May 22 (Bloomberg) -- When Apple Inc.’s chief executive officer, Tim Cook, bragged to a U.S. Senate subcommittee this week about his company’s culture of innovation, he probably hoped people would think of Apple’s gadgets, not its tax strategies.
That seems unlikely, at least for now. Apple has opened a new front in the battle between corporations that aggressively avoid U.S. taxes and lawmakers who want to collect more of them. In so doing, Apple has made the case for why Congress must update the tax code.
The company not only has used loopholes to sidestep U.S. taxes on $44 billion in offshore income from 2009 through 2012, according to the subcommittee, but also has three Irish subsidiaries that claim to have no residence -- anywhere -- for tax purposes. Senator Carl Levin, the Michigan Democrat who is chairman of the Senate Permanent Subcommittee on Investigations, which looked into Apple’s tax-avoidance strategies, calls this alchemy. We’re inclined to agree.
The case of Apple is part of a broader trend in which companies use increasingly complicated tax maneuvers to claim more of their income is derived from overseas, or otherwise reduce their U.S. taxes. Companies can legitimately avoid paying taxes on that income, now an accumulated $1.9 trillion, until they bring it home.
Ideally, revising the treatment of overseas income should be part of a broader tax overhaul. It’s hard to separate the treatment of foreign income from the rest of the corporate tax code, which encourages companies to move their operations overseas.
If an overhaul fails to advance, however, lawmakers should revise foreign-income rules separately. By one estimate, the Treasury is losing $90 billion a year as a result of multinational companies’ shifting income overseas to avoid taxes.
Any deal on foreign-source income should meet two principles. First, if companies are allowed to repatriate foreign earnings at a reduced tax rate, they must be required to follow tighter rules that bar the kinds of strategies Apple and others use to minimize taxes.
The lawmakers leading the reform effort, House Ways and Means Chairman Dave Camp, a Michigan Republican, and Senate Finance Chairman Max Baucus, a Montana Democrat, have said they support such changes. The trick will be making sure any changes are meaningful, in the face of pressure from companies that would face a higher tax burden.
There are a variety of options, including restricting or eliminating the 1996 “check the box” rules, which let a company declare a subsidiary a “disregarded entity,” thus limiting its U.S. tax liability. In the words of one tax expert who testified in this week’s hearing, J. Richard Harvey of Villanova Law School, the effect of those rules could be described as “making things go poof.”
Second, any deal would need to raise significant revenue. The Joint Committee on Taxation estimates that a Levin proposal to revise the check-the-box system and related rules would increase revenue by $78 billion over 10 years.
Another revenue-raising option would impose a minimum tax on foreign income, possibly with a credit for taxes already paid to the host government. In an informal survey by Bloomberg Government in February, many tax experts cited a minimum levy as a way to bridge the divide between defenders of the current system and those who advocate a territorial system, in which income is taxed only where it’s earned. President Barack Obama called for a minimum tax, without specifying a number, in his tax-reform proposal last year.
The question is: At what level should the tax be set? When Congress granted companies a temporary tax holiday for foreign income in 2004 and 2005, the money was subject to a 5.25 percent levy. Clearly, a higher level is appropriate for a permanent change. We’ve called for a minimum of 15 percent, but Congress should be willing to apply a higher number if other revenue-raising measures are blocked.
If a 15 percent rate were applied to foreign earnings now held overseas, it could generate as much as $285 billion in revenue if all the money were repatriated, before accounting for credits for taxes paid to other governments.
Apple’s Cook endorsed this week a corporate tax overhaul that would eliminate all tax breaks, reduce the existing 35 percent rate and impose an unspecified “reasonable” tax on foreign earnings -- somewhere in the single digits to induce companies to bring their money home. We’re skeptical that such a low rate is necessary; it could even backfire by encouraging more businesses to move their operations abroad.
There’s no point castigating Apple for taking maximum advantage of existing tax law. We expect the company to redefine the possible in the devices it makes, so it shouldn’t be a surprise that Apple exerts the same determination when it comes to keeping its money.
The consternation spurred by the subcommittee’s report should be directed toward pushing Congress to adopt a fairer, more reasonable system of taxation for the foreign earnings of U.S. companies.
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