John Russell, 80, in his office at his Kawakawa Bay home, Auckland. Russell owes IRD $400m. Photo / Jason Oxenham
Why is the Inland Revenue Department (IRD) billing an 81 year old New Zealander $40 million per annum while a major multinational - with NZ sales in excess of $550 million - has an annual tax bill of less than $10 million?
The individual in this story is John George Russell and the multinational is Apple.
Russell is the IRD's so called "public-enemy number one" because he owes over $400 million in tax liabilities, penalties and accrued interest that he cannot pay.
The octogenarian was the high profile managing director of Securitibank, which played a major role in the development of New Zealand's money markets in the 1970s. Russell became a tax advisor and business consultant after Securitibank collapsed in December 1976.
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According to the IRD, Russell received income of only $299,000 from two companies between 1985 and 2000 when he should have received an additional $15.46 million. The IRD argued that this was tax avoidance and assessed Russell for $5.69 million of core tax on this additional $15.46 million. Core tax excludes any interest or penalties.
The courts have consistently upheld the IRD's assessment and the $5.46 million has soared to more than $400 million because of penalties and accrued interest.
Russell first offered to pay $1,000 per week for the rest of his life in 2006 but the Commissioner declined. He continues to offer $1,000 per week and "to permit the Commissioner to provide in his deceased estate for the remainder of any debt claimed to be owing to her at the time of his death".
The IRD has rejected this proposal and Russell is now being levied with a penalty interest rate of nearly 10 per cent. This represents approximately $40 million of additional tax liabilities in the current year.
Russell will probably be declared bankrupt by the IRD in the next few weeks.
Meanwhile Apple and other multinationals have been strongly criticised for reducing their tax bill by shifting profits from high to low tax countries, particularly to Ireland.
Ireland is an ideal country for a United States multinational to set up a subsidiary because the US defines corporate tax residency as the country where the entity is incorporated whereas the Irish definition is the country where central management and control is based.
An investigation by the Australian Financial Review (AFR) last year concluded that A$8.9 billion in untaxed profits had been moved to a tax haven structure in Ireland to avoid paying Australian tax over a ten year period.
The AFR investigation was essentially based on a study by Antony Ting, a senior lecturer in taxation law at the University of Sydney.
Ting concluded that Apple had successfully sheltered US$44 billion of tax between 2009 and 2012 as "the US Government has knowingly facilitated the avoidance of foreign income tax by its multinational enterprises, thus creating double non-taxation".
The company at the centre of the group's complex tax structure is Apple Sales International (ASI), which is incorporated in Ireland. ASI purchases iPhones and iPads from unrelated contract manufacturers in China and sells them to Apple companies in Germany, Australia, New Zealand and elsewhere.
These products are not transported through Ireland yet a number of small Irish subsidiaries, with few employees, are responsible for about two-thirds of Apple's total earnings.
Ireland is an ideal country for a United States multinational to set up a subsidiary because the US defines corporate tax residency as the country where the entity is incorporated whereas the Irish definition is the country where central management and control is based.
Thus, a US subsidiary does not have to pay company tax in Ireland as long as central management and control remains in the United States and none of its business activities are undertaken in Ireland.
Nevertheless, Apple negotiated a 2 per cent corporate tax rate in Ireland for any ASI purchases in China that are on sold to Apple subsidiaries in Germany, Australia, New Zealand and elsewhere. The full Irish 12.5 per cent corporate tax rate only applies to Apple's Irish sales.
Earlier this year the European Union initiated a formal investigation against Ireland for alleged state aid to Apple. Apple released the following comment; "The Company believes the European Commission's assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid".
Regardless of the outcome of this investigation Apple has taken advantage of legitimate tax legislation to transfer profits from high tax countries to Ireland because of the 2 per cent corporate tax rate. The accompanying table shows how this has been achieved as far as its New Zealand and Australian operations are concerned.
The most important figures are revenue, cost of sales, gross profit and the gross margin.
Cost of sales are the direct costs of purchasing Apple products from offshore Apple companies. This figure excludes any indirect costs such as distribution, sales staff and advertising.
These figures show that the New Zealand company had a gross margin of only 3.1 per cent, Australia 9.1 per cent and the United States parent 38.6 per cent for the September 2014 year. As a consequence Apple has a New Zealand tax provision of only $6.8 million on sales of $568.5 million.
The clear conclusion from these figures is that Apple's Australian and New Zealand operations are purchasing iPhones and iPads at a relatively high price, probably from Irish based Apple Sales International. This allows Apple to shift profits from this part of the world to Ireland through a process called transfer pricing.
There are clear advantages to this strategy because Australia and New Zealand have company tax rates of 30 per cent and 28 per cent respectively, while Apple pays only 2 per cent in Ireland for goods transported directly from China to Australasia.
The OECD is disturbed by these types of international tax rules and agreements and has established a Base Erosion and Profit Shifting Project (BEPS) to look at the issue. The OECD is concerned that profits are being shifted "to no or low-tax locations where the business has little or no economic activity".
An example of this is Apple's hugely profitable Irish subsidiary which operates from a small office in the suburbs of Cork.
A 2013 OECD study concluded that gaps and mismatches in international tax rules resulted in annual corporate tax revenue losses of between US$100 billion and US$240 billion or 4 to 10 per cent of total global company tax.
The OECD recently released its final BEPS report containing a number of recommendations including;
• Countries need to undertake more research to determine the impact of base erosion and profit shifting.
• Transfer pricing rules need to be strengthened.
• Tax treaties should only eliminate double taxation, they should not facilitate complex schemes that are aimed at shifting income into no or low-tax locations.
• Governments should ensure that they have tax regimes that encourage substantive business activities rather than paper income.
There are suggestions that New Zealand tax officials will celebrate when John Russell is bankrupted for refusing to pay $5.69 million of tax. This is the original core tax on income earned by companies associated with Russell nearly 20 years ago.
Any celebrations would be inappropriate because the main issue these days is the transfer pricing strategies adopted by Apple and other multinationals.
Apple Australia, with $463 million of cash, and Apple NZ, with $53 million cash, have plenty of money to pay more tax while Russell could never pay $400 million, particularly with this liability increasing by more than $100,000 per day because of interest costs.
Prospect of rivers of fresh tax revenues shrank, on reflection, to mere trickles.