Apple set for showdown on Capitol Hill over corporate taxes

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A report released Monday by Senators John McCain, R-Arizona, and Carl Levin, D-Michigan, charged that Apple “has used a complex web of offshore entities — including three foreign subsidiaries the company claims are not tax resident in any nation — to avoid paying billions of dollars in U.S. income taxes.”

The report says Apple (AAPL, Fortune 500) relies on a number of unusual accounting tactics along with a handful of subsidiaries in Ireland — where it has negotiated a tax rate of less than 2% — to reduce its tax bill. The U.S. corporate tax rate stands at 35%.

One Irish subsidiary — Apple Operations International, or AOI — has no employees or presence in Ireland, holding its board meetings and keeping its bank accounts in the U.S., the senators said. AOI reported $30 billion in income from 2009 to 2012, but its management structure allowed Apple to exploit a gap between U.S. and Irish law and avoid paying taxes in either country, the report claims.

Another Apple subsidiary in Ireland, Apple Sales International, booked $74 billion in revenue between 2009 and 2012 but paid taxes only on “a tiny fraction” of that sum, the report says, generating an effective 2011 tax rate of just five hundredths of one percent. The company also ducked taxes on $44 billion in income by transferring the rights to its intellectual property though cost-sharing agreements with its subsidiaries, the senators alleged.

“A company that found remarkable success by harnessing American ingenuity and the opportunities afforded by the U.S. economy should not be shifting its profits overseas to avoid the payment of U.S. tax, purposefully depriving the American people of revenue,” McCain said in a statement Monday. The senators did not weigh in on the legality of Apple’s tactics.

Apple CEO Tim Cook will take questions from McCain, Levin and other members of the Senate’s Permanent Subcommittee on Investigations at a hearing Tuesday morning alongside Apple CFO Peter Oppenheimer and Head of Tax Operations Phillip Bullock.

In testimony posted online ahead of Tuesday’s hearing, Apple brushed off charges that it is gaming the U.S. tax system, saying it “pays an extraordinary amount in U.S. taxes” and “does not use tax gimmicks.”

The company disputed the characterization of its subsidiaries as tax shelters, saying its Irish operations employ nearly 4,000 people and “are involved in manufacturing, distribution, technical support, sales support and finance support services.”

“For cash management purposes, these subsidiaries distribute foreign, post-tax income as dividends within Apple’s corporate structure,” Apple said. “Under US tax law, these foreign intercompany payments are not taxable.”

The cost-sharing agreement with its subsidiaries, Apple added, “is authorized by US law and complies with all US tax regulations.”

“This agreement allows the Company to co-develop and share the risk of developing new products with its foreign subsidiaries,” Apple said.

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