A pair of reports issued Monday -- one by the very subcommittee before which Cook will appear -- accused the company of exploiting a variety of loopholes and tax shelters to shift income overseas to avoid paying taxes on tens of billions of dollars in income in recent years. In fact, one of the two reports suggests that Apple has paid virtually no taxes on the $102 billion in overseas cash it held at the end of March.
Senator John McCain, R-Ariz., the ranking member of the Senate subcommittee before which Cook will testify, termed Apple's tax practices "highly questionable."
"Apple claims to be the largest U.S. corporate taxpayer, but by sheer size and scale, it is also among America's largest tax avoiders," said McCain in a statement. "The proper place for the bulk of Apple's creative energy ought to go into its innovative products and services, not in its tax department."
The reports and McCain's statement came on the eve of Cook's appearance before the Senate Permanent Subcommittee on Investigations. Amid concerns about federal debt and deficits, the subcommittee is examining corporate tax practices and has already scrutinized those of Microsoft and Hewlett-Packard (HPQ). Apple declined to comment. But separately on Monday, it released the written testimony Cook is slated to give to the subcommittee.
In the testimony, Cook denied that Apple used "gimmicks" to avoid U.S. taxes and emphasized the company's contributions to the U.S. economy, claiming that Apple is likely the largest corporate payer of U.S. income taxes.
"Apple complies fully with both the laws and spirit of the laws," Cook said. "And Apple pays all its required taxes, both in this country and abroad."
But the new reports detail just how little tax Apple has paid in recent years relative to its jumbo-sized sales and profits.
U.S.-based companies such as Apple owe federal income taxes on all their profits, whether earned overseas or in the country. But tax rules allow them to defer paying taxes on foreign earnings until they bring those profits to the United States. The tax laws also allow companies to deduct from their federal obligations any taxes they pay overseas.
Apple discloses how much cash it holds overseas and the potential U.S. tax liability it has on those holdings. Extrapolating from those figures, Citizens for Tax Justice, a consumer advocacy group, determined that the taxes Apple owes on its overseas cash horde amount to nearly the entire 35 percent standard federal corporate tax rate.
"That means that virtually no tax has been paid on those profits to any government," CTJ said in a statement.
The report from the congressional subcommittee detailed how Apple has managed to avoid paying more taxes. One loophole it allegedly exploits involves two of its primary overseas subsidiaries, one of which is a holding company, that are effectively stateless. Even though they're based in Ireland and oversee all of Apple's overseas' sales, for tax purposes they don't legally reside anywhere. As a result, Apple has paid almost no taxes on the tens of billions of dollars of income earned by those entities, according to the report.
Another loophole Apple is accused of tapping relates to the ownership of its intellectual property. Apple's overseas subsidiaries -- which are wholly owned by the company -- help fund its research and development in return for the exclusive right to sell Apple products overseas. The net effect is that while the vast majority of Apple's development efforts are done in the United States, the value of the intellectual property it generates is mostly realized in low-tax overseas countries.
Thanks to that loophole, one of the subsidiaries, which accounted for 30 percent of Apple's worldwide profits between 2009 and 2011, didn't pay any taxes to any national government on that income over that period, according to the subcommittee report. And the other paid just $10 million in global taxes on $22 billion in income in 2011 and just $7 million on $12 billion in profits in 2010.
Noting that U.S. tax laws can force companies to pay taxes immediately on the profits of their foreign subsidiaries if those are nothing more than shell companies, the report urged the Internal Revenue Service to take a closer look at how Apple has allocated its profits.
"The facts here warrant examination," the report said.
In his testimony, Cook noted that some of Apple's tax strategies date back to 1980, when the company was setting up its overseas operations. The research funding agreements in particular benefit the U.S. by encouraging Apple and other companies to continue to develop their products here, he said.
"If (such) agreements were no longer available, many U.S. multinational companies would likely move high-paying American R&D jobs overseas," Cook said.
That may be so, but it's unfair to other American taxpayers who can't exploit that loophole, said Martin Sullivan, chief economist at Tax Analysts, a nonprofit that publishes researches on tax policy.
"The crux of the matter is Apple has been able shift a disproportionate amount of its worldwide profit into low-tax Ireland," he said.
Staff Writer Dan Nakaso contributed to this report. Contact Troy Wolverton at 408-840-4285 or email@example.com. Follow him at Twitter.com/troywolv.
Apple CEO Tim Cook will appear before the Senate Permanent Subcommittee on Investigations on Tuesday to answer claims it uses unusual tax-avoidance schemes, including:
Avoiding paying billions of dollars in U.S. income taxes by employing two key offshore companies that are not tax residents of Ireland, where they are incorporated, or of the United States. Apple Operations International, which was established in 1980 in Ireland, for instance, has no employees and no physical presence, but keeps its bank accounts and records in the United States and holds its board meetings in California. Apple Operations International has not filed an income tax return in either the United States or Ireland but reported income totaling $30 billion from 2009 to 2012, according to the Senate subcommittee.
Using tax-avoidance strategies similar to those explored during a September 2012 hearing that looked at Microsoft and Hewlett-Packard, including employing a so-called cost sharing agreement to transfer valuable intellectual property assets offshore and shift the resulting profits to a tax haven jurisdiction.
Taking advantage of weaknesses and loopholes in tax law and regulations to shield billions of dollars in income that could otherwise be taxable in the United States.
Negotiating a tax rate of less than 2 percent with the government of Ireland - significantly lower than that nation's 12 percent statutory rate - and using Ireland as the base for its extensive network of offshore subsidiaries.
Source: Mercury News reporting