Tuesday, May 21, 2013

Apple in Congress Today

I've never been a true Apple "Fanboy", but the leadership there is excellent, I was never a fan of the products in the 1990's but since the switch to Unix/BSD - they've made good looking and performing products - my favorite, the iPhone - which I've owned since it's inception.

Apple is in congress today defending it's tax strategies.  My favorite line is from Rand Paul (a republican in Kentucky) - he is 100% right on.  He says...."Instead of Apple executives, we should have brought in a giant mirror. This problem is solely and completely caused by our tax code. This committee should look in the mirror. I find it abominable."

He is 100% right - the US Tax code is a joke!  It needs to be fixed - everybody and everything needs to be taxed at the same rate.  Period.  A flat tax is what we need to level the playing field.  Of course, that and some MAJOR spending reductions in Washington - government makes nothing - they just take from everybody and spend it on crap most people don't want.

Anyway, here's some snippets of the discussion.....

Apple yesterday released a statement laying out some of its international operations and financial strategies, noting that it paid $6 billion in federal income tax in 2012 and that it has created hundreds of thousands of jobs in the United States.

A bipartisan group of Senators responded with a statement of its own, accusing Apple of using several offshore subsidiaries to avoid paying income taxes. Said Senator Carl Levin (D-MI), "Apple sought the Holy Grail of tax avoidance. It has created offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere."

Earlier today, the Irish government -- where a number of Apple's subsidiaries are headquartered -- said that it was not responsible for the tax rates Apple pays in other countries and that its system was transparent.


- Senator Carl Levin (D-MI), chairman of the U.S. Senate Permanent Subcommittee on Investigation, is reading a prepared statement accusing Apple of evading billions of dollars in taxes through subsidiaries in Ireland and elsewhere. Senator Levin noted that he is an iPhone owner.

- Levin says domestic companies that are not in a position to offshore their tax burden are at a competitive disadvantage. He accuses Apple of being partially responsible for the sequester and other budget cuts because of its tax avoidance strategies.

- He says Congress should close the tax loopholes that companies like Apple use, even if they don't pass a rework of the overall corporate tax system.

- Senator John McCain (R-AZ) is now giving an opening statement. "It's important all of us make it very clear the admiration we hold for Apple." However, the company is taking advantage of a system that allows profits to be shifted and allows the company to avoid paying taxes on $44 billion in income over the past 6 years. "It's completely outrageous that Apple has avoided paying US taxes and indeed avoided paying taxes around the world with its convoluted and pernicious strategies."

- McCain: American companies cannot continue avoiding paying taxes. "Our military can not afford it, our economy can not endure it, and the American people will not tolerate it." Our tax system is broken but that is not an excuse.

- Rand Paul (R-KY) is up and saying he is "offended" by the hearing. "Tell me a politician who is up here and doesn't try to minimize his taxes… Tell me what Apple has done is illegal. I am offended by a government… that convenes a hearing to bully one of America's greatest success stories… If anyone should be on trial here, it should be Congress. I frankly think the committee should apologize to Apple."

- Instead of Apple executives, we should have brought in a giant mirror. This problem is solely and completely caused by our tax code. This committee should look in the mirror. "I find it abominable."

- Paul: I have a bill that would tax repatriated money at 5% and target that money to infrastructure. We need to apologize to Apple, compliment them for the job creation they're doing, and get on with our job and redo the tax code.

- Senator Levin is angry and fired up: Senator Paul, you can apologize if you wish but that isn't what this hearing is about. No company should be able to determine how much tax to pay and use gimmicks to pay lower taxes in this country. This subcommittee is not going to apologize to Apple. We did not drag them, they have come here willingly. We intend to hear from them and some experts.

- Tax experts from Harvard and Villanova are the first two witnesses in the hearing. Apple's executives will be the next group of witnesses.

- Professor Richard Harvey - Villanova: After reviewing their structure, I suspect… that what Apple has done is within the bounds of what is acceptable under International tax law. … However, the statement that Apple made "Apple does not use tax gimmicks…", I nearly fell off my chair when I read that. The bottom line is that Apple had a substantial amount of income recorded in Ireland and they paid essentially no tax.

- Senator Ron Johnson (R-WI) - "Who benefits from Apple's tax strategy?" Professor Harvey: The shareholders. Johnson goes on to say that corporate tax rates should be eliminated entirely and corporate income should be taxed at the shareholder level.

- Senator Paul - "Neither this panel nor anyone on the committee has said Apple has broken any laws… it would probably be malpractice for them not to do so… I don't know of anybody on this panel who tries to maximize their tax burden. Mr. Harvey, do you take any deductions on your taxes?" "No." "Do you think you're a bad person for doing that?" "Absolutely not."

- Paul - "Money goes where it's welcome… we have a 35% corporate income tax, we're chasing people away from us… we should be giving them an award today." They are obeying the law. They are doing what their shareholders have asked, which is to maximize profit. Let's not vilify American companies.

- Levin - We are trying to shine a spotlight on big companies, we are not trying to vilify them. To call this vilification misses the function of the subcommittee and misses the function of Congress. We are here to look at the functions of Government and see how they work and don't.

- Senator Claire McCaskill (D-MO) - I'm very proud of Apple as an American company. I use Apple products and I harangued my husband until he switched. I think Apple is utilizing the tax code we have given them.

CEO Tim Cook, CFO Peter Oppenheimer and Apple's head of tax operations Phillip A. Bullock are now appearing in front of the Senate panel.

- Cook: "I am proud to represent Apple today… I am often asked if Apple still is an American company… My answer is an emphatic yes… Much of our innovation takes place in one zip code… Cupertino, California…"

- "We estimate 300,000 jobs have been created in the U.S. because of the App Store." We've chosen to keep the design and development of our revolutionary products right here. Over the last decade, our workforce grew by fivefold. We have employees in all fifty states. Apple has created hundreds of thousands of jobs at small and large businesses that support us.

- iPhone components are made in Texas and Kentucky. Apple is responsible for creating or supporting 600,000 new jobs. We've invested billions in the U.S. to create even more American jobs. We're investing $100 million jobs to create a line of Macs in the U.S. later this year. This will be assembled in Texas, and rely on equipment and supplies from other states.

- We've invested a huge new data center in North Carolina, building more in Oregon and Nevada, a new campus in Texas and a brand new headquarters in Cupertino.

- Apple has 'real' operations, in 'real' places, with Apple employees selling real products to real customers. We not only comply with the laws but we comply with the spirit of the laws. We don't move intellectual property offshore and use it to sell products back on the U.S. Our foreign subsidiaries pull 70% of our cash because of the rapid growth of our international business. We use this money to finance construction of Apple retail stores around the world and fund production of products. 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. We are handicapped in relation to our foreign competitors who do not have such constraints on the free movement of capital.

- We are a company of strong values. We believe our extraordinary success brings increased responsibilities to the communities where we live, build and sell our products. We believe in President Kennedy's phrase 'to whom much is given, much is required.' 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 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. 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. We strongly believe that such reform would be fair to all taxpayers and would keep the U.S. competitive.

- Peter Oppenheimer: In the U.S., our operational structure is quite simple. We sell and support products through our retail stores and partners. Outside the U.S., we strive to provide the same sales in support as our customer expect in the U.S. Apple's presence in outside countries often takes the form of Apple-owned subsidiaries. These acquire products from other Apple subsidiaries which in turn buy product from Apple contract manufacturers.

- We are in full compliance with all laws and regulations. Virtually all of our R&D and the jobs that go with it, take place in the U.S. Apple and Apple Ireland use a cost-sharing R&D agreement to fund research. In return, Apple Ireland receives rights to sell products in Europe and Asia.

- For many years, our Irish subsidies have had thousands of employees in Ireland. The fact that our subsidiary does not pay taxes in Ireland does not affect our U.S. tax payments.

Cook/Oppenheimer/Bullock Q&A Beginning

- Subcommittee Chairman Levin quotes President Kennedy. Cook: President Kennedy and his brother are longtime heroes of mine. I don't believe deferral of tax payments is a sham in any way.

- Bullock in response to a question: Apple legally owns a number of subsidiaries in Ireland and overseas. It is "functionally managed and controlled" (an Irish legal term) in the United States. Our conclusions of Irish law addresses tax management and control if it takes place somewhere else. If it is managed and controlled in the U.S., we are not responsible for Irish taxes. Applying the Irish legal standard of central management and control, our Irish subsidiaries are managed in the U.S. 'Central management and control' is not a term under U.S. tax law.

- Cook: We have a significant number of employees in Ireland, but some of our most strategic decisions are made in the United States. They are functionally and practically managed in the United States.

- Bullock: U.S. taxes are paid by Apple, Inc. Cash that is distributed from our operating subsidiaries that come to the U.S., largely in terms of interest, is paid by Apple. The income of Apple subsidiaries is subject to tax in the local countries in which they operate. There is no U.S. tax on the transfer of balances from subsidiaries to other subsidiaries. Our companies pay the appropriate taxes in Ireland as per our agreement with the Irish government.

- Bullock: AOI has not filed an corporate income tax return on revenue earned overseas. Apple Inc. pays U.S. income tax on revenue it receives as a passthrough. AOI and AOE (Apple subsidiaries) own intellectual property rights to Apple IP overseas.

- John McCain questioning now. Calls Tim Cook a "tough guy". "Do you feel that you've been bullied or harassed by this committee or its members?" Cook: "I feel very good to be participating in the process. I would like for comprehensive tax reform to be passed this year. Any way that Apple can help, we're here to help." I feel that it's important for us to tell our story. I want people to hear that from me. I didn't get dragged here, sir.

- McCain: You have obviously, legally, taken advantage of the tax code both foreign and domestic. I think we agree that you are not paying the 35% tax rate that domestic companies are paying. Are you and Apple receiving an unfair advantage compared to domestic companies?

Cook: No, that's not the way I see it. Apple pays 30.5% of its profits in taxes in the United States. I don't know exactly where this stacks up relative to other companies. I think it stacks high on the list. I believe we are the top taxpayer in the United States. We do have a low tax rate outside the United States. This tax rate is for products we sell outside the United States. There's no shifting going on that I see at all.

McCain: Why does AOI exist? Why does AOI exist in Ireland?

Cook: AOI was created in 1980. The relationship between Apple and the Irish government still exists today. We've built up a significant skill base there of people who have a significant understanding of the European market. AOI is nothing more than a holding company. A holding company is a concept that many companies use. It's not an operating company. The dividends that go into this company have already been taxed appropriately in their local jurisdictions. AOI to me is nothing more than a company that has been set up to provide an efficient way to manage Apple's cash. From income that's already been taxed. The investment income that comes out of AOI is taxed in the United States at the full 35% rate. AOI does not reduce our US taxes at all.

McCain: Where is AOI, ASI and AOE a tax resident?

Cook: It is my understand that there is no tax resident for any of the three subsidiaries.

McCain: Does that sound logical?

Cook: ASI and AOE are paying Irish taxes. I personally don't understand the difference between a tax presence and a tax residence but I know they fill out and pay Irish taxes. AOI, because it's a holding company, it only makes investment income. All of that investment income is taxed in the US at the full 35% level.

McCain: If you look at the 35% tax burden, that I'm sure we're in agreement is way too high, you said the purpose of AOI is to ease administrative burdens. Isn't it obvious that you are not bearing the same tax burden as if you were bearing in the United States? This gives you some advantage over smaller companies located strictly in the US?

Cook: Sir, I have tremendous respect for you. I see this differently from you. Apple is earning these profits outside the US. By law and regulation, these are not taxable in the US. AOI invests that money overseas and then the interest from those investments is taxed in the US. I see this as a very complex topic and I'm glad we're having the discussion. Honestly, I don't see it as being unfair. I am not an unfair person. That's now who we are as a company and who I am as an individual. I do not see it that way.

McCain: I'm out of time, but why the hell do I have to keep updating the apps on my iPhone? Why can't you fix that?

Cook: We're looking to do better all the time.

- The panel is breaking for a short recess.

Senator McCaskill: If you don't tax plan, then you're incompetent as an American business. I hope I can understand better why the structure you've used has been embraced. You borrowed $17 billion, issued bonds to pay dividends to your shareholders. It was in the economic news because of your large cash reserves. You made a decision that it would be cheaper for you to service that debt and use the cash to pay dividends than to bring this cash back. Do you have the analysis that would show how much cheaper it would be than bringing the cash back?

Cook: The cost of capital is at an all-time low. Our weighted average cost of the borrowing was less than 2%. We were faced with a decision to go that route or pay 35% to repatriate. As we looked at that analysis, we felt strongly that in the best interests of our shareholders to secure the debt.

McCaskill: You negotiated a 2% interest rate with Ireland.

Cook: In part of recruiting Apple in 1980, we made an agreement with the country. They were trying to attract new tech companies. The skills of our 4,000 employees there are essential to servicing the European market. We have quite a strong presence there.

McCaskill: If Ireland recruited you and gave you a very good deal, how do we set tax policy? 3/4ths of net tech mobile growth will be in emerging markets? Do you agree with that?

Cook: A significant amount of growth will be in emerging markets.

McCaskill: If we simplify our tax code and get it down and clear out the underbrush, what keeps another country in these emerging markets from undercutting us like Ireland did?

Cook: The US has such enormous advantages and the barrier right now in terms of repatriating cash is that its at the 35% level. Our proposal is that we eliminate all corporate tax expenditures -- get to a very simple system and have a reasonable tax on bringing money back. Not 0%. I think if we did that, many companies would bring back capitol to invest in the US and it would be great in the United States.

McCaskill: What would it cost to move out of California or move entirely to Ireland or China? What keeps you from moving on a cost analysis basis?

Cook: We're an American company. We're proud to be an American company. The vast amount of our R&D is in California. We love it there.

McCaskill: It's an intangible?

Cook: It's who we are as people. We're an American company whether we're selling in China or Egypt. We're an American company. It has never entered my mind that we would move to another country. It's beyond my imagination and I have a wild imagination. It's beyond it.

McCaskill: On the bonds, I understand the business rationale. Do you think you should be able to deduct the interest on those? Would that be one of the corporate expenditures we do away with?

Cook: It could be. The way the tax code is written currently, my understand is that it would be deductible. It would be a very very small percentage of the overall tax rate we pay.

McCaskill: You decide where to allocate sale proceeds. Some of that is being made based on where the product is sold, but not all. How do you determine that? How much goes to the American company and how much goes to the International companies.

Cook: Everything we sell in the US is taxed in the US. For a foreign country, generally speaking, it is taxed in the local market and then if its one of the countries that are being served from Ireland, those units are generally sold by an Irish subsidiary. That income is taxed to the degree it needs to be in the local jurisdiction and then the proceeds go to an Irish subsidiary in many cases called AOI. This acts as a holding company and invests Apple's earnings. Then we pay taxes on those earnings in the United States.

McCaskill: Do any of the proceeds from my purchases actually get parked in Ireland under the aegis of intellectual property?

Bullock: No. 100% of the proceeds on any sale from a customer in the US is fully taxed in the US. There is no outbound payments going offshore.

Senator Johnson: This is complex. It has to do with how do you allocate income? What kind of transfer price is an appropriate price? I did notice that your US sales is 39% and 35% of income and international sales of 61% and 35% of income. Can you explain this?

Cook: Generally, Apple's Macintosh business is a larger percentage of its sales in the US than internationally. As we launch the iPhone, iPhone became a larger percentage of its business internationally than in the US because we had a nice base of Mac sales in the US.

iPhone has larger gross margin than Mac business. International business carries higher margins than US business.

Johnson: More profitable product mix outside the US than in the US?

Cook: Yes.

Johnson: You get a deduction for foreign taxes paid, right?

Bullock: It's a dollar for dollar credit.

Johnson: Now Apple has a lot more money and if you repatriate it, you'll tax it a lot more. The US would be a beneficiary if we can get more money repatriated?

Bullock: Yes, if its taxed and repatriated.

Johnson: Do you have IRS employees at your company full time basically? Being audited constantly?

Bullock: We are constantly under audit in many jurisdictions around the world and they are constantly looking at our numbers.

Johnson: Can you describe your shareholders in general?

Cook: Generally, Apple is widely owned because it is part of the indexes in the stock market. Across mutual funds and pension funds.

Oppenheimer: Our top 50 shareholders own half the company. Public employee retirement systems, mutual funds like Fidelity or Black Rock, and individual retail shareholders as well.

Johnson: Even the top 50 have wide fund shareholder bases. So those folks benefit that Apple can retain more of its profits by not paying taxes to foreign governments. What other taxes does Apple generate? What can you take credit for?

Oppenheimer: We paid $325m in federal employment taxes, in addition to our employees. We've paid $100 million to state and local governments in property taxes and other fees. Last year, we collected and remitted $1.3 billion in sales tax.

Johnson: $2 billion in total. When we talk about transfer pricing, we face the same dilemma between states, don't you? Between which state claiming what income?

Bullock: The income that the company generates in the US, the company generates 40% more or less, that income does get apportioned between the states amongst a slightly different system.

Johnson: What is the difference between that and allocating between different countries?

Bullock: Some states apportion based on relative sales. Some states use a multi factor test, may look to sales, property and payroll.

Johnson: Do you negotiate between the states? Do you have more of your income allocated to pay state income tax?

Bullock: It is approximately 100%. It is not double taxed.

Johnson: But that's a similar type of problem to allocating income across multiple countries, right?

Bullock: Similar, yes.

Johnson: Talk about how you pay taxes in other countries.

Bullock: In Fiscal 2012, the company paid a little over $900 million in international income taxes. We're projecting that number to be larger this year. That number is significantly larger than a few years ago. I don't have the statistics available but similar to the US there are employer contributions to payroll tax, and considerable amount of VAT and GST that is connected and remitted to various countries.

Johnson: What of your employment is based in the US and overseas?

Oppenheimer: 2/3rds of employment is in the US. Partially because of our retail stores.

Senator Kelly Ayotte (R-NH): The issue of the $102 billion that is present overseas, regarding repatriation. You'd be willing to pay some rate on repatriation. As we look on tax reform, what do you think is the rate, not just for Apple but for multinational corporations around the world, if we simplify the code, what rate should we be at to be competitive?

Cook: The rate on the US sales in my judgement from most of the studies would indicate it would need to be in the mid 20's. To incentivize a huge number of companies to repatriate, it would need to be in the single digits. Some companies would need to pay a bit more, other companies would pay less. More important than all of that, it would be great for growth in this country. That's why I am so adamant about doing this.

Ayotte: You're building a new data center here, you can't use overseas cash for that, right?

Cook: Yes, we can't use our overseas cash to make any investments in the U.S.

Ayotte: If you were in our position, how important is it that we change the tax code to make this a good place for investment? What would you do? You're not the only corporation that has significant monies overseas right now.

Cook: It's vital to do, it's great for America to do. We would have a much stronger economy if we did that. It would create jobs and investment.

Ayotte: If we create more jobs and investment, that means more taxes too, right?

Cook: That's a very excellent point. All ships rise with the tide.

Ayotte: What about an issue of a territorial rate? Hopefully we will reform the code to create a better dynamic for investment, but what about a territorial rate?

Cook: The US is advantaged if more capital moves into the country. It would strengthen our economy. I don't propose zero, but a reasonable tax on doing so. Some people refer to that as territorial and hybrid. That's how I believe it should work. We don't support a temporary tax holiday. We want comprehensive reform for a long time.

Ayotte: If we create a temporary tax holiday, does that encourage long term investment?

Cook: A permanent change is better because its predictable.

Ayotte: You talked about the advantages of being in this country. One is the IP protections in the US. You have faced significant challenges in China. What would be those challenges and thinking about IP protections in the US, how would we address this with our international partners?

Cook: We've faced more significant areas in other countries than China.

Ayotte: I've heard stories about knock off Apple Stores in China.

Cook: That has clearly been an issue. I think that the US court system is currently structured in such a way that its very difficult to get the protection a tech company needs because our cycles are very fast. The court system is very long, and the foreign competitors in the US can quickly take IP and use it and ship products with it and they're on to the next product as well. I would love to see conversations between countries and see protections between IP globally. For us, our intellectual property is so important, I would love the system to be strengthened in order to protect it.

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