Rude VC: Governments’ bite of the Apple

May 28, 2013
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apple-irsThere has been a lot of gnashing of teeth recently about Apple’s alleged dodging of paying taxes on tens of billions of profits from 2009~2012. Incidentally, that’s merely what the U.S. government deems it forfeited. Apple of course pays a paltry tax bill in France, despite the fact the France remains the world’s third best market in sales of iOS devices.

“Apple, champion du monde de l’évasion fiscale?” questioned Hervé Nathan in Marianne. Indeed, Apple’s complex contortions to reduce its tax bill give grounds for outrage: Apple owns a subsidiary called Apple Operations International, an Ireland-based shell company that is not registered in the U.S., thus avoiding U.S. tax liability. Furthermore, this Irish subsidiary is exempt from Irish taxation, too, on the basis that it’s not managed in Ireland. This setup, combined with an accounting technique called accelerated depreciation, renders profits in Apple Operations International totally tax free (and profits of this shell reached almost $30 billion over the four-year period). Sound complicated ? Here’s a parody video that explains it.

Yes, it’s revolting that corporations like Apple can afford the expertise and geographic flexibility to seemingly dodge a significant chunk of taxes. Even more revolting is the list compiled by Citizens for Tax Justice of 26 major American companies that paid no taxes whatsoever from 2008 to 2011, including firms like Boeing, GE, and Verizon. U.S. Senator Carl Levin notes that the average American public company pays an effective income tax rate of just 15%, well below the statutory rate of 35%.

My relationship with Apple is multi-faceted: I’m a shareholder; I’m a customer of its products; and I’m a citizen of two countries arguably losing out on tax revenues. As a shareholder, Apple’s tax optimization is beneficial to me: lower taxes leads to higher free cash flow, which leads to a higher share price.

As a customer, my benefits are less clear. In theory, an Apple with more cash in its pocket will produce better products that improve my life. However, it’s not evident that Apple passes on its tax savings directly to the consumer. As The Onion quipped in response to the news of Apple’s tax dodge, “That must be how they keep their prices so low.”

Finally, as a citizen and taxpayer, I’m indirectly but undisputedly harmed by these fiscal loopholes that reduce the tax receipts of my indebted governments.

So is this a problem that needs fixing, and if so, how do we do it ?

To the first question, I would argue yes. Apple CEO Tim Cook claims his company did nothing illegal, which is probably true. Similarly, while under criticism in the UK, Eric Schmidt described Google’s approach to tax optimization as ‘just capitalism’.

And these comments point to the core of the challenge of closing these corporate tax loopholes. While these tax schemes are despicable, Apple and Google are merely playing within the rules of the game to optimize shareholder value. Indeed, Schmidt is right that, for better or worse, capitalism requires him, in fact obliges him with a fiduciary duty, to maximize shareholder value.

As Sarah Gordon at the FT points out, companies should be run for the benefit of their shareholders and other stakeholders. They are not tasked with looking after the common good – that is government’s job. So while the corporate tax contortions represent the proximate causes of forfeited tax revenues for deeply-indebted government coffers, the ultimate cause lies with the politicians that set the laws. Apple’s actions demonstrate the unfairness of the tax code.

Unfortunately, resolving the hopeless complexity of the tax code is no simple feat. Suggestions abound, albeit each are complicated. In the meantime, perhaps the most effective techniques are corporate boycotts, such as the recent mass consumer migration from Starbucks to competitor Costa Coffee in the UK.