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February 15, 2012
Apple Reports High Rate but Saves Billions on Taxes

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By Martin A. Sullivan --

By taking advantage of lax U.S. transfer pricing rules, Apple Inc., the world's most valuable company, cut its federal tax bill by billions of dollars in 2011. Moreover, by taking advantage of flexible accounting rules, the company masked its tax avoidance by reporting a relatively high effective tax rate.

Apple does most of its research in the United States. Most of its key employees are in the United States. Fifty-four percent of its long-lived assets, 69 percent of its retail stores, and 39 percent of its sales are in the United States. A recent study funded by the Sloan Foundation and the National Science Foundation concluded: "Apple continues to keep most of its product design, software development, product management, marketing and other high-wage functions in the U.S." (See Kenneth Kraemer, Greg Linden, and Jason Dedrick, "Capturing Value in Global Networks: Apple's iPad and iPhone," July 2011.)

                         Apple's Financial Information
      (For fiscal year ending September 2011, unless otherwise indicated;
                          dollar amounts in billions.)

 Market value               $444.4     Reported effective                 24.2%
 (Feb. 8, 2012)                        tax rate*

 Before-tax profits*         $34.2     Foreign effective tax rate          4.7%

 Before-tax foreign            $24     Accumulated foreign earnings*      $54.3

 U.S. share of               29.8%     Permanently invested foreign       $23.4
 before-tax profits                    earnings*

 U.S. share of sales         38.6%     Accumulated foreign earnings       $30.9
                                       not permanently invested

 U.S. share of long-lived    54.2%     Deferred tax liability of not       $8.9
 assets                                permanently invested foreign
                                       earnings, end of 2011*

 U.S. share of retail        68.6%     Deferred tax liability of not         $5
 stores                                permanently invested foreign
                                       earnings, end of 2010*

 U.S. sales margin           24.4%     Estimated book U.S. tax             $3.9
                                       expense on foreign profit

 Foreign sales margin        36.1%     Estimated foreign profit with
                                       booked U.S. tax expense            $12.4

 Additional U.S. tax if       $2.4     Estimated U.S. tax rate on
 50% profits in U.S.                   repatriated foreign earnings       28.8%

 Additional U.S. tax if       $4.8     Adjusted effective tax rate        12.8%
 70% profits in U.S.


 Asterisk (*) means information is directly from 2011 annual report.

 Market value. From Yahoo Finance. Second in market capitalization is Exxon
 Mobil at $403.9 billion.

 U.S. share of before-tax profits. Calculated from 2011 reported total
 before-tax profits ($34.2 billion) and 2011 reported before-tax foreign
 profits ($24 billion).

 Additional U.S. tax if 50% profits in U.S. The difference between 50 percent
 and 29.8 percent multiplied by $34.2 billion (before-tax profits) and 35
 percent (the marginal U.S. federal corporate tax rate).

 Foreign effective tax rate. Total foreign tax liability ($602 million) divided
 by total before-tax foreign profits ($24.0 billion).

 Accumulated foreign earnings not permanently invested. The difference between
 accumulated foreign earnings at the end of 2011 ($54.3 billion) and
 permanently invested foreign earnings at the end of 2011 ($23.4 billion).

 Estimated foreign profit with booked U.S. tax expense. Increase from 2010 to
 2011 (from $18.5 to $30.9 billion) in accumulated foreign profit not
 permanently reinvested.

 Estimated book U.S. tax expense on foreign profit. Increase from 2010 to 2011
 (from $5 to $8.9 billion) in deferred tax liability related to foreign
 earnings not permanently invested.

 Estimated U.S. tax rate on repatriated foreign earnings. Booked U.S. tax
 expense on foreign profits as a percentage of estimated booked foreign profit
 with U.S. tax expense.

 Adjusted effective tax rate. The difference between booked tax expense ($8.238
 billion) and estimated book tax expense on foreign profits ($3.9 billion)
 divided by before-tax profits ($34.2 billion).

Yet the company reports only 30 percent of its profits as being from the United States. By shifting large amounts of profits out of the United States, Apple is doing nothing illegal or out of line with the tax practices of other companies with lots of high-value intangibles. U.S. transfer pricing rules are a sieve. (For prior analysis of Apple, see Tax Notes, Aug. 1, 2011, p. 459, Doc 2011-16455, or 2011 TNT 147-3.)

There will never be a precise answer as to where profits are created. But if the corporate tax is a tax on income, it is reasonable to place profits where value is created. In Apple's case, can there be any doubt that most of its value is created inside the United States? If we assume, conservatively, that 50 percent of profits should be U.S. sourced, then Apple's federal taxes would have been $2.4 billion more in 2011. Given the pivotal importance to Apple's success of product design and other functions performed in the United States, one could reasonably expect U.S. profits to be 70 percent of the worldwide total. In this case, payments to the U.S. government would have been $4.8 billion more in 2011.

Apple reports a worldwide effective tax rate of 24.2 percent. A lower effective tax rate increases a company's reported book profits. Apple would have a lower reported effective tax rate and higher profits if it recorded its tax expense the way most other companies do. Under generally accepted accounting principles, U.S. companies do not have to book tax expense on foreign profits if the company deems them to be permanently invested overseas. To lower their reported effective tax rates and boost their reported after-tax profits, most companies assume all of their unrepatriated foreign profits are permanently reinvested offshore. If Apple asserted that all of its foreign earnings were permanently invested outside the United States, it would have booked an estimated $3.6 billion less in tax expense, and its effective tax rate would be 12.8 percent. (See the table.) When assessing Apple's tax situation relative to that of most other companies, this adjusted rate is probably more relevant than the reported 24.2 percent rate.

Why doesn't Apple maximize reported profit like most other companies? We can only speculate. Perhaps because it is breaking all records for profitability now, it is saving some profits for less fortunate times in the future. As the Joint Committee on Taxation recently wrote: "If the company accrues the tax expense in the year the profits are earned, it may later decide that those funds will not be repatriated after all. At that later time it may then reverse the tax expense and shift financial statement income from the prior period into the current period." (See "Present Law and Background Relating to the Interaction of Federal Income Tax Rules and Financial Accounting Rules," JCX-13-12, Feb. 7, 2012, Doc 2012-2443 or 2012 TNT 26-15.)

An alternative explanation is that perhaps Apple -- with its young, socioeconomically elite customer base -- does not want the negative publicity that a low effective tax rate could generate with groups like Citizens for Tax Justice and US Uncut.

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