LONDON Apple's ability to shelter billions of dollars of income from tax has hinged on an unusual loophole in the Irish tax code that helps the country compete with other countries for investment and jobs.
A U.S. Senate investigation has revealed that Apple, maker of iPhones, iPads and Mac computers, had channeled profits into Irish-incorporated subsidiaries that had "no declared tax residency anywhere in the world".
Apple revealed on Tuesday that the arrangements dated back over 30 years and had been negotiated with Ireland's government, which has long angered European peers such as France and Germany by helping multinationals to avoid paying tax on sales its makes to their citizens in their domestic markets.
Apple's annual reports show that over the past three years, Apple paid taxes worth 2 percent of its $74 billion in overseas income.
Apple channels most of its overseas sales through three companies which are incorporated in Ireland but tax resident in no jurisdiction. U.S. rules that allow companies incorporated abroad not to pay U.S. taxes complement that arrangement.
Apple tax head Phillip Bullock told the U.S. Senate Permanent Subcommittee on Investigations on Tuesday that one of these three subsidiaries, Apple Operations International (AOI), had not submitted a tax return anywhere for five years.
All three were registered in Ireland in 1980 and reregistered as unlimited companies in 2006, which means under Irish law that they do not have to publish annual accounts, so the subcommittee's report was the first time the current structure had been publicly revealed.
Peter Vale, tax partner at accountants Grant Thornton in Dublin, said it was unusual for companies incorporated in Ireland not to be tax resident there - but it is legal.
Apple relies for its tax benefits on contrasting approaches to determining tax residence in Ireland and the United States.
Vale said that if a group has at least one trading Irish subsidiary - as Apple does, in the form of units that employ 4,000 staff - it can establish a corporation that will not be deemed tax resident in Ireland providing this unit's "central management control" is outside the country.
The subcommittee said AOI and ASI held board meetings in the United States and most board members were based there. That means the units would not be deemed to have Irish management control, accountants said.
Apple told the subcommittee that AOI's assets are managed by employees at an Apple subsidiary, Braeburn Capital, located in Nevada, while its assets are held in bank accounts in New York, and its primary accounting records are maintained at Apple's U.S. shared service centre in Austin, Texas.
Despite this, AOI did not have tax residency in the United States, because, said Lyn Oates, professor of tax and accounting at the University of Exeter Business School, the United States determines tax residence on the place of incorporation only.
Britain also used to allow companies to be incorporated there without being tax resident, but changed its system over 20 years ago, to stop tax avoidance, said Penelope Tuck, Associate Professor of Public Finance and Policy at the University of Warwick.
Ireland did not change its rules, probably because there was not the same concern about the loss of tax revenues, said Professor Eamonn Walsh, Professor of Accounting at University College Dublin's Graduate School of Business.
Ireland's small population of 4.6 million means multinationals generate relatively little by way of sales or profits there.
"From a policy point of view, people are more concerned with the idea that high-paid jobs are being delivered to the local economy," Walsh said.
Apple's Chief Executive Tim Cook told a hearing of the subcommittee on Tuesday in Washington that Apple was attracted to Ireland in 1980 at a time when the country offered incentives to technology companies as it tried to build an industrial base.
Over the years, the structures Apple uses have evolved but it appears the support of the Irish government has continued.
"Since the early 1990s, 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," Apple tax chief Bullock told the subcommittee in earlier testimony.
A Reuters analysis of Apple's annual reports shows that it was in the late 1990s that Apple's overseas tax rate really began to hit rock bottom, after the United States began to let firms avoid U.S. tax on overseas earnings in what became known as the "check-the-box" (CTB) loophole.
From 1993 to 1995, the three years before CTB emerged, Apple had an effective overseas tax rate of 16 percent. After this the rates plummeted and averaged 2 percent in the past three years.
One former official with the Irish Development Authority, which had the task of enticing foreign companies to invest in Ireland, said that after the introduction of CTB in the United States firms began to demand lower tax deals in Ireland.
While the Senate subcommittee referred to Apple negotiating tax rates of below 2 percent, Ireland usually facilitates low tax payments not by undercutting its headline corporate tax rate of 12.5 percent but by allowing companies to declare low taxable profits - often by making deductions for payments to tax-exempt affiliates, usually offshore.
Ireland said the low tax payment was not its fault and blamed other countries' tax legislation.
Apple's exact arrangements in Ireland have changed over the years.
Up until 2004 or later, the three Apple companies were assessed for taxation in Ireland, although the declared profits were much lower then.
In 2004, ASI declared a profit of $325 million and paid Irish tax of $21 million, its accounts from the time show.
In 2011, according to the subcommittee's report, ASI earned $22 billion and paid just $10 million in "global taxes".
Apple's retail units in France, Germany and Britain purchase goods from the Irish units. The prices are set at levels that ensure these units in bigger states do not report much profit.
This means the company avoids tax on sales in its bigger markets.
In 2011, the last year for which accounts are available, Apple Retail UK Ltd reported profits of 31 million pounds on sales of 860 million pounds and paid tax of 9 million pounds.
In the same year, Apple Retail France reported a loss of 21 million euros on sales of 346 million euros and paid income tax of 7 million euros.
Apple Retail Germany reported a 4-million euro loss on sales of 174 million euros and paid no income tax.
Other jurisdictions also offer tax advantages like Ireland.
Online retailer Amazon.com Inc, for example, pays low taxes on its overseas income by channeling European sales through a Luxembourg-based company that makes untaxed payments worth hundreds of millions of euros each year to a tax-exempt partnership, also resident in Luxembourg.
Web search giant Google pays low taxes by channeling overseas sales through an Irish unit that pays most of its income to an affiliate in Bermuda.
The schemes used by all three companies work by arranging for the units that make sales to customers in Europe and elsewhere to make tax-deductible payments to untaxed, or little taxed, affiliates for the use of intellectual property such as brands and business processes.
The Group of 20 leading nations has asked the Organisation for Economic Co-operation and Development think-tank to look at such corporate profit-shifting, and one area it is examining closely is such payments for intangible assets.
The companies say they follow the tax rules in all the countries where they operate.
(Reporting by Tom Bergin; Editing by Will Waterman and Alastair Macdonald)