European Court Decision Re-Opens Pandora’s “Patent Box”
Apple, Inc. (“Apple”) has a history of working within Irish law to minimize the taxes it pays, a relationship which spans back decades[1] and evolved through many phases from the “double Irish”[2] to “leprechaun economics”[3] to “patent boxes.”[4] Ireland has a relatively favorable environment for such corporate tax planning; it has a 12.5% corporate tax rate,[5] much lower than the U.S.’s 21%, a rate set in 2017.[6] Before that, the difference was even greater, as the highest margin of the U.S.’s corporate tax rate was 35%.[7] Ireland’s tax laws also allow for more flexibility in tax planning than do those of the US,[8] which Apple has long used to its advantage,[9] shifting strategies as laws changed and legal decisions were handed down.
One such strategy used by Apple and other companies, especially tech companies, is called “patent boxing,” “IP boxing,” or “IP offshoring.”[10] Broadly speaking, patent boxing is a tax planning strategy in which corporations transfer ownership of lucrative intellectual property from a high-tax country (like the US) to a lower-tax country (like Ireland).[11] The corporation then pays less tax on royalties, licensing fees, interest, and other revenue generated by the intellectual property.[12]
One of the most effective iterations on a patent box was the so-called “Double Irish” strategy.[13] Apple “was among the pioneers” of using the Double Irish in the 1980s,[14] but it was far from the only user—companies like Google,[15] Facebook,[16] Adobe,[17] Airbnb,[18] IBM,[19] Microsoft,[20] LinkedIn,[21] and others have used a Double Irish or variation thereupon at some point.
The overall goal of the Double Irish was to implement a patent box which earns “stateless income,”[22] subject to no nation’s taxes. To achieve this, a parent company creates two subsidiaries—it fully owns the first subsidiary, and the first subsidiary in turn wholly owns the second.[23] Both subsidiaries register in Ireland but claim that they are “controlled and managed” in a low- or zero-tax state like Bermuda.[24] This means that revenue they earn is not taxed by the US federal government (which considers the companies located in Ireland based on registration) or by Ireland (which considers the companies located in Bermuda based on control and management).[25]
Now that the subsidiaries can earn almost completely untaxed income, the parent company concentrates its overseas revenues into the subsidiaries. It does this first by having a subsidiary be a kind of internal middleman—the subsidiary buys finished goods for a very low price and then sells them for a higher price to another entity (which can be another subsidiary of the parent company).[26] Because of a so-called “check-the-box” regulation, the parent company can fill out a short form to make the IRS essentially treat some subsidiaries as if they were all one entity, so transfers between subsidiaries “disappear for tax purposes, because U.S. tax regulations do not recognize payments made within the confines of a single entity.”[27] In some cases, these transfers between subsidiaries can even be used as tax deductions, reducing the amount of taxable income in future years.[28] The parent company also treats the subsidiaries as a patent box by transferring some right to use its “intangible assets” (usually, but not always, intellectual property) to the holding companies, which allows the holding companies to capture “passive foreign income such as dividends, royalties, fees, and interest.”[29]
Apple used all of these strategies and more to minimize the tax it paid both in the US and overseas. It avoided a potential 20% Irish tax[30] by routing dividends through the Netherlands.[31] It didn’t pay U.S. taxes on dividends, because it “indefinitely reinvested” the earnings outside of the US.[32]
Combining all of these strategies proved wildly profitable for Apple. A 2013 US Senate report found that from 2009 to 2012, one of Apple’s subsidiaries, Apple Operations International, “reported net income of $30 billion, but declined to declare any tax residence, filed no corporate income tax return, and paid no corporate income taxes to any national government for five years.”[33] Apple reported that “[s]ince the early 1990’s, the Government of Ireland has calculated Apple’s taxable income in such a way as to produce an effective rate in the low single digits . . . . since 2003 [it] has been 2% or less.”[34] Figures Apple supplied to the Senate Permanent Subcommittee on Investigations indicate that another of Apple’s subsidiaries paid an average of 0.06% global tax on the $38 billion it earned from 2009 to 2011.[35]
Apple is not the only beneficiary in this relationship. Following a change in Irish tax law that allowed Apple’s subsidiary to move “$300 billion of intellectual property from Jersey [to Ireland] in Q1 2015,”[36] Ireland’s GDP increased 26.3%.[37] Nobel Prize-winning economist and columnist Paul Krugman called this increase “leprechaun economics” and explained that the increase came not from changes in practice, but in “the surge in the value of production they [Apple] reported doing in Ireland, a surge that didn’t correspond to anything real.”[38] What is real, though, is Apple’s campus in Cork, Ireland—it currently employs 6000 people (and enjoys the title of “the largest private employer in Cork”),[39] and future expansions could increase that number by 1300.[40] Indeed, in 2016 when the European Commission declared that Ireland’s tax practices gave Apple “selective treatment,”[41] Ireland chose to appeal the decision rather than accept the €13 billion Apple was ordered to pay in back taxes.[42]
The European Commission decision concluded that Ireland “substantially and artificially lowered the tax paid by Apple in Ireland since 1991”[43] by issuing the rulings that Apple could allocate most of its profits to its subsidiaries’ “head offices” and thereby avoid Irish taxes.[44] It ruled that Ireland treated Apple differently than other companies in a similar position and that the different treatment so sharply reduced Apple’s tax liability that it had a selective advantage.[45]
It concluded that the profits that Apple made, including revenue from their intellectual property licenses (that were sealed away in a patent box), should have come to Ireland and been taxed there.[46] After this ruling came down, some speculated that this would be the end of the Double Irish tax structure,[47] but the decision was not without detractors—some opposed the decision ideologically, while others recognized that companies who were savvy enough to use a Double Irish in the first place probably had backup plans.[48] Generally speaking, while the Court agreed with some of the Commission’s reasoning, it ruled that the Commission had neither the power to pick and choose the standard by which it evaluated the tax practices, nor the authority to require Ireland to apply that standard and change its behavior.[49] It also ruled that the Commission did not sufficiently prove that Apple’s intellectual property licensing profits should have gone to Ireland.[50]
It’s debatable what effect, if any, these decisions had on real-world use of the Double Irish. Indeed, according to its tax filings, Apple’s effective income tax rate has decreased every year since 2015 to its current level of 13.3%, regardless of either decision.[51] Nonetheless, the Court’s decision defanged whatever power the Commission’s decision might have had. So where does that leave Apple? Or other big tech companies in Ireland? Even before the General Court decision was handed down, some companies moved on to other tax structures,[52] ranging from the creatively-named “Single Malt”[52] to the less exciting “Capital Allowances for Intangible Assets.”[53] It seems that even before governments close old loopholes, corporations (and sometimes other governments)[54] find new ones.
At this point, it might be prudent to update Ben Franklin’s old aphorism to include three things of which we can be sure: death, taxes, and trying as hard as we can to avoid both.
Footnotes
