Apple's legal defence against European Commission charges of improper tax avoidance is yet to be heard. But even based on the company's own reporting, Apple's claim that it has always paid all the taxes it owed is disingenuous.

The recent ruling - forcing Ireland to hit the iPhone maker with 13 billion euros ($14.5 billion) in back taxes - throws harsh light on a long-standing practise that Apple described to investors but never stressed. Now it will be tested in the courts.

Both Apple chief executive Tim Cook and chief financial officer Luca Maestri have angrily rebutted the European Commission's statement that Apple's effective tax rate in Ireland in 2014 was a mere 0.005 percent. Cook called it "total political crap." They claim Apple paid $400 million in Irish taxes that year.

A careful reading of the statement, though, shows that the 0.005 per cent rate is only ascribed to one of Apple's Irish entities, Apple Sales International. Though Commissioner Margrethe Vestager got the headlines she wanted by stressing the miniscule figure, this line of discussion is a red herring. What does require scrutiny is how Apple's 26 per cent effective tax rate, which Cook keeps bringing up in his company's defence, is worked out.


Apple's profit and loss statements for several recent years have indeed provided for about 26 percent of its pretax profits to be paid as income taxes.

As often happens, the company didn't actually pay that much: On a cash basis, it has spent about 18 per cent of its pre-tax profit on taxes in the last three financial years.

The rest of the expenses the company accounted for swelled the tax liability on its balance sheet. When its 2015 financial year ended, the company had a net deferred liability of $16.2 billion sitting on its books .

The income tax provision includes foreign taxes, which are calculated at a low effective rate. In its 2015 annual report, Apple said, for example, that 2014 foreign pre-tax earnings reached $33.6 billion, for which it made a $1.5 billion foreign tax provision.

That's a 4.5 per cent effective rate on profits earned in Europe, Asia, Africa and Latin America; in there somewhere is the $400 million in payments to Ireland, the much smaller payments made in other European countries and the growing tax bills from China.

The amount of unrecognised deferred tax liability related to these temporary differences is estimated to be $30.0 billion.


That may seem to vindicate Vestager's charge of underpayment, but Cook wasn't wrong to say Vestager took her figure out of context. Apple makes a provision for US taxes on a portion of its foreign earnings, which it may at some point repatriate. Once it does so, it will have to shell out the difference between the US taxes due and the foreign ones already paid.

In the meantime, the provision makes the effective tax rate on the US portion of Apple profits look outsized: 64.7 per cent in 2015 and 62.8 per cent in 2014.

Those booked but not necessarily paid US taxes account for some of the difference between the tax amounts Apple carries on its profit and loss statement and the actual cash payments, and they explain the 26 per cent effective rate of which Cook boasts. But there is another, underwater part of Apple's tax iceberg on which the company doesn't even make a provision for US taxes, only for foreign ones at low rates. Apple says in its 2015 annual report:

"Substantially all of the Company's undistributed international earnings intended to be indefinitely reinvested in operations outside the US were generated by subsidiaries organised in Ireland, which has a statutory tax rate of 12.5 per cent. As of September 26, 2015, US income taxes have not been provided on a cumulative total of $91.5 billion of such earnings. The amount of unrecognised deferred tax liability related to these temporary differences is estimated to be $30.0 billion."

I think it's a desire to reallocate taxes that should be paid in the US to the EU.


That's a 32.8 effective rate that Apple calculates it might face if it repatriated all the "indefinitely reinvested" profits, less than the US statutory rate of 35 per cent. Ostensibly, a provision for Irish taxes on the $91.5 billion in earnings has already been made -- but given Apple's outraged reaction to the European Commission's ruling, that may not be the case.

Even before the Commission decision was published, Irish economist Seamus Coffey arrived at the approximate amount of back taxes the EU might force Ireland to extract from Apple. Applying Ireland's statutory tax rate, 12.5 per cent, to the profits of Apple Sales International from 2004 to 2013 gives about $14 billion. In effect, the European Commission is telling Apple to pay full Irish taxes, and not the single-digit rates that it provided for, on earnings it never planned to repatriate.

"I think it's a desire to reallocate taxes that should be paid in the US to the EU," Cook told the Irish Independent. His company, however, did not make a provision for paying the taxes in the US - and made an insufficient one for paying in Ireland.

Being forced to pay US taxes on these profits would be far more damaging, but Apple failed to plan for the potential that its special tax-minimising arrangement with the Irish government - one which allowed it to allocate substantial profits to a "head office" outside Ireland - would prove a contravention of EU law.

When the Commission's decision was announced, many assumed - and Irish Finance Minister Michael Noonan promised - to appeal it. Cook, too, has expressed hope that this would be the case.

But the government has delayed a decision on the appeal: Some ministers doubt that Ireland was right in undertaxing Apple as it did, and the windfall would be welcome in a debt-ridden country hurt by years of post-crisis austerity.

Apple will appeal the decision in any case. If it loses - that is, if courts decide that profits booked in Ireland should have been taxed there at the statutory rate or close to it so that all companies operating there get a level playing field - the US company will have to admit to investors that it had been overoptimistic on its tax provision.

It has already admitted it indirectly by boosting its effective foreign tax rate to 6.1 per cent in 2015. Its tech peers such as Google, Microsoft, Oracle, Qualcomm and Cisco, which also have been accumulating untaxed or barely taxed profits overseas, now will need to look at their tax provisions, too, and decide if they are safe.

Talk about European overreach is beside the point: It's not going to sway the courts, which will be more concerned with the issue of whether taxes were properly charged and paid. That's something that would take Apple some serious effort to prove.

- Bloomberg>