 Hello, today on Wednesday, July the 15th, Apple wins a tax battle with the EU as the court annulls 2016 order to pay 15 billion in taxes. So what happened in 2016, the European Commission, the EU, said that Ireland has enabled Apple to pay substantially less taxes than other businesses for many years. Four years later today, but EU General Court decided that the commission failed to prove that the Irish government had given the US tax giant a tax advantage. So for now, Apple does not have to pay that 15 billion. Now the EU will have two months to appeal this order. But it's very important to understand what's the issue of this case. Why are we here? Because this deals with taxes, international tax. So this is what the this is the EU case. And I'm going to revisit the slide later on after I explain everything. So basically what the EU is saying, Ireland is helping Apple and avoid paying taxes. So simply put in a nutshell, all the revenue from Europe, the Middle East and India is recorded in Ireland. Ireland is given a tax break to Apple and Apple don't have to pay any taxes. So this is the idea or barely any taxes. This is the idea we'll come back and we'll explain this graph in details. So to understand this whole EU-Apple fight in Ireland, you have to understand how that how did it all started. In 2014, the EU started an investigation. But to understand the the reason for this investigation, you have to go back to 1991. Actually, to really understand, you have to go back to 1980 when Apple launched a manufacturing plan in Holly Hill above Kirk and Ireland. So this is when it all started. Steve Job announced a 7 million a deal and investments in the country along with 700 new jobs. So this is we're talking back in the 1980s. Now 10 years later, we'll talk in 1990, Apple was employing hundreds of people. So they met with the Irish government for talks. Now, why did they do so? What was the motivation behind Apple stock? At that time, Steve Jobs was not the CEO of the company because he resigned in 1985 and did not return until 1997. John Scully was the CEO and at that point, Apple was losing market share. Apple was losing market share to Microsoft and what they wanted to do, they wanted to find ways to save money and one way to save money is let's try to squeeze the Irish from taxes. Let's try to pay less taxes. That was the whole idea. So in 1990, Apple's financial team met with the Irish government to draft an arrangement for how much tax it is paid for this country. So they wanted to kind of find, basically save money. That was the whole purpose of this. So what did Apple presented back in 1990? Well, Apple was the largest employer in the Cork area. It's like the Silicon Valley of Ireland, a large tech hub. They had 1000 direct employees and close to 500% engage in subcontract. So they had some leverage and what they tell the Irish company is they told them at this point they are reviewing their worldwide operation and they wish to establish a profit margin on its Irish operation. So simply put, we want to reduce our expenses so we have a certain margin, a profit margin. And what they did, they produced the account prepared for the Irish branch for for the accountant ended 1989, which show a net profit of 270 million on a turnover of 751 million. So what they told them to look, we made 751 million in 1989, the prior year, and our profit was 270 million. Now this was back then. Just to kind of just kind of give you an idea what's going on here. This was per year, per year. Today, Apple just kind of put things into perspective. Today in 2019, the total revenue was 260 billion. So if you take 260 billion and you divide it by 365 days, you'll get approximately 712 million per day. So Apple back then, they were making 725 million per year and they were trying to negotiate. They have, they thought they have the upper hand with Ireland. Think about what upper hand they have now. That's per day. That's per day. So this is what was happening back then. And they told the Irish government, look, there's no other Irish company produce a similar net profit margin. So what they wanted to do is to kind of reduce their tax bill. That's basically what they wanted to do. So what they argued is our income derived from three sources, technology, manufacturing, marketing and manufacturing. And what they told the Irish, look, we only manufacture in Ireland. So you should, we only manufacture in Ireland. Therefore, we should not be taxed on the marketing revenue and any technology revenue. That's, that's what they, that's, that's the argument that they made. And we've been here for 10 years, okay, we're viral part of Cork. And if you don't like us, if you don't like, if you don't like to keep us, we'll go somewhere else. That was the argument. Look, this was in 1990. You know, this is, you're talking 2020 today, 30, 30 years later. So what happened? The Irish government caved in. Okay, they agreed to the deal with Apple to only tax a certain bracket of its earning, given it a dramatically lower tax rate than it would have paid in the U.S. So why was, the thing is, why is, why is Apple located, why the international headquarters located in the, in Ireland, because Ireland is a tax haven. What is a tax haven? That means you pay less taxes. So Ireland has 12.5. It's something called signature tax, signature tax. Just say it's a tax. Today, the U.S. is 21% for the corporate. Now in the U.S., it used to be 40%. You know, it's progressive, but it could go up to 40%. Or even more in some years. Okay, depending on who's in control of the White House. So all of Apple, European, also Middle East and India revenue is taxed in Ireland. All that revenue that generate in Europe, it's assumed it's a generate in Ireland. So the EU is complaining that Apple is paying way less than 12.5. If Apple was paying 12.5, the EU is okay with this. But you're going to see shortly that Apple is paying way, way less than 12.5. So that's not only not paying 21, not paying 12.5. It's paying less. So the EU is what they're saying. Their case is the commission investigation concluded that Ireland granted illegal tax benefit, which is you cannot have the government helping a company. That will put other companies at a disadvantage. That's the argument of the EU. Simply put, the argument they want more money from Apple, but that's the argument that they are making. Which enable it to pay substantially less taxes than other businesses over many years. In fact, the selective treatment allow Apple to pay an effective tax rate of only 1%. And at some point, 0.005%. So practically, Apple is not paying any tax under international operation. So Ireland doesn't want to upset Apple because if Apple leaves, it's a major employer. So it's employing a lot of people. Also, the US don't want Apple to pay more taxes in Europe. Because if Apple pay more taxes in Europe, then what happens is for every dollar you pay in Europe, the US government gives you a tax credit. So you pay more overseas, that's less revenue for the US government. So US government, it's not in their best interest to for Apple to pay taxes. Now, the US government would prefer if Apple is located in the US. Not in Ireland, but that's Canada in the US. Not in Ireland, but that's a different story. And obviously, Apple doesn't want to pay the taxes. So the only one that's going after Apple is the EU. So they're fighting really an uphill battle. So what did Ireland and Apple did? What they did is they created two Irish incorporated companies. One is Apple Sales International, which holds the right to use Apple's intellectual property to sell. And they created also Apple Operations Europe. So two companies. And this one, they manufacture Apple product outside North America and South America under a so-called cost sharing agreement with Apple. There are two basically two Irish companies that they belong to Apple. Apple is the headquarter. Apple is the owner. So these companies under this agreement make yearly payment to Apple in the US to fund research and development effort conducted on behalf of the Irish companies. So it's a subsidiary. So what they do is part of their profit. They send it to the US for R&D because they benefit from that R&D. So let's take a look a little bit more at Apple Sales International to see how this all works and how do they avoid paying taxes. So Apple Sales International is responsible for buying Apple product and equipment, manufacturers around the world, and selling these products in Europe as well as in Middle East, Africa and India. However, when you purchase that Apple product anywhere in these countries, contractually, the transaction is taken place in Ireland. So although it's sold physically in Germany, but the transaction is taken place in Ireland, therefore, it stacks in Ireland. From shops that are physically sold, it doesn't matter where it's physically sold. It's contractually sold in Ireland. In this way, Apple recorded all sales and profit stemming from these sales directly in Ireland. Now why? Why do Apple wants this? Because under the agreed method, this is the agreed method, which is what Apple and the Irish government agreed on. Most profit were eternally allocated away to Ireland to a head office with an Apple Sales International. Now here's the technical part of it. So Apple makes the sale, so they have revenue, let's assume revenues of 10 billion. Then after you have your revenues, you have to deduct your expenses. One of these expenses is something called the head office. Okay, maybe like $7 billion and head office expenses. Now what is this head office? The head office was not based in any country and did not have any employees or even own premises. There's no physical location for that head office. Its activity consists solely of occasional board meetings. So simply put, there was an expense because they wanted to reduce their taxes. The Irish government said, look, find a way to reduce your taxable income. And Apple says, okay, we're going to have an expense called the head office. And what we do is we're going to have that expense and as a result, it's going to reduce our taxable income. So this is what the head office is. So what end up happening, only a fraction of the profit of Apple Sales International were allocated to the Irish branch and subject to the taxes in Ireland. So what they did is you have the phantom expense called the head office and that expense reduces your taxable income. So the remaining vast majority of the profit were allocated to the head office where they remain untaxed. So there's a lot of money that Apple generate because the way they set up their corporation in Ireland and the way they agreed with the Irish government is they have this expense called head office. Once again, when this deal was created, Apple was only generating $700 million per year. So it was not a big deal for anyone, but that deal's still legitimate. And this is not, but now Apple is generating $700 million a day in sales. So that's why it's making a big deal. So just to kind of give you an idea how this work in 2011, according to the figures released at the U.S. Senate public hearing, Apple Sales International which is the Irish company recorded profit of 22 billion or let's in euro, 16 billion euros or 22 billion U.S. dollar. But under the terms of the tax ruling only around 50 million. So 0.003, you're talking 16 billion. So this is a 16 billion kind of nine zeros. Of this amount, only 50 million was taxed. Of this amount, 50 million was taxed. So of the 16 billion, 50 million was taxed. And the remaining is untaxed, basically in that head office somewhere. As a result, Apple Sales International paid less than 10 million in 2011, which has gave it an effective tax rate of 0.005 on its overall annual profit. And in subsequent year, it even went lower. Apple Sales International recorded profit continued to increase but profit considered taxable in Ireland under the terms of the tax ruling did not and the effective rate became 0.005 in 2014 on all that profit. So notice what's happening. They make money internationally. The transaction appears from a tax perspective in Ireland. They have a deal with the Irish government where they don't have to pay any taxes on that profit. This is basically what's happening. Once again, let's revisit the initial graph. You make sales in Europe. The sales is under Apple Sales International. Apple Sales International, they have to pay a fee for the U.S. The headquarter to finance R&D. They can also reduce their taxable income from this, but that's not what they want because if they think about it, when they pay a fee to the U.S. company in the U.S., that fee becomes a revenue. That fee becomes a revenue. Actually, if anything, the U.S. prefer to pay them if anything. Yes, we prefer to pay them. But here's the problem. The problem is this thing here. Almost all the profit allocated the head office existing only on paper and left and taxed. So when they take this revenue and they put it into the cloud somewhere, then that sales that's in the cloud, it's not taxed. It's not taxed anywhere. It's not transferred in the U.S. It's not taxed in Ireland. And why did they do this? Because Ireland allowed them that head office line deduction. And this is basically the story. And it seems the EU could not prove that there was anything that they were trying to do tax avoidance because it's legal. The Irish government agreed with them. Now, if the Irish government wants to change the agreement with Apple, then that will change. But as long as that agreement exists, then everything seems to be, as of today, all good. I hope you like this recording. If you're studying for your CPA exam or if you're taking accounting courses, please check out my website, farhatlectures.com. Good luck and study hard.