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How Apple Lowers Its Tax Bill

Apple is one of America’s most profitable companies. And it pays a substantial income tax bill to the U.S. government – by its own account, $6 billion in 2012 and an estimates $7 million this year.

But many tax experts and lawmakers say Apple’s tax bill should be bigger. A lot bigger.

The concern is that Apple (AAPL, Fortune 500), while complying with U.S. laws, is nevertheless taking advantage of loopholes in the tax code to shift a substantial amount of income to offshore subsidiaries in low-tax countries. The result is billions of dollars in profits every year that go untaxed.

Apple is hardly the only American company to minimize its offshore tax bite. But it has become a poster child for it.

In Apple’s case, the focal point is its subsidiaries in Ireland, where the company faces a maximum tax rate of just 2 percent. That’s well below the 35 percent top rate in the United States and even well below Ireland’s top statutory rate of 12.5 percent.

Apple CEO Tim Cook told lawmakers on Tuesday that the company is not engaging in tax “gimmicks” and shifting profits overseas. The company’s tax strategies serve both the interest of Apple shareholders and help create many jobs in the United States, he said.

Nevertheless, as lawmakers consider how to reform the corporate tax code, they will be taking a hard look at how offshore profits are managed.

Here are some of the techniques at the heart of the controversy over Apple’s offshore tax strategies:

Let offshore subsidiaries enjoy outsized profits: Most of Apple’s research and development is done in the United States. But some of those R&D costs are borne by its Irish subsidiaries under what’s known as a cost-sharing agreement.

That, in turn, lets the subsidiaries enjoy the economic benefits that result from the R&D — namely the profits from the intellectual property that’s created, noted Martin Sullivan, chief economist at the publisher Tax Analysts.

The problem, tax experts say, is that Apple’s Irish subsidiaries appear to get a sweetheart deal for their R&D investment — the kind of deal that the company wouldn’t give to an outside entity that might want to get in on the ground floor of the next great Apple product, Sullivan said.

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