Apple, the world’s most profitable technology company, doesn’t design iPhones in
Reno, Nevada. It doesn’t run
AppleCare customer service from this city. And it doesn’t manufacture
MacBooks or
iPads anywhere nearby. Yet, with a handful of employees in a small office here,
Apple has done something central to its corporate strategy: it has avoided millions of dollars in taxes in California and twenty other states.
Apple’s headquarters are in
Cupertino, California. But, by putting an office in
Reno, just two hundred miles away, to collect and invest the company’s profits,
Apple sidesteps state income taxes on some of those gains. California’s corporate tax rate is 8.84 percent. Nevada’s is Zero.
Setting up an office in
Reno is just one of many legal methods
Apple uses to reduce its worldwide tax bill by billions of dollars each year. As it has in Nevada,
Apple has created subsidiaries in low-tax places like Ireland, the Netherlands, Luxembourg, and the British Virgin Islands— some little more than a letterbox or an anonymous office— that help cut the taxes it pays around the world.
Almost every major corporation tries to minimize its taxes, of course. For
Apple, the savings are especially alluring because the company’s profits are so high. Wall Street analysts predict
Apple could earn up to $45.6 billion in its current fiscal year, which would be a record for
any American business.
Apple serves as a window on how technology giants have taken advantage of tax codes written for an industrial age and ill suited to today’s digital economy. Some profits at companies like
Apple,
Google,
Amazon,
Hewlett-Packard, and
Microsoft derive not from physical goods, but from royalties on intellectual property, like the patents on software that makes devices work. Other times, the products themselves are digital, like downloaded songs. It is much easier for businesses with royalties and digital products to move profits to low-tax countries than it is, say, for grocery stores or automakers. A downloaded application, unlike a car, can be sold from anywhere.
The growing digital economy presents a conundrum for lawmakers overseeing corporate taxation: although technology is now one of the nation’s largest and most valued industries, many tech companies are among the least taxed, according to government and corporate data. Over the last two years, the seventy technology companies in the
Standard & Poor’s 500-stock index— including
Apple,
Google,
Yahoo, and
Dell— reported paying worldwide cash taxes at a rate that, on average, was a third less than other S&P companies’. (Cash taxes may include payments for multiple years.)
Even among tech companies,
Apple’s rates are low. And, while the company has remade industries, ignited economic growth, and delighted customers, it has also devised corporate strategies that take advantage of gaps in the tax code, according to former executives who helped create those strategies.
Apple, for instance, was among the first tech companies to designate overseas salespeople in high-tax countries in a manner that allowed them to sell on behalf of low-tax subsidiaries on other continents, sidestepping income taxes, according to former executives.
Apple was a pioneer of an accounting technique known as the
Double Irish With a Dutch Sandwich, which reduces taxes by routing profits through Irish subsidiaries and the Netherlands, and then to the Caribbean. Today, that tactic is used by hundreds of other corporations— some of which directly imitated
Apple’s methods, say accountants at those companies.
Without such tactics,
Apple’s federal tax bill in the United States most likely would have been $2.4 billion higher last year, according to a recent study by a former
Treasury Department economist,
Martin A. Sullivan. As it stands, the company paid cash taxes of $3.3 billion around the world on its reported profits of $34.2 billion last year, a tax rate of 9.8 percent. (
Apple does not disclose what portion of those payments was in the United States, or what portion is assigned to previous or future years.) By comparison,
Wal-Mart last year paid worldwide cash taxes of $5.9 billion on its booked profits of $24.4 billion, a tax rate of 24 percent, which is about average for non-tech companies.
Apple’s domestic tax bill has piqued particular curiosity among corporate tax experts because, although the company is based in the United States, its profits, on paper, at least, are largely foreign. While
Apple contracts out much of the manufacturing and assembly of its products to other companies overseas, the majority of
Apple’s executives, product designers, marketers, employees, research and development, and retail stores are in the United States. Tax experts say it is therefore reasonable to expect that most of
Apple’s profits would be American as well. The nation’s tax code is based on the concept that a company “earns” income where value is created, rather than where products are sold.
However,
Apple’s accountants have found legal ways to allocate about seventy percent of its profits overseas, where tax rates are often much lower, according to corporate filings.
Neither the government nor corporations make tax returns public, and a company’s taxable income often differs from the profits disclosed in annual reports. Companies report their cash outlays for income taxes in their annual
Form 10-K, but it is impossible, from those numbers, to determine precisely how much, in total, corporations pay to governments. In
Apple’s last annual disclosure, the company listed its worldwide taxes— which includes cash taxes paid as well as deferred taxes and other charges— at $8.3 billion, an effective tax rate of almost a quarter of profits.
However, tax analysts and scholars said that figure most likely overstated how much the company would hand to governments because it included sums that might never be paid. “The information on
10-Ks is fiction for most companies,” said
Kimberly Clausing, an economist at
Reed College who specializes in multinational taxation. “But for tech companies it goes from fiction to farcical.”
Apple, in a statement, said it “has conducted all of its business with the highest of ethical standards, complying with applicable laws and accounting rules.” It added: “We are incredibly proud of all of
Apple’s contributions.”
Apple “pays an enormous amount of taxes, which help our local, state and federal governments,” the statement also said. “In the first half of fiscal year 2012, our US operations have generated almost $5 billion in federal and state income taxes, including income taxes withheld on employee stock gains, making us among the top payers of US income tax.” The statement did not specify how it arrived at $5 billion, nor did it address the issue of deferred taxes, which the company may pay in future years or decide to defer indefinitely. The $5 billion figure appears to include taxes ultimately owed by
Apple employees.
The sums paid by
Apple and other tech corporations is a point of contention in the company’s backyard. A mile and a half from
Apple’s
Cupertino headquarters is
De Anza College, a community college that
Steve Wozniak, one of
Apple’s founders, attended from 1969 to 1974. Because of California’s state budget crisis,
De Anza has cut more than a thousand courses and eight percent of its faculty since 2008. Now, however,
De Anza faces a budget gap so large that it is confronting a “death spiral”, the school’s president,
Brian Murphy, wrote to the faculty in January.
Apple, of course, is not responsible for the state’s financial shortfall, which has numerous causes. But the company’s tax policies are seen by officials like
Murphy as symptomatic of why the crisis exists. “I just don’t understand it,” he said in an interview. “I’ll bet every person at
Apple has a connection to
De Anza. Their kids swim in our pool. Their cousins take classes here. They drive past it every day, for Pete’s sake. But then they do everything they can to pay as few taxes as possible.”
In 2006, as
Apple’s bank accounts and stock price were rising, company executives came to
Reno and established a subsidiary named
Braeburn Capital (photo) to manage and invest the company’s cash. (
Braeburn is a variety of apple that is simultaneously sweet and tart.)
Today,
Braeburn’s offices are down a narrow hallway inside a bland building that sits across from an abandoned restaurant. Inside, there are posters of candy-colored
iPods and a large
Apple insignia, as well as a handful of desks and computer terminals.
When someone in the United States buys an
iPhone,
iPad, or other
Apple product, a portion of the profits from that sale is often deposited into accounts controlled by Braeburn, and then invested in stocks, bonds, or other financial instruments, say company executives. Then, when those investments turn a profit, some of it is shielded from tax authorities in California by virtue of
Braeburn’s Nevada address.
Since founding
Braeburn, Apple has earned more than $2.5 billion in interest and dividend income on its cash reserves and investments around the globe. If
Braeburn were located in
Cupertino, where Apple’s top executives work, a portion of the domestic income would be taxed at California’s 8.84 percent corporate income tax rate.
But, in Nevada, there is
no state corporate income tax and
no capital gains tax. What’s more,
Braeburn allows
Apple to lower its taxes in other states— including Florida, New Jersey, and New Mexico— because many of those jurisdictions use formulas that reduce what is owed when a company’s financial management occurs elsewhere.
Apple does not disclose what portion of cash taxes is paid to states, but the company reported that it owed $762 million in state income taxes nationwide last year. That effective state tax rate is higher than the rate of many other tech companies, but, as
Clausing and other tax analysts have noted, such figures are often not reliable guides to what is actually paid.
Dozens of other companies, including
Cisco,
Harley-Davidson, and
Microsoft, have also set up Nevada subsidiaries that bypass taxes in other states. Hundreds of other corporations reap similar savings by locating offices in Delaware.
But some in California are unhappy that
Apple and other California-based companies have moved financial operations to tax-free states— particularly since lawmakers have offered them tax breaks to keep them
in the state.
In 1996, 1999, and 2000, for instance, the California Legislature increased the state’s research and development tax credit, permitting hundreds of companies, including
Apple, to avoid billions in state taxes, according to legislative analysts.
Apple has reported tax savings of $412 million from research and development credits of all sorts since 1996.
Then, in 2009, after an intense lobbying campaign led by
Apple,
Cisco,
Oracle,
Intel, and other companies, the California Legislature reduced taxes for corporations based in California but operating in other states or nations. Legislative analysts say the change will eventually cost the state government about $1.5 billion a year.
Such lost revenue is one reason California now faces a budget crisis, with a shortfall of more than $9.2 billion in the coming fiscal year alone. The state has cut some health care programs, significantly raised tuition at state universities, cut services to the disabled, and proposed a $4.8 billion reduction in spending on kindergarten and other grades.
Apple declined to comment on its Nevada operations. Privately, some executives said it was unfair to criticize the company for reducing its tax bill when thousands of other companies acted similarly. If
Apple volunteered to pay more in taxes, it would put itself at a competitive disadvantage, they argued, and do a disservice to its shareholders.
Indeed,
Apple’s decisions have yielded benefits. After announcing one of the best quarters in its history last week, the company said it had net profits of $24.7 billion on revenues of $85.5 billion in the first half of the fiscal year, and more than $110 billion in the bank, according to company filings.
Every second of every hour, millions of times each day, in living rooms and at cash registers, consumers click the “Buy” button on
iTunes or hand over payment for an
Apple product.
And, with that, an international financial engine kicks into gear, moving money across continents in the blink of an eye. While
Apple’s
Reno office helps the company avoid state taxes, its international subsidiaries— particularly the company’s assignment of sales and patent royalties to other nations— help reduce taxes owed to the American and other governments. For instance, one of
Apple’s subsidiaries in Luxembourg, named
iTunes S.à r.l., has just a few dozen employees, according to corporate documents filed in that nation and a current executive. The only indication of the subsidiary’s presence outside is a letterbox with a lopsided slip of paper reading
ITUNES SARL.
Luxembourg has just half a million residents. But, when customers across Europe, Africa, or the Middle East (and potentially elsewhere) download a song, television show, or app, the sale is recorded in this small country, according to current and former executives. In 2011,
iTunes S.à r.l.’s revenue exceeded a billion dollars, according to an
Apple executive, representing roughly twenty percent of
iTunes’s worldwide sales. The advantages of Luxembourg are simple, say
Apple executives. The country has promised to tax the payments collected by
Apple and numerous other tech corporations at low rates if they route transactions through Luxembourg. Taxes that would have otherwise gone to the governments of Britain, France, the United States, and dozens of other nations, go instead to Luxembourg, at discounted rates. “We set up in Luxembourg because of the favorable taxes,” said
Robert Hatta, who helped oversee
Apple’s
iTunes retail marketing and sales for European markets until 2007. “Downloads are different from tractors or steel because there’s nothing you can touch, so it doesn’t matter if your computer is in France or England. If you’re buying from Luxembourg, it’s a relationship with Luxembourg.” An Apple spokesman declined to comment on the Luxembourg operations.
Downloadable goods illustrate how modern tax systems have become increasingly ill-equipped for an economy dominated by electronic commerce.
Apple, say former executives, has been particularly talented at identifying legal tax loopholes and hiring accountants who, as much as
iPhone designers, are known for their innovation. In the 1980s, for instance,
Apple was among the first major corporations to designate overseas distributors as “commissionaires”, rather than retailers, said
Michael Rashkin,
Apple’s first director of tax policy, who helped set up the system before leaving in 1999.
To customers, the designation was virtually unnoticeable. But, because commissionaires never technically take possession of inventory— which would require them to recognize taxes— the structure allowed a salesman in high-tax Germany, for example, to sell computers on behalf of a subsidiary in low-tax Singapore. Hence, most of those profits would be taxed at Singaporean, rather than German, rates.
In the late 1980s,
Apple was among the pioneers in creating a tax structure— known as the
Double Irish— that allowed the company to move profits into tax havens around the world, said
Tim Jenkins, who helped set up the system as an
Apple European finance manager until 1994.
Apple created two Irish subsidiaries— today named
Apple Operations International and
Apple Sales International— and built a glass-encased factory amid the green fields of
Cork. The Irish government offered
Apple tax breaks in exchange for jobs, according to former executives with knowledge of the relationship.
But the bigger advantage was that the arrangement allowed
Apple to send royalties on patents developed in California to Ireland. The transfer was internal, and simply moved funds from one part of the company to a subsidiary overseas. But as a result, some profits were taxed at the Irish rate of approximately 12.5 percent, rather than at the American statutory rate of 35 percent. In 2004, Ireland, a nation of less than five million, was home to more than one-third of
Apple’s worldwide revenues, according to company filings. (
Apple has not released more recent estimates.)
Moreover, the second Irish subsidiary, the
Double, allowed other profits to flow to tax-free companies in the Caribbean.
Apple has assigned partial ownership of its Irish subsidiaries to
Baldwin Holdings Unlimited in the British Virgin Islands, a tax haven, according to documents filed there and in Ireland.
Baldwin Holdings has no listed offices or telephone number, and its only listed director is
Peter Oppenheimer,
Apple’s chief financial officer, who lives and works in Cupertino. (
Baldwin apples are known for their hardiness while traveling.)
Finally, because of Ireland’s treaties with European nations, some of
Apple’s profits could travel virtually tax-free through the Netherlands— the
Dutch Sandwich— which made them essentially invisible to outside observers and tax authorities.
Robert Promm,
Apple’s controller in the mid-1990s, called the strategy “the worst-kept secret in Europe.”
It is unclear precisely how Apple’s overseas finances now function. In 2006, the company reorganized its Irish divisions as unlimited corporations, which have few requirements to disclose financial information.
However, tax experts say that strategies like the
Double Irish help explain how
Apple has managed to keep its international taxes to 3.2 percent of foreign profits last year, to 2.2 percent in 2010, and in the single digits for the last half-decade, according to the company’s corporate filings.
Apple declined to comment on its operations in Ireland, the Netherlands, and the British Virgin Islands.
Apple reported in its last annual disclosures that $24 billion, or seventy percent, of its total $34.2 billion in pretax profits were earned abroad, and thirty percent were earned in the United States. But
Sullivan, the former
Treasury Department economist who today writes for the trade publication
Tax Analysts, said that “given that all of the marketing and products are designed here, and the patents were created in California, that number should probably be at least fifty percent”.
If profits were evenly divided between the United States and foreign countries,
Apple’s federal tax bill would have increased by about $2.4 billion last year, he said, because a larger amount of its profits would have been subject to the United States’ higher corporate income tax rate. “
Apple, like many other multinationals, is using perfectly legal methods to keep a significant portion of their profits out of the hands of the IRS,”
Sullivan said. “And when America’s most profitable companies pay less, the general public has to pay more.”
Other tax experts, like
Edward D. Kleinbard, former chief of staff of the
Congressional Joint Committee on Taxation, have reached similar conclusions. “This tax avoidance strategy used by
Apple and other multinationals doesn’t just minimize the companies’ US taxes,” said
Kleinbard, now a professor of tax law at the
University of Southern California. “It’s German tax and French tax and tax in the UK and elsewhere.” One downside for companies using such strategies is that when money is sent overseas, it cannot be returned to the United States without incurring a new tax bill. However, that might change.
Apple, which holds $74 billion offshore, last year aligned itself with more than four dozen companies and organizations urging Congress for a “repatriation holiday” that would permit American businesses to bring money home without owing large taxes. The coalition, which includes
Google,
Microsoft, and
Pfizer, has hired dozens of lobbyists to push for the measure, which has not yet come up for vote. The tax break would cost the federal government $79 billion over the next decade, according to a Congressional report.
In one of his last public appearances before his death,
Steven P. Jobs,
Apple’s chief executive, addressed
Cupertino’s City Council last June, seeking approval to build a new headquarters. Most of the Council was effusive in its praise of the proposal. But one councilwoman,
Kris Wang, had questions. How will residents benefit? she asked. Perhaps
Apple could provide free wireless Internet to
Cupertino, she suggested, something
Google had done in neighboring Mountain View.
“See, I’m a simpleton; I’ve always had this view that we pay taxes, and the city should do those things,”
Jobs replied, according to a video of the meeting. “That’s why we pay taxes. Now, if we can get out of paying taxes, I’ll be glad to put up Wi-Fi.” He suggested that, if the City Council were unhappy, perhaps
Apple could move. The company is
Cupertino’s largest taxpayer, with more than eight million dollars in property taxes assessed by local officials last year.
Wang dropped her suggestion.
Cupertino,
Wang said in an interview, has real financial problems. “We’re proud to have
Apple here,” said
Wang, who has since left the Council. “But how do you get them to feel more connected?”
Other residents argue that
Apple does enough as Cupertino’s largest employer, and that tech companies, in general, have buoyed California’s economy.
Apple’s workers eat in local restaurants, serve on local boards, and donate to local causes. Silicon Valley’s many millionaires pay personal state income taxes. In its statement,
Apple said its “international growth is creating jobs domestically, since we oversee most of our operations from California. The vast majority of our global work force remains in the US,” the statement continued, “with more than 47,000 full-time employees in all fifty states.”
Moreover,
Apple has given nearby
Stanford University more than fifty million dollars in the last two years. The company has also donated fifty million dollars to an African aid organization. In its statement,
Apple said: “We have contributed to many charitable causes, but have never sought publicity for doing so. Our focus has been on doing the right thing, not getting credit for it. In 2011, we dramatically expanded the number of deserving organizations we support by initiating a matching gift program for our employees.”
Still, some, including
Murphy, the president of
De Anza College, say the philanthropy and job creation do not offset
Apple’s and other companies’ decisions to circumvent taxes. Within twenty minutes of the financially ailing school are the global headquarters of
Google,
Facebook,
Intel,
Hewlett-Packard, and
Cisco. “When it comes time for all these companies—
Google and
Apple and
Facebook and the rest— to pay their fair share, there’s a knee-jerk resistance,”
Murphy said. “They’re philosophically antitax, and it’s decimating the state. But I’m not complaining,” he added. “We can’t afford to upset these guys. We need every dollar we can get.”
