According to Levin, Apple’s tax-avoidance strategy is to shift the
profit-generating power of its intellectual property to an offshore tax haven.
“Next, it uses a number of tactics to ensure that, once this income is offshore,
it remains shielded from U.S. taxes, despite provisions of U.S. tax law designed
to capture that income as taxable,” Levin said.

Subcommittee ranking member John McCain, R-Ariz., joined Levin in
criticizing Apple, saying that the company’s three primary Irish entities hold
60 percent of the company’s profits, but avoid global taxation by not claiming
citizenship. McCain said that Apple Operations International (AOI) received
roughly $30 billion in dividends from other Apple subsidiaries around the world
from 2009 to 2012.

“This made up 30 percent of Apple’s total worldwide net profits over the
last few years,” McCain said. “However, AOI did not pay corporate income taxes
to any national government. Furthermore, AOI, a company with tens of billions of
dollars in cash, has never had any employees and appears to be completely
directed by Apple in California.”

Timothy D. Cook, Apple’s chief executive officer, said the company
complies fully with both the laws and spirit of the laws. “And pays all its
required taxes, both in this country and abroad,” according to Cook. In the
company’s defense, Cook said Apple has created approximately 600,000 U.S. jobs
and paid $9 billion worldwide to software developers.

In fiscal year 2012, the company paid $6 billion in U.S. taxes on profits
earned from sales as well as taxes on the investment income its controlled
foreign corporations, including AOI. Cook denied that Apple shifts its profits
overseas to avoid U.S. taxation. “Apple does not move its intellectual property
into offshore tax havens and use it to sell products back into the U.S. in order
to avoid U.S. tax,” Cook said. “It does not use revolving loans from foreign
subsidiaries to fund its domestic operations; it does not hold money on a
Caribbean island; and it does not have a bank account in the Cayman Islands.”

Recommendations to Close Loopholes

Levin and McCain issued a 40-page memorandum that offers recommendations
to close offshore corporate tax loopholes. They include strengthening U.S.
transfer pricing rules and reforming the so-called “check-the-box” and
“look-through” loopholes that enable multinationals to shield offshore income
from U.S. taxes.

The subcommittee, which previously explored tax avoidance by other
multinational corporations using offshore subsidiaries, found similar practices
at Apple. “Apple wasn’t satisfied with shifting its profits to a low-tax
offshore tax haven,” said Levin. “Apple sought the Holy Grail of tax avoidance.
It has created offshore entities holding tens of billions of dollars, while
claiming to be tax resident nowhere.”

The May 21 hearing was the subcommittee’s second examining the
tax-avoidance strategies of multinationals. A September 2012 hearing explored
how Microsoft and Hewlett-Packard used dubious strategies to avoid billions in
U.S. taxes. Similar practices at Apple include:

Using a so-called cost sharing agreement to transfer valuable intellectual
property assets offshore and shift the resulting profits to a tax haven
jurisdiction;

Taking advantage of weaknesses and loopholes in tax law and regulations to
“disregard” offshore subsidiaries for tax purposes, shielding billions of
dollars in income that could otherwise be taxable in the United States; and

Negotiating a tax rate of less than 2 percent with the government of
Ireland—significantly lower than that nation’s 12-percent statutory rate—and
using Ireland as the base for its extensive network of offshore subsidiaries.

By Stephen K. Cooper and Jeff Carlson, CCH News Staff

According to Levin, Apple’s tax-avoidance strategy is to shift the
profit-generating power of its intellectual property to an offshore tax haven.
“Next, it uses a number of tactics to ensure that, once this income is offshore,
it remains shielded from U.S. taxes, despite provisions of U.S. tax law designed
to capture that income as taxable,” Levin said.

Subcommittee ranking member John McCain, R-Ariz., joined Levin in criticizing
Apple, saying that the company’s three primary Irish entities hold 60 percent of
the company’s profits, but avoid global taxation by not claiming citizenship.
McCain said that Apple Operations International (AOI) received roughly $30
billion in dividends from other Apple subsidiaries around the world from 2009 to
2012.

“This made up 30 percent of Apple’s total worldwide net profits over the last
few years,” McCain said. “However, AOI did not pay corporate income taxes to any
national government. Furthermore, AOI, a company with tens of billions of
dollars in cash, has never had any employees and appears to be completely
directed by Apple in California.”

Timothy D. Cook, Apple’s chief executive officer, said the company complies
fully with both the laws and spirit of the laws. “And pays all its required
taxes, both in this country and abroad,” according to Cook. In the company’s
defense, Cook said Apple has created approximately 600,000 U.S. jobs and paid $9
billion worldwide to software developers.

In fiscal year 2012, the company paid $6 billion in U.S. taxes on profits earned
from sales as well as taxes on the investment income its controlled foreign
corporations, including AOI. Cook denied that Apple shifts its profits overseas
to avoid U.S. taxation. “Apple does not move its intellectual property into
offshore tax havens and use it to sell products back into the U.S. in order to
avoid U.S. tax,” Cook said. “It does not use revolving loans from foreign
subsidiaries to fund its domestic operations; it does not hold money on a
Caribbean island; and it does not have a bank account in the Cayman Islands.”

Recommendations to Close Loopholes

Levin and McCain issued a 40-page memorandum that offers recommendations to
close offshore corporate tax loopholes. They include strengthening U.S. transfer
pricing rules and reforming the so-called “check-the-box” and “look-through”
loopholes that enable multinationals to shield offshore income from U.S. taxes.

The subcommittee, which previously explored tax avoidance by other multinational
corporations using offshore subsidiaries, found similar practices at Apple.
“Apple wasn’t satisfied with shifting its profits to a low-tax offshore tax
haven,” said Levin. “Apple sought the Holy Grail of tax avoidance. It has
created offshore entities holding tens of billions of dollars, while claiming to
be tax resident nowhere.”

The May 21 hearing was the subcommittee’s second examining the tax-avoidance
strategies of multinationals. A September 2012 hearing explored how Microsoft
and Hewlett-Packard used dubious strategies to avoid billions in U.S. taxes.
Similar practices at Apple include:

Using a so-called cost sharing agreement to transfer valuable intellectual
property assets offshore and shift the resulting profits to a tax haven
jurisdiction;

Taking advantage of weaknesses and loopholes in tax law and regulations to
“disregard” offshore subsidiaries for tax purposes, shielding billions of
dollars in income that could otherwise be taxable in the United States; and

Negotiating a tax rate of less than 2 percent with the government of
Ireland—significantly lower than that nation’s 12-percent statutory rate—and
using Ireland as the base for its extensive network of offshore subsidiaries.

By Stephen K. Cooper and Jeff Carlson, CCH News Staff

Senate Finance Committee Chairman Max Baucus, D-Mont., began the hearing
by posing a question to Acting IRS Commissioner Steven T. Miller and former IRS
Commissioner Douglas H. Shulman: “It’s my understanding that the IRS
headquarters shut down the use of political terms such as tea party and the
other terms we’ve all learned about, in June of 2011,” Baucus said. “Why weren’t
people then fired or transferred…why wasn’t more definitive action taken?”
Miller responded that he “did not believe” he was aware at the time that
happened. “I first became aware of this in May 2012,” said Miller.

Baucus then asked Shulman, who responded that he, too, “did not believe he
was aware” of the problem at the time. Shulman told lawmakers that he was
“dismayed” and “saddened” to read the TIGTA report indicating that “actions had
been taken creating the appearance that the Service was not acting as it should
have—that is, as a nonpolitical, nonpartisan agency.”

Ranking committee member Orrin G. Hatch, R-Utah, demanded to know why
Miller ignored questions in earlier letters from Hatch and other senators asking
whether the IRS was improperly selecting Tea Party organizations for extra
scrutiny. “[Treasury Inspector General J. Russell] George stated that he briefed
you on May 3, 2012, about TIGTA’s audit, so we know you were aware of it when
you responded to my second letter, if not both letters,” said Hatch. “But you
didn’t mention any of this in your responses to me, to the Senate or to any
other congressional body.” Miller responded that he did not lie. Hatch countered
that Miller “lied by omission.”

Sen. Patrick J. Toomey, R-Pa., frustrated by the officials’ responses,
turned to Baucus for help. “Given the obvious one-sided nature of this criteria
and the fact that we still don’t know—Mr. Chairman, I would just suggest that
what we need to do is to bring before this committee some people who might
actually know the answers to these questions about who actually decided that
this was a good idea, who decided that we ought to resume this after the initial
malfeasance was ended. But it’s frustrating to have no answers for a hearing
like this,” said Toomey.

Baucus said further investigation is called for in order to uncover who is
responsible for the IRS’s reported behavior and why the controversial actions of
the “determinations unit” of the IRS’s Cincinnati office were allowed to
reemerge after IRS officials in Washington attempted to end them. “We need to
understand how and why this targeting occurred,” said Baucus. “We need to know
who was involved and who was responsible, and we need to install new safeguards
to ensure this targeting never happens again.”

According to data collected by the website OpenSecrets.org, 501(c)(4) s
spent $254 million in the 2012 election—an amount equal to the combined spending
of the 2012 Democratic and Republican political parties. Baucus said that
neither the tax code nor the regulations pertaining to nonprofits provide clear
standards for how much political activity a 501(c)(4) group can undertake. He
added that the tax code also lacks a clear definition of what qualifies as
political activity and that these ambiguities may have led, in part, to the
IRS’s behavior.

Lerner to Invoke Fifth Amendment at House Hearing

House lawmakers will continue their investigation into the IRS controversy
on May 22 with a hearing scheduled by the House Oversight and Government Reform
Committee. IRS Director of Exempt Organizations Lois Lerner has been subpoenaed
to testify but plans to invoke her Fifth Amendment rights and refuse to answer
questions, according to a spokesman for the committee. Other witnesses scheduled
to testify include Treasury Deputy Secretary Neal S. Wolin, George and Shulman.

By Jeff Carlson and Stephen K. Cooper, CCH News Staff

The individual gave no consideration for the option other than his promise to continue managing the company and the S corporation granted the option intending to secure the individual’s continued employment. Moreover, the individual exercised his option through a cashless exercise provision and received shares of the S corporation’s stock. Therefore, the value of the stock was properly based on a per-share value established by the cashless exercise provision and the transaction was arm’s-length between the individual and the S corporation. Since the shares were not valued with reference to listed securities, it was reasonable for the Tax Court to use the parties’ own valuation of the shares on the date of individual exercised the option.

Further, nonrecognition treatment under Code Sec. 1041 did not apply to the individual’s exercise of the option. Although the individual and his wife were not required to recognize any gain or loss when the option was transferred to the individual pursuant to a divorce settlement, Code Sec. 1041 did not apply to the subsequent exercise of the option by the receiving spouse. Moreover, the rights contained in the option, which the individual subsequently exercised by using the cashless exercise provision, were transferred to him by the S corporation and not by his wife or incident to divorce.

Affirming the Tax Court, 102 TCM 575, Dec. 58,831(M) , TC Memo. 2011-286.

A.L. Davis, CA-11, 2013-1 ustc ¶50,330

CCH Comment: The privatization occurred under a Conservative government policy to transfer the companies from government ownership to private investors. The windfall profits tax was enacted by a subsequent Labour government to recapture some of the profits realized by the private investors. The tax was imposed only on companies that were not allowed to raise their prices for a fixed period (generally, four years) after they became private.

Creditable Tax

A foreign tax is creditable if its predominant character is that of an income tax in the U.S. sense. This analysis was based on the normal manner in which the tax applied, regardless of the terms of the statute or how the tax was characterized by the foreign government. A foreign tax’s predominant character is that of a U.S. income tax if the tax is likely to reach net gain. Net gain for this purpose was realized gross receipts reduced by significant costs and expenses attributable to them; in other words, net gain was the same as net income.

The windfall profits tax met this test because it was economically equivalent to a tax on the difference (over a certain threshold) between the profits each company actually earned and the amount the government believed it should have earned based on what the private investors paid for it. Accordingly, a company’s net income was an essential component of the windfall tax formula. It was irrelevant that the windfall tax was formally imposed on value, specifically the difference between a company’s imputed profit-making value and what the investors paid for it. Imputed profit-making value was not a real value; instead, it was an artificial construct based on the profits a company actually realized during the relevant period. Thus, in a substance-over-form analysis, the windfall tax was nothing more than a tax on a company’s actual profits above a certain threshold.

CCH Comment: The fact that the windfall tax was based on a company’s actual, realized net income set it apart from (i) value-based taxes, such as U.S. estate and gift taxes, that consider past income for purposes of estimating future earning potential; and (ii) Reg. §1.901-2(b)(3)(ii) , Example 3, in which a noncreditable tax was based on imputed gross receipts rather than actual net income.

Predominant Character Test

In a concurring opinion, Justice Sotomayor agreed that the majority analysis was correct with respect to the companies that were subject to the tax for roughly four years after they were privatized. In contrast, when affected companies with other tax periods were considered, the windfall tax appeared to operate as a tax on average profits, which was much closer to a tax on value than it was to a tax on income or excess profits. However, since the government failed to make this argument, this was not an appropriate case for deciding whether the determination of a foreign tax’s predominant character should be based on how it applied to all, as opposed to most, affected taxpayers.

CCH Comment: The Court’s opinion resolved a conflict between the Third Circuit’s opinion and Entergy Corp. , CA-5, 2012-1 ustc¶50,386 .

Reversing CA-3, 2012-1 ustc ¶50,115 .

PPL Corp., SCt, 2013-1 ustc ¶50,335