If you are an Apple shareholder, have you been cheating on your taxes?
Probably not. As an Apple shareholder, you do not pay personal taxes each time Apple makes money. Under current U.S. tax law, you do not have to pay taxes until you receive your share of the profits as a dividend.
The same logic applies to international income taxation. Apple Inc., a U.S. corporation, owns the equity of its Irish subsidiary, just as you own the equity of Apple. When the Irish subsidiary makes money, it pays taxes to the Irish government (more on this below). Its shareholder, Apple Inc., however, does not pay taxes on this income until it is paid to Apple in the form of a dividend. (In an international context, we call the payment of the dividend “repatriating income.”)
To see the logic, take an example where Apple’s Irish subsidiary makes 100 million dollars. The subsidiary would typically pay the standard Irish corporate tax rate of 12.5%, or 12.5 million dollars, to the Irish government. If the Irish subsidiary then paid the remaining cash as a dividend to its shareholder, Apple would owe an additional 22.5 million dollars to the U.S. government (assuming a corporate tax rate of 35% and credit for the 12.5 million that was paid to the Irish government).
Apple pays this additional U.S. tax only when it receives its dividend. Unlike shareholders like you and me, however, Apple gets to choose when to pay a dividend and thus when to pay the taxes—and thanks to the time value of money, the longer it waits, the lower the present value of its taxes. This creates an incentive to postpone repatriation of foreign income from low-tax countries.
Apple apparently structured their Irish subsidiary so the Irish tax rate was only 2%, meaning that in the scenario above, 2 million dollars would go to the Irish government and 33 million to the U.S. (Note that the lower the Irish tax rate, the less Apple actually pays to Ireland and the more they eventually pay to the U.S. In fact, the party you might expect to be most upset by the low Irish tax rate is the Irish tax-payer. They are receiving 2% as opposed to 12.5% of the income that flows through Apple’s Irish subsidiary.) What would happen if the U.S. could pressure Ireland to raise their corporate tax rate to 35%, the U.S.’s rate? Apple would pay 35 million dollars to Ireland, leaving them with absolutely nothing due to the U.S. government when they bring the money back.
The foreign tax rate matters because it affects where firms choose to operate and where they choose to earn their income. Taxes are not the only factor that influences where firms choose to locate, but they are an important consideration (and one that will only become more important in the future). If a firm makes concrete, for instance, it has to make it close to its customers, as concrete is expensive to transport. If, however, a firm makes a virtual good where shipping costs are trivial, it has much greater flexibility on where to produce the product or service.* In fact, when making virtual goods, verifying where exactly value is added in the supply chain, and thus where income is earned and should be taxed, has become increasingly complex. This, I believe, is the source of the problem.
There may be growing interest in corporate tax reform in the U.S. Any discussion should include a consideration of how the U.S. and other countries should tax corporations in an increasingly global landscape. It would be wise to remember that it is difficult to tax mobile resources at high rates. High corporate tax rates don’t just pressure U.S. corporations to earn their income in lower tax jurisdictions—they also encourage ownership of these assets to migrate to non-U.S. corporations. Imagine if Apple was an Irish corporation with a U.S. subsidiary that handled distribution of their products in the U.S. Then the U.S. would never receive any tax revenue from the Irish income. It is not good U.S. economic policy to encourage the migration of assets out of U.S. corporations.
*In 2004, the U.S. temporarily lowered the tax that U.S. firms paid on their repatriated income. Approximately $312 billion dollars was repatriated under the American Jobs Creation Act. A large fraction of the money was repatriated by firms whose value is derived predominantly from intellectual property including drugs, computer equipment, computer programming and data processing. For more about this, see here.