Five ways Apple & Microsoft save taxes

30 May, 2013
Source



Some of the largest US multinationals resort to ingenious—though legal—practices to pay virtually no tax on their non-US profits, muchto the growing chagrin of governments and civil society.

One of them has a subsidiary in Ireland that does not pay income tax to any government in the world. Another has negotiated with the government of Puerto Rico to pay tax of just 2% on its profits.

ET outlines the five methods they deploy to avoid taxes:

Use transfer pricing to reduce non-US profits

Companies try to reduce tax rate by using transfer pricing—the rules that govern inter-company transactions within the same ownership.

Take Microsoft, whose operating systems reside in computers across the world. In 2011, according to the US senate investigations subcommittee, the company incurred 85% of its $9.1 bn R&D expenditure in the US. Yet, for tax purposes, Microsoft showed only 35% of this as contributed by Microsoft US.

Microsoft apportioned it to subsidiaries around the world in proportion to the revenues earned by them—termed a 'cost-sharing arrangement'. Thus, if its Irish arm accounted for 30% of its global revenues, 30% of Microsoft's R&D spend was expensed by this entity, enabling it to reduce its net profit further.

Apple has a similar structure, where economic rights of intellectual property for non-US sales are transferred to an Irish subsidiary. This Irish arm earned pre-tax profits of $22 bn in 2011, but Apple paid tax of just $10 mn on that income— an effective tax rate of 0.05%.


Use transfer pricing to reduce US profits too

Companies have also been transferring—and reducing—their US profits and tax liability. For example, Microsoft has a Puerto Rican subsidiary, Microsoft Operations Puerto Rico (MOPR), which holds the rights to sell to US customers.

'The US entities retain 53% of the gross profits and send the remaining 47% to MOPR in Puerto Rico, where it is taxed at a pre-negotiated rate of around 2%', says an earlier US Senate's investigation subcommittee.

By this method, the report adds, Microsoft saved $4.5 billion in taxes during three years.

Form an Irish company, but control it from the US

The tax laws of most countries, including the US, apply to companies on the basis of where they are registered. Thus, if a company is registered in the US, it is taxed in the US.

Ireland is different, in that it uses 'control' as the basis of taxation. Thus, a company that is registered in Ireland but controlled from, say, the US will not be liable to be taxed.

Multinationals exploit this loophole extensively. For example, an Apple subsidiary, Apple Operations International, earned $30 billion in net profit between 2009 and 2012. But the firm never declared tax residence
and paid no tax. Ireland's low corporate income tax rate of 12.5% is its main attraction.




In Pic: Apple Operations International, a subsidiary of Apple Inc, in the south of Ireland.

Even better, form two Irish companies

By setting up more than one subsidiary in Ireland, and structuring transactions between them, companies can lower even the 12.5% rate. The first Irish subsidiary, say A, will buy the intellectual property rights (IPR) from its US parent by participating in a cost-sharing agreement. This company would be controlled and managed outside Ireland, usually in the US, as in the case of Apple, or in a tax haven like Bermuda.

Since, it's controlled outside Ireland, it need not pay tax in Ireland. In the second step, A sub-licences the IPR to B, the second Irish subsidiary. Usually, B would be selling the company's product and services in non-US locations. So, for B, income would be in the form of sales and the expense would be payment of licensing fee to A, enabling it to lower its tax outgo further. This method is referred to as 'double Irish'.

A US senate panel report says Microsoft saved $4.5 bn in taxes between 2009 and 2011 by offshoring profits. Similarly, Apple has three Irish entities.

Go Dutch to save withholding tax

The Dutch tax system does not tax dividends and capital gains received from foreign subsidiaries. At the same time, it has zero withholding taxes on outgoing interest and royalties. So, both the inward and outward flow of money is not taxed.
In addition, the Netherlands has a multitude of tax treaties that reduces withholding taxes. So, effectively, if the payment goes from India to Netherlands, it will be subject to a lower withholding tax. Likewise from all countries with whom the Netherlands has a tax treaty.

The Dutch company will be placed between the two Irish firms, A Ltd and B Ltd. So, if B Ltd was paying royalties to A Ltd, then it would be liable for Irish withholding tax. But now the payment from B Ltd would be routed first to the Dutch entity, which in turn would transfer almost the entire money received to A Ltd.

This is because Irish tax laws exempt withholding taxes on royalties on payments made to companies in other European Union countries. Since the Dutch company is placed in between two Irish firms, this method is called the 'Dutch sandwich'.

In Pic: Apple Operations International, a subsidiary of Apple Inc, in south of Ireland.