies, Apple must follow the
local laws and regulations in each region where we operate.
This often requires Apple to establish a physical presence not
only in the region but also in the particular country where we
wish to sell our products and services.
Apple's presence in these countries often takes the form of
Apple-owned subsidiaries. These in-country subsidiaries acquire
products to sell in their markets through Apple-owned regional
operating subsidiaries, which in turn acquire products from our
contract manufacturers.
In the European region, our primary operating subsidiaries
are incorporated in Ireland. These subsidiaries, which were
established in the early 1980s, now employ nearly 4,000 people
in Ireland, and we recently broke ground on an expansion to our
campus in Cork.
Since 1980, Apple has had an R&D cost-sharing agreement
with our Irish subsidiaries. The agreement was first put in
place when Apple was about 5 years old and wanted to sell its
computers overseas. At that time, Apple's revenues were one-
tenth of 1 percent of what they are today, and the invention of
the iPhone was decades away.
Today the substance of the agreement is largely unchanged
except for our expansion into more countries and recent updates
to comply with new U.S. Treasury regulations. Our cost-sharing
agreement, which is common in the industry, is audited by the
IRS, and we are in full compliance with all laws and
regulations.
The agreement enables Apple to share the costs and risks of
developing new products with our Irish subsidiaries. Virtually
all of this R&D, and the jobs that go with it, take place in
the United States. In exchange for this funding, the Irish
subsidiaries have rights to distribute in Europe and Asia
products created by the R&D funded by the agreement.
We have used this method to distribute our products
internationally for more than 30 years. More than half of our
ongoing R&D costs are funded by Apple Ireland. When times are
good, as they have been in recent years, our Irish subsidiaries
benefit greatly, as we do in the United States. When Apple lost
money in the mid-1990s, our Irish subsidiaries lost money as
well. I mention losing money in the 1990s because it serves as
a reminder of how close Apple came to going out of business.
In 1997, we were on the brink of bankruptcy and about out
of cash. In just 2 years, we lost $2 billion. I can tell you
firsthand we were facing the very real possibility of a world
without Apple.
A big part of the turnaround was a company-wide effort to
streamline and simplify so Apple could survive. We restructured
our operations and finances to make everything as simple and
efficient as possible.
As part of that effort, we consolidated our European post-
tax income into two existing subsidiaries: a holding company,
Apple Operations International, or AOI; and an operating
company, Apple Sales International, or ASI.
The consolidation eliminated enormous complexity in
handling foreign bank accounts and improved our ability to
manage currency risk. While AOI and ASI are both incorporated
in Ireland, neither is tax resident there under the rules of
Irish law. Indeed, Irish law contemplates that companies may be
incorporated in Ireland without being tax resident there.
I should clarify one point here. For many years ASI has had
thousands of employees in Ireland. Until 2012, the payroll for
these ASI employees was run through another Apple subsidiary,
AOE. The fact that AOI and ASI are not tax resident in Ireland
does not reduce our U.S. taxes at all.
The profits held by AOI and ASI have already been taxed by
foreign governments according to the local laws where the money
is earned. The investment income on their cash holdings is
taxed by the U.S. Government at the corporate tax rate of 35
percent. Apple could certainly choose to manage foreign after-
tax profits in numerous foreign subsidiaries without moving the
cash to AOI or ASI, but that would have absolutely no effect on
the taxes we pay in the United States.
However, eliminating the central cash management function
would be inefficient. Managing larger pools of cash centrally
rather than many places around the world reduces complexity,
better protects the asset, and helps us earn higher returns
through the economies of scale.
Today Apple is in the fortunate position of having more
cash from international operations than we need to run our
company and pursue strategic opportunities. Some observers have
questioned Apple's decision to fund part of its capital return
to shareholders by issuing $17 billion in debt rather than
repatriating foreign earnings. Apple respectfully suggests that
any objective analysis will conclude that this decision was in
the best interest of our shareholders. If Apple had used
foreign earnings to return capital, the funds would have been
diminished by the very high U.S. corporate tax rate of 35
percent. By contrast, given today's historically low interest
rates, the cost of issuing debt was less than 2 percent.
Mr. Cook, Mr. Bullock, and I would be happy to answer your
questions. Thank you.
Senator Levin. Thank you very much, Mr. Oppenheimer. Mr.
Bullock.
Mr. Bullock. Good morning.
Senator Levin. Good morning. Do you have any----
Mr. Cook. Our statement is concluded, Senator.
Senator Levin. Thank you. First let me thank Apple for the
cooperation that it has extended to the Subcommittee. We very
much appreciate that.
I think, Mr. Cook, you made reference to--you quoted
President Kennedy. I am wondering whether you would agree with
the following statement of President Kennedy that he made in
his April 1961 tax message, that ``deferral has served as a
shelter for tax escape through the unjustifiable use of tax
havens, such as Switzerland. Recently more and more enterprises
organized abroad by American firms have arranged their
corporate structures aided by artificial arrangements between
parent and subsidiary regarding intercompany pricing, the
transfer of patent licensing rights, the shifting of management
fees, and similar practices which maximize the accumulation of
profits in the tax haven.''
Do you agree with that?
Mr. Cook. The President and his brother have been long-term
heroes of mine, so I am sure if he said it, at the time it was
true. Today, from at least our point of view, I do not consider
deferral to be a sham or abuse in any kind of way.
Senator Levin. Mr. Bullock, does Apple Inc. own directly or
indirectly AOI, AOE, and ASI?
Mr. Bullock. Yes, Apple Inc. owns directly or indirectly
AOI, AOE, and ASI.
Senator Levin. All right. So all those companies in Ireland
are owned by Apple effectively. Is that correct?
Mr. Bullock. They are all legally owned by Apple Inc., yes.
Senator Levin. And where is AOI, Mr. Bullock, functionally
managed and controlled?
Mr. Bullock. In our view, it is functionally managed and
controlled, which is an Irish legal concept, in the United
States.
Senator Levin. In a February 11 letter to the Subcommittee,
Apple wrote us that it has ``not made a determination regarding
the location of AOI central management and control.'' Why did
you tell us that?
Mr. Bullock. Mr. Chairman, the reason we responded in that
manner is that under Irish law, the requirement for evaluating
or concluding on the tax residency of Ireland looks to whether
or not central management and control takes place in Ireland or
not. It does not formally require that you make a determination
that it takes place somewhere else.
Senator Levin. But you have told us here this morning that
you believe that the location of AOI's central management and
control is in the United States, so Apple has concluded that.
Is that correct?
Mr. Bullock. Yes, and I believe that in a previous meeting
with your staff, they asked the same question, and I believe
that I provided the same response.
Senator Levin. Okay. Mr. Cook, do you agree that the
location of AOI's central management and control is in the
United States?
Mr. Cook. Sir, I do not know what the legal definition of
that is, but from a practical point of view, yes.
Senator Levin. All right. Now, relative to ASI, Mr.
Bullock, is ASI functionally managed and controlled in the
United States?
Mr. Bullock. As a practical matter, applying the Irish
legal standard of central management and control, I believe
that it is centrally managed and controlled from the United
States.
Senator Levin. And does Apple agree that it is functionally
managed and controlled in the United States?
Mr. Bullock. Under Irish law----
Senator Levin. No. Under our law, do you believe that?
Mr. Bullock. I do not believe that central management and
control is a legal term under U.S. tax law.
Senator Levin. All right. Do you believe it is functionally
managed and controlled in the United States?
Mr. Bullock. Yes.
Senator Levin. Mr. Cook, do you agree?
Mr. Cook. We have significant employees in Ireland. We have
about 4,000. And so there is a significant amount of decisions
and leadership and negotiations that go on in Ireland. But some
of the most strategic ones do take place in the United States.
Senator Levin. Would you agree on balance that ASI is
functionally managed and controlled in the United States?
Mr. Cook. From a practical matter. I do not know the legal
definition of the word.
Senator Levin. As a practical matter, you would agree that
it is functionally managed and controlled in the United States?
Mr. Cook. Yes, Senator.
Senator Levin. Thank you.
Now, Mr. Bullock, AOI is incorporated in Ireland. Is that
correct?
Mr. Bullock. Yes, Mr. Chairman, it is incorporated in
Ireland.
Senator Levin. And where is AOI a tax resident?
Mr. Bullock. It does not have a tax residency. That does
not mean that it does not pay taxes. The interest that it earns
is paid--U.S. taxes are paid in full on its interest by Apple
Inc.
Senator Levin. And the interest you are talking about is on
the tens of billions of dollars that it has in cash. Is that
correct?
Mr. Bullock. Correct. The cash that was distributed from
the operating subsidiaries underneath.
Senator Levin. All right. So those tens of billions of
dollars of cash earn interest, and that interest is paid by
Apple Inc. is that correct?
Mr. Bullock. The U.S. tax on that interest is paid by Apple
Inc. at the U.S. statutory rate of 35 percent, yes.
Senator Levin. But there is no income--there is no tax paid
on the money itself that has been sent to Apple--excuse me, to
AOI by the distributors. Is that correct? There has been no tax
paid on that either in Ireland or in the United States on those
tens of billions of dollars which has been sent to AOI from the
subsidiaries below that?
Mr. Bullock. The income of the subsidiaries has been
subject to tax in the countries in which they operate.
Senator Levin. Right, but there has been no tax paid in
Ireland on those distributions nor in the United States on
those profits. Is that correct?
Mr. Bullock. There has been no--there is no U.S. tax on the
transfer of those balances to AOI. The income earned by ASI and
AOE has been subject to Irish tax in full in accordance with
the agreement that we have with Ireland.
Senator Levin. And is that a maximum of 2 percent?
Mr. Bullock. Mr. Chairman, I am not precisely sure of the
mechanics of the computation.
Senator Levin. Not the mechanics, but is that a maximum of
2 percent?
Mr. Bullock. Approximately, yes.
Senator Levin. Thank you. Has AOI filed a corporate income
tax return in the last 5 years?
Mr. Bullock. No. Prior to that, it made filings in France
for a branch operation there.
Senator Levin. All right. But they have paid no corporate
income tax for the last 5 years, at least. Is that correct?
Mr. Bullock. Again, they did not pay any corporate income
tax, but Apple Inc. has paid corporate income tax----
Senator Levin. I did not ask you about Apple Inc. I asked
you about AOI.
Mr. Bullock. That is correct. AOI----
Senator Levin. That is where most of the profits go,
doesn't it?
Mr. Bullock. They receive dividends from the operating
subsidiaries underneath.
Senator Levin. And what is the amount of cash that went to
ASI from those dividends?
Mr. Bullock. Over what period of time?
Senator Levin. The last 5 years.
Mr. Bullock. In the last 5 years, the company has received
dividends from its operating subsidiaries approximating $30
billion.
Senator Levin. That is ASI or AOI?
Mr. Bullock. And a number of other operating subsidiaries.
AOI is a holding company. One of its roles is to own a number
of Apple's international subsidiaries.
Senator Levin. But ASI has received about $70 billion in
cash, has it not, from those subsidiaries and about $30 billion
of that $70 billion went to AOI? Is that about right?
Mr. Bullock. I do not have the precise details. There were
distributions from a number of other subsidiaries as well.
Senator Levin. Does that sound about right?
Mr. Bullock. Approximately.
Senator Levin. Okay. Just to summarize here, AOI has
received about $30 billion over the last 5 years, but has not
filed a corporate income tax return. Is that correct?
Mr. Bullock. That is correct. That income is not subject to
U.S. tax under both statute and by regulation, and while it has
not filed a tax return, Apple Inc. has paid tax on the interest
earned by AOI.
Senator Levin. I understand that, but I am not talking
about the interest earned on the $30 billion that it has put in
banks or whatever and invested and received interest. I am
talking about the $30 billion that it received in dividends,
approximately. It has not filed a corporate income tax return
on that money. Is that correct?
Mr. Bullock. That is correct. But all of the subsidiaries
underneath have earned that money in their countries and paid
taxes required by law.
Senator Levin. Whatever taxes were owed there.
Mr. Bullock. Right.
Senator Levin. Okay. Does ASI own the economic rights to
Apple's intellectual property offshore other than in the
Americas?
Mr. Bullock. Yes, it does in part. It owns that in
combination with AOE, which is the subsidiary that handles some
of the manufacturing that the company continues to do in
Ireland.
Senator Levin. All right. And neither one of those
companies files an income tax with the United States. Is that
correct?
Mr. Bullock. Neither of those companies file a tax return
with the United States, although Apple Inc. reports----
Senator Levin. We just went through that, the interest.
Mr. Bullock. Actually, both interest and there is a small
amount of what is known as foreign-based company sales income
that is subject to current U.S. tax from ASI's business
activity.
Senator Levin. My time is up. Senator McCain.
Senator McCain. Thank you, Mr. Chairman. And I thank the
witnesses.
Mr. Cook, we congratulate you on all of your successes and
that of Apple, and as we said earlier, you have managed to
change the world, which is an incredible legacy for Apple and
all of the men and women who serve it.
Also, I think you have to be a pretty smart guy to do what
you do, and a pretty tough guy, too. You have that reputation,
and I say that in a complimentary fashion. And I enjoyed our
conversation. And so I wonder, do you feel that you have been
bullied or harassed by this Committee or its Members?
Mr. Cook. I feel very good to be participating in this, and
I hope to help the process. I would really like for
comprehensive tax reform to be passed this year, and any way
that Apple can help do that, we are ready to help.
Senator McCain. So it was my understanding that you sought
to testify before this Committee for that purpose, and other
purposes. Is that correct?
Mr. Cook. I think it is important that we tell our story,
and I would like people to hear it directly from me.
Senator McCain. So you were not dragged before this
Committee?
Mr. Cook. I did not get dragged here, sir.
Senator McCain. You do not drag very easily, I understand.
[Laughter.]
And I thank you. This is an issue of concern for Congress,
and I guess my first question to you, Mr. Cook, is: You have
obviously legally taken advantage of a number of aspects of the
Tax Code, both foreign and domestic, and that has reduced the
tax burden, I think we would agree, than if you were paying the
35-percent corporate tax rate that domestic companies pay. So
my question is: Couldn't one draw the conclusion that you and
Apple have an unfair advantage over domestic-based corporations
and companies, in other words smaller companies in this country
that do not have the same ability that you do to locate in
Ireland or other countries overseas?
Mr. Cook. No, sir, it is not the way that I see it, and I
would like to describe that. The way that I look at this is
Apple pays 30.5 percent of its profits in taxes in the United
States, and I do not know exactly where this stacks up relative
to other companies. But I would guess it is extremely high on
the list. I know with the $6 billion that we are the top payer
in the United States.
We do have a low tax rate outside the United States, but
this tax rate is for products that we sell outside the United
States, not within. And so the way that I look at this is there
is no shifting going on that I see at all, and in addition, if
you look at Apple versus other companies that do not sell in
the United States I would say that the applicable comparison
would be the 30.5 percent effective rate, not our foreign tax
rate.
Senator McCain. Well, let us get a little simpler here. Why
does AOI exist? How is its income generated? How is its income
taxed? Why was AOI incorporated in Ireland? Four thousand
employees is impressive, but not impressive when you look at
your overall workforce. So maybe you can clear that up for us.
Mr. Cook. Yes, thanks very much for the question. AOI was
created in 1980, and at this period of time, Apple was--this is
before the days that the iPhone, iPad, iPod, and the things
that we are known for today were even invented. As a matter of
fact, the Mac was not even announced until 1984. And so Apple
was looking for a place to distribute its products in Europe--
--
Senator McCain. I understand that was 1980. Is that still
operative today?
Mr. Cook. The relationship between Apple and the Irish
Government is still there today, and we built up a sizable
population----
Senator McCain. I say with respect, given the tax rate that
you are paying in Ireland, I am sure you have a very close
relationship.
Mr. Cook. But it is more than that, sir. It is that we have
built up a significant skill base there of people that really
understand deeply the European market, that serve our customers
well, that provide a number of functions for that. Also I think
it is important to understand that AOI is nothing more than a
holding company. A holding company, as you know, is a concept
that many companies use. It is not an operating company. And so
the dividends that go into this holding company have already
been taxed as appropriately in their local jurisdiction. And so
AOI is nothing more----
Senator McCain. To a great advantage to Apple, wouldn't you
agree?
Mr. Cook. AOI to me, sir, is nothing more than a company
that has been set up to provide an efficient way to manage
Apple's cash from income that has already been taxed, and the
investment income that comes out of AOI is taxed in the United
States at the full 35-percent rate. And so, sir, from my point
of view, AOI does not reduce our U.S. taxes at all.
Senator McCain. Can you please state for the record where
AOI, ASI, and AOE is a tax residence?
Mr. Cook. Yes, sir. My understanding is there is not a tax
residence for either--for any of the three subsidiaries that
you just named.
Senator McCain. Does that sound logical?
Mr. Cook. Well, again, as I look at it, ASI and AOE are
paying Irish taxes, and so I am not--I personally do not
understand the difference between a tax presence and a tax
residence, but I know that they fill out Irish taxes and pay
those. AOI, because it is just a holding company, the
interest--it only makes investment income, and all of that
investment income is taxed in the United States at the full 35-
percent level.
Senator McCain. When you look at that avoidance or relief
of a 35-percent tax burden, which I am sure that we are in
agreement is way too high and now the highest in the world, I
understand, but you said the purpose of AOI is to ease
administrative burdens. But are there certain U.S. tax
burdens--isn't it obvious that you are not bearing the same tax
burden as if you were bearing in the United States, which then
gives you some advantage over corporations and companies which
are smaller, which are strictly located in the United States of
America?
I am not saying that is wrongdoing. But I think you would
agree that it gives you a significant advantage.
Mr. Cook. Again, sir, I have tremendous respect for you. I
see this differently than you do, I believe. What I see is
Apple is earning these profits outside the United States. By
law and regulation, they are not taxable in the United States.
We have set up a holding company to collect these after-tax
profits from our different foreign subsidiaries into AOI. It
then invests, as any treasury kind of arm would, and the
interest investment--or the interest profits off of that are
paid in the United States as they are required to under
existing U.S. Treasury regulations.
Senator McCain. Can you understand there is a perception of
unfair advantage here, Mr. Cook?
Mr. Cook. Sir, I see this as a very complex topic that--I
am glad that we are having the discussion, but, honestly
speaking, I do not see it as being unfair. I am not an unfair
person. That is not who we are as a company or who I am as an
individual. And so I would not preside over that, honestly. I
do not see it in that way.
Senator McCain. I thank you. I am out of time. What I
really wanted to ask is why the hell I have to keep updating
the apps on my iPhone all the time. [Laughter.]
And why you do not fix that.
I thank you, Mr. Chairman.
Mr. Cook. Sir, we are trying to make them better all the
time.
Senator Levin. Thank you. We have only 5 minutes left, I
believe on a roll call. Have you voted already?
Senator McCain. No.
Senator Levin. I think we better recess for about 10
minutes. Thank you.
Mr. Cook. Yes, sir. Thank you. [Recess.]
Senator Levin. Okay. We will come back into session.
Senator McCaskill.
Senator McCaskill. I certainly understand that what you all
have engaged in is what every good American business does, and
that is, tax planning. If you do not tax-plan, then you are
incompetent as an American business. But I do hope that I can
understand better why the structure you have used has been
embraced so that it will better inform our decisions and how to
make it simpler and how we can support international growth for
all of our companies that are American companies.
You borrowed $17 billion and issued bonds to pay dividends
to your shareholders fairly recently. It was in the economic
news because of your large cash reserves, so clearly you made a
decision that it was going to be cheaper for you to service
that debt and then use the cash to pay dividends, then to bring
any of this cash back.
Do you have the analysis that would help us understand how
much cheaper it was for you to borrow that money?
Mr. Cook. I can describe it at a broad level, Senator. The
cost of capital today is at an all-time low, as you know, and
so our weighted average cost for the borrowing that we just did
was less than 2 percent. And we were faced with a decision to
go that route or pay 35 percent to repatriate.
So as we looked at that analysis, we felt strongly that it
was in the best interest of our shareholder for us to secure
the debt.
Senator McCaskill. Okay. Let us assume that we simplify
this. Ireland gave you a 2-percent rate, which was negotiated
for your company. Correct?
Mr. Cook. We went to Ireland in 1980, and they were very
much recruiting, I believe, technology companies at that time,
and Apple was a small, $100 million business that had no
operations in Europe. And so as a part of recruiting us, the
Irish Government did give us a tax incentive agreement to enter
there, and since then we have built up a sizable operation
there, nearly 4,000 people. We are building a new site. We are
continuing to grow. And the skills of our people there are very
fundamental for understanding the European market and servicing
our customers there from tech support to sales to reseller
support, et cetera. And so we have quite a very strong presence
there.
Senator McCaskill. I guess my question, Mr. Cook, is: If
Ireland recruited you back when you were a $100 million company
and gave you a really good deal, how do we, if we are setting
tax policy, how do we do it in a way that there is not going to
be--I mean, correct me if I am wrong, but I believe that
probably three-fourths of net new mobile activity growth is
going to be in emerging markets in--would you disagree with
that percentage, that net new growth in markets in terms of
mobile activity are going to be out there in emerging markets
as opposed to Europe and North America?
Mr. Cook. I think a significant amount--I am not sure of
the exact number, but I think a significant amount of growth
will be in emerging markets.
Senator McCaskill. So I guess the point I am trying to get
to here is let us assume we simplify our Tax Code and let us
assume that we get it down, we clear out all the underbrush, we
take away some of the goodies and some sectors of our economy.
We understand the reality of international moving of capital
because of international economies and international trade.
What keeps another country in one of the emerging markets from
undercutting us once again, like Ireland did back in 1980?
Mr. Cook. I think the United States has such enormous
advantages, and the barrier right now in terms of repatriating
cash is that it is repatriated at the 35-percent level. And so
our proposal--and I may be a bit different than my peers here--
is I am not proposing zero. My proposal is that we eliminate
all corporate tax expenditures, get to a very simple system,
and have a reasonable tax on bringing money back from overseas.
And I think if we did that, I think many companies would bring
back capital to invest in the United States, and it would be
great for the economy.
Senator McCaskill. What about the other way? What would it
cost you to move out of California and go entirely to Ireland
or to a country that is going to be--for example, China, if you
get that deal with China Mobile soon? Which I know you are
working on, right? That is a big one, hopefully, that you get
done. You have been working on it awhile. What keeps you from--
in terms of the relative cost analysis and the benefit
analysis, what keeps you from moving out of California?
Mr. Cook. Well, we are an American company, and we are
proud to be an American company. We do the vast majority of our
R&D in California, and so we are there because we love it
there, and this is where we can create and make things that
people have not even imagined yet. And----
Senator McCaskill. So it is an intangible? You are saying
it is an intangible? It is not something that you can reduce
to----
Mr. Cook. I am saying it is who we are as people, and we
are an American company. We are an American company whether we
are selling in China, Egypt, or selling in Saudi Arabia.
Wherever we are, we are always an American company. And so I
have never thought, it has never entered my mind honestly,
Senator, of moving our California headquarters to another
country. It is beyond my imagination. And I have a pretty wild
imagination, but it is beyond it.
Senator McCaskill. On the money that--the corporate bonds
you issued, do you think--and I am not being judgmental about
you doing that. I understand the business rationale behind it
in terms of the low cost of capital. But do you think you
should be able to deduct the interest on those? Would that be
one of the corporate expenditures we could do away with?
Mr. Cook. It could be one of the corporate expenditures to
do away with. I think, the way the Tax Code is written
currently, my understanding is it would be deductible. It would
be a very small percentage of the overall that we pay. We paid
$6 billion at an effective rate of 30.5 percent. But, yes, it
is certainly one of the things that I think this group should
talk about in terms of doing comprehensive tax reform.
Senator McCaskill. Okay. And this is kind of complicated,
but somewhere along the way you are deciding how to divide up
sale proceeds as to where the money goes. And I know some of it
depends on where the sale occurred. But some of it depends on a
decision you are making internally about where you are going to
allocate what you are getting for your intellectual property.
Where is that decision being made? And what do you base it
on in terms of how much money comes back to the American
companies that are paying taxes versus how much is attributable
to the international companies?
Mr. Cook. It is a good question. Today everything that we
sell in the United States is taxed in the United States. For a
foreign country, generally speaking, when we sell something in
a foreign country, it is taxed in the local market, and then if
it is one of the countries that are being served from Ireland,
those units are generally sold by an Irish subsidiary. And so
that income, if you will, is taxed, to the degree it needs to
be, in the local jurisdiction. And then the proceeds move to an
Irish sub in most cases--or in many cases called AOI, which
acts as a holding company and invests Apple's earnings. And
then we pay taxes on those earnings in the United States.
Senator McCaskill. So does any of the proceeds of the many
thousands of dollars you have taken from me over the years, do
any of the proceeds of that actually get parked in Ireland or
in any of the international companies under the aegis of
intellectual property?
Mr. Cook. I think maybe Mr. Bullock can probably answer
this better than I.
Mr. Bullock. Thank you, Tim. The answer to that is no. One
hundred percent of the profits on any sale to a customer in the
United States, whether it is through the channels or through
our online stores, all of that is fully taxed in the United
States.
Senator McCaskill. Okay.
Mr. Bullock. There are no outbound payments going offshore.
Senator McCaskill. Okay. Thank you.
Mr. Cook. Thank you.
Senator Levin. Thank you very much, Senator McCaskill.
Senator Johnson.
Senator Johnson. Thank you, Mr. Chairman.
Let me kind of pick up where Senator McCaskill left off
there. This is complex, and it has to do with how do you
allocate income, what kind of transfer price is an appropriate
price.
I did notice that your U.S. sales were about 39 percent of
your total sales, international was about 61. So U.S. sales
about 39, and you had income of about 35 percent in the United
States; international sales, 61, and about 65 percent of
income.
Can you just explain that? I mean, it is pretty close. If I
were taking a look at that, you are getting pretty darn close,
I would think, to proper allocation between sales and income.
Can you just explain that disparity?
Mr. Cook. Sure, Senator, and I will make some comments,
then pass it to Peter. He may be able to add something.
Generally, Apple's Macintosh business is a larger
percentage of its sales in the United States than
internationally. As we launched the iPhone, iPhone became a
larger percentage of our international business than it did a
part of our U.S. business, because we had this nice base of
Macintosh sales in the United States.
The iPhone, generally speaking, has higher gross margins
than our Macintosh business, so it is logical that the
international business generally would carry higher margins
than our domestic business. And Peter may be able to add
something to this.
Senator Johnson. But basically to summarize, you have a
more profitable product mix internationally than you have in
the United States.
Mr. Cook. That is correct.
Senator Johnson. That pretty well explains that difference?
Mr. Oppenheimer. It does.
Senator Johnson. I was talking earlier about who are the
beneficiaries of your very good tax rates overseas. I would
point out--I think this is true--that if we ever do tax reform,
if we ever do incentivize companies to start bringing some of
that money back home, the way current tax law is written is you
get a deduction for foreign taxes paid, correct? Mr. Bullock.
Mr. Bullock. That is correct. It is actually a credit, a
dollar-for-dollar credit, to the extent you pay foreign taxes.
Senator Johnson. Okay. So as a result, now Apple has a lot
more money that when you repatriate it we will be able to tax
more of it. Correct? So the U.S. Government, you could argue,
will be a net beneficiary if we ever get our tax house in
order.
Mr. Bullock. To the extent of repatriation in one form or
another, if it is taxable, yes, that would yield more U.S. tax.
Senator Johnson. Mr. Bullock, I would imagine you probably
know this better than anybody. Because you are a large
corporation, my guess is you have full-time IRS agents
stationed in your operation basically doing a full-time audit
non-stop. Is that pretty accurate?
Mr. Bullock. That is correct. We are under audit in a
number of jurisdictions around the world, including the United
States not unlike many of our multinational peers.
Senator Johnson. And they are looking at all this corporate
structure, they are looking at all the transfer prices, and
they are basically giving you the nod, saying that you are
following tax law.
Mr. Bullock. They look at it in detail, yes.
Senator Johnson. Okay. Mr. Cook, again, talking about who
are the beneficiaries of not only your excellent products but
also just your lower tax rates and corporate profit, that would
be shareholders. Can you describe your shareholders, in
general?
Mr. Cook. I think Peter can probably add more to this, but
generally, Apple is very widely owned because it is a part of
the underlying indexes in the stock market, and a number of
mutual funds own us in addition to pension funds. Peter.
Mr. Oppenheimer. Yes, Senator, roughly our top 50
shareholders own about half the company and these include
public employee retirement systems, mutual funds such as
Fidelity, Pimco, or BlackRock where people are saving for their
retirements, and we also have individual retail shareholders as
well.
Senator Johnson. So even the top 50 percent is widely
dispersed, and those are large funds that also have a very
diverse shareholder base in those funds.
Mr. Oppenheimer. Absolutely.
Senator Johnson. So, again, those folks benefit from the
fact that Apple is able to retain more of its profit by not
paying out taxes to foreign governments?
Mr. Oppenheimer. Yes, and they also receive our dividends.
Senator Johnson. In addition to U.S. and State income
taxes, what other taxes in the United States does Apple
basically generate? What could you almost take credit for?
Mr. Oppenheimer. Last year, we paid more than $325 million
in Federal employment taxes that Apple paid in addition to our
employees, and we have paid over the last couple of years I
think nearly $100 million to State and local governments in
property taxes and various other fees. And I believe last year
we collected and remitted and paid approximately $1.5 billion
in sales taxes.
Senator Johnson. So that is getting close to about $2
billion in total. Mr. Bullock.
Mr. Bullock. Just to clarify that a little bit, it was a
little over $1.3 billion in sales and use tax.
Senator Johnson. When we are talking about transfer pricing
and allocation of income, you face the same dilemma between
States, don't you, in terms of which State claims how much
income when you are paying those State income taxes?
Mr. Bullock. Well, the income that the company generates in
the United States the approximate 40 percent that you alluded
to earlier of our total global profits, which is relatively
commensurate with our U.S. customer base, that income does get
apportioned around and divvied up amongst the States, under a
slightly different system but it does get allocated out to the
States.
Senator Johnson. So can you just tell me, what is the basis
of that allocation? And how would that differ really from
trying to allocate income between different countries?
Mr. Bullock. Well, that, too, varies by State. Some States
apportion based on relative sales, sales to customers in that
State over total sales domestically. Some States use a
multifactor test. They may look to sales, property, and
payroll.
Senator Johnson. Do you end up having to negotiate between
the States in terms of who gets to claim what percentage of
your income? Do you end up paying more--do you have more of
your income allocated to pay State income tax than you
actually--in other words, more than 100 percent?
Mr. Bullock. It is not over 100 percent, but it is
approximately 100 percent. So in our fact pattern it is not
double taxed, which would be the case if more than 100 percent
of the income was apportioned. But it does approximate 100
percent.
Senator Johnson. But, again, that is a similar type of
problem you have trying to allocate income between different
countries, isn't it?
Mr. Bullock. If you had different States apportion in
different ways, yes.
Senator Johnson. Can you tell me a little bit about the
taxes you pay to foreign countries? Is that income taxes? Are
those sales taxes? Is it property taxes? Is it a combination of
all those? And can you give me some sort of relative amount?
Mr. Bullock. Well, there is a combination. Last year, in
fiscal year 2012, the company paid a little over $900 million
in international income taxes around the world. We are
projecting that number to be larger this year. And that number
is significantly larger than it was a few years ago.
In addition to that, I do not have the statistics
available, but I would imagine similar to in the United States
there are employer contributions for payroll tax for employees
outside of the United States, and there is a considerable
amount of VAT and GST that gets collected and remitted by the
company to various countries around the world.
Senator Johnson. Of your total worldwide employment, how
much is based in the United States, how much is based overseas?
Mr. Oppenheimer. About 50,000 of our 75,000 employees are
here in the United States.
Senator Johnson. So even though 60 percent of your sales
are overseas, what percentage is that? Almost two-thirds----
Mr. Oppenheimer. Yes.
Senator Johnson [continuing]. Of your employment is here in
the States?
Mr. Oppenheimer. And that is also influenced by our retail
stores. Of our approximately a little over 400 retail stores,
about 260 of them are here, and that influences it.
Senator Johnson. Okay. Thank you for your testimony, and
thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator Johnson.
Senator Ayotte.
Senator Ayotte. Thank you, Mr. Chairman. I want to thank
the witnesses for being here today.
Mr. Cook, is there any dispute at this hearing that Apple
has complied with our tax laws?
Mr. Cook. I have heard no dispute of that.
Senator Ayotte. One of the issues that I heard raised when
you were being asked questions by Senator McCaskill about the
issue of the $102 billion that is present overseas that you
have now is this idea of repatriation. You had said that you
would be willing to pay some rate on repatriation. As we look
at tax reform, what do you think is the rate, thinking not only
of Apple but of multinational corporations around the world, if
we do tax reform and let us say we simplify the Code so
deductions are eliminated and then we take that and pour that
into reducing the rate? What rate do you think we have to be at
if we want to be competitive in terms of making sure that we
have investment here?
Mr. Cook. I think the rate on the U.S. sales in my
judgment, from most of the studies I have seen, would indicate
it would need to be in the mid-20s as all of the expenditures
are dropped out. I think in terms of a rate on bringing back
foreign earnings, I think to incent a huge number of companies
to do that, it would need to be a single-digit number. And I
think by doing that, you wind up in a revenue-neutral kind of
situation, which means some companies may pay a bit more, and I
think we would be one of those. Other companies would pay less.
But I think more important than all of the tax, it would be
great for growth in this country. And so that is the reason I
feel so adamant about doing this.
Senator Ayotte. So as I understand it, let us say you are
building a data center here, you are building a new facility
here. Right now that money you have parked overseas, you cannot
use that to invest in plant facilities here. Is that right?
Mr. Cook. That is correct. We cannot use our overseas cash
to make any investments in the United States.
Senator Ayotte. If you were in our position and thinking
about tax policy and making sure that our country remains
competitive, how important do you think it is that we change
the Tax Code to ensure that this remains a good place for
investment? I understand there are many other advantages to
being here, including intellectual property advantages, et
cetera, but you are not the only corporation that has
significant monies overseas right now that we would like to see
come back here. What do you think that would do in terms of our
economy? I think you have touched on it.
Mr. Cook. I think it is vital to do. I think it is great
for America to do. I think we would have a much stronger
economy if we did that. I think it would create jobs and
increase investment. And so I put my whole weight and force
behind it.
Senator Ayotte. And if we create more jobs and increase
investment, isn't that more taxes that can be collected here as
well in terms of thinking about, the fiscal State of the
country?
Mr. Cook. It is, and I think that is a very excellent
point, is that all ships rise with the tide.
Senator Ayotte. Right, especially with where our
unemployment rate is right now.
I wanted to ask you about the issue of thinking about--as
we do tax reform, the issue of a territorial rate. How
important is it that, as we go forward--hopefully we will on a
bipartisan basis--to reform the Code to really create a better
dynamic, simpler, lower rates for investment here that a
component of that be a territorial rate? Because there has been
some discussion around here about not having a territorial
rate.
Mr. Cook. I think the United States is advantaged if more
capital moves into the country, because I think it would really
strengthen our economy significantly. And so I think there has
to be--I do not propose zero. I think it has to be a reasonable
tax on doing so. And some people refer to that as
``territorial,'' some people refer to that as ``hybrid.'' I
have heard different terminology for it, but that is how I
believe it should work.
Apple does not support a temporary tax holiday. We think
that the Tax Code needs to be comprehensively reformed for a
long period of time.
Senator Ayotte. If we create a temporary tax holiday, which
we have done in the past, don't we just perpetuate the
situation, meaning it may have a short-term but it does not
encourage long-term investment?
Mr. Cook. I think it is very important for business to be
predictable, and a permanent change to me is materially better
than a short-term tax holiday.
Senator Ayotte. I actually have a question on an unrelated
topic to the tax issue today. But can you tell us, when you
think about--when you were talking to Senator McCaskill, you
talked about the advantages, for example, of being in this
country. One of them I view very significantly is, of course,
the intellectual property protections of this country, which I
know are very significant to you as a technology company.
You have faced significant challenges in China, so what
would be--can you tell me what those challenges are? And
thinking about intellectual property protection certainly is an
advantage that the United States has. How do we address this
with our international partners?
Mr. Cook. We have actually faced more significant areas in
other countries other than China.
Senator Ayotte. The reason I raise China is I have heard
the stories about the knock-off Apple stores, but please speak
to other countries as well.
Mr. Cook. Yes, that has been an issue. That has clearly
been an issue. I think that the U.S. court system is currently
structured in such a way that it is very difficult to get the
protection a technology company needs because our cycles are
very fast. And when the cycles are very fast and the court
system is very long, foreign competitors or even competitors in
the United States can quickly take certain IP and use it and
ship products with it, and they are on to the next product
before the court system rules.
And so I actually think that we require much more work on
IP in this country as well, and I would love to see
conversations between countries to try to strengthen IP
protection globally. I do not know how likely that is to occur
in the current environment, but for us, our intellectual
property is so important to our company, and I would love the
system to be strengthened in order to protect it.
Senator Ayotte. I thank all of you for being here. I
appreciate it.
Mr. Cook. Thank you very much.
Senator Levin. Thank you, Senator Ayotte. Senator Portman.
OPENING STATEMENT OF SENATOR PORTMAN
Senator Portman. Thank you, Mr. Chairman. I appreciate the
opportunity, having just left the Finance Committee on the IRS,
to talk about tax reform and not just tax administration.
Look, this hearing is important because it is talking about
a specific provision of our international tax rules that allows
U.S. companies to effectively take IP rights created here in
the United States to foreign jurisdictions. Some of it is by
means of cost sharing. Some of it is through other agreements.
I agree with you, Mr. Chairman, and the Ranking Member that
we need to address this issue. I totally disagree that we ought
to do it through picking out specific tax loopholes or tax
preferences. We have to reform this Code, and if we do not do
that, our companies will continue to be uncompetitive.
If you think about it, we have an uncompetitive tax system
now. We are competing with one hand tied behind our back. And
if we are going in and taking away certain preferences, it may
make us feel better about getting more of this IP income back
here, but, in effect, it makes our companies even less
competitive and hurts U.S. employment.
So that is why we have to do tax reform. We have to do it
now. We are now living with an international Tax Code that is a
relic of the 1960s. It was not even reformed in 1986 when the
rate was lowered to 34 percent, now 35 percent. So we are
looking at several decades now of tax policy that really is
antiquated and does not keep up with the times.
So I have a proposal to do that. It has been scored by the
Joint Committee on Taxation. It is revenue neutral. It is a 25-
percent rate with a territorial system. There are other ideas
out there. The President has talked about it. He has said in
his February 2012 white paper he believes the rate ought to be
lowered, it ought to be reinvested when you get rid of these
tax preferences in lowering that rate.
So there is a lot of commonality now between where Senator
Baucus is, Senator Hatch is, and where Congressman Camp is. And
the Ways and Means Committee and the Finance Committee are
working together on this.
So that is the way to approach it. Eighty percent of our
world's purchasing power now lies beyond our borders, and so a
key strategy to grow jobs here at home is by tapping into that.
And that is what Apple does. That is what a lot of companies in
the United States do. We want them to do that. It is also where
our international Tax Code puts our workers at a disadvantage
and puts our companies at a disadvantage, because when you are
operating overseas you pay the tax rate of the company you are
operating in plus you pay the residual U.S. tax when that
income is brought home.
The other is a tax credit. In some jurisdictions, like
Ireland, the tax is so low that you do not get much of a
credit. But it is also incredibly complicated to go through
that process. And so, in effect, it puts us, again, in a
noncompetitive position.
Almost all of our industrial competitors, by the way, have
shifted to a territorial type system. That includes the U.K. It
includes France. It includes Germany. It includes Japan. In
fact, when you look at the OECD, now 26 of our 35 fellow OECD
countries have moved to this dividend exemption system, which
is a specific territorial system. Congressman Camp has talked
about that. I think that is the right way to go. Essentially
they do not tax active business income earned beyond their
borders, and their businesses are a lot more competitive
internationally as a result.
So the U.S. penalty for repatriating earnings has resulted
in somewhere, Mr. Chairman, between $1.5 and $2 trillion being
locked up overseas. That means that money is starting to be
deployed for R&D overseas, for putting factories overseas that
otherwise could be here. So I think we have to move, and we
have to move very quickly. No other nation in the world imposes
such a high barrier to bringing foreign earnings home as the
United States. No other one.
And, by the way, every one of our little competitors have
reformed their tax code since we have back in 1986. Every one
of them, their corporate tax code and their international tax
codes have all been reformed. They have not just lowered their
rates. Canada just lowered theirs from 16.5 to 15 percent, and
our rate, as you know, is the highest in the world. But they
have reformed the code to make it more competitive for their
companies.
So we have to do this. If we do not, we are going to
continue to lose opportunities, and I think our guiding
principle should be how do we create competitiveness so we can
win customers overseas. Tightening rules related to sourcing of
IP income, as again Chairman Camp has proposed and as my plan
would do, is important to do. Let us just do it in the context
of a comprehensive proposal.
I note, Mr. Oppenheimer and Mr. Cook, whoever wants to
answer, that you all do a lot of sales overseas. I think I just
heard from Senator Johnson that 65 percent of your revenue is
overseas, about 60 percent of your business is overseas now. Is
that accurate?
Mr. Cook. Yes, sir, that is accurate. About two-thirds last
quarter were overseas.
Senator Portman. And how many U.S. jobs does that
represent? In other words, how many jobs in the United States
of America are in the U.S. because they support your foreign
sales?
Mr. Cook. In total, we have created or support 600,000 U.S.
jobs. It is difficult to allocate a certain percentage of those
for international business, but I would say it is significant.
We are able to invest a lot more because we sell our products
around the world.
Senator Portman. It would be tens of thousands of jobs in
the United States that are here because of your sales overseas,
right?
Mr. Cook. Our earnings overseas have powered our company,
yes.
Senator Portman. I would suggest you come up with that
number. I know it is not easy, but it is probably 40 percent of
your workforce, something like that, in the United States, and
it is a huge boon to us. Again, we want you to sell stuff
overseas because it creates jobs in America.
Would it be fair to say that your biggest competitor
globally is Samsung?
Mr. Cook. They are certainly one of them, yes.
Senator Portman. So Samsung would be a major competitor?
Mr. Cook. Yes, sir.
Senator Portman. And is Samsung an American company?
Mr. Cook. Korean company.
Senator Portman. They are headquartered in South Korea that
has as top corporate tax rate of 24 percent, which is 15 points
lower than the U.S. corporate tax rate of 39.5 percent, which
is our combined State and Federal. So they have a lower tax
rate there.
Based on public financial statements for both the
companies, my staff tells me it appears that Apple and Samsung
actually pay about the same global effective tax rates. At
least they did last year. And this is just looking at public
documents. Apple's global tax payments were about $7.7 billion
out of $56 billion in global pre-tax earnings. Samsung's global
tax payments were about $4 billion out of $28 billion in global
pre-tax earnings. So it comes out to a global rate of about 14
percent, the same for both companies.
Mr. Bullock, is that consistent with your estimate of
Apple's rate and what you know about Samsung's rate?
Mr. Bullock. Senator, yes, that was Apple's global cash tax
rate last year. We believe it will be actually a few points
higher this year.
Senator Portman. Okay. Well, let us be conservative and say
that it is going to be the same. So it sounds like all the tax
planning discussed at the hearing today ultimately resulted
last year in nothing more than the same global tax rate as your
main foreign competitor. Is that accurate?
Mr. Bullock. Yes, that sounds like----
Mr. Oppenheimer. Senator, yes, with one difference. Samsung
is able to freely move its capital back----
Senator Portman. I am getting to that. You are ahead of me,
Mr. Oppenheimer.
So I would say the answer is it is worse for Apple because
they cannot bring their money home.
Mr. Oppenheimer. Yes.
Senator Portman. And think about that. It is partly the
rate, but it is partly the fact that they cannot bring it home
at 35 percent, so their investment options are a lot more
limited, aren't they? Your investment options are a lot more
limited.
Mr. Bullock. Yes.
Senator Portman. How much money does Apple spend on tax
compliance efforts to go through all this rigmarole we talked
about earlier?
Mr. Bullock. I do not have the exact figure, but it is a
lot.
Senator Portman. Again, I would suggest you get that
number. I think the American people would like to know how
broken our tax system is. I mean, I am a recovering lawyer
myself, but you do not need more tax lawyers. You need more
engineers, you need more innovators. You need people to keep
America on the cutting edge, and, your products are great
already, but they could be even greater if you had fewer
lawyers and more engineers, probably.
How big is your tax department?
Mr. Bullock. It is approximately three dozen people around
the world, and we have a couple dozen additional resources
through our shared service centers in Cork and Austin,
Singapore, and we do have some personnel in Shanghai and
Brazil.
Senator Portman. And I imagine it is a lot more than three
dozen plus those folks, because you hire a lot of law firms,
too.
Mr. Bullock. Well, yes, there is a lot of outside help as
well. If you could encourage Peter to help me out with more
people, that would be appreciated.
Mr. Oppenheimer. Senator, I would add----
Senator Portman. You want to have fewer people. We want to
reform this Tax Code so you do not have to mess with all this
stuff.
Go ahead. I am sorry.
Mr. Oppenheimer. I would add, if I could, that the tax
return that I sign each year in the United States is 2 feet
tall or greater, and we are under continuous examination, and
much of the effort that Phil spoke about, both internally and
particularly with our outside advisers, deals with continuous
examination. So we would very much support a simplified Code
that would lead to a smaller tax return.
Senator Portman. So you have high tax compliance costs. You
cannot bring your money home so you cannot invest it where you
want to. Let me ask you this: What would it do to Apple's
ability to compete successfully with Samsung if Congress
effectively hiked the tax rate on your international earnings
without doing anything to modernize the Tax Code so that you
could move to a dividend exemption system or some other
modernized system?
Mr. Cook. It would be very bad, sir.
Mr. Oppenheimer. It would not be helpful.
Senator Portman. And that is essentially what some are
advocating here today. Would you like to be able to cut your
tax compliance costs and invest more of that in some productive
uses?
Mr. Cook. Yes, definitely.
Senator Portman. With no offense to Mr. Bullock.
Well, let me just summarize by saying, look, I appreciate
the hearing today. None of us would design a Tax Code that has
a company like Apple engaging in these costly, complex tax
planning efforts. Not to achieve some windfall, as the
Subcommittee report suggested to me, but, rather, to achieve
parity and a roughly level playing field with its foreign
competitors, not including, again, the costs of compliance and
not including the disadvantage of not being able to bring the
money home. It is an antiquated, complex---needlessly complex,
in my view--tax system.
So I do not think the solution is to tinker at the margins
or go backward toward a worldwide system that makes it even
harder to compete. I think we should take the President up on
his offer to do corporate tax reform. He says he wants to do
it. The Chairman of the Ways and Means Committee and the
Chairman of the Finance Committee say they want to do it. It is
bipartisan. And I hope this hearing will help us to move toward
that goal.
Thank you, Mr. Chairman.
Senator Levin. Thank you very much, Senator Portman.
Let me just, first of all, say of course you can bring the
profits home. You bring the profits home from South America,
don't you?
Mr. Cook. Do we bring the profits home from South America?
I do not know the answer----
Senator Levin. Well, you have not transferred your
intellectual property for that geography, have you? It is just
for the rest of the world, other than the Americas. Isn't that
correct?
Mr. Cook. The economic transfer for Europe is in Ireland,
yes.
Senator Levin. I am saying that you bring the profits home
from your sales in South America, don't you?
Mr. Cook. I would guess there is some cash in South
America. I do not know, sir. I would----
Senator Levin. Well, your transfer agreement relative to
the intellectual property is the rest of the world outside of
the Americas. Is that correct, Mr. Bullock?
Mr. Bullock. Yes, that is correct.
Senator Levin. All right. So the other parts of the world
that are not covered by that transfer of intellectual property,
which is the creator of profits, that is your Golden Goose, and
you have shifted that Golden Goose, except for the Americas, to
Ireland. You shifted it to three companies that do not pay
taxes in Ireland, Okay? They do not even exist for taxpaying
purposes in terms of income tax. You shifted your intellectual
property there. That is your choice. You did that in a transfer
price agreement. You did not shift the intellectual property,
however, as I understand it, as far as sales in the Americas is
concerned. Is that right, Mr. Bullock?
Mr. Bullock. The economic rights----
Senator Levin. Economic rights. That is the right--but
shorthand, the economic rights to that intellectual property
were not transferred as far as the Americas is concerned. Is
that right?
Mr. Bullock. Mr. Chairman, the economic rights to the
intellectual property for distribution in the Americas is owned
by Apple Inc. The intellectual rights for distribution in
Europe and Asia Pacific are owned by ASI and AOE as a result of
the cost-sharing arrangement.
Senator Levin. All right. So to answer my question
directly, they were not transferred as far as the Americas are
concerned. Is that correct? They belong to the home company,
Apple Inc. Is that correct?
Mr. Bullock. That is correct. Apple Inc.----
Senator Levin. All right. So the profits that result in the
Americas outside of the United States, you pay income taxes on
here. Is that correct? You are bringing them back here to the
United States, is that correct? As far as the Americas are
concerned.
Mr. Bullock. There is a selling profit in both Canada and
in Brazil and in Mexico. And, yes, any residual profit is
subject to U.S. tax in full.
Senator Levin. All right. So you are bringing those profits
home.
Mr. Bullock. I would characterize it as Apple Inc. is
generating those profits.
Senator Levin. Well, they are generating the profits
through its intellectual property in Europe and Asia, too. I am
just talking about the profits in those countries are brought
home. Is that correct? In Canada, Mexico, the ones you just
mentioned, they are brought home?
Mr. Bullock. I would characterize it as those profits are
generated by the U.S. company. So I would not say that they are
brought home. I would say that they are earned by Apple Inc.
Senator Levin. Apple Inc. keeps those intellectual--those
economic rights, right?
Mr. Bullock. It has, yes.
Senator Levin. And it has chosen not to keep the economic
rights for the rest of the world. Is that right?
Mr. Bullock. Via a co-funding arrangement since 1980.
Senator Levin. Right, which it controls. Is that right? I
mean, that agreement is an Apple agreement. People who signed
it all work for Apple, right?
Mr. Bullock. It is between two related parties.
Senator Levin. I understand. But they all work for Apple,
don't they? Is there any doubt in your mind that Apple controls
that agreement and could write that agreement the way it wants
to write it, Apple Inc.?
Mr. Bullock. Well, I do not think that is the standard. The
standard is: Would parties at arm's-length enter into that type
of arrangement?
Senator Levin. Is that an arm's-length agreement? Are you
suggesting that agreement is an arm's-length agreement when all
of the signatories are Apple Inc employees?
Mr. Bullock. I would, yes. It is evidenced by parties at
arm's-length enter into joint development arrangements all the
time.
Senator Levin. Who signed that agreement? Three parties,
right?
Mr. Bullock. Parties at arm's-length enter into joint
development arrangements all the time. The U.S. Treasury
Department on three separate occasions and even the U.S.
Congress have approved cost sharing, as evidenced by arm's-
length behavior.
Senator Levin. I am just asking you, was Apple in control--
Apple Inc.'s employees in control of that agreement. It is a
very simple question.
Mr. Bullock. Chairman, I----
Senator Levin. Did they all work for Apple Inc.?
Mr. Bullock. They all work for Apple Inc.
Senator Levin. Okay.
Mr. Oppenheimer. Senator, may I add some context to this?
Senator Levin. No, I think we ought to be able to try to
get a straight answer on this. In terms of this so-called cost-
share agreement, which shifted the economic rights to
intellectual property--shifted the economic rights. These are
the crown jewels of Apple Inc. They were shifted to these Irish
companies in an agreement signed by three people, all of whom
work for Apple. That is factually the case. If that is not, say
I am wrong.
Now, you signed----
Mr. Cook. I would disagree with your characterization.
Mr. Oppenheimer. I disagree with your characterization.
Senator Levin. Well, you signed the agreement in 2008,
didn't you?
Mr. Oppenheimer. Yes, but I think there is some very----
Senator Levin. Don't you work for Apple?
Mr. Oppenheimer. I do, but I think there is some very
important context----
Senator Levin. Okay. Well, you can give the context in a
minute, but I want to get the facts out, and then we will call
on you for the context.
Mr. Cook, you signed that agreement, did you not, in 2008?
Mr. Cook. I signed the 2008 agreement, yes.
Senator Levin. And you were working for Apple at that time?
Mr. Cook. I have been working for Apple for 15 years, sir.
Senator Levin. And the other person who signed it I believe
was Mr. Wipfler, is that correct, in 2008 who was the treasurer
for Apple?
Mr. Cook. I am not sure. I do not have the agreement in
front of me.
Senator Levin. Okay. Do you know, Mr. Oppenheimer?
Mr. Oppenheimer. Yes, he is our treasurer.
Senator Levin. And he was then?
Mr. Oppenheimer. Yes.
Senator Levin. Three people working for Apple signed this
agreement. This agreement shifted the economic rights in your
crown jewels to three Irish companies that you own and control.
Mr. Oppenheimer. Senator, I would respectfully disagree
with that characterization.
Senator Levin. Well, you already said you own and control
them earlier this morning. Let me just finish my question, and
if you do not agree that you own and control them, you can stop
me. But you agreed earlier this morning you do own and control
those corporations. So I am relying on your testimony that you
own and control those corporations. So now you transfer, you
shift--and, by the way, when you said you shifted nothing, Mr.
Cook, I could not disagree with you more. Of course you shifted
something, the most valuable thing you have. The economic
rights in your intellectual property you shifted to those three
companies in an agreement. I am not saying it was legal or
illegal. I am simply saying you shifted the economic rights to
the most valuable thing you own--intellectual property. The
thing that produces the profits you shifted to those three
Irish corporations which you own.
Now the profits, about 70 percent of the profits worldwide
now end up with those three Irish corporations. That is the
fact. And now those profits are abroad. And when one of my
colleagues says you cannot bring them home, of course you can
bring it home--if you will pay the tax on it that would be
owing on them if you brought them home. Of course you can bring
them home. You bring home the profits from Mexico and Canada
and South America. The only reason you are not bringing them
home is because they were transferred to the companies in--
these three Irish companies. That is the reason why they are
there. It is your judgment, your decision. I am not saying you
are making the wrong decision. It is your decision not to bring
those profits home. And so $100 billion plus is now stashed
away in these three Irish companies that you control but
nonetheless it is in their legal name.
And the question is: Will you bring them home? You have
told us in one place, I believe, Mr. Cook, that you do not
intend to bring those monies home unless our tax rates are
reduced. I believe that is what you told our staff. Is that
correct? You are not going to bring that money home unless we
reduce our tax rates. Is that accurate as to what you told our
staff?
Mr. Cook. Senator, there is a lot there. I would appreciate
being able----
Senator Levin. You can, but I just want to ask you that one
question. Is it true you told our staff you are not bringing
the $100 billion home unless we reduce our tax rates? Is that
accurate?
Mr. Cook. I do not remember saying that.
Senator Levin. Is it true?
Mr. Cook. I said I do not remember saying it.
Senator Levin. No. I am saying is it true that you are not
going to bring them home unless we reduce our tax rates.
Mr. Cook. I have no current plan to bring them back at the
current tax rate.
Senator Levin. All right. Is that the same way as saying
unless we reduce our tax rates you are not bringing them home?
Is that the same way----
Mr. Cook. No, I do not think it is the same, sir.
Senator Levin. How is it different?
Mr. Cook. Your comment sounds like it is forever, and I am
not projecting what I am going to do forever because I have no
idea how the world may change.
Senator Levin. All right. It is not your intent to bring
them home unless we reduce our tax rates. Is that correct?
Mr. Cook. I have no current plan to do so at the current
tax rates.
Senator Levin. Okay. Here is where we are at, here is the
situation. You have an agreement which shifts the economic
rights, the most valuable thing you have, to three Irish
companies that pay no taxes. That is the shift. That is the
Golden Goose right there. That is your crown jewels. That is
your intellectual property. You have a right to do that just
the way you had a right not to shift that intellectual property
for Mexico, Canada, and South America. You decided not to do it
there. You are going to pay--Apple Inc. is going to pay the
taxes on the income for all the parts of the world except for
where two-thirds of the profits are created, roughly, and that
is the rest of the world that you have transferred the economic
rights to.
So, Okay, here is where we are at. You have profits going
now--you have $100 billion in profits that are sitting there
and you say it is your current intent to not pay your taxes on
them because you do not think you need to pay taxes on those
because the profits were shifted, as we have indicated, the
economic value has been shifted, and, therefore----
Mr. Oppenheimer. But, Senator, I must say we do not agree
with the characterization.
Senator Levin. That the economic rights to that--to your
intellectual property was shifted to those three companies? You
do not agree with that?
Mr. Oppenheimer. We do not.
Senator Levin. Oh, Okay. What was shifted to them?
Mr. Cook. Senator----
Senator Levin. Well, what was shifted to them in that
agreement that the three people signed, all of whom worked for
Apple Inc.? What was shifted?
Mr. Oppenheimer. Well, Senator, it began in 1980.
Senator Levin. I know that. I am talking about 2009, the
most----
Mr. Oppenheimer. Yes, but, Senator, it began in 1980----
Senator Levin. We have been through that history----
Mr. Oppenheimer. It fundamentally----
Senator Levin. We have been through the history.
Mr. Oppenheimer. It fundamentally did not change since
1980, and I think there is some very important context that
gets to the essence of the agreement that began over 30 years
ago.
Senator Levin. I understand, but I want to talk about the
agreement signed in 2008 and 2009. There was an agreement
signed in 2008 and 2009. You signed that agreement in 2008.
Three Apple employees signed that agreement in 2008. That
agreement did two things: it shifted the economic rights, the
way they had been shifted before, 30 years ago, it continued to
shift the economic rights to three Irish companies under your
control that do not pay taxes in the United States.
Mr. Oppenheimer. Senator, I respectfully disagree with
that.
Senator Levin. Okay. It did not shift the economic rights?
Mr. Oppenheimer. No, I do not--that is not the way I would
characterize it.
Senator Levin. What did it shift?
Mr. Oppenheimer. What it did, beginning in 1980----
Senator Levin. Did it shift----
Mr. Oppenheimer. What it did, beginning in 1980----
Senator Levin. Let us start in 2008----
Mr. Oppenheimer [continuing]. And it continued----
Senator Levin. I am sorry, Mr. Oppenheimer. You have gone
through the 1980. I want to talk about the 2008 and 2009
agreements. Did it shift anything? Did it give rights to those
three Irish companies? Did they get any rights in those three--
--
Mr. Oppenheimer. It was a continuation of the same rights
they have had for 30 years----
Senator Levin. Fine.
Mr. Oppenheimer [continuing]. That they have co-funded.
Senator Levin. Real good. Now, in 2008, you continued under
Apple's control, totally under Apple's control--I do not think
we ought to kid ourselves about that. Under Apple's control, in
2008 and 2009, there is an agreement that is reached, so-
called, with a controlled corporation, which you folks have
agreed this morning you control, and under that agreement,
which continues an earlier arrangement--that could have been
changed. You did not have to shift the profits in 2008. You did
not have to shift your intellectual property, the economic
benefits in 2008 and 2009. You are in control. It is your
company. You are signatories. You made a decision to do it. You
had a right to make a decision. But do not kid ourselves as to
the implications of what this means in terms of America's
revenue.
Apple makes this shift--again, I am not saying it is
illegal. I am not saying it is legal. I am saying you made a
decision to shift most of your crown jewels in terms of
economic value and rights that creates the profits which are so
massive, you made that decision to continue that arrangement in
2008 and 2009. Okay. Now, we----
Mr. Oppenheimer. So we did that.
Senator Levin. Yes.
Mr. Oppenheimer. Beginning in 1980, and that is the way we
set up Apple. We went to Ireland when we first wanted to begin
to sell computers overseas----
Senator Levin. I understand. But we heard that this
morning. I understand that.
Mr. Oppenheimer. We have continued to do that for the last
30 years. We have built up a lot of skills. Our systems are set
up that way. Our processes are set up that way. Our operations
are, and that is why we do it today. It has been unchanged for
over 30 years.
Senator Levin. The result of continuing that in 2008 and
2009 is most of your profits worldwide are now in three Irish
companies that you control that do not pay taxes. That is the
result of what you did in 2008. I know the origin----
Mr. Oppenheimer. Thankfully, customers around the world
love the iPhone and the iPad and they are buying them.
Senator Levin. We love the iPhone and the iPad.
Mr. Oppenheimer. And so do people around the world, and
they are buying them, and we are selling----
Senator Levin. People around the world--people in Mexico
and Canada love the iPhone and the iPad. I got one right here.
My granddaughter even knows how to use it. All of it.
Mr. Cook. Thank you.
Senator Levin. It is a terrific instrument. That is not the
question. People love it in Canada, Mexico, and in South
America. But the intellectual property was not transferred
there.
Mr. Oppenheimer. And it is because it is the way we set
ourselves up over 30 years ago. We have not changed.
Senator Levin. I understand. As a result of the
continuation of that process, in 2008 and 2009, most of your
profits that come from this brilliant intellectual property,
which everybody that I know of applauds, the continuation of
that system means that most of your profits worldwide are
sitting in three Irish companies that you control that do not
pay taxes. That is the result, Okay? You can defend it. But
that is the result. And, folks, there is a huge drain as a
result. You point out, and accurately so, Mr. Cook, that 95
percent of the creativity that goes into those products is in
California. But two-thirds of the profits are in Ireland. And
you have made a decision, which you have a right to do, not to
bring that money home.
Mr. Cook. Senator, we are proud that all of our R&D or the
vast majority of it is in the United States.
Senator Levin. I know, but the profits that result from it
are sitting in Ireland in corporations that you control that do
not pay taxes. You ought to be proud----
Mr. Cook. All of the profits from all of the products we
sell in the United States----
Senator Levin. I know that.
Mr. Cook [continuing]. We pay taxes in the United States.
Senator Levin. Oh, I know that. And all the profits that
you make from your products that are sold in Canada are taxed
in the United States, and all of the profits that are produced
from products that you sell in Mexico and Argentina and South
America, all of those profits you pay taxes on in the United
States. But you made a decision. You signed an agreement that
continues an earlier agreement. You signed two agreements in
2008 and 2009, and in those two agreements you continued to
shift most of your crown jewels in terms of economic value, you
continued that arrangement, with the result that most of your
profits worldwide are not taxed. You are an American company.
You are proud of it. We are proud of you being an American
company. We are glad you are where you are at. But the result
of these arrangements that you have continued is that most of
your profit is now where we have described all morning, in
Ireland, in these companies that do not exist anywhere except
on the water.
Now, of course we have to change it. Of course we have to
change this system. But in order to change it, we have to
understand it, not deny it. We have to understand what is going
on. And what is going on is a huge loss of revenue to the
United States because we have these corporations--and you are
the biggest one--that are able to shift profits to places where
you, an American company, do not pay income tax on it. That is
where we are at. And we have to better understand that if we
are going to correct it. And that is our purpose here today, to
shed a light on that.
And so I hope that purpose has been achieved. We cannot
continue a system, and I say this from the bottom of my heart.
We cannot continue a system where the company, a multinational
company, as phenomenally successful as yours, and deservedly
so, can make a decision, sitting down in 2008 and 2009, as to
where the profits are going to flow. An American company where
the R&D is 95 percent in the United States, we--you created it.
I will not say ``we.'' You created it. You got some real
benefits, by the way, in doing that. You got R&D tax credits.
You have all the benefits of living in this country. You have
the protection of patents.
So with all of that, you are sitting there unilaterally
deciding in 2008 and 2009 whether to continue a system where
profits are shifted to a place where they are not available to
the American tax man. Everyone agrees apparently we have to
change this system. I hope everybody agrees to that. How we do
it we may not agree to. But in order for us to change this
system, we have to understand what is going on, which is that
you make a unilateral decision, three Apple employees in 2008
and 2009 essentially decided where these profits are going to
be taxed or non-taxed.
Folks, it is not right. That is not right, to leave that
decision, it seems to me, the way it is decided so
unilaterally, that a company can shift its value to a place---
to a tax haven, which is what Ireland is.
I hope we have--I know it is your intention here--and I
applaud you for your constructive view. I do. I know it is not
easy to come in front of a spotlight. We understand that. But
it is important for us that have to write the laws--and you
agreed, Mr. Cook, and your colleagues there, that we have to
rewrite these laws. It is important for us that we know what is
going on if we are going to change it in a sensible way.
And so we are going to move to our third panel, and I want
to again thank you, all of you, and I want to commend your
company for the great work that you produce.
With that, we are going to move to our third panel. Thank
you.
Mr. Cook. Thank you.
Senator Levin. We are now going to move to our third panel.
We call our witnesses: Mark Mazur, Assistant Secretary for Tax
Policy at the Department of Treasury; Samuel Maruca, the
Director of Transfer Pricing Operations of the Large Business &
International Division at the Internal Revenue Service. We
appreciate both of you being with us here today, and we look
forward to your testimony. And I think you both know our rules,
that under Rule VI all witnesses who testify before the
Subcommittee are required to be sworn, so we would ask you if
you would please stand and raise your right hand. Do you swear
that the testimony you are about to give here today will be the
truth, the whole truth, and nothing but the truth, so help you,
God?
Mr. Mazur. I do.
Mr. Maruca. I do.
Senator Levin. One minute before the red light comes on,
you are going to see the light change from green to yellow,
which will give you an opportunity to conclude your remarks.
The written testimony will be printed in the record in its
entirety, and we ask that you limit your oral testimony to no
more than 10 minutes.
Mr. Mazur, we will have you go first.
TESTIMONY OF MARK J. MAZUR,\1\ ASSISTANT SECRETARY FOR TAX
POLICY, U.S. DEPARTMENT OF THE TREASURY, WASHINGTON, D.C.
Mr. Mazur. Thank you, Chairman Levin. I appreciate the
opportunity to testify on the issue of the potential shifting
of profits offshore and between foreign companies and countries
by U.S. multinational corporations.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Mazur appears in the Appendix on
page 139.
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Obviously this is a complex subject that has numerous tax
policy issues, and it also brings up issues relating to tax
accounting and tax administration. I hope to address some of
the most important ones today.
The geographic allocation of profits earned by
multinational enterprises historically has been challenging and
has become more difficult with the rise of globalization. In my
prepared testimony, I offer a stylized example of the way that
this shifting could occur. The basic point, though, is if you
have a multistep process that takes place over a number of
jurisdictions where decisions are made to develop and market a
product around the world, each of these steps is important for
ensuring that the product is profitable, but the important
question arises: Where is that income earned? And presumably
some sliver of income goes to each of those steps in the
process for a successful marketing of a product, but it is not
obvious what the appropriate geographic allocation should be.
However, our Tax Code requires that the income be allocated
to various subsidiaries based on an arm's-length standard, one
that would exist if you have unrelated parties who charge each
other for goods or services provided. But when parties are
related and there is not a very well defined market, it may be
very difficult to determine the arm's-length price that should
prevail in those transactions.
And it is important to realize this is not just a U.S.
problem. Virtually every country with a corporate income tax
faces the challenge of determining what share of a global
enterprise's income is part of that country's tax base.
Multinational corporations under current law are able to
shift profits offshore and between subsidiaries using various
organizational structures and transactions. In some cases a
U.S. company transfers rights to intangible property to an
offshore affiliate. These can occur through various constructs
including cost-sharing arrangements. Under this type of an
agreement, the foreign subsidiary is required to pay the U.S.
parent an arm's-length price for any existing intangible
property or other resource. And thereafter, the subsidiary
contributes a portion of the costs of the shared research and
development activities of the intangible. And then they share
in anticipated benefits from that.
In theory, up front, the payment that is made for the
intangible property originally contributed, combined with the
reduction in the U.S. parent's tax deductions, should result in
no anticipated risk-adjusted loss of tax revenue to the United
States. However, there is considerable controversy whether this
result is actually achieved in fact.
There are a number of ways that U.S. multinationals may
shift profits, including moving intangible property through
various transactions that will not result in recognized income
in the United States. Some taxpayers have taken the position
that certain intangible assets are not subject to the arm's-
length transfer pricing rules, as one example.
What I want to do is spend a moment or two talking about
the overall context. Changes in the U.S. corporate tax rates--
both in absolute terms and relative to the rates of our major
trading partners--have changed the economic incentives greatly
over the last few decades. Before the 1986 Tax Reform Act, the
United States and other developed countries had relatively high
tax rates, and they were roughly similar. After the 1986 Tax
Reform Act, the United States was a relatively low-tax
jurisdiction. Since then, however, other countries have reduced
their corporate tax rates, and now the U.S. corporate rate is
among the highest in the developed world.
A higher statutory rate can encourage companies to shift
income and production to lower-tax jurisdictions, especially in
a global marketplace. The immediate gain from shifting a dollar
is the difference in statutory tax rates, and while there may
be costs to managing operations and earnings that were shifted,
the multinational firm may be better off from having done so.
So that is the role of tax rates.
There is also, though, the role of accounting treatment.
U.S. multinationals are concerned not just about the tax
treatment of their earnings but also about the financial
accounting treatment of their earnings. There is a presumption
under U.S. Generally Accepted Accounting Principles (GAAP) that
deferred income taxes should be recognized in the financial
statements for the same period in which the earnings are
generated because these rules presume that the earnings will be
repatriated back to the United States or remitted back to the
U.S. parent at some point in time. However, this presumption
can be overcome by the firm either permanently investing abroad
or saying that they will permanently reinvest the earnings
abroad. And then you have a situation where the deferral of
earnings offshore offers not just the tax benefit, the deferral
of the tax that will be due, or a lower effective tax rate paid
over time, but also a higher earnings for financial statement
purposes. And so financial income reporting rules may also add
to the incentive to shift earnings.
Estimates of how big this issue is vary all over the lot.
There are some estimates that are less than $10 billion a year,
some estimates greater than $80 billion per year. The estimates
try to account for all the possible ways of doing profit
shifting between shifting intangibles, shifting risk, and using
debt to shift income around. But the point of all these
estimates is that you need to have a set of assumptions about
behavior, profitability and so on to generate these estimates.
Some studies assume that the rates of return are not
affected by income shifting or profit margins are not affected
by income shifting. Others try to estimate statistical
relationships. The point here is that while there are a range
of estimates, they tend to be relatively large in absolute
dollar terms.
I want to change gears a little bit and look at some of the
specific tax rules. Subpart F is a section of the Tax Code that
is intended to limit income shifting to low-or no-tax
jurisdictions. It generally focuses on passive and mobile
income, and the idea is that that type of income will be taxed
currently in the United States. That is, the tax on that income
is not deferred.
Subpart F goes back to the 1960s. The Kennedy
Administration proposed to end deferral. Subpart F was
Congress' response to that. It was a more modest step toward
ending deferral, and it focused on types of income that were
more easily shifted.
However, Subpart F today may not being doing what it was
intended to do 50 or so years ago. It is possible for taxpayers
to use hybrid entities and hybrid instruments in order to avoid
some of the aspects of Subpart F. Hybrid entities would be
entities that are considered a corporation in one jurisdiction
and a non-corporate entity in another. Hybrid instruments would
be a financial instrument that is considered debt in one
jurisdiction and equity or preferred stock in a different one.
This type of situation effectively allows multinational firms
to arbitrage tax rules by having different results in two
different countries.
The Administration has several proposals to address this
situation, both proposals contained in the annual budget
submission and in the President's Framework for Business Tax
Reform.
I want to focus a moment on the Framework. It was really
intended to provide a multi-pronged approach to reduce the
incentives for companies to shift income and shift investment
to low-tax countries, also to put the United States on a more
level playing field with our international competitors, and to
help slow the global race to the bottom on corporate tax rates.
The underlying principle of the President's Framework for
Business Tax Reform was that the United States should become a
more attractive place to create and retain high-quality jobs.
Among other things, the President's Framework would impose
a minimum tax on the income earned by foreign subsidiaries of
U.S. multinationals. If a U.S. multinational had a subsidiary
in a low-tax country paying a low effective tax rate, the
minimum tax would kick in. That income would be taxed currently
at the minimum tax rate. That would provide a balance by
limiting the opportunities to shift profits to low-tax
jurisdictions and place U.S. multinationals on a more level
playing field with their local competitors.
The President's Framework for Business Tax Reform also
would incorporate many of the international tax proposals in
the President's fiscal year 2014 budget that would discourage
U.S. multinationals from shifting profits--and specifically
profits related to intangible property offshore. One proposal
that is important is the excess returns proposal. This would
provide that if a U.S. firm transferred intangible property to
a related foreign affiliate subject to a low foreign effective
rate and where there is excess income shifting, the U.S. firm
would be taxed currently on the amount of excess shifting
abroad. This would eliminate a large part of the incentive for
inappropriate shifting of intangibles.
There are a number of other proposals in the President's
budget that also would focus on the situation where income from
intangibles is not appropriately taxed in the United States.
And the last point I want to make has to do with the work
that the Treasury Department has been doing with the
Organisation for Economic Co-operation and Development to
analyze profit shifting. We are actively participating in the
OECD's project on base erosion and profit shifting, and it is
an indication where a multilateral set of steps really is
necessary to address this problem in the worldwide context.
Thanks for your attention. I would be happy to answer any
questions.
Senator Levin. Thank you very much, Mr. Mazur. Mr. Maruca.
TESTIMONY OF SAMUEL M. MARUCA,\1\ DIRECTOR, TRANSFER PRICING
OPERATIONS, LARGE BUSINESS & INTERNATIONAL (LB&I) DIVISION,
INTERNAL REVENUE SERVICE, WASHINGTON, D.C.
Mr. Maruca. Chairman Levin, thank you very much for the
opportunity to appear and speak on tax compliance and tax
administration issues related to the shifting of profits
offshore by U.S. multinationals.
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\1\ The prepared statement of Mr. Maruca appears in the appendix on
page 146.
---------------------------------------------------------------------------
The IRS takes very seriously the need to ensure that U.S.
multinational corporations are abiding by the U.S. tax laws and
paying their fair share of tax. Over the past few years, we
have been working to enhance our approach to international tax
enforcement in general and to income shifting in particular. We
have been refocusing our enforcement efforts to be more
strategic by viewing taxpayers through the prism of their tax
planning strategies and allocating our limited resources to
cases presenting the highest compliance risk.
We have been aligning our resources and training our
employees in key strategic areas, including income shifting,
deferral planning, foreign tax credit management, and accessing
profits accumulated offshore.
Further, to better manage our collective knowledge in
strategic international compliance areas, we have formed 18
what we call ``International Practice Networks,'' which are
focused on integrating our training and our data management
with our overall strategy in this area.
With respect to transfer pricing, the IRS is charged with
ensuring that taxpayers report the results of transactions
between related parties as if those transactions had occurred
between unrelated parties. Under this standard, the results of
the transaction as reported by the taxpayer are compared to
results that would occur between unrelated taxpayers in
comparable transactions under comparable circumstances.
Now, establishing an appropriate arm's-length price by
reference to comparable transactions is relatively
straightforward for the vast majority of international
commerce. But enforcing the arm's-length standard becomes much
more difficult in situations in which a U.S. company shifts to
an offshore affiliate the rights to intangible property that is
at the very heart of its business--what may be referred to as
the company's ``core intangibles.'' In fact, over the past
decade, applying Section 482 in these types of cases has been
our most significant international enforcement challenge.
Transfers of a company's core intangibles outside of a
corporate group rarely occur in the market, so comparable
transactions are difficult, if not impossible, to find. In some
cases the IRS has had to resort to other valuation methods not
based on market benchmarks, which are often referred to as
``income-based methods.'' Under these methods, the IRS
typically has to conduct an ex ante discounted cash-flow
analysis. Evaluating underlying assumptions about projects
cash-flows and discount rates after the fact is a complex
undertaking.
Moreover, a business' core intangible property rights are
by their nature high-risk, high-reward assets, and it is often
difficult to assess the extent of the risk and by whom it is
borne.
The IRS has been attuned to this issue for many years and
has devoted substantial resources to enforcement in this area.
We are now redoubling our efforts. In 2011, a new IRS executive
position, in which I am the first to serve, was created to
oversee all transfer pricing-related functions, to set an
overall strategy in the area, and to coordinate work on our
most important cases. In building a new function devoted
exclusively to tackling our transfer pricing challenges, we
have recruited dozens of transfer pricing experts and
economists with substantial private sector experience to help
us stay on the cutting edge of enforcement and issue
resolution. We are working closely with exam teams in the field
to ensure the best case selection and development possible.
I would like to briefly address the issue of cost sharing.
The IRS has worked with the Treasury Department over the last
several years to adopt revised regulations on cost sharing.
These new rules clarify a number of issues that were
contentious under the prior set of cost-sharing regulations and
better define the scope of intangible property contributions
that are subject to taxation in connection with cross-border
business restructurings. While to date the IRS has had limited
experience in auditing transactions covered by these new
regulations, early anecdotal information indicates that the
regulations have had a positive impact.
However, concerns remain that we are considering and
following very closely. Some taxpayers are taking the position
that a cost-sharing arrangement, or other transaction taxable
under Section 482, has, in fact, been preceded, either
explicitly or implicitly, by the incorporation or
reorganization transfer of core intangibles. In these cases,
the taxpayers assert, among other positions, that foreign
goodwill and going concern, which are exempted from tax under
the regulations, are the most valuable elements in these
transactions. In response, we are now training our agents to
address these issues and to challenge taxpayers' positions
where appropriate.
The IRS has been and continues to be vigilant and forceful
in addressing compliance issues we have seen in regard to
income shifting activities of United States and foreign-based
multinationals. Based on a recent survey, as of May 9, 2013, we
estimate that we are currently considering income shifting
issues associated with approximately 250 taxpayers involving
approximately $68 billion in potential adjustments to income.
Mr. Chairman, thank you again for this opportunity to
testify on the IRS' efforts to enforce the tax law as it
applies to multinational companies. Although enforcing and
administering international tax law will present challenges for
us well into the future, the agency has made great strides in
recent years, and this is a tribute to our strategic focus and
to the highly dedicated and professional men and women of the
IRS. I would be happy to respond to any questions you may have.
Thank you.
Senator Levin. Thank you very much, both of you.
Mr. Maruca and Mr. Mazur, do you agree that Subpart F of
the Tax Code was designed to stop tax haven abuse, that it was
supposed to stop these controlled foreign corporations from
converting deferrable active income that is not easily movable
into non-deferrable--i.e., taxable--passive income that is
easily shifted into a tax haven for tax avoidance?
Mr. Maruca. I would agree, Mr. Chairman, as originally
conceived that was the purpose of Subpart F. But over the
years, there have been numerous exceptions and exceptions
within exceptions. And that circumstance, together with the
check-the-box rules, as well as the interaction of our law and
foreign law, create multiple different opportunities, if you
will, to avoid the reach of Subpart F as it was originally
conceived.
Senator Levin. And would you agree that the original
conception, Mr. Mazur, of Subpart F was to do what I just
described?
Mr. Mazur. I think I would characterize the original
characterization of Subpart F is to prevent the shifting of
passive income abroad, yes.
Senator Levin. The shifting of passive income. I think it
also, was it not, because it covered dividends that were made
to corporations, for instance, that if those dividends came
from a corporation and the income was active income in the
first corporation, that when it shifted it in the form of a
dividend or a royalty, that then became passive income, which
under Subpart F was intended to be taxed.
Mr. Mazur. I think the general idea was to focus on mobile
income, passive income, sweep that up into the U.S. tax base,
active income could be deferred, yes.
Senator Levin. Active income deferred, passive income was
not supposed to be deferred. Is that correct?
Mr. Mazur. Basic rule, yes.
Senator Levin. And that is the basic rule, and the passive
income included dividends and royalties. Is that specified?
Mr. Mazur. Sir, it's harder to say on that one because if
you look at the role of Subpart F to prevent shifting passive
income out of the U.S. tax base, then that would be correct.
Over the years the focus has mostly been on the U.S. tax base,
not so much on the foreign-to-foreign tax base.
Senator Levin. I am talking about the original intent.
Mr. Mazur. The 1962 intent, sir?
Senator Levin. Yes.
Mr. Mazur. Hard to say, but you are probably right.
Senator Levin. Okay. In your written testimony, I think you
make reference to regulations that were issued in March 1998
that would have modified the check-the-box regulation, restored
an anti-deferral regime, but that in 1998--excuse me, that
subsequent to 1998 those regulations were withdrawn. Is that
correct? The 1998 regs were withdrawn?
Mr. Maruca. I believe so, yes.
Senator Levin. And is it fair to say that they were
withdrawn because of pressure from the Hill, Capitol Hill, and
business interests? Is that what the history shows here? You
are familiar with the history. You were not here at the time, I
do not think.
Mr. Mazur. I was not at Treasury at the time.
Senator Levin. But you are familiar with the history here.
Is that a fair statement?
Mr. Mazur. I think the fairer statement would be that the
rules were proposed, they were withdrawn; there was a lot of
opposition from the business community and from folks on the
Hill.
Senator Levin. That is fine.
I believe that you indicated in your testimony that we are
trying or you folks are trying at Treasury and the IRS to avoid
a situation where there is shifting of revenue between the
parent corporation and subsidiaries pursuant to agreements that
are transfer pricing agreements, unless those subsidiaries are
making payments based on, in your words, an arm's-length
standard. Is that correct?
Mr. Maruca. That is correct.
Senator Levin. And the arm's-length standard that you
require to be followed is essentially, in your words, what
unrelated parties would charge each other for the goods or
services provided. Is that correct?
Mr. Mazur. Correct.
Mr. Maruca. That is correct.
Senator Levin. And I think I am actually quoting from your
testimony, Mr. Mazur, so----
Mr. Mazur. I will take the ``correct.''
Senator Levin [continuing]. You would agree it is correct.
So now we have heard of--just an example, we have put the
spotlight on one example of where three Apple employees sign an
agreement to transfer the economic rights to intellectual
property to three of their wholly owned Irish subsidiaries.
That was the example that we are looking at, and you have
indicated that somehow or other it is the goal of the IRS to
make sure that that payment and that shift of the profits, in
essence, to the subsidiary is based on an arm's-length
standard. Somehow or other you have to figure out, if there
were an arm's-length deal here, what would be shifted. What
part of the profits would be shifted? What part of the cost
would be shifted? And that is what you are trying to do. Is
that correct, Mr. Maruca?
Mr. Maruca. Yes, Mr. Chairman. I cannot comment on the
particulars with respect to----
Senator Levin. No, I am not asking----
Mr. Maruca [continuing]. Any taxpayer, but----
Senator Levin. No, I am not asking you to comment on this
taxpayer. What I am asking you to comment on, your goal is to
find a way to apply an arm's-length standard to a transfer
pricing agreement. Is that correct?
Mr. Maruca. Yes. So we would analyze the facts and
circumstances.
Senator Levin. All right. Now, you also indicated, I
believe, that you now have an ability to go back after the fact
and to look at what the allocation of costs and profits were.
Is that true?
Mr. Maruca. Under some circumstances, yes.
Senator Levin. All right. So that now you have the ability
to--when you have clearly a non-arm's-length transaction, I am
going to--it is so obvious this is not an arm's-length that we
talked about this morning, but I will not talk about this
morning. I will just simply say: Where there is obviously not
an arm's-length transaction, where the parties are all working
for the parent corporation but are signing a transfer pricing
agreement between a parent corporation and a controlled foreign
corporation, wholly owned subsidiary, that you now have the
ability to pierce that, to look at that, but to look at it
afterwards and to see whether or not, in fact, knowing what has
taken place during the life of that agreement or when that
agreement is in effect, whether that is a fair allocation of
benefits, risks, and profit? Are we together? Or put it in your
own words.
Mr. Maruca. Yes, I think our regulations do allow a
retrospective look, but the way we apply our rules is we go
back and look and see what the playing field was like when the
transactions were struck. And if they are appropriately priced
based on the information available at that time and the risks
play out differently, we would not revisit that transaction.
Senator Levin. All right. And so when the--let us assume
that you have a series of transfer pricing agreements signed
between an American corporation and a controlled foreign
corporation and there was an agreement that was signed in year
one and then there was another transfer agreement, another
transfer pricing agreement for the same property in year two,
and then in year three, and then in year four, do you look at
the most recent agreement to see if that was in effect, had the
arm's-length standards met? Would you look at the most recent
agreement?
Mr. Maruca. I think we would probably have to look at the
totality of the circumstances.
Senator Levin. Would that include----
Mr. Maruca. That fact pattern.
Senator Levin. Would that include the most recent
agreement?
Mr. Maruca. It would include all the facts.
Senator Levin. All the agreements?
Mr. Maruca. Yes.
Senator Levin. Up to date, Okay.
Do we have or do you have an obligation to stop
multinational corporations from shifting income to tax haven
jurisdictions? Mr. Mazur?
Mr. Mazur. I think the obligation of the Treasury
Department here is to ensure that laws that are passed are
implemented in the way that Congress intended them through
regulatory activity; and, second, where there are problems that
arise, to propose legislative fixes to those.
Senator Levin. Mr. Maruca, you made reference, I believe,
to Section 482 of the Code.
Mr. Maruca. Yes, sir.
Senator Levin. That section reads that, ``The Secretary may
distribute a portion or allocate gross income, deductions,
credits or allowances, between or among such organizations,
trades, or businesses if he determines that such distribution,
apportionment, or allocation is necessary in order to prevent
evasion of taxes or to clearly reflect the income of any such
organizations, trades, or businesses.''
So under Section 482, is that still the law?
Mr. Maruca. Yes, sir.
Senator Levin. And that is the one you made reference to, I
believe, in your testimony.
Mr. Maruca. Yes.
Senator Levin. You at the IRS and the Treasury Department
can change the allocation if you find it necessary to prevent--
excuse me. I will put it positively. If you find it necessary
to clearly reflect the income of such organization, trade, or
businesses. Right?
Mr. Maruca. That is correct.
Senator Levin. Okay.
Mr. Mazur. And one of the things that has been done, in
2009 we issued temporary regulations related to cost sharing,
and those were finalized in 2011. They address a particular set
of problems that we had seen in the cost-sharing area.
Senator Levin. All right. Now, we have been looking at U.S.
multinationals, this Subcommittee has been looking at U.S.
multinationals and their offshore entities for a number of
years. This is the first time that we have ever come across
entities that have no tax residence. Our experts have told us--
except we heard slightly differently today, but at least one of
our experts had told us that they had never heard about
entities without a known tax jurisdiction.
In either of your experiences, have you ever heard of a
controlled foreign corporation that does not have a tax
residence?
Mr. Maruca. Yes.
Senator Levin. Mr. Mazur.
Mr. Mazur. No.
Senator Levin. So now you have heard of one that does not
have a tax residence. Mr. Maruca, explain what that situation
was.
Mr. Maruca. Well, it typically arises where there is a
difference between treatment under U.S. law and treatment under
foreign law. So the residence rule, for example, could be
different.
Senator Levin. They are different. That is what happens.
Here the question is whether--have you ever heard of a
controlled foreign corporation that has no residence?
Mr. Maruca. A controlled foreign corporation----
Senator Levin. That says it has no residence.
Mr. Maruca. Is a foreign corporation for U.S. law purposes.
Senator Levin. Right.
Mr. Maruca. It is not a U.S. resident corporation. It is
not a U.S. corporation. It does not have Irish or foreign law
residency either because under those rules, it is not the place
of organization.
Senator Levin. Right. We understand. That is what we went
through this morning.
Mr. Maruca. It is where it is managed and controlled.
Senator Levin. Right.
Mr. Maruca. That is how it arises.
Senator Levin. Okay. It arises--we had an example of it
here this morning. That is exactly what happened. My question
is: Is it a rare event that you find a controlled foreign
corporation that does not have a tax residence?
Mr. Maruca. That I could not say.
Senator Levin. Well, from our perspective, from what we
have seen, it is rare. And, Mr. Mazur, I guess you have never
even seen one.
Now, the next question relates to a shell entity that is
incorporated in a foreign tax jurisdiction. Can it be
disregarded for U.S. tax purposes if the entity is controlled
by its parent to such a degree that the shell entity is nothing
more than an instrumentality of its parent? And here I will
refer to a legal principle that was described by the IRS in a
letter ruling in 2002. Did you follow the question? Mr. Mazur,
let me ask you first. Did you follow the question?
Mr. Mazur. No.
Senator Levin. If a shell entity is incorporated in a
foreign tax jurisdiction, can it be disregarded for U.S. tax
purposes if that entity is controlled by its parent to such a
degree that the shell entity is nothing more than an
instrumentality of its parent?
Mr. Mazur. I believe it is possible, yes.
Mr. Maruca. I would be happy to respond to that, Mr.
Chairman.
Senator Levin. Okay.
Mr. Maruca. It is possible, there are circumstances under
which we have been successful in disregarding incorporations or
other arrangements, contractually or otherwise, between related
parties. However, those circumstances are fairly narrow under
our common law. So, for example, if you have a company that is
duly organized and existing, it has capital, it has assets, and
it takes business risk, in those circumstances it is extremely
difficult to succeed in disregarding the existence of that
entity or the transactions it engages in.
Senator Levin. Now, is that true even if the assets are
totally controlled by the parent?
Mr. Maruca. Well, there is a difficult----
Senator Levin. It has no employees, for instance. It has no
employees.
Mr. Maruca. There is a difficult issue----
Senator Levin. AOI has no employees.
Mr. Maruca. That is a difficult issue that we confront
fairly regularly where the management and control is in one
corporate entity and the funding and business risk is in
another. We have rules that allow us to apply our transfer
pricing valuation principles in that context, but it is
typically a pricing question and not a question of whether that
entity is a sham or can be disregarded.
Senator Levin. So if it is a sham entity, has no employees,
all of its assets are controlled by the parent, its directors
are the parent's directors, the meetings are held on the
telephone and never held in an offshore location, there is no
there there, would those be factors that you would look at to
determine whether or not, in fact, the shell entity is nothing
more than an instrumentality of its parent?
Mr. Maruca. Those would definitely be factors. But there
are other factors.
Senator Levin. Other factors as well. I understand. Cost-
sharing agreements are supposed to be arm's-length or meet
arm's-length standards. Is that correct?
Mr. Maruca. They are supposed to meet the requirements of
our regulations, yes.
Senator Levin. Is the purpose of your regulation that they
meet arm's-length standards?
Mr. Maruca. Yes.
Senator Levin. Mr. Mazur.
Mr. Mazur. Roughly consistent with arm's-length standards,
yes.
Senator Levin. Roughly consistent?
Mr. Mazur. Consistent with arm's-length standards, yes.
Senator Levin. Arm's-length standards.
Mr. Mazur, if a transaction is only done for tax reasons,
is it appropriate for the IRS to disallow such a transaction
when it does not have a business purpose but is being done to
shift profits to avoid tax?
Mr. Mazur. There are some situations where the economic
substance is the appropriate standard, but often we look at the
legal standards here, and if there is risk that is shifted or
some other----
Senator Levin. If there is what?
Mr. Mazur. Risk that is shifted or some other attributes
that are shifted, those transactions may be respected for tax
purposes.
Senator Levin. All right. And that might be true even if a
company has no employees?
Mr. Mazur. Again, it is a facts and circumstances
situation, and the question really comes down to, I think, as
Mr. Maruca brought up, the pricing that is at issue here.
Senator Levin. And the pricing, when you look at the facts
and circumstances, is it also the value of what is transferred?
Mr. Mazur. Yes, and as pointed out, if you transfer
property in year one and you are looking at a situation in year
ten, you look at the totality of the facts and circumstances
over the entire timeframe.
Senator Levin. All right. Of the entire----
Mr. Mazur. Of the entire timeframe.
Senator Levin. Timeframe, all right. And you look at the
fact that it is totally in the control of the parent as to what
the content of that agreement is? Is that a fact that you look
at?
Mr. Mazur. I think one of the things that you are pointing
out is the most difficult areas to look at transfer pricings
are where you have related parties and you do not have an
active market for the goods or services that are being
transferred. Those are the most difficult, and that is where
the tax administrator has the most difficult time trying to
assess what the arm's-length standard should be.
Senator Levin. Now, when the company has a consolidated
financial statement which it issues and consolidates all of its
profit in a financial statement--it does not pay taxes on the
profit, but it consolidates it for its financial statement--is
there a risk that is really being transferred away from the
parent when the world looks at that consolidated financial?
Mr. Mazur. I think there is a risk of how well each of the
entities will do on that transfer. You are right that if you
look at the financial statements, they sweep up all the
multinational firm's income from wherever it is earned and
group it together. But for tax purposes, you have sometimes a
different outcome.
Senator Levin. And if all of the money, all of the assets
belong to the parent, they totally control the parent, you are
still going to act as though the controlled foreign corporation
has somehow or other risked its assets, even though its assets
totally belong to the parent. You are still looking at that
aspect.
Mr. Mazur. We typically would respect that, yes.
Senator Levin. Okay. Now, there is a statutory rate in the
United States of 35 percent. Is the effective rate different
typically for companies than 35 percent?
Mr. Mazur. Sure, sure----
Senator Levin. Do you know what the average effective rate
is for corporations in the United States?
Mr. Mazur. It would be in the mid-20 percent range, 27-ish
percent range, something like that.
Senator Levin. Different from the statutory rate.
Mr. Mazur. Different from the statutory rate for a number
of reasons.
Senator Levin. And is it true that a number of corporations
pay no taxes at all?
Mr. Mazur. There is a wide range of effective tax rates in
the United States from very low to very high.
Senator Levin. So that many corporations, including many of
our most profitable corporations, pay no taxes. Is that
correct?
Mr. Mazur. I cannot answer the exact number, sir.
Senator Levin. I did not say exact----
Mr. Mazur. Even----
Senator Levin. I said ``many.''
Mr. Mazur. There are several million corporations in the
United States, many of which are very small, those pay no tax.
So that is true----
Senator Levin. I was talking about our most profitable.
Mr. Mazur. The larger ones----
Senator Levin. Have you seen the study that shows that 30
of our most profitable corporations over a period of 3 years
recently paid no taxes?
Mr. Mazur. I have seen that study, sir, yes.
Senator Levin. Do you----
Mr. Mazur. I think part of what you are seeing in a study
like that would be first the effect of the recession on
lowering profits for a number----
Senator Levin. No. I said ``highly profitable
corporations.''
Mr. Mazur. Lowering of profits for tax purposes----
Senator Levin. No. I said ``highly profitable
corporations.''
Mr. Mazur. Lowering of profits for tax purposes; and,
second, we had bonus expensing and--bonus depreciation and
expensing for a number of years, which would have reduced the
taxable income for those companies for those years. Presumably
that income gets picked up in the future when they are unable
to claim those depreciation deductions.
Senator Levin. All right. But you are familiar with that
study?
Mr. Mazur. I am familiar with the study, yes.
Senator Levin. And that study showed that those companies
had $160 billion in profits for those 3 years. Do you
remember----
Mr. Mazur. I do not remember that number, sir.
Senator Levin. All right. Mr. Mazur, is the transfer of
economic rights a way to shift tax liability?
Mr. Mazur. I think the transfer of economic rights
associated with intellectual property affects a number of
things, one of which is possibly shifting income and risk to
other places. Another is potentially shifting some potential
tax liability, yes.
Senator Levin. So that is one way of shifting tax
liability. Is that correct?
Mr. Mazur. Possible to do it that way, yes.
Senator Levin. What is the impact on U.S. tax revenue if
U.S. multinationals can enter into cost-sharing agreements with
offshore companies that they control and then direct most of
the profits to those offshore companies, most of their
worldwide profits to those offshore companies, and on top of
that, if they can use offshore companies that have no tax
residence anywhere, what is the effect on our revenue?
Mr. Mazur. I do not have the number for that exact fact
pattern, but as I noted in my testimony, the estimates for
profit shifting that come from academic economists who know
this, who have looked at it, range from somewhere below $10
billion a year to somewhere above $80 billion a year. There is
a wide range of estimates.
Senator Levin. Mr. Mazur, the Treasury might be able to fix
some of these problems if it would reform check-the-box,
develop regs making it easier for the IRS to go after shell
corporations that are used for tax avoidance, particularly
those that are not tax resident anywhere. It could stop
treating cost-sharing agreements that push money offshore as
acceptable arm's-length agreements or arrangements.
What are the chances that the Treasury is going to take any
of those actions?
Mr. Mazur. I think, sir, in the Administration's budget
proposal there are a number of legislative options that would
perhaps be more effective at addressing this situation. There
is an excess intangibles income proposal which really would
limit some of the incentives to shift intangibles abroad. There
are a number of proposals that would clarify the types of
intangibles that would be subject to Section 482. And another
proposal that would look at----
Senator Levin. Are there any regulatory proposals? I think
the ones you talk about are legislative. Are you looking at any
regulatory proposals?
Mr. Mazur. We are always looking at regulatory----
Senator Levin. Any specific regulatory proposals to address
the problems I have just described?
Mr. Mazur. None that are in the very immediate pipeline to
be popped out in the very short term.
Senator Levin. Okay.
Mr. Mazur. Some longer-term projects are underway, though.
Senator Levin. Well, we want to thank our witnesses here.
The hearing that we have had today was aimed at shining a light
on how the U.S. Tax Code functions in the real world and real
companies. We focused on one, but the problem exists obviously
in much more than one company. We have had previous hearings
which looked at two additional companies and saw how they
shifted--either shifted revenue overseas and profits overseas
or how they took funding and profits from overseas and brought
them home without paying a tax on them when they effectively
repatriated them. So we have looked at a number of ways in
which taxes are avoided by some of our wealthiest companies.
The facts are mighty clear to me that loopholes in our tax
laws and regulations allow many companies, including Apple, to
shift enormous amounts of income from this country to other
countries where they pay little or no tax. I would disagree
with the Apple witness on a number of important points. I think
it is clear that Apple engages in tax gimmicks. Apple tries to
act as though it does not engage in tax gimmicks. Other
companies engage in tax gimmicks as well, and I will insert for
the record here examples of the tax gimmicks that were used by
Apple.\1\
---------------------------------------------------------------------------
\1\ See Exhibit No 1a, which appears in the Appendix on page 152.
---------------------------------------------------------------------------
It is also clear that Apple used cost-sharing arrangements
that it has with offshore subsidiaries to shift income from the
United States to Ireland, an effective tax haven, where it pays
effectively no taxes at all. And so the real question for us is
not whether these actions comply with the letter of the law.
Others will make that decision. The question is whether we
should continue to tolerate this state of affairs, which is
doing tremendous harm to our Nation's fiscal health, to our
ability to protect and to serve our people, and to families and
businesses that cannot or will not take advantage of these
loopholes.
We had a situation this morning where three employees of
Apple, a tremendously creative company, sat around a table and
agreed on what share of the world's profits of Apple basically
are going to come back to the United States to be taxed. They
decided that they would shift a certain part of the jewels, the
crown jewels of that company, to a tax haven. And that tax
haven received the profits from the sales of those products in
most of the world.
That decision was just made by three employees of the
company unilaterally, and for our tax laws to tolerate that---
it was supposed to be an arm's-length agreement to something
which is just obviously not an arm's-length agreement but which
has a huge effect on the revenues of this country, is
unacceptable and intolerable, and we should not continue to
accept it. It is unfair, needs to change, and it needs to
change regardless of the broader debate about tax reform. We
should close these unacceptable, these unfair corporate
offshore tax loopholes, not just to simplify the Tax Code, not
just as part of tax reform and, heaven knows, not just in order
to keep it revenue neutral when corporations' percentage of the
revenues coming into our Treasury is now down to 9 percent.
Revenue neutrality, which is something that we heard from Mr.
Cook today, cannot be the litmus test when we need additional
revenues as part of a comprehensive deficit reduction program.
But, in any event, one way or another, whether it is
closing these tax loopholes because they are so totally
unjustified and because they are unfair to others who do not
use them or cannot use them, or whether it is part of a larger
comprehensive tax reform, one way or another these tax-shifting
capabilities that these major corporations have cannot
continue.
So I hope and believe that the facts that the Subcommittee
has discovered will provide a catalyst for that change. We
thank all of our witnesses today, and we will stand adjourned.
[Whereupon, at 2:24 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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