Expert witness on tax gimmicks: if Apple lives by the sword, it should die by the sword

One of the expert witnesses at the Apple hearings in the U.S. Senate Permanent Subcommittee on Investigations in May 21 was J. Richard Harvey of Villanova University, a former top I.R.S. official, who said "I about fell off my chair" when Apple claimed not to be using tax gimmicks.

Now Harvey has published a short article, via Tax Notes, entitled Apple Hearing: Observations From an Expert Witness, which is free to download. In it, he makes some excellent observations. It opens with two related -- and very good -- questions:

• Should the U.S. and the rest of the world let Apple record two thirds of its global income in Ireland, with few employees and little or no real economic activity there?
• If not, where should the income be recorded?

More generally, should multinationals be allowed to record a disproportionate amount of their global income in tax havens, when that's not where their real economic activity is?

At the hearings, one of Apple's defenders said it was just fine for Apple to record 70 percent of its 2011 global income outside the U.S., given that 60 percent of its sales were there. Apple executives made a similar argument.

On the face of it, that sounds reasonable. But, Harvey notes, Apple allocated more than 90 percent of Apple's non-U.S. income to Ireland. Apple's defenders:

"appear to have argued that Apple allocated the correct amount of income to the United States because the ratio of U.S. to global pretax income is approximately equal to the ration of U.S. sales to global sales. But if that theory is used, Ireland should have been allocated less than 1 percent og global pretax income, as opposed to approximately two-thirds. As a result, foreign countries that were allocated approximately 6 percent of 2011 global pretax income should instead be allocated approximately 70 percent.
. . .
As the Bible says: "Live by the sword, die by the sword." In other words, Apple should not have it both ways."

Excellent point. So where should tax haven income be recorded? Harvey says that global agreement on how to do this 'could take a while' - but in the meantime, unilateral U.S. action is possible. Notably:

• Should the U.S. respect cost-sharing agreements and other transfers of valuable intangible profits to tax havens?
• Should the U.S. strengthen its defences against 'base erosion'? For example, tightening the rules on which foreign income can be taxed, or imposing a minimum tax on income recorded in tax havens, or restricting the deductibility of interest and other expenses attributable to foreign operations?
• Should there be increased transparency regarding the geographical location of income, tax and so on?
• Should formulary apportionment be adopted, either to replace the OECD's "Arm's length" system or as a backstop to it? [TJN: this is on the way to unitary taxation.]

Obviously, we'd argue, all of these are a good idea.

Harvey also notes that Apple's testimony referred to Apple's 2012 U.S. federal cash effective tax rate (ETR) of 30.5 percent. What's the problem here then? Well, ETR is a highly slippery concept, and Harvey provides calculations using various common methods of calculating ETR, and he comes up with a rate of between 7 and 15 percent, less than half of what Apple wants everyone to believe.

A useful contribution to this debate. And for those who argue that Apple, like Google, was merely responding to its responsibilities to its shareholders to cut taxes to the minimum, this and this and this should be sufficient to disabuse them.