How Apple Avoids Taxes through R&D Spending

Apple CEO Tim Cook came under fire in Washington today at a U.S. Senate hearing focused on the elaborate strategies Apple used to avoid paying tens of billions of dollars in corporate taxes. 

The company’s methods of financing its R&D operations, which in 2011 were based almost exclusively in the United States, are among the tactics at the center of the controversy.

Between 2009 and 2012, Apple—the U.S.-based entity we all know and love—contributed a total of $4 billion to research and product development and had pretax earnings of $38.7 billion, according to the Senate’s investigation released Monday. That’s a cost-to-profits ratio of 7:1.

By contrast, Apple’s Ireland subsidiary, Apple Sales International, assigned $4.9 billion to R&D and returned $74 billion in pretax earnings, a cost-to-profit ratio of 15:1. The Senate report says this is evidence of Apple’s (entirely legal) evasion strategy:

The figures disclose that Apple’s Irish subsidiary, ASI, profited more than twice as much as Apple Inc. itself from the intellectual property that was largely developed in the United States by Apple Inc. personnel. That relative imbalance suggests that the cost-sharing arrangement for Apple Inc. makes little economic sense without the tax effects of directing $74 billion in worldwide sales revenue away from the United States to Ireland, where it undergoes minimal—or perhaps—no taxation due to ASI’s alleged non-tax resident status.

Cook defended Apple’s practices before a Senate panel, testifying that cost-sharing arrangements help Apple to use foreign revenues to keep high-paying R&D jobs in the United States. It’s also highly unlikely that Apple is alone among tech companies in using such methods.

It is worth noting, however, that Apple actually spends relatively small sums on R&D relative to peers like Google and Microsoft, even as it generates record profits. Last quarter, for example, it devoted 2.5 percent of its revenue to R&D, compared with Google’s 13 percent (see “Apple’s R&D Spending Rises, But It’s Still Small Change”). In light of these tax revelations, it appears that Apple is even more efficient than previously suspected at squeezing value out of its meager R&D budget.