The tax strategies of US-based tech giant, Apple, have been in the headlines and under scrutiny in Europe for a few years now.  But the time has come to pay the piper. The Register has reported that Apple, as of September, has now paid the €14.3 billion, mandated by the European Commission, in back taxes and interest to the Irish government.

The whole affair started after Tim Cook of Apple testified to a US Senate subcommittee that the company did pay an effective tax rate of under 2% in Ireland.  The European Commission smelled blood in the water and quickly swooped in to investigate.  After looking into the tax rulings Ireland had given Apple Operations International (AOI), Apple Sales International (ASI), and Apple Operations Europe (AOE), the commission found that the emerald isle had provided huge tax breaks to Apple in exchange for the jobs it created for its local residents according to the Irish Times.

In the global and highly digital economy we find ourselves in today, it is often tricky to determine where in the world a company incurs most of its marketing and selling expenses, where it earns most of its profits, what countries are providing what supporting services to them, and what constitutes an official presence in a country.  Perhaps the marketing personnel are in the US, but they are paying for ads in France; perhaps they are selling more devices to customers in Germany, but more software to customers in the UK; perhaps they utilize a small shipping office serviced by the roads in Poland, but they have a massive plant serviced by the same length of roads in China.

If costs and benefits have to be allocated to various countries in which a company operates, how do they determine what costs and benefits belong where?  This can be a nightmare for corporate accountants and lawyers.  And yet, it can also present an opportunity for the company to take advantage of the allocation method that benefits them the most.

How to calculate the profits attributable to Apple’s tax base in Ireland is at the heart of this case.  Apple Sales International had a branch in Ireland that was essentially a distributor for Apple products.  Ireland’s Revenue department ruled that ASI, as a whole, should record 12.5% of its operating costs as the profits for the Irish branch.  The other 87.5% would belong to a head office.  This head office also resided in Ireland, but it was not considered a taxable entity by the Irish.  Up to this point, the reasonability of Apple’s profit allocations would seem debatable.  What really clinched their culpability in the eyes of the Commission was the fact that no employees worked out of the “head offices”.

Transfer pricing is how related companies charge each other for goods.  In principle, namely the Treaty on the Functioning of the European Union, transfer prices should be set as if the two companies were unrelated and operating at an “arm’s length” from each other.  Setting transfer pricing in any other manner to capitalize on some type of tax or other benefit for the parent company is not acceptable according to this Treaty.

This is what the European Commission charged Apple was doing, and Ireland was allowing.  The result, they maintain, is an unfair amount of profits retained by the company, and an unfair amount of corporate tax withheld from the host country.

Seamus Coffey, in the Irish Examiner, has a different theory.  He posits that corporations are, in fact, paying their fair share of taxes and that governments of other countries in which the corporations operate are simply out to get a bigger piece of the pie.  Governments around the world are targeting large, headline-grabbing, multinational corporations to take to task. The Irish Examiner noted in subsequent investigations, these governments neglect to mention the vast sums of money the companies may have paid to countries from which more of their profits were actually derived and attributable to.

Apple, for example, has paid an effective tax rate of almost 25% when counting profits paid everywhere.  The European Commission simply wants Apple to pay Ireland closer to that 25% rate than the .05% they claim has been paid.  And when these foreign governments win, it rarely increases the overall tax rate paid by the company; instead, it simply shifts some of it from another country to their own.  Seamus explains that the majority of Apple’s profits should, rightly, be paid to the U.S.  Simply selling hardware from the Irish branch does not constitute much profit-making activity.  But designing the hardware, producing it, branding it, and marketing it does.  So, should more taxes be paid where the company incurs more costs?  Or, should more taxes be paid where the customers buy more products?

Like I said, in our highly global and digital world, complexities abound.  A new era of international accounting and taxation rules need to be set, and they will be.  But for now, the waters are still muddied, and until treaties and legislation are rewritten to catch up to the world we live in, governments around the world will fight to get their piece of the pie.

Ultimately, the settlement paid by Apple will be held in escrow until all appeals have been exhausted – appeals from Ireland, not just Apple.