Apple Executives Questioned by Senate Subcommittee on Cost-Sharing, Subpart F, and Check-the-Box Regulations

June 4, 2013 01:24 PM
In a lively hearing  punctuated by protests and political posturing, Subcommittee Chairman Carl Levin, Ranking Member Senator John McCain, and other members of the Subcommittee confronted Apple’s Tim Cook, Peter Oppenheimer, and Phillip Bullock about the company’s use of allegedly objectionable tax benefits available under U.S. law.  Noting a perceived mismatch between the location of Apple’s core economic activities (i.e., the United States) and the amount of taxable income allocated to other, lower-tax, jurisdictions (Ireland in particular), Subcommittee members called upon Apple to explain and justify transactions undertaken with two of its Irish affiliates over the 2009-2012 period.  The Subcommittee’s criticisms primarily concerned Apple’s use of cost-sharing arrangements with one of its Irish subsidiaries, its “negotiated” tax rate of less than 2 percent in Ireland, and the fact that certain Apple subsidiaries were not considered “tax residents” in any country.  The result of these arrangements, Senator Levin noted, was that Apple’s Irish holding company, Apple Operations International (“AOI”), paid no corporate taxes on the $30 billion it earned between 2009 and 2012, and that its Irish cost-sharing participant, Apple Sales International (“ASI”), paid a special negotiated tax rate of less than 2 percent of its 2009-2012 earnings of $74 billion to the Irish tax authorities.  Despite these substantial allocations of income to Ireland, the Subcommittee noted, AOI and ASI performed minimal functions and had few, if any, employees from 2009 to 2012. 
The Subcommittee’s two academic experts, J. Richard Harvey Jr. and Stephen E. Shay, appeared broadly sympathetic with the Subcommittee’s concerns about current law, though they were careful not to comment on the propriety of Apple’s particular arrangements.  In addition to the income-shifting potential of cost-sharing arrangements, Harvey and Shay both criticized the CFC “check-the-box”/“look-through rules” concerning disregarded entities; the limitations of Subpart F of the Internal Revenue Code; and the potential for “deduction dumping” of SG&A expenses in the United States.  Harvey expressed support for a combination of measures, including greater coordination with the OECD, restriction of the CFC check-the-box and look-through rules, and reduction of the statutory corporate tax rate from 35 percent to 15 percent.  Shay echoed many of Harvey’s sentiments, and proposed a “minimum tax” of 15 percent on the U.S. shareholder(s) of CFCs operating in low-tax jurisdictions.
In response, Apple’s CEO, CFO, and Head of Tax Operations offered a spirited defense of the company.  After providing an account of the company’s history of innovation and U.S. job creation, Apple CEO Tim Cook emphasized that the company paid $6 billion in U.S. corporate taxes in FY 2012, and that it was subject to a fairly typical 30.5 percent rate of tax on its U.S. income.  Cook also noted that the cost-sharing arrangement with ASI had been in place since the early 1980s for sound business reasons rather than tax avoidance.  The company received additional support from two Republican Senators: Senator Rand Paul and Senator Rob Johnson.  Senator Paul went so far as to state that Congress should apologize to Apple for “vilifying” one of “America’s greatest companies.”  Senator Johnson offered more tempered support noting that Apple executives had a responsibility to minimize the company’s tax liability on behalf of its shareholders, which the Senator said represent “everyone.”  Senator Johnson went on to suggest that Congress eliminate the entity-level tax on corporations and switch to the flow-through approach applied to partnerships and LLCs.
After questioning its academic witnesses and Apple executives, the Subcommittee questioned U.S. Treasury economist Mark J. Mazur and the director of the IRS transfer pricing unit, Samuel M. Maruca.  Maruca offered particularly valuable insight into the Internal Revenue Service’s (“Service”) approach to transfer pricing in general and intangible property transfers in particular.  Not surprisingly, Maruca noted that the Service intends to focus its limited resources on what it deems its “most significant international enforcement challenge”:  related-party transfers of “core” intangibles, or of those intangible assets that are central to a company’s operations and critical to its success.  Notably, Maruca suggested that the Service intends to exercise restraint in invoking the periodic adjustment provisions of Treas. Reg. §§ 1.482-4 and  7, which authorize it to retrospectively adjust companies’ intangible asset transfer prices with the benefit of hindsight.  So long as the ex ante valuation is reasonable and transparent, Maruca said, the Service will generally not attempt to adjust taxpayers’ taxable income in light of the subsequent profits earned in connection with the transferred intangibles.  Maruca nevertheless struck an assertive tone.  He stated that, despite the Service’s loss in Veritas, it intends to continue litigating its position that “synergies” and goodwill constitute compensable intangibles for transfer pricing purposes, notwithstanding the exclusion of foreign goodwill for purposes of Section 367(d). 
In his testimony, Maruca stated that the Service is currently considering litigation with roughly 250 multinational taxpayers, with the potential for $68 billion in adjustments.  And the United States is not alone; tax authorities around the world have been aggressively scrutinizing transfers of intangibles, especially transfers made in connection with mergers and acquisitions.   In this environment, it is critical that companies receive expert advice from an independent tax firm who can help structure and advocate the best tax positions and strongest defense for each of its clients.  True Partners Consulting’s transfer pricing and international tax teams have the experience and expertise necessary to advise multinationals before, during, or after their transfers of intangible assets in this challenging environment.  Call one of our transfer pricing experts listed below or a regional managing director to determine whether your company would be a good candidate for a complimentary review of your asset transfer positions and processes.
Daniel Falk


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