Margaret, Lady Hodge, Appears To Demand That Apple Act Illegally Over Tax

This is a rather sad commentary on the state of democracy today. For we’ve a senior UK politician, Margaret, Lady Hodge, appearing to demand that Apple AAPL +0.66% acts against international tax law when considering its price and tax policies. At the heart of this is the system known as transfer pricing: how does, how should, a corporation determine prices that one subsidiary sells to another at? Clearly this is an important point for manipulation of such prices can mean that a corporation can shift profits to pretty much any tax jurisdiction it likes.

The standard solution to this is that a corporation must treat transactions between subsidiaries as if they are being done at arms’ length: as if each subsidiary were in fact an entirely independent company, one without common ownership. Sure, this is more an art than a science because much intra-company trade is in things that simply don’t have free market prices. So there’s always going to be some estimation. But there are times when the product being traded between subsidiaries is exactly the same product as that being sold to genuine third parties. At which point that international tax law states, insists, that the sale from one subsidiary to another must be made at the same price that such a third party is being offered. Not to do so is to be in breach of those transfer pricing rules.

Which brings us to the latest blather from Margaret, Lady Hodge, and the Public Accounts Committee of the House of Commons:

Apple faced fury last night after it was revealed that it paid just £11.4million in British corporation tax last year – despite sales of a record £10.5billion.

The US technology giant rakes in billions selling its high-end gadgets but funnels its sales through Ireland to minimise its UK tax bill.

Yesterday MPs said the practice, which is also used by Google GOOGL +0.56%, was ‘less than honest’ and called on the company to pay more.

And specifically from Hodge:

Labour MP Margaret Hodge, who chairs the influential Public Accounts Committee, said: ‘It is completely outrageous. Everybody knows that they manipulate their financial accounts so that they don’t pay tax on the profits they make here.

‘It’s disappointing that the UK Government isn’t as assertive as governments elsewhere over what are obviously less than honest ways of accounting for the money they make.’

So let us examine what Apple actually does about its tax outside the US. Without getting into too much detail there is an Apple subsidiary in Ireland. Thus buys all of the components that make up iKit, contracts to have it assembled and then wholesales those completed iPhones, iPads and iMacs on to the various distributors and retailers around the world (this is, please note, only outside the US).

In most countries there is an independent sector which sells such equipment to consumers. There is also, in most countries, an Apple subsidiary (Apple, UK, Apple DE and so on) which also sells to consumers. The Apple Stores for example, online sales and so on.

It is entirely true that Apple sells to these various national companies at high prices. This means that the vast majority of the profits stay with that Apple Ireland. That they’re not taxed very much in Ireland is of course nothing to do with the tax systems of the UK, Germany or anywhere else. That they’re also not taxed in the US because they are not repatriated to the US is a feature (or bug, to your taste,) of the US tax system.

But here’s the point about transfer pricing: the price at which Apple Ireland sells to Apple UK, Apple DE, must be the same as the price at which it sells to independent retailers in those countries. For Apple not to do this would be in breach of those transfer pricing rules. It would, quite simply, be illegal for Apple Ireland to charge Apple UK more, or less, than it charges to Carphone Warehouse or any other truly independent entity.

UK retail trade that there’s not really very much margin on Apple equipment. So little in fact that no one particularly makes a profit from its supply: the margins just about cover costs and not much more. And given the transfer pricing rules this means that Apple must also charge its own subsidiaries those same prices: prices which produce almost no local profit once costs have been deducted.

Which is how we end up at this interesting position. The low margins that Apple can get away with on selling iKit to third party retailers mean that it would be in breach of transfer pricing rules if it were to deliberately use a different price to increase domestic UK (or DE etc) profits. Margaret, Lady Hodge’s, demand that Apple onshore more of its profits is thus illegal under international tax law.

And a politician insisting that a corporation must break the law is a pretty odd thing to see really. It is possible that she simply doesn’t understand the above of course but that’s not saying all that much about the health of democracy either.