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April 2012, Week 5

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Mon, 30 Apr 2012 00:20:04 -0400
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How Apple Sidesteps Billions in Taxes
By CHARLES DUHIGG and DAVID KOCIENIEWSKI
New York Times
April 28, 2012
http://www.nytimes.com/2012/04/29/business/apples-tax-strategy-aims-at-low-tax-states-and-nations.html

RENO, Nev. - Apple, the world's most profitable
technology company, doesn't design iPhones here. 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
in Reno, Apple has done something central to its
corporate strategy: it has avoided millions of dollars
in taxes in California and 20 other states.

Apple's headquarters are in Cupertino, Calif. By putting
an office in Reno, just 200 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? 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 71 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 70 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
U.S. 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 U.S. 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 8 percent of its
faculty since 2008.

Now, 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 Mr. 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."

Escaping State Taxes

In 2006, as Apple's bank accounts and stock price were
rising, company executives came here to Reno and
established a subsidiary named Braeburn Capital 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 Ms. 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.

A Global Tax Strategy

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 $1 billion, according
to an Apple executive, representing roughly 20 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 to Luxembourg instead, 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.

The Double Irish

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 5
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 70 percent - of its total $34.2 billion in
pretax profits were earned abroad, and 30 percent were
earned in the United States. But Mr. 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 50 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 I.R.S.," Mr.
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' U.S.
taxes," said Mr. Kleinbard, now a professor of tax law
at the University of Southern California. "It's German
tax and French tax and tax in the U.K. 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.

Fallout in California

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," Mr.
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 $8 million in property
taxes assessed by local officials last year.

Ms. Wang dropped her suggestion.

Cupertino, Ms. Wang said in an interview, has real
financial problems. "We're proud to have Apple here,"
said Ms. 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 U.S.," the statement continued, "with more than
47,000 full-time employees in all 50 states."

Moreover, Apple has given nearby Stanford University
more than $50 million in the last two years. The company
has also donated $50 million 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 De Anza College's president, Mr.
Murphy, say the philanthropy and job creation do not
offset Apple's and other companies' decisions to
circumvent taxes. Within 20 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," Mr. 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."

Additional reporting was contributed by Keith Bradsher
in Hong Kong, Siem Eikelenboom in Amsterdam, Dean
Greenaway in the British Virgin Islands, Scott Sayare in
Luxembourg and Jason Woodard in Singapore.

___________________________________________

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