The Transatlantic Squabble Over Apple's Taxes

A home in Ireland.

Photographer: Aidan Crawley/Bloomberg

The U.S. Treasury thinks it's bad enough that companies such as Apple park piles of cash overseas to avoid paying tax. What's worse is when foreign authorities change the rules that attracted the money in the first place, and tax those holdings for themselves.

In effect, the European Commission is threatening to do just that. Apple and other U.S. companies could soon be hit with retrospective demands for tax running into the billions of dollars. This week the Barack Obama administration objected, accusing the commission of, among other things, exceeding its authority and violating the norms of international tax policy.

Neither side is entirely in the wrong. Mainly, though, the squabble underlines a larger point that should have been obvious already. Taxing multinationals fairly and efficiently requires both an entirely new approach in the U.S. and much closer cooperation among governments.

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The Apple case began as an internal European Union dispute. The commission is investigating whether Ireland's tax treatment of the company's earnings amounts to illegal state aid. It suspects Apple of using so-called transfer pricing to shift profits to Ireland, and Ireland of helping the company do this by means of tendentious tax opinions.

Ireland's main corporate tax rate is already low, at 12.5 percent -- the U.S.'s is 35 percent, give or take -- and these maneuvers are said to have cut the rate paid by Apple to almost nothing. If the commission rules that this amounts to an illegal subsidy, Apple may have to pay billions in back taxes.

The commission is right to make sure member states' tax policies conform to Europe's single-market rules. Far more debatable is the remedy the commission proposes when it finds the rules have been broken. In a case of illegal state aid, the principal offender is the government, not the company that benefited. If Apple and the other companies followed the EU's national tax rules in good faith, a hefty retroactive tax bill would be unjust. It would also defeat the purposes of certainty and clarity in tax administration.

The U.S. Treasury objects to the retrospective remedy on those very grounds -- but its real grievance is that the profits at risk of incurring back taxes would in due course probably have been repatriated to the U.S., allowing the U.S. to tax them excessively.

With the U.S. tax code in its current state, the administration is hardly in a position to lecture other governments on the subject of clarity and certainty in tax policy. The charge that the commission is violating international tax norms is especially rich, considering that the U.S. is almost unique in taxing its companies on their worldwide income and its citizens regardless of where in the world they live and work.

By far the best remedy for the U.S. complaint would be to fix the U.S. tax system. For corporate taxes, that means two things: Apply a lower, internationally competitive rate to a simpler and broader base. And switch to a so-called territorial system -- as is used almost everywhere else -- which taxes profits according to where they're earned, not where the company resides. These reforms wouldn't eliminate international tax avoidance, but they would reduce it, both directly and by making it easier for governments to cooperate effectively to that end.

The alternative is to feud and strike postures -- a lot easier than comprehensive tax reform, admittedly, but much less productive.

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