Tech companies have been racing to acquire as many patents as possible. Last month, Microsoft announced that it had reached a monster deal with AOL, buying 925 patents from Facebook for $1 billion, and then quickly reaching a deal to share the patents with Facebook for a cool $550 million. Many, many more examples of all the top tech companies – Yahoo, Apple, Google, Motorola, RIM – buying and selling huge numbers of patents have proliferated. Many of these patents are frivolous. For example, Apple patented ‘smartphone multitasking’ and ‘swipe to unlock‘ years ago. Nevertheless, the companies have rushed to create as many patents as possible.
Why is this fight going on? The headline reason is to avoid lawsuits. These certainly happen, and are on the mind of tech executives dishing out huge sums of money to acquire libraries of patents. They are probably the biggest factor behind the tremendous value placed upon patents. But I think there is another potential, not mutually exclusive, explanation out there: tax avoidance.
The New York Times expose on Sunday showed that Apple uses patents as a key cog in its tax avoidance apparatus. In part by moving patents overseas, claiming royalties from those patents as income in offshore tax havens, and not repatriating the profits back to the United States, Apple is able to get its global effective tax rate down to 9.8%. They saved $2.4 billion in U.S. taxes in 2011 according to one estimate. Wal-Mart, a company making plenty of money, but trading and owning more physical assets than intellectual property, couldn’t get their rate lower than 24%. Not all of that can be attributed to profit shifting via patent, but the New York Times report makes it clear that patents are central,
Apple created two Irish subsidiaries — today named Apple Operations International and Apple Sales International — and built a glass-encased factory amid the green fields of Cork. The Irish government offered Apple tax breaks in exchange for jobs, according to former executives with knowledge of the relationship.
But the bigger advantage was that the arrangement allowed Apple to send royalties on patents developed in California to Ireland. The transfer was internal, and simply moved funds from one part of the company to a subsidiary overseas. But as a result, some profits were taxed at the Irish rate of approximately 12.5 percent, rather than at the American statutory rate of 35 percent. In 2004, Ireland, a nation of less than 5 million, was home to more than one-third of Apple’s worldwide revenues, according to company filings. (Apple has not released more recent estimates.)
Moreover, the second Irish subsidiary — the “Double” — allowed other profits to flow to tax-free companies in the Caribbean. Apple has assigned partial ownership of its Irish subsidiaries to Baldwin Holdings Unlimited in the British Virgin Islands, a tax haven, according to documents filed there and in Ireland. Baldwin Holdings has no listed offices or telephone number, and its only listed director is Peter Oppenheimer, Apple’s chief financial officer, who lives and works in Cupertino. Baldwin apples are known for their hardiness while traveling.
The tax benefits of holding a vast library of patents seems huge. A profitable tech company may be acquiring large numbers of patents primarily to fend off future lawsuits. But at the same time, they have to be thinking about tax benefits when trying to buy or sell them. And a really profitable company – like Apple or Google – may even see tax avoidance as the most valuable benefit from loading up on patents.
The key point to remember is that this is not ‘worldwide income’ in the sense that we traditionally think of it. Apple creates its value, by designing, researching, and manages its products, in the United States. But through creative, although legal, transfer pricing arrangements using, in part, intellectual property like patents, Apple is able to claim that their profits aren’t actually being made in the United States, and thus subject to U.S. corporate income tax. Instead they are being made in tax havens with little-to-no corporate tax. They are making some international money by selling products to real people in the real world, but that doesn’t add up to a 9.8% global tax rate.
Disclaimer: Unless specifically stated to be the views of the Task Force, the opinions expressed on this blog are solely the opinions of the individual blogger and are not necessarily those of the Task Force on Financial Integrity & Economic Development.