Senator Carl Levin (D-Mich.) may have tried to take a bite out of Apple (AAPL) in congressional hearings last May examining the company’s overseas tax structure, calling it “the holy grail of tax avoidance.” However, it appears that more than just Irish eyes are smiling on the company these days, for in the eyes of the SEC, Apple’s efforts to minimize its tax burden are just fine thank you. See e.g., O’Brian, Chris, “SEC reveals review of Apple’s Irish tax disclosures.” Los Angeles Times, 3 Oct. 2013, LATimes.com, 9 Oct. 2013.
But is that the happy end of the story for Apple and the many other companies such as Google (GOOG), Facebook (FB), Microsoft (MSFT) and Oracle (ORCL) that have replicated the Double Irish structure in one form or another? Not necessarily given the continuing threat posed by a sweeping application of the economic substance doctrine. For example, does the creation of foreign subsidiaries for the primary purpose and intent of minimizing tax liabilities meet either or both prongs of the infamous two-prong test examining objective non-tax profitability and subjective non-tax intent?
It very well should if cases like IES v. Comm’r. 253 F. 3d 350 (8th Cir. 2001) and Compaq Computer Corp. v. U.S., 277 F.3d 778 (5th Cir. 2001) continue to represent the state of the economic substance law. IES’s and Compaq’s transactions were pure tax arbitrage plays whose profitability was derived solely from the monetization of foreign tax credits. Is anything conceptually different really happening here? Yes, all the fuss over the Double Irish centers around keeping profits abroad beyond the reach of U.S. tax collectors but at bottom, each situation involves ways to reduce ETR and increase after-tax net profits (presumably along with shareholder value) through effective tax structuring. At this point, the Supreme Court’s pronouncement in Gregory, v. Helvering, 293 U.S. 465 (1935), comes to mind: “The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.”
The problem is that there remains considerable uncertainty about the potential reach of the economic substance doctrine based on the plethora of less taxpayer-friendly decisions, particularly recent ones. Moreover, uncertainty about how and when the ESD could apply – along with the new strict liability penalty under § 6662(b)(6) – has only been heightened by the enactment of a statute, § 7701(o), containing far too many undefined terms. For example, left open under the codified doctrine are such critical questions as when the doctrine is relevant and what the threshold is for non-tax profits to be substantial relative to tax benefits.
Finally, as reflected by taxpayers’ unsuccessful litigation of leveraged lease (LILO and SILO) transactions, the imprimatur by a government agency blessing the transaction is no assurance that it will thereafter be respected by the IRS.
During his illustrious career, the legendary Steve Jobs was renowned for his prescience. Such talents would have come in handy in foreseeing the end to this story. For the legion of companies employing these tax strategies, the hope is for a happy ending rather than a Tofflerian “Future Shock.”