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tax notes federal
Apple’s Cost-Sharing Arrangement: Frankenstein’s Monster
by Stephen L. Curtis and David G. Chamberlain

III. Apple and the Frankenstein Reg . . . . 1062
A. A Monster Tax Shelter . . . . . . . . . . . 1062
B. The 2008 CSA Transition Rules . . . . 1069
C. What Does ‘Former’ Mean? . . . . . . . 1070
D. Apple CSA Transition Failure . . . . . 1071
E. CSA and Evidence of Transition
Failure . . . . . . . . . . . . . . . . . . . . . . . . . 1073
F. Effect of Transition Failure. . . . . . . . 1078
I. Introduction
On April 13 IRS Commissioner Charles Rettig
testified in a Senate Finance Committee hearing
that the annual tax gap between the amount owed
Stephen L. Curtis is a transfer pricing and the amount paid by all taxpayers may be
economist and the president of Cross Border larger than $1 trillion, and that much of it can be
Analytics Inc. David G. Chamberlain is an attributed to high-income individuals and
assistant professor of accounting and tax at corporations.1 That projection would be more than
California Polytechnic State University in San twice the most recent IRS tax gap estimate, which,
Luis Obispo. The authors thank Jeffery Kadet for corporations, is “only” $44 billion per year
and Paul Blankfeld for their assistance and
(gross).2 However, academic estimates of
contributions to this report.
corporate offshore profit shifting alone exceed
In this two-part report, Curtis and $100 billion. Which brings us to Apple Inc.
Chamberlain break down Apple’s cost-sharing Because the IRS tax gap estimate is based
arrangement and explain how corporate largely on a small number of examination
taxpayers have been able to exploit the cost-
outcomes and appears to exclude corporate
sharing regulations to shift hundreds of billions
or even trillions in U.S. profits offshore with offshore tax avoidance, the amount of any
little or no IRS detection or enforcement. offshore tax underpayments by Apple or other
large companies included in the estimate is likely
The views expressed in this report are solely 3
zero. This is despite a conclusion by the European
the authors’ and do not necessarily reflect those Commission, based on substantial evidence
of any other person or institution.
Copyright 2021 Stephen L. Curtis and
David G. Chamberlain.
All rights reserved.
Table of Contents
1
I. Introduction . . . . . . . . . . . . . . . . . . . . . . 1049 Alan Rappeport, “Tax Cheats Cost the U.S. $1 Trillion Per Year, I.R.S.
Chief Says,” The New York Times, Apr. 13, 2021.
II. A Transfer Pricing View of Apple . . . 1051 2
IRS, “The Tax Gap” (updated Oct. 21, 2020).
A. Financial Perspective . . . . . . . . . . . . 1051 3
Treasury Inspector General for Tax Administration, “The Internal
B. Functional Perspective . . . . . . . . . . . 1056 Revenue Service Needs to Improve the Comprehensiveness, Accuracy,
Reliability and Timeliness of the Tax Gap Estimate” (Aug. 21, 2013).
TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1049
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provided by Apple, that the company underpaid iOS and Alphabet’s Android mobile operating
as much as $41 billion of U.S. taxes between 2003 systems are a duopoly that have about a 99
4
and 2014. This report finds that the true U.S. tax percent market share globally for wireless
7
underpayments could be as much as $84 billion or operating systems.
more. It further finds that those underpayments Around 2010 something interesting happened
were likely facilitated by the IRS’s failure to audit in Apple’s profit reporting. In the prior year
Apple’s apparent noncompliance with the 2008 Apple’s U.S. and foreign revenue and pretax
temporary cost-sharing transition rules on income reflected only minor differences, with U.S.
January 5, 2009, and by inaccurate or possibly revenue slightly exceeding foreign revenue, but
false documentation of the group’s cost-sharing with foreign profits having just overtaken U.S.
arrangement (CSA) as in effect from January 5, profits that year (see Table 1, derived from Apple’s
2009. Form 10-K reports). Apple’s foreign revenue was
Apple is now the most valuable company on about 92 percent of U.S. revenue, and pretax
the planet, with a market capitalization exceeding income was about 120 percent of the U.S. figure.
$2 trillion. Since the company launched the However, in 2010 Apple’s foreign revenue
iPhone under CEO Steve Jobs in June 2007, it has overtook the U.S. revenue by about 28 percent,
been a revenue and profit juggernaut. Consider and foreign pretax profits exploded — exceeding
that between June 2007 and 2015, annual iPhone U.S. profits by 135 percent. Clearly something
sales increased an astounding 16,600 percent, changed in 2010 that altered (that is, increased)
5
from 1.4 million to more than 230 million. Apple’s the trajectory of profit shifting per marginal dollar
revenue increased by 1,350 percent, and its pretax of U.S. and foreign sales. Soon thereafter, Apple’s
income by 2,330 percent, from the year before the tax arrangements began to attract attention in
launch of the iPhone through 2019. Beginning academic and practitioner circles.8 And in 2013 the
with AT&T in the United States, Apple began U.S. Senate and the European Commission each
selling iPhones in the hundreds of millions to the launched investigations into Apple’s transfer
world’s largest wireless carriers, which purchased pricing.9
them upfront to provide to customers, often with This coincided with greater scrutiny by the
multiyear wireless services contracts. The iPhone U.S. and foreign tax news media, predominantly
spawned the App Store and its walled garden, focused on apparent indications of
generating 30 percent commissions on all
purchases conducted through the store or
through apps.6 The rest is history. Today Apple’s
7
International Data Corp., “Smartphone Market Share” (Apr. 28,
2021).
8
4 See, e.g., Edward D. Kleinbard, “Stateless Income,” 11 Fla. Tax Rev.
This is based on applying the U.S. federal tax rate to the pretax 699 (2011); Michael F. Patton, “Will the New IRS Transfer Pricing
income indicated by the assessment of €13 billion in taxes to Apple’s Director Bring Sanity to the IRS’s Transfer Pricing Enforcement Efforts?”
stateless income from 2003 to 2014 at the Irish rate of 12.5 percent, using 40 Tax Mgmt. Int’l J. 537 (2011); Reuven S. Avi-Yonah, “Back From the
the dollar/euro exchange rate of $1.13 applicable in late August 2016. Dead: How to Revive Transfer Pricing Enforcement,” University of
Although the European Commission ordered Ireland to tax this income, Michigan Public Law Research Paper No. 372 (2013); Samuel Maruca,
its report stated that this was in lieu of taxation of the same profits by tax “Ineffective U.S. Transfer Pricing Enforcement One Factor Leading to
authorities in the United States or other countries, where it believed the BEPS,” 24 Transfer Pricing Rep. 892 (2015); Stephen L. Curtis, “Forensic
income should have been reported. See European Commission, Approaches to Transfer Pricing Compliance and Enforcement,” 8 J.
“Commission Decision of 30 August 2016 on State Aid Implemented by Forensic & Investigative Acct. 359 (2016); Curtis and Y. Lahav, “Forensic
Ireland to Apple,” SA.38373 (2014/C) (ex 2014/NN) (ex 2014/CP) Approaches to Transfer Pricing Enforcement Could Restore Billions in
implemented by Ireland to Apple, C(2016) 5605 final, at paras. 449 and Lost U.S. Federal and State Tax Losses: A Case Study Approach,” 12 J.
450 (Aug. 30, 2016). Forensic & Investigative Acct. 285 (2020).
5
Statista, “Unit Sales of the Apple iPhone Worldwide From 2007 to 9
Senate Homeland Security and Governmental Affairs Permanent
2018.” Subcommittee on Investigations (PSI), “Offshore Profit Shifting and the
6
Recently, Apple reduced this 30 percent to 15 percent for some U.S. Tax Code — Part 2 (Apple Inc.)” (May 21, 2013); and commission
smaller developers. There is also now considerable focus on whether decision, supra note 4. See also Jeffery M. Kadet, “Attacking Profit
Apple’s walled garden and its commission structure might be subject to Shifting: The Approach Everyone Forgets,” Tax Notes, July 13, 2015, p.
anti-competition laws. 193, which was partially inspired by the PSI investigation.
1050 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021
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noncompliance with U.S. international tax and Ireland was in fact commercialization income
transfer pricing laws by Apple, and a possible (exploitation or services income) attributable to
10 12
breakdown in U.S. transfer pricing enforcement. U.S. sources. Moreover, the European
Condemnation of Apple’s profit shifting and Commission disclosed that Apple had informed it
violation of at least the spirit of U.S. tax laws was that the functions listed in the company’s revised
almost universal, with one notable exception: the CSA contract of June 25, 2009, as being performed
U.S. Treasury Department, as part of its challenge by Apple’s Irish affiliates, Apple Sales
to the European Commission’s state aid International (ASI) and Apple Operations Europe
investigations, defended Apple’s transfer pricing (AOE), were actually performed by Apple Inc.
and international tax planning. This sort of knowingly false documentation in an
To date, there has been no definitive forensic intercompany agreement might even suggest to
transfer pricing analysis of the evidence disclosed some observers that the agreement itself is a
in the Senate and European Commission sham.
investigations — or provided by Apple in filings This report describes those findings and their
with those bodies, the SEC, courts, and other regulatory and factual support. It also provides
sources — regarding the company’s compliance additional background that may help explain
with U.S. transfer pricing laws. We undertake that how corporate taxpayers have been able to exploit
study in this report and find that Apple could be the U.S. cost-sharing regulations to shift hundreds
subject to a U.S. tax adjustment under reg. section of billions or even trillions in U.S. profits offshore
1.482-7(i)(6) that could exceed by several to foreign shell and holding companies in
multiples the amount of taxes at issue in the complex corporate tax shelters — apparently with
European Commission state aid case (now under little or no IRS detection or enforcement.
appeal) and Apple’s reserves for uncertain tax
positions. That result is consistent with prior II. A Transfer Pricing View of Apple
research that, if applied to Apple, would likely
find that much of the company’s stateless income A. Financial Perspective
is taxable in the United States because it is Table 1 shows Apple’s U.S. and foreign
effectively connected to a U.S. trade or business, revenue, U.S. and foreign pretax income, and
and that some of the rest of it is subpart F income estimates of its stateless income — all since 1992
under the foreign base sales company income (the first year after Apple’s 1991 tax ruling with
branch rule. Ireland). These figures are based on an
Alternatively, the stateless income could be extrapolation of several years of actual results
taxable in the United States under the economic disclosed by the Senate in 2013. The figures show
substance doctrine.11 Apple itself has effectively that Apple apparently reported more pretax
admitted as much in filings with the General income in what were effectively offshore tax
Court of the European Union (GCEU), indicating haven shell companies than it reported in the
that the company’s stateless income reported in United States, which is consistent with greater
foreign revenue. The location of revenue (and the
product mixes and prices on which it is based) is,
10
See H. David Rosenbloom, “Kumquat: The U.S. International Tax of course, the result of uncontrolled arm’s-length
Issues,” Tax Notes Int’l, June 25, 2018, p. 1521; Aisling Donohue, “Apple
to Argue in State Aid Case That Irish Subs’ Profit Belongs to US,” MNE transactions with unrelated customers. However,
Tax, Feb. 20, 2017; Avi-Yonah and Gianluca Mazzoni, “Taking the First the distribution of profits between Apple U.S.
Bite: Who Should Tax Apple’s $187B in Ireland?” University of Michigan
Research Paper No. 16-033 (2017); Lee A. Sheppard, “The Cracks in the group members and its foreign group members,
European Commission’s Apple Case,” Tax Notes, Jan. 2, 2017, p. 55; including tax haven shell companies (for reasons
Sheppard, “How Did We Lose the Economic Substance Doctrine?” Tax
Notes Federal, Nov. 9, 2020, p. 893; and Sheppard, “What About discussed later), is almost exclusively the result of
Cupertino?” Tax Notes Federal, July 27, 2020, p. 565. an internal transfer pricing exercise. Whether
11
In particular, Kadet, supra note 9; Kadet and David L. Koontz,
“Profit-Shifting Structures and Unexpected Partnership Status,” Tax
Notes, Apr. 18, 2016, p. 335; Kadet and Koontz, “Effects of the New
Sourcing Rule: ECI and Profit Shifting,” Tax Notes, May 21, 2018, p. 1119; 12
Rosenbloom, “U.S. International Tax Issues,” supra note 10; Sheppard, Testimony submitted to the European Court of Justice, action
“Economic Substance Doctrine,” supra note 10; and Curtis and Lahav, brought on 19 December 2016 — Apple Sales International and Apple
“Forensic Approaches,” supra note 8. Operations Europe v. Commission (Case T-892/16).
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a
Table 1. Estimates of Apple Inc. Stateless Income
($ million)
Estimated
Foreign U.S. Pretax Foreign Pretax Stateless Pretax
U.S. Revenues Revenues Income Income Income
Year (a) (b) (c) (d) (e)
1992 $3,885 $3,202 $244 $611 $306
1993 $4,388 $3,589 ($276) $416 $208
1994 $4,982 $4,206 $26 $474 $237
1995 $5,791 $5,271 $102 $572 $286
1996 $4,735 $5,098 ($1,154) ($141) ($71)
1997 $3,507 $3,574 ($780) ($265) ($175)
1998 $3,287 $2,654 $14 $315 $158
1999 $3,394 $2,740 $64 $612 $306
2000 $4,145 $3,838 $73 $1,019 $510
2001 $2,936 $2,427 ($415) $363 $182
2002 $3,272 $2,470 ($197) $284 $142
2003 $3,627 $2,580 ($158) $250 $165
2004 $4,893 $3,386 ($1) $384 $253
2005 $8,194 $5,737 $893 $922 $609
2006 $11,486 $7,829 $1,318 $1,500 $990
2007 $14,128 $9,878 $2,808 $2,200 $1,452
2008 $18,469 $14,010 $3,395 $3,500 $2,310
2009 $22,325 $20,580 $5,466 $6,600 $4,000
2010 $28,633 $36,592 $5,540 $13,000 $12,000
2011 $41,812 $66,437 $10,205 $24,000 $22,000
2012 $60,949 $95,559 $18,963 $36,800 $36,000
2013 $66,197 $104,713 $19,655 $30,500 $28,500
2014 $68,909 $113,886 $19,883 $33,600 $31,600
2015 $81,732 $151,983 $24,915 $47,600 $41,600
2016 $75,667 $139,972 $20,272 $41,100 $35,100
2017 $84,339 $144,895 $19,389 $44,700 $38,700
2018 $98,061 $167,534 $24,903 $48,000 $42,000
2019 $102,266 $157,908 $21,437 $44,300 $38,300
2020 $109,197 $165,318 $28,991 $38,100 $32,347
Total $945,206 $1,447,866 $225,575 $421,316 $370,014
Proportion of pretax income 35% 65% 57%
a
Columns (a)-(d) are from SEC filings, and results in column (e) for years 2009-2011 are actuals reported by the Senate as
exhibits to the Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations, “Offshore Profit
Shifting and the U.S. Tax Code — Part 2 (Apple Inc.)” (May 21, 2013); and remaining years are estimates based on
extrapolating the ratios established by the Senate report. An adjustment was made to reduce the stateless pretax income
beginning in 2015 due to additional Irish taxes reported by Apple.
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Apple’s profit distribution is reasonable typically subjecting those profits to a combined federal and
cannot be determined based on book income state tax rate of around 40 percent would equate
reporting alone; one would need information on to approximately $150 billion of additional taxes.
the company’s internal activities. However, the These tax benefits give Apple a substantial
information on Apple’s internal functions that is advantage over domestic competitors (which
available from reliable public sources is sufficient include domestic companies selling apps in
to allow us to draw some meaningful insights on Apple’s App Store that compete with Apple
at least a preliminary or indicative basis. offerings). One could say that around a third of
In November 2017 Apple reported that in Apple’s earnings per share is attributable to tax
response to changes in Irish tax rules in 2015 it planning. As demonstrated below, transfer
had moved the residency of its cash holding pricing appears to be a primary means of
company into the U.K. crown dependency of generating that additional net income.
Jersey (a tax haven in the Channel Islands). Apple Tables 2 and 3 are based on information that
also reported that it had restructured so that all its Apple provided in its SEC filing for fiscal 2011
Irish operations were conducted through Irish (covering its 2009-2011 tax years), including the
resident entities, and that its Irish taxes increased consolidated income statement and information
an average of $500 million per year beginning in note 8, “Segment Information and Geographic
13
after 2014. Note that before it phased out the Data,” and note 5, “Income Taxes” in that filing.
Double Irish tax avoidance structure in 2020, Importantly, in note 8 Apple breaks out the retail
Ireland established a capital allowance program segment from the geographic segments but adds
for depreciation of acquired intangible assets at a the following footnote: “The Americas asset
rate of 100 percent for intellectual property assets figures do not include fixed assets held in the U.S.
purchased by an Irish entity, including Such fixed assets are not allocated specifically to
deductibility of interest payments on intragroup the Americas segment and are included in the
loans used to purchase the IP. This made it corporate and Retail assets figures below.”
particularly tax-efficient for an Apple Irish Because the corporate and retail assets are
resident company to purchase the IP held by ASI held in the United States, Table 2 adds the
at the time of this restructuring. The role of the Americas and retail segment figures together to
Jersey affiliates in this new arrangement would capture all Apple U.S. results in the Americas
appear to be to hold cash and provide loans to the segment. Apple notes that its retail assets include
Irish resident company to fund the purchase of what are often described as flagship venues in
the CSA-related IP, thereby eliminating taxes on expensive locations, whose high costs can
most if not all of the IP income that might flow to produce perpetual losses but are often considered
the Irish resident entity. This would largely a type of corporate marketing expense that
replicate the tax benefits of their pre-2015 benefits the group’s brand. In our experience, loss-
structure, with the profits now ending up untaxed making flagship retail operations are often
14
in Jersey instead of Ireland. reimbursed by the corporate parent, which bears
Table 1 shows that Apple’s foreign the risks of what is a corporate-level flagship retail
subsidiaries are estimated to have recorded and marketing strategy. Apple in July 2011 had
around $370 billion of pretax stateless income 326 retail stores (all based on an original design by
15
since 1992 — more profits than were recorded in Jobs ) and disclosed in SEC filings that it
the United States (noting that Apple obtained its consolidated those assets into a retail segment
first Irish tax ruling in 1991, which contributed to that appears to be a U.S.-based segment that
those results). This is important because manages and controls these geographically
16
dispersed flagship and other retail operations.
13
Apple, “The Facts About Apple’s Tax Payments” (Nov. 6, 2017). 15
14 Walter Isaacson, Steve Jobs 375 (2011 Kindle ed.).
See Martin Brehm Christensen and Emma Clancy, “Exposed: 16
Apple’s Golden Delicious Tax Deals — Is Ireland Helping Apple Pay To the extent that Apple U.S. does not manage and control the retail
Less Than 1% Tax in the EU?” European United Left/Nordic Green Left segment and bear the risks of the flagship and other retail investments,
(June 21, 2018). these results in Table 2 may be inaccurate. But see infra note 17.
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a
Table 2. Marginal Rates of Return by Segment Reported by Apple Inc. (2009-2011)
($ million)
2011 2010 2009 Three-Year Change
Americas and Retail:
Net Sales 52,442 34,296 25,637 105%
Operating Income 16,882 9,954 8,335 103%
Operating Margin 32% 29% 33% 0%
% Change in Income Minus % Change in Sales -2.0%
Europe:
Net Sales 27,778 18,692 11,810 135%
% Change in Income Minus % Change in Sales 33%
Japan:
Net Sales 5,437 3,981 2,279 139%
Operating Income 2,481 1,846 961 158%
Asia-Pacific:
Net Sales 22,592 8,256 3,179 611%
2011 2010 2009 Sum
Sum of Non-Americas $23,596 $13,017 $6,357 $42,970

Op. Profit
Foreign Pretax Income $24,000 $13,000 $6,600 $43,600

(Note 5)
Difference (Non- $404 ($17) $243 $630

Operating Income)
Difference as % of Non-Americas Op. Profit 1.5%

a
Apple Inc. FY2011 Form 10-K, Note 8 (Segment Information and Geographic Data).
17
Two observations are immediately apparent. triple-digit increase in sales over the period. This
First, the Americas segment (which includes both is the opposite of the foreign segments in Europe,
North and South America but is mostly the U.S. Asia-Pacific, and Japan, which show double- or
parent), now including the retail segment, had a
decline in marginal profit (that is, the change in
profit per change in sales) over the three years,
17
and zero growth in operating margin, despite a A similar analysis was performed with the Americas segment
alone, and the results were substantially unchanged.
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triple-digit growth in these same marginal employees, executives, and assets, yet it reports
profitability metrics. only a fraction of Apple’s pretax income.
This comparison is important in a transfer Table 3 provides an additional reconciliation
pricing context because it indicates that margins of these corporate allocations, showing they are
are growing with sales outside the Americas but borne almost exclusively in the Americas segment
not within the Americas territory. Barring any (and, in particular, the United States). This
substantial differences in product mixes, this appears to be one factor in the disproportionate
would be unusual because Apple products are marginal profitability between the Americas and
mostly manufactured in the same locations at the other segments.
same costs. Given that a growth in sales requires
Table 3. Reconciliation of Estimated
growth in operating expenses, this could be
Corporate Cost Allocations
consistent with bearing an increasing share of
those marginal costs in the Americas segment, Measurement
holding down profit margins despite sales (2009 Through 2011 per Value
Calc Apple FY2011 Form 10-K) ($ mil)
growth. A second observation from Table 2 is that
the operating profit of the non-Americas (a) Americas + Retail Segment $35,171
segments over the three years as reported in note Op. Profit
8 is less than the foreign pretax income reported in (b) Total Non-Operating $896
note 5, which appears to mean that the non- Income From Income
Americas segments are (1) not bearing much, if Statement
any, of the worldwide corporate and operating
(c) Non-Americas Segments $630
expenses and (2) earning the majority of Apple’s Non-Op. Income From
nonoperating income. Table 2
Apple operates an almost completely
(d) = b - c Americas Non-Operating $266
centralized supply chain, in which almost all Income
critical internal supply chain activities are
performed, managed, or controlled by U.S. group (e) Apple US Pre-Tax Income $21,211
members. (Production of iPhones and other From Income Statement
products is outsourced to third parties, mostly in (f) = a - e + d Plug for Est. Allocations of $14,226
China, in accordance with a strategy engineered Corp. Expenses to
by Apple’s current CEO, Tim Cook — who was Americas + Retail Segment
18
hired by Jobs in March 1998 to do exactly that. ) (g) Corp. Expenses + Corp. $14,431
U.S. group members also had the preponderance Depreciation From Note 8
of the company’s fixed assets and employees
19 (h) = f/g Est. Corp. Expense and 99%
during that period. Apple U.S. is the primary
Depr. Allocations to
generator of Apple’s worldwide profits, and it Americas + Retail
performs almost all the IP development and IP Segment: % Total
exploitation activities, with the majority of
During roughly the same period, Apple
reported the following results in its schedule of
18
Leander Kahney, Tim Cook — The Genius Who Took Apple to the Next
UTPs in its SEC filings:
Level (2019).
19
The location of fixed assets is reported in SEC filings, and in
information Apple reported to the Senate in 2013. The exhibits to the
Senate report, at 17, state that Apple had 80,000 employees worldwide
and 52,000 in the United States, or a 65 percent U.S. share. This figure has
remained constant over time, because in 2019 Apple reported on its
website that its U.S. employment was 90,000 and reported in SEC filings
that its total employment in the same year was 137,000, for a U.S.
employment ratio of 65.7 percent. Apple’s centralized supply chain and
U.S. management structure has been documented in many books and
news reports. Among the most detailed is Adam Lashinsky, Inside Apple:
How America’s Most Admired — and Secretive — Company Really Works
(2012 Kindle ed.); and Lashinsky, “Apple’s Core, and Who Does What,”
Fortune, Aug. 25, 2011.
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Table 4. Apple UTP Reporting in SEC Filings
($ million)
Reductions in UTP
Additions to UTP for Additions to UTP for (assumed booked
Year Prior Years Current Year into earnings) Tax Settlements
2008 $27 $85 $81 $-
2009 $847 $151 $24 $-
2010 $61 $240 $227 $102
2011 $49 $425 $42 $-
2012 $340 $467 $117 $3
2013 $745 $626 $127 $592
2014 $1,295 $882 $284 $574
2015 $2,056 $1,278 $358 $109
2016 $1,121 $1,578 $257 $1,618
2017 $333 $1,880 $991 $539
2018 $2,431 $1,824 $2,212 $756
2019 $5,845 $1,697 $765 $852
2020 $454 $1,347 $860 $85
Totals $15,604 $12,480 $6,345 $5,230
As disclosed in SEC filings, the IRS has now United States, there is good reason to investigate
examined and closed Apple’s tax years through what might be behind the apparent U.S.-source
2015. According to those UTP figures, Apple income shifted offshore and the potential that
reported a total of $5.2 billion in tax settlements much or all of that income should have been
from all countries and states since 2007, which is reported in the United States on a current basis.
very small compared with Apple’s estimated
stateless income booked into its Irish CSA B. Functional Perspective
participants since its 1991 Irish tax ruling, as Apple is a highly centralized company, with
reported in Table 1. Moreover, Apple has added (according to sources listed below) almost
$28 billion to UTP and booked $6.3 billion of UTP complete control over U.S. and foreign operations
into earnings between 2008 and 2020. by U.S. executives and personnel, including
It seems probable that Apple’s UTP reserves generating foreign revenue and managing foreign
relate to various country- and issue-specific items production conducted by unrelated contract
and not to the general risk of its entire profit- manufacturers. Beginning with sales generation
shifting structure. This is because the UTP balance and focusing on the iPhone (Apple’s primary
of approximately $16.5 billion as of the September source of profits almost since the product’s launch
26, 2020, balance sheet date is small compared in 2007), consider that U.S. executives negotiated,
with what the U.S. tax would be on the approved, and executed virtually all the sales
cumulative $370 billion of estimated stateless contracts for iPhones to the world’s largest
income if all that income had been currently carriers. That is indicated in the following
subject to U.S. or other countries’ taxes. With published information, which includes
Apple maintaining during the European information from Apple Inc. and Apple
Commission investigation that its stateless executives, and information provided in
income is attributable to value created in the
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governmental investigations, court filings, and • “The negotiations and the signing of
news media reports: contracts with customers, such as
• “When the iPhone came out, Cook telecommunications operators . . . were
spearheaded negotiations with wireless signed on behalf of the Apple Group by
carriers around the world.”
20
Apple Inc.”25
• “Mobile operator O2 is preparing to unveil • “As of September 24, 2011, the Company
Apple’s much anticipated iPhone in the UK distributed iPhone in 105 countries through
tomorrow. . . . The UK’s largest mobile 228 carriers.”26
operator came from behind at the last In addition to negotiating, approving, and
minute to seal an agreement with Steve Jobs, executing foreign sales, U.S. executives directly
Apple’s chief executive, to market the managed foreign supply chain operations, as
iPhone in the UK. . . . The deal . . . will return described in the following anecdotal information
to Apple as much as 40 percent of any from various public sources, including published
revenues it makes from customers’ use of governmental investigations:
21
the device.”
• “Mr. Cook, who joined the company in 1998,
• “The three visits in 13 months that Cook
is the architect of Apple’s China business. As
undertook after becoming CEO are part of
head of operations, he assumed
the reason Apple was able to ink a deal in
responsibility for a company saddled with
December with China Mobile. That ended
extra inventory and reliant on its own U.S.
six years of negotiations, according to The
manufacturing plants. . . . Around 2000, he
Wall Street Journal, which has a recap of the
met Foxconn founder Terry Gou, who
most recent meeting between Cook and
would become the dominant contract
China Mobile Chairman Xi Guohua. Those
22 manufacturer in Asia. Foxconn struck deals
negotiations were started in 2008 by Jobs.”
to be one of the few manufacturers of iPods,
• Regarding getting the iPhone into Japan:
which made its debut in 2001, and an early
“According to [Masayoshi] Son, Jobs said,
maker of the iPhone, which launched in
‘We have not talked to anybody, but you
2007. . . . In 2001, Apple officially entered
came to see me as the first guy. I’ll give it to
China with a Shanghai-based trading
you.’ The negotiation continued, as Son
company.”27
asked that Jobs put in writing that Apple
• “Contracts with third-party original
would give him exclusivity for the Japanese
equipment manufacturers . . . for the
market.”23
manufacture of a large proportion of the
• “One day after announcing the iPhone
products sold by ASI, were negotiated and
would go on sale in the UK on November 28
signed by the parent company, Apple Inc.”
9th . . . Apple announced the device will hit
• “The framework agreements with the
German stores on the same day, but through
manufacturers of Apple-branded products
T-Mobile. . . . Deutsche Telekom AG’s
(or OEMs) had been concluded centrally in
[T-Mobile’s parent company] CEO Rene
respect of the Apple Group as a whole by
Obermann and Apple CEO Steve Jobs made 29
24 Apple Inc. and ASI in the United States.”
the announcement in Berlin.”
25
Apple Sales International and Apple Operations Europe v. European
20
Lashinsky, Inside Apple, supra note 19, at 96. Commission, joined cases T-778/16 and T-892/16, at paras. 300-301 (GCEU
21 2020) (Judgment of the General Court).
Richard Wray, “O2 Wins Apple iPhone Deal — at a Hefty Price,” 26
The Guardian, Sept. 17, 2007. Apple’s fiscal 2011 Form 10-K.
22 27
Connie Guglielmo, “Apple’s Cook Says iPhone China Mobile Deal Tripp Mickle and Yoko Kubota, “Tim Cook and Apple Bet
Is the Beginning of a Beautiful Friendship,” Forbes, Jan. 15, 2014. Everything on China. Then Coronavirus Hit,” The Wall Street Journal,
23 Mar. 3, 2020.
Mark Milian, “How Steve Jobs Got the iPhone Into Japan,” 28
Bloomberg, Mar. 12, 2014. Judgment of the General Court, supra note 25, at para. 301.
24 29
Mashable, “iPhone to Launch in Germany on T-Mobile,” Sept. 19, Id. at para. 381. ASI had no employees, but several directors in the
2007. United States were Apple Inc. employees.
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• “It is also apparent from that evidence that time in China, where Apple contracts with
the . . . organisation of distribution on the Chinese manufacturers to build its
33
European markets . . . had been managed at computers and mobile devices.”
the Apple-Group level by, inter alia, the • “Early in his tenure, Cook remarked at a
Executive Team . . . in Cupertino.”30 meeting with his team that a certain
• “For such a sprawling organization, Apple situation in Asia was a real problem and that
also is a headquarters-centric company. one of his executives ought to be in China
Sure, there are sales offices and retail stores dealing with it. The meeting continued for
throughout the world. And Apple has another half hour or so, when Cook stopped
established China as its base of abruptly, looked up at one of his executives,
manufacturing. But its entire management and asked in all seriousness: ‘Why are you
team is based in Cupertino. . . . Apple people still here?’ The executive stood up, drove to
board airplanes at the drop of a hat, but . . . the airport without a change of clothes, and
[m]eetings generally happen in Cupertino. flew to China.”34
Moreover, there’s a sense that only people in
31 Finally, Apple’s stateless pretax income was
Cupertino are truly to be trusted.”
generated by U.S. activities, according to the
• “The Apple approach to management and
following information, some of which was
talent development is top-down. It begins
provided by Apple executives and in sworn
with an all-knowing CEO aided by a
testimony or court filings:
powerful executive team — the ‘ET,’ as it is
• “All the functions that drive Apple’s profits
known throughout the company. ‘The
are directed by Apple Inc. executives in the
purpose of the executive team is to 35
US and performed largely in the US.”
coordinate things and set the tone for the
• “No decisions concerning the exploitation of
company,’ Jobs once said. This ten-member
Apple’s IP . . . are made in Ireland. No
group, including the CEO, comprises the
employee of the Irish branches has
heads of product marketing, hardware and
responsibility for . . . any decision associated
software engineering, operations, retail
with the right to use and exploit Apple’s
stores, Internet services, and design, all of
IP . . . [D]ecisions concerning the
whom directly have a hand in Apple’s
exploitation of Apple’s IP . . . are made in
products. They’re joined by the heads of 36
32 the US by Apple Inc.”
finance and legal.”
• “Neither ASI nor AOE is able to monitor
• “When a product is ready to leave the lab,
business risk in the absence of employees.”37
two key people will take control: an
• “Based on the facts presented to the
engineering program manager, or EPM, and
Commission, it appears that during the
a global supply manager, or GSM. . . . The
period the contested tax rulings were in
global supply manager, working on the
force the head offices of ASI and AOE
operations group that Tim Cook built, 38
existed on paper only.”
figures out how to get the materials to make
• “The applicants’ [ASI and AOE’s] profit-
it. They do everything from sourcing to
driving activities, in particular the
procurement to overseeing production. . . .
development and commercialisation of
EPMs and GSMs at Apple are based in
intellectual property (‘Apple IP’), were
Cupertino, but they spend much of their
controlled and managed in the United
33
Id. at 55.
34
Id. at 94.
35
Commission decision, supra note 4, at para. 126.
30 36
Id. at para. 300. Id. at para. 163.
31 37
Lashinsky, Inside Apple, supra note 19, at 75. Id. at para. 290.
32 38
Id. at 69. Id. at para. 281.
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States. The profits from those activities were company, would have been subject to tax only on
attributable to the United States, not the income attributable to activities in Ireland.”41
39
Ireland.” Of course, Treasury excluded from this
These examples point to a highly centralized argument any discussion of where exactly the
U.S. management and control of foreign activities that created these profits took place,
operations, including execution of foreign sales perhaps because if they took place in the United
agreements with major carriers, and the States, the income would have been immediately
management and conduct of foreign production taxable there under U.S. transfer pricing laws as
through personnel who identify sources of raw active services income — although clearly, this
materials and components and contract income was not taxed in the United States. Apple,
manufacturers, negotiate terms with them and however, answered this question with its own
execute contracts, manage and determine submission to the European court only months
inventory levels, set order quantities and timing, later, in December 2016, when it noted that ASI
oversee quality control, manage and control and AOE’s profit-driving activities — in
logistics and distribution, etc. Together with the particular, the development and
Apple group’s predominant share of employees, commercialization of Apple IP — “were
assets, and expenses in the United States, this controlled and managed in the United States. The
would indicate that the foreign segment profit profits from those activities were attributable to
results shown in Table 1 are largely the product of the United States, not Ireland.”42
an internal transfer pricing exercise that Apple appears to be stating that the stateless
underallocates U.S. commercialization expenses income booked into Ireland was indeed the direct
to foreign affiliates while overvaluing the IP rights result of ASI and AOE’s businesses being
in the hands of the Irish affiliates. conducted on their behalf by Apple U.S.
The super-profitability of these foreign personnel and U.S.-located ASI and AOE
affiliates stands in stark contrast to the central and directors (who were also senior personnel of
almost exclusive role of Apple U.S. in generating Apple Inc., according to the Senate investigation),
these foreign profits while earning what appear to although there appeared to be at least one Irish
be much lower profit levels. This mismatch seems director at each company.43 Importantly for tax
extreme and at odds with the small tax law interpretation, with ASI and AOE being
settlements of only $5.2 billion shown in Table 4, disregarded-entity subsidiaries of Apple
especially considering that the European Operations International (AOI), the controlled
Commission’s investigation and Apple’s later foreign corporation, the U.S.-located ASI and
submissions to the GCEU established that very AOE directors are properly characterized for tax
few U.S. commercialization and head office purposes as AOI employees (or at least agents)
expenses had been charged by Apple U.S. to its who have management responsibility for AOI
Irish affiliates.
40 divisions. This means that AOI has employees (or
agents) physically within the United States
In contrast to all this evidence, Treasury has
conducting regular business activities.
strongly defended Apple’s position in Ireland’s
dispute with the European Commission. Treasury It seems probable that by the time Apple made
wrote a white paper in August 2016 that it this statement, it had already reached an
submitted to the GCEU in support of Apple’s agreement with the IRS on the years to which the
defense against the state aid investigation. The statement applied (that is, through 2014).
white paper stated: “Under Irish law, an Irish non- Nevertheless, this statement is at odds with what
resident company, just like any other non-resident Apple told the Senate in May 2013, when it stated
41
Treasury, “The European Commission’s Recent State Aid
39 Investigations of Transfer Pricing Rulings” (Aug. 24, 2016).
Testimony submitted to the European Court of Justice, supra note 42
12. Testimony submitted to the European Court of Justice, supra note
40 12.
See, e.g., commission decision, supra note 4, at paras. 181, 313, 316, 43
and 450. Senate investigation, supra note 9, at 21 and 24.
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under oath that the stateless income reported in in Ireland for which Ireland had issued its private
Ireland was foreign-source income, qualifying for rulings. (The European Commission investigation
deferral from U.S. taxation: and the later GCEU opinion focused on just the
two disregarded entity subsidiaries — AOE and
International operations accounted for 61
ASI — in contrast to the U.S. treatment of those
percent of Apple’s revenue last year. . . .
subsidiaries as mere divisions or branches of AOI.
These foreign earnings are taxed in the
From a U.S. perspective, some of the totality of the
jurisdiction where they are earned
income would be attributable to AOI’s other
(“foreign, post-tax income”). . . . Apple
check-the-box subsidiaries in Europe and the rest
carefully manages this foreign, post-tax
44 of world.)
income to support its foreign operations.
Although the commission’s decision and the
While the concept of stateless income has GCEU’s opinion do not provide details, it is likely
generally been taken to mean that the income in that ASI and AOE earn income both from selling
question is not taxable in any state under the laws tangible and intangible personal property and
of those states, Apple is conveying the exact from performing cloud transactions that would be
opposite. In other words, Apple is representing to classified as services.46 Under U.S. laws, various
authorities in each “state” (in this case, each state source rules apply to these sales and services
being represented by the Senate and the European income in the hands of ASI and AOE. Given the
Commission) that the income in question was in extent of sales and production activities in the
fact earned in and taxable under the laws of the United States for both tangible and intangible
other state. This is a much different argument property sales, as well as the management and
than claiming that the income is not taxable in any operation within the United States of the various
state. Apple internet-based platforms through which
Note that under U.S. income sourcing laws, IP services are provided to customers worldwide, a
income is sourced where the IP was used. So if the considerable portion of ASI and AOE’s gross
income in question was license fees earned by the income should be U.S.-source.47
Irish affiliate for IP licensed to third parties in its Consistent with this, an Irish tax journal
territories, it would be foreign-source income in looked at Apple’s submission with more scrutiny
45
the hands of ASI and AOE for U.S. purposes. It than was apparent from U.S. tax authorities:
would also be foreign-source income when Irish
affiliates use the IP to conduct manufacturing For the first time, Apple has expressly
(whether directly or through unrelated contract attributed the profits of its Irish
manufacturers) and sales, which is contractually subsidiaries to the United States . . . the
what has occurred. Apple’s filing with the GCEU commercialization of the IP happening in
did not address IP income because it the US . . . the US is driving sales,
appropriately claimed, based on the contractual negotiating contracts, etc., for the rest of
form, that the income reported in ASI and AOE the world. Apple must have a high degree
was exploitation income related to the IP rights of comfort that the IRS is okay with this
48
they hold under the group’s CSAs. Apple’s filing argument.
addressed the commercialization (or IP The European Commission concluded that
exploitation) income that arose from the activities the stateless income allocated to the nonexistent
that took place in the United States that generated head offices of ASI and AOE under the tax rulings
the totality of the income in question, except to the was effectively characterized in Ireland as
extent of the routine functions actually conducted payments for services that were performed by
Apple Inc., but fees for those services were never
44
Senate investigation, supra note 9, at 2 and 8 (Apple Inc. testimony).
45 46
The Senate investigation, supra note 9, makes clear that ASI and See prop. reg. section 1.861-19.
AOE are disregarded entity subsidiaries of AOI. Although AOI is the 47
See section 865(e)(2) and reg. section 1.861-4(b)(1).
taxpayer for U.S. tax purposes, we sometimes refer to ASI or AOE 48
despite the fact that AOI is the true taxpayer from a U.S. perspective. Donohue, supra note 10.
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remitted to Apple Inc., a fact that was supported could also be seen as a violation of the 2008 cost-
by the analyses presented earlier and by Apple’s sharing regulations under reg. section 1.482-
submissions to the GCEU. The commission 7(a)(3)(iii), which state: “Controlled transactions
described this situation as “fictitious between controlled participants that are not PCTs
remuneration” that was in effect taken as a or CSTs [platform contribution transactions or
deduction against Irish taxable profits (through cost-sharing transactions] . . . require arm’s length
the division of profits between the nonexistent consideration under the rules of sections 1.482-1
head offices, and Irish branches allowed for each through 1.482-6, and 1.482-9.”
company under the rulings) but never paid to There is some debate about why Treasury
Apple Inc. Based on the commission’s findings, included this regulation. It seems superfluous in
these “expenses” appear to provide a value for that it simply restates the existing U.S. compliance
virtually all of Apple Inc.’s commercialization and requirements for transfer pricing in general. The
headquarters services that generated AOI’s consensus view that emerged after discussions
stateless income. In other words, the only with the reviewers of this report is that two
payments to Apple Inc. by ASI and AOE were objectives are apparently connected to the
payments under the CSA and some intercompany addition of this separate provision within reg.
marketing expenses. There was little or no section 1.482-7T, addressing this requirement
payment by AOI or its disregarded entity within the cost-sharing regulations:
subsidiaries to Apple Inc. for the day-to-day 1. If one scrutinizes the calculations for a
actions of its personnel that exploited ASI’s and periodic trigger under reg. section 1.482-
AOE’s IP on their behalf. Referring to earlier 7(i)(6), this trigger can be generated by
proceedings, the European Commission stated: violations of reg. section 1.482-1 through
The Commission then explained, in -6 and -9 that cause the foreign CSA
response to claims made by Apple in its participant division profit to exceed the
observations on the Opening Decision, actually experienced return ratio (AERR)
that functions performed by Apple Inc. limitations, and Treasury is alerting
employees are outside the scope of the taxpayers to the fact that a violation of
assessment of the contested tax rulings: these regulations could trigger a violation
“fictitious remuneration for services of reg. section 1.482-7(i)(6); and
provided for free by the group employees 2. those violations could give the IRS more
to the supposed benefit of ASI or AOE power to invalidate CSAs or prevent their
cannot reduce the profits to be allocated grandfathering under the 2008
between the ASI and AOE head offices regulations, because taxpayers were
and their respective branches.” explicitly required to substantially comply
with this very regulation, according to reg.
... section 1.482-7(m)(1).
The terms of those agreements . . . were That transition rule reads in part: “An
not in line with a level of contribution that arrangement in existence on January 5, 2009, will
would have been agreed between be considered a CSA . . . only if the activities of the
independent companies negotiating at controlled participants substantially comply with
arm’s length . . . because Apple Inc. the provisions of this section . . . by July 6, 2009.”
employees performed activities for the If a significant portion of Apple’s stateless
benefit of ASI and AOE beyond the income was represented by uncharged or
remunerated contributions covered by the unallocated U.S. commercialization and head
CSA.
49
office services expenses in violation of reg. section
1.482-9, -4, or other sections, as Apple has
It is unclear whether such a violation of U.S. represented to the GCEU, that would appear to
transfer pricing laws — if flagrant enough — run afoul of reg. section 1.482-7(a)(3)(iii) — which
is one of “the provisions of this section” for which
49 such noncompliance can result in a failure to
Commission decision, supra note 4, at paras. 181 and 450.
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comply with reg. section 1.482-7(m)(1) and in a years in question with only de minimis
loss of the attendant compliance benefits. adjustments, if any, as mentioned around the time
53
Despite the European Commission’s of these various statements.
identification of what appeared to be violations of As noted earlier, the commission’s state aid
the U.S. transfer pricing regulations by Apple Inc., investigation revealed several potentially serious
a Treasury lawyer (presumably speaking for the violations of U.S. laws that could be problematic
IRS) claimed that the U.S. government could not for Apple if the IRS and Treasury were to reverse
perform an analysis of Apple’s transfer pricing to course and examine this evidence under
50
determine if Apple broke any U.S. laws. It is not applicable regulations. Facts coming to light since
clear why that would be the case, given that Apple 2016 suggest that the IRS may simply have never
told the Senate in 2013 that it was regularly examined Apple’s transition to the 2008 CSA
51
examined by the IRS. Even then-Treasury regulations, the functions borne by its CSA
Secretary Jacob Lew spoke up around the same participants, and whether those functions
time, saying: “The European Commission’s complied with regulations or were accurately
finding that Apple received illegal state aid from represented in relevant documents.
Ireland to the tune of €13 billion represents an These types of risks prompted Congress in
52
attempt to tax income that belongs to the U.S.” 1986 to mandate the commensurate-with-income
Treasury appears to be maintaining that (1) standard, which is embodied in the periodic
54
Apple’s transfer pricing was compliant with U.S. adjustment regulations, so that these mistakes
laws; (2) Apple’s stateless income recorded within could be corrected in a practical manner in future
AOI and its disregarded entity subsidiaries was years. However, there is no evidence that the IRS
properly deferred under the U.S. deferral tax has ever enforced the commensurate-with-
regime; (3) Treasury agreed with Ireland that the income rules in any prior cases or in connection
Irish income was properly stateless because it was with the 2008 CSA regulations. And Treasury and
taxable in neither the United States nor Ireland; the IRS’s enforcement approaches to CSAs have
and (4) the income belonged to the United States failed to reduce outbound profit shifting.
by virtue of the U.S. right to tax the income when The situation at Apple highlights the many
repatriated as a dividend (or a deemed dividend). unintended consequences of the reg. section
These arguments are the foundations of 1.482-7 cost-sharing regulations — a beast of a
Treasury’s challenge to the European regulation whose flawed design produces exactly
Commission’s state aid investigations into Apple the opposite of its intended effects in a way that
and other U.S. companies. We must take from perfectly personifies a Frankenstein regulation.
Treasury’s comments that it and the IRS had no
intention of ever examining the commission’s III. Apple and the Frankenstein Reg
allegations of U.S. tax law violations by Apple
Inc., and indeed the IRS closed its exams of the tax A. A Monster Tax Shelter
Consider the following two comments in 2016
concerning the European Commission’s state aid
case against Apple Inc. and the Irish government.
Importantly, the text describes Apple’s two cost-
53
The commission’s investigation covered years through 2014;
however, Apple’s September 2016 Form 10-K reported that the company
had settled tax years through 2009 with the IRS before the commission’s
August 2016 report, and had partially settled 2010 through 2012 by the
time of the report. It settled the remainder of the years covered by the
50 European Commission investigation by September 2018, while the
William Hoke, “State Aid Decisions Defy Transfer Pricing Analysis, commission decision was under appeal. One can only conclude from
Treasury Says,” Tax Notes, Oct. 10, 2016, p. 220. these events that the IRS exams proceeded independently of the
51
Senate investigation, supra note 9, at 10. European Commission investigation and did not consider the evidence
52 of U.S. tax violations produced by the commission.
Alexander Lewis, “Apple’s Income Should Be Taxed in U.S., Not 54
Ireland, Lew Says,” Tax Notes, Sept. 5, 2016, p. 1341. Reg. section 1.482-4(f)(2) and -7(i)(6).
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sharing participants, ASI and AOE, as they Apple Inc. that have not been detected by the IRS
existed at least up to 2014 (the final year covered on examination.
by the commission’s state aid investigation). Lee The fact that AOI, long after reg. section 1.482-
A. Sheppard noted: 7T became effective in 2009, paid for only a
AOE and ASI were cash boxes . . . lacking portion of the total exploitation expenses that
substance. . . . Bare financial capacity was generated its territory profits (that is, primarily
regarded as good enough to be deemed to exploitation expenses that were direct costs
bear risk under U.S. transfer pricing rules within AOI’s disregarded entity subsidiaries and
at the time (Veritas, 133 T.C. 297). . . . AOE not the expenses expended by U.S. group
and ASI were hollow corporations, and all members) raises the question whether Apple’s
management and decision-making for cost sharing was in compliance with some aspects
them took place in Cupertino. . . . The of the 2008 cost-sharing regulations. In particular,
commission found no evidence of separate if Apple did not comply with the transition rules
remuneration beyond the cost-sharing of reg. section 1.482-7T(m)(1), its CSA could be
payments.
55 subject to a periodic adjustment under reg. section
1.482-7(i)(6). Further, even if the IRS were to make
Reuven S. Avi-Yonah and Gianluca Mazzoni a significant section 482 adjustment for the
commented that “95 percent of Apple’s research services Apple Inc. has conducted for AOI, the
and development was conducted in the United periodic adjustment rules of reg. section 1.482-
States, making Apple’s arrangement with ASI 7(i)(6) would still apply, as discussed later.
closer to a cost reimbursement where ASI simply The 2008 temporary cost-sharing regulations
received a contribution from Apple Inc. and paid were perhaps the most important upgrade to
56
it back.” these rules since their origin in the 1968 transfer
It is almost beyond belief that these two 57
pricing regulations. However, that substantial
companies (or more precisely, AOI, which is the upgrade was one in a long list of modifications
CFC taxpayer as a result of the check-the-box that tried, unsuccessfully, to repair what many
elections for AOE, ASI, and other AOI direct and believe was a disastrous regulation for tax
indirect subsidiaries that conduct operations) enforcement. Perhaps more than any other, this
made only cost-sharing payments (and some regulation is a classic example of a Frankenstein
marketing payments, according to the European regulation.
Commission’s state aid decision) and apparently In Mary Shelley’s 1818 Gothic novel
paid nearly zero remuneration to Apple U.S. for Frankenstein, the scientist Victor Frankenstein
managing and executing Apple’s global supply sought to overcome, and in some ways reverse,
chain. Because of this, Apple U.S. was left to bear the laws of nature and create something he
significant operating expenses that supported believed would be magical and wonderous —
AOI’s revenue stream, but without any something that would establish him as one of the
remuneration from AOI or its disregarded entity great scientists of all time. However, his
subsidiaries. This could represent a substantial undertaking, which technically succeeded
enforcement failure that helps explain why Apple spectacularly, instead created a monster that he
Inc. may now have a periodic adjustment. Note rejected, causing unforeseen and disastrous
that even if the IRS addressed any unallocated consequences he could not control. What started
commercialization or head office services, the out as a vain endeavor wrought from hubris and
existence of a periodic trigger would indicate overconfidence became a curse he would greatly
additional undercompensated or uncompensated regret:
PCTs and routine or nonroutine contributions by
55
Sheppard, “Commission’s Apple Case,” supra note 10.
56
Avi-Yonah and Mazzoni, “The Apple State Aid Decision: A Wrong 57
Way to Enforce the Benefits Principle?” Tax Notes Int’l, Nov. 28, 2016, p. Alex Naegele, “Cost Sharing Arrangements: The Case for Formula
837. Apportionment Transfer Pricing,” J. Int’l Tax’n 28-60 (Dec. 2010).
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What had been the study and desire of the the research is unsuccessful, then the taxpayer
wisest men since the creation of the world, risks losing its ability to deduct the costs sent
was now within my grasp. . . . The offshore (the deduction is shifted to the CFC,
61
materials present within my command which does not have U.S.-source income).”
hardly appeared adequate to so arduous There are at least five immediate problems
an undertaking; but I doubted not that I with these lines of thought:
58
should ultimately succeed. 1. It was not basic theoretical or exploratory
... research that was conducted within the
typical CSA; rather, it was applied
A flash of lightning illuminated the object, research focused on specific products that
and discovered its shape plainly to me . . . were inserted into a CSA only if there was
more hideous than belongs to humanity, some expectation that further R&D
instantly informed me that it was the activities would not result in failure.
wretch, the filthy daemon to whom I had Accordingly, there were too often
given life.59 spectacular successes in which the profits
Perhaps similarly, the reg. section 1.482-7 shifted offshore were exponential
qualified cost-sharing regulations first emerged multiples of the forgone U.S. R&D
from a laboratory deep inside Treasury around deductions.
1968 and immediately unleashed hideously 2. These new R&D activities, especially in
unenforceable tax-shelter-like outcomes that high tech, led to an ever-growing share of
defied — actually reversed — the laws of successful R&D in a virtuous circle of new
economics and the arm’s-length principle. This and successful versions, upgrades, and
was a regulatorily authorized transaction that no extensions (such as the iPhone, search
corporate taxpayer in its right mind would even algorithms, or social networking
think of doing with an unrelated counterparty. websites).
Treasury obviously envisioned a transaction it 3. The system was easily gamed because
would create out of thin air (because it had no much if not most R&D was already
counterpart in the real world) that would focused on successful products. Initial
accomplish something that it must have thought research on a project is often conducted
would improve tax administration. Instead, the solely by the U.S. parent and moved into a
CSA transaction authorized by Treasury achieved CSA with a foreign group member only
exactly the opposite of what transfer pricing laws when there is some belief in the ultimate
are supposed to do — prevent uncontrolled profit success of the project. The recorded buy-in
shifting. price of the platform contribution at the
One tax expert put it bluntly: ”Cost-sharing time the project is moved into the CSA is
has been an expensive mistake. It enables then set at an artificially low amount.
multinationals to shift the profits from intangibles Although a common refrain posits that 90
developed in the U.S. offshore without incurring percent of all R&D is unsuccessful, or
any serious risk of losing the R&D deductions.”60 something to that effect, in these
Another comment hints that Treasury may have arrangements, over time the majority if not
believed that cost sharing would produce a net all of the CSA-related R&D spending by
benefit to the United States by shifting research the participants is successful — often
and development deductions offshore: “Why spectacularly.
would the IRS regulations permit this? Because if 4. To the extent that R&D activities are not
the primary value driver in an enterprise,
the regulation produces a massive
58
Shelley, Frankenstein, Vol. I, Ch. III, at 32 (1996 edited version).
unsupported-by-the-facts tax giveaway
59
Shelley, Frankenstein, Vol. I, Ch. VI, at 50 (1818).
60
Avi-Yonah, “Amazon vs. Commissioner: Has Cost Sharing 61
Outlived Its Usefulness?” University of Michigan Public Law and Legal Avi-Yonah and Mazzoni, “The Apple State Aid Decision,” supra
Theory Research Paper No. 551 (May 2017). note 56.
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(for example, the significantly effective This expensive mistake arising from, in effect,
supply chain structure developed, betting on the failure of U.S. R&D efforts has been
managed, and conducted daily from one large factor behind the estimated $100 billion
Cupertino by Apple Inc. personnel, and or more in annual tax underpayments from
the capabilities of its management offshore profit shifting, as shown in Figure 1 —
executives such as Jobs and Cook, which estimates that are not included in the IRS tax gap
are widely credited for Apple’s success estimate.
and high profitability). If taking a follow- According to a former IRS international
the-money approach to the importance of examiner, the 2008 temporary cost-sharing
commercial functions to profitability, regulation was so complex and distortive that it
R&D might often be way down the list — was difficult to even read and impossible to
behind key executive functions, supply enforce. The level of complexity and workload it
chain, possibly marketing, and other placed on examiners (some of whom may manage
functions — where executives are more as many as 50 examinations at once) was so great
highly paid and the corporate that it was beyond any resources the IRS has ever
expenditures are much greater. The choice had. Even the examples in the 2008 regulations
to write a regulation focused only on the were of no use in practice because most
sharing of R&D expenses that has resulted implemented CSAs looked nothing like the ones
in asymmetric profit-shifting externalities described. For instance, the 2008 cost-sharing
seems ill-informed at best. regulations contain at least 40 separate examples
5. Successful R&D produces asymmetric of various applications of the regulations. In every
returns that are often multiples of the example, the foreign CSA participant performs as
limited R&D deductions moved offshore. an independent taxpayer its own physical use or
The IRS’s response to the disastrous out-of- exploitation of the CSA-covered IP through that
control profit shifting produced by these participant’s own production, distribution, or
regulations was to try to vastly increase CSA buy- other applicable functions. In many cases, the
in payments beginning around 2007 in ways that foreign CSA participant even brings valuable self-
might recoup the future profits into the United developed intangibles that are independent of
States. The IRS tried to extend the scope of the those developed by the U.S. participant to the
buy-in payment and considered unspecified arrangement. Despite all these examples, the most
62
methods to be the best method for IP buy-ins. common application of the CSA regulations was
This response was costly and time-consuming, exactly the opposite — where the U.S. parent
such that the IRS could try to apply it only to a performs both the IP development and much or
relatively few taxpayer groups. Moreover, the Tax all of the IP exploitation. The CSA mechanism has
Court and the Ninth Circuit were unsympathetic been used as simply one component of profit-
to the strategy.63 In any event, the regulatory shifting arrangements that siphon profit from
monster was already long out of the bag and loose mid- and high-tax countries, where real
on the rampage; the tax losses could not be operations take place, to tax haven shell
64
staunched. A complete rethink was needed if companies — such as Apple’s arrangement, but
Treasury was not going to simply repeal these also those of Google, Facebook, and others. If ever
regulations. The 2008 temporary regulation was a tax rule personified a Frankenstein regulation,
that rethink. this is it.
62
IRS, “Coordinated Issue Paper — Section 482 CSA Buy-In
Adjustments,” LMSB-04-0907-62 (Sept. 27, 2007). See also Rocco V. Femia
and David Blair, “Hazards Ahead: The IRS’s Coordinated Issue Paper on 64
In her work before becoming Treasury deputy assistant secretary
Cost-Sharing Buy-In Payments,” BNA Tax Management Memorandum for tax analysis, Kimberly A. Clausing calculated that roughly two-thirds
(2008). of the real activities that earned these zero- and low-taxed profits took
63
See Veritas Software Corp. v. Commissioner, 133 T.C. 297 (2009); and place within the United States. See Clausing, “5 Lessons on Profit
Amazon.com Inc. v. Commissioner, 148 T.C. 108 (2017), aff’d, 934 F.3d 976 Shifting From U.S. Country-by-Country Data,” Tax Notes Federal, Nov. 9,
(9th Cir. 2019). 2020, p. 925.
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One reason this regulation is so calamitous is regulations do require payment for platform and
that it actually reverses the arm’s-length standard. other contributions, but in practice, this
Take, for example, a paper company with no requirement has in no way created real arm’s-
employees that owns no valuable intangible or length results. Rather, the CSA regulations
tangible assets, makes no operational provide a tool that has been aggressively used to
contributions, and neither manages nor controls implement profit-shifting structures that often
any exploitation activities (meaning the existence violate other regulations and statutes, such as
of other affiliates under its control with sufficient effectively connected income and economic
substance to exploit the IP). At arm’s length, that substance.
company should have no bargaining power or In Apple’s case, between 2009 and 2011 for
competitive advantage that would enable it to instance, its total operating expenses (including
force the much larger and more capable parent R&D) were $22.8 billion, but R&D development
company to pay over the majority of its profits for was only $5.5 billion of that, or about 24 percent.
a simple cash contribution for a fraction of its It is an open question why Treasury decided to
operating expenses (that is, solely a portion of its apply a formula apportionment method (that is,
R&D costs, which may be a small portion of total apportionment based on reasonably anticipated
operating expenses). The regulation also treats the benefits) to only that 24 percent of operating
R&D function as paramount, ignoring in expenses and then attribute to that particular
particular the exploitation function that often subset of costs all revenue and profits from
represents the bulk of other operating expenses foreign territories that immediately shifted to the
after the execution of the CSA. Yes, the current foreign CSA affiliate. Apportioning all operating
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expenses may have been better than the ultimate with a level of speed, quality, and profitability that
result in which, in some cases, such as Apple, the was truly astounding. Research firm Gartner
R&D allocations were effectively the only ranked Apple’s supply chain the best in the world
expenses apportioned against the shifted foreign from 2010 to 2013 — a period encompassing 700
revenue. percent growth in shipments of the iPhone from
66
As to Treasury’s selection of the R&D function 20.7 million to 150.2 million. Jobs and Cook were
as being more important to profits than any other management executives. R&D is important, but it
corporate function (because whomever pays for is always only a piece of the puzzle.
the R&D earns the rights to all the profits, By assuming that the value of people like Jobs
regardless of whether they originated from this or Cook to profits is approximately zero (or
R&D), one only need look at the development of perhaps no more than the cost of a portion of their
the iPhone. This was not Apple’s first attempt to compensation as assumed in reg. section 1.482-9),
build a smartphone. In fact, as early as 2004, and that the functions of the R&D department are
Apple began creating a smartphone in a worth the entire profits of the enterprise by fiat of
partnership with Motorola (a maker of wireless a CSA election, the cost-sharing regulations
handsets) and Cingular (a provider of wireless override the arm’s-length principle and are
services), with Apple developing the software. fundamentally flawed to the point of being
The result was the Motorola Rokr, and it failed in catastrophic to tax administration. Taxpayers
the market. The success of the iPhone in 2007 know this and exploit these regulations to transfer
compared with the failure of the Rokr in 2005 windfall profits to tax haven shell companies for
cannot be attributed to any change in R&D bearing only a sliver of the company’s U.S.
activities, but instead to executive decisions by expenses through a cash contribution the
Apple’s CEO. company could frankly obtain from a bank at
Jobs realized that to develop the iPhone that single-digit interest rates.
he envisioned and to achieve its full potential, he Other particularly important functions of
would need to wrest control of the operating companies (for example, creation and day-to-day
system from the wireless carriers. This was management of the supply chain;
because before the iPhone, handset makers had to commercialization, including sales activities; and
design their devices to work within the executive functions) were historically (before the
limitations of each carrier’s network, which 2008 CSA regulations) not explicitly within the
reduced innovation of the devices. Jobs scope of the CSA regulations but were covered by
understood that the device he envisioned would other transfer pricing regulations, such as reg.
reverse this arrangement and make the handset section 1.482-9 and -4. This report shows how that
and its apps more important than the network, loophole was exploited by Apple Inc. and AOI,
which would become a commodity that had to capitalizing on the fact that these activities might
conform to the iPhone’s requirements and rarely be examined in an audit of the CSA activity
operating system. And he was prepared to because of these flawed perceptions and
transform Apple into a wireless carrier to release examination guidance (such as the coordinated
65
the company from these design constraints. issue paper mentioned earlier). Would Apple ever
These were management decisions — not R&D pay Google, for instance, or two guys working out
decisions. It seems clear that Jobs was likely the
single most important factor in the creation of the
iPhone and Apple’s subsequent business success.
He was a management executive who oversaw
the design, R&D, production, and sales strategies
of the iPhone, and together with COO Cook built
a world-leading supply chain to get it to market
65
Fred Vogelstein, “The Untold Story: How the iPhone Blew Up the 66
Wireless Industry,” Wired, Jan. 9, 2008. Statista, supra note 5.
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of a van in Dublin, the majority of its worldwide recognition by many taxpayers despite those
income for setting up a shell company and important contributions being subject to other
running a loan through it? Because that is exactly relevant section 482 regulations.
67
how many CSAs work. In the case of Apple, it appears that AOI paid
Note that in a conventional joint development almost nothing for the various routine and
agreement among unrelated parties, each party nonroutine commercialization functions
brings to the table nonroutine, high-value assets performed within the United States. Another
that, when combined, create synergies. The example is Caterpillar’s Swiss strategy, described
arrangement is almost always structured as a in connection with a report from the Senate
profit split, generally aligned with the bargaining Homeland Security and Governmental Affairs
power or the relative value of the contributions by Permanent Subcommittee on Investigations (PSI).
each party. An excellent example is a 2001 joint Although the profit-shifting structure did not
development and commercialization agreement involve a CSA, it was disclosed that an
involving Bayer AG and CuraGen Corp. CuraGen intercompany service agreement valued the U.S.
was responsible for identifying several gene and management, supply chain, inventory
protein targets for which Bayer then developed management, and other major functions as being
69
small-molecule compounds that could bind to worth only cost plus 5 percent. Too often in CSA
those targets. Both parties also engaged in arrangements, but also in non-CSA contexts (such
commercialization efforts, with profits split in as IP licensing arrangements), the foreign
proportion to the costs represented by these participants in these transactions can earn the
68
widely divergent but nonroutine contributions. majority of profits from the arrangement while
Note that: undertaking few of the operational or financial
• the respective costs were for completely contributions and related expenses that in fact
70
different activities, but included all generate the foreign affiliate’s profits.
activities, including commercialization; Real-world taxpayers and their accountants
• the different activities by each party were could not fail to see this mistake, yet over the past
each nonroutine and not easily replicated by 30 years or so, Treasury has found it impossible to
the other party or by competitors; and repair these regulations to produce arm’s-length
• each party made valuable IP development
and exploitation contributions to the
arrangement.
This differs significantly from a common
intercompany CSA under reg. section 1.482-7, in
which only one party might perform all the IP
development and a significant portion of the
exploitation activities. Highly important
contributions to profits (in particular,
management and operation of the supply chain
and group internet-based platforms) are
effectively ignored or given less than cursory
67
Google’s CSA was described by Facebook’s COO as “tax breaks to
run international revenues through” in an internal email describing how 69
Google set up an Irish shell company only three months before entering PSI, “Caterpillar’s Offshore Tax Strategy: Majority Staff Report,” at
into a CSA with the U.S. parent that eventually shifted more than $100 39 (Apr. 1, 2014).
billion in profits to this entity. This email was disclosed in the ongoing 70
Recent examples of this include Pfizer, which reported $43 billion
Facebook Tax Court case (Facebook Inc. v. Commissioner, Dkt. No. 012738- in U.S. pretax losses and $190 billion in foreign pretax income from 2008
18 (T.C.)). through 2020; AbbVie Inc., which reported $76 billion in foreign pretax
68
See also Joseph Schohl, “Working Together in the Pharmaceutical, profits and $20 billion in U.S. losses from 2011 through 2020; and
Biotech and Medical Device Industries: Contractual Terms and Medtronic PLC (Medtronic Inc., before 2015), which reported $300
Conditions,” Northwestern University Independent Study Project (Aug. million in U.S. losses and almost $16 billion in foreign profits between
2004). 2017 and 2019.
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outcomes. It should be no surprise that academics even if the IP development function is not the
and practitioners have been calling for the repeal most important contributor to profits.73
71
of these regulations for years. A highly esteemed Unlike the monster created by Dr.
tax policy expert stated the following about these Frankenstein, which eventually gets onto a ship
arrangements in 2011: and sails into oblivion, these cost-sharing
The most remarkable aspect of the entire regulations shamble along and won’t die or leave.
structure . . . is the ready acceptance by Nevertheless, Treasury has continued to work on
countries of the fantastic notions that (i) a them, and in 2008 made two important changes
wholly-owned subsidiary has a mind of its that were just ingenious enough that they could
own with which to negotiate “arm’s- — if enforced — reverse at least two of the most
length” contractual terms with its parent, disastrous aspects of the regulations. The first was
(ii) capital provided to the subsidiary by the addition of the reg. section 1.482-7T(m)
the parent somehow becomes the transition rules, which were clearly designed to
property of an independent actor (the end the no-substance CSAs with shell companies.
subsidiary) with which it can take The second was the addition of the reg. section
business risks that for tax purposes are not 1.482-7T(i)(6) periodic adjustment rules to
simply assimilated into those borne by the implement a CSA-specific commensurate-with-
parent (as both provider of the capital and income rule, which simply limited the amount of
ultimate economic owner of the assets profits that could be transferred offshore through
acquired therewith), and (iii) a a CSA. Perhaps the monster could be tamed?
multinational enterprise that exists as a
B. The 2008 CSA Transition Rules
global platform to exploit a core set of
intangible assets best is analogized to The 2008 temporary cost-sharing regulations
wholly independent actors taking on were issued as T.D. 9441 on December 31, 2008,
limited and straightforward roles in a and published in the Federal Register January 5,
vertical chain of production or a 2009. They contained the following transition
horizontal array of distribution of a rules, which remained unchanged in the final
product. The second and third of these regulations (emphasis added):
notions in particular transcend the Section 1.482-7T(m) Transition rule — (1)
question of transfer pricing.72 In general. An arrangement in existence
At its core, cost sharing is nothing more than a on January 5, 2009, will be considered a
formulary apportionment method applied to split CSA, as described under paragraph (b) of
IP development expenses in isolation. However, this section, if, prior to such date, it was a
this comes with a massive externality in which the qualified cost sharing arrangement under
choice of this method results in the wholesale the provisions of section 1.482-7 (as
transfer of the foreign territory revenue and contained in the 26 CFR part 1 edition
profits instantly to the foreign shell company — revised as of January 1, 1996), hereafter
referred to as “former section 1.482-7”), but
only if . . . the activities of the controlled
71 participants substantially comply with,
See Avi-Yonah and Ilan Benshalom, “Formulary Apportionment:
Myths and Prospects — Promoting Better International Policy and the provisions of this section . . . by July 6,
Utilizing the Misunderstood and Under-Theorized Formulary 2009.
Alternative,” 3 World Tax J. 371-398 (2011); Yariv Brauner, “Cost Sharing
and the Acrobatics of Arm’s Length Taxation,” University of Florida
Legal Studies Research Paper No. 2010-19 (2010); Naegele, supra note 57;
Avi-Yonah, Clausing, and M.C. Durst, “Allocating Business Profits for
Tax Purposes: A Proposal to Adopt a Formulary Profit Split,” 9 Fla. Tax
Rev. 497 (2009); J. Clifton Fleming Jr., Robert J. Peroni, and Stephen E.
Shay, “Formulary Apportionment in the U.S. International Income Tax 73
A product that results from R&D can of course lead to revenue
System: Putting Lipstick on a Pig?” 36 Mich. J. Int’l L. 1 (2015); and
from manufacturing and selling that product. However, whether the
Fleming, Peroni, and Shay, “Getting Serious About Cross Border
company can make a profit on these sales often has plenty to do with
Earnings Stripping: Establishing an Analytics Framework,” 93 N.C. L.
other factors outside the R&D function, such as product strategy and
Rev. 673-740 (2015).
72 positioning, the efficiency of the enterprise and the supply chain,
Kleinbard, supra note 8. competitive advantage, bargaining power, etc.
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(2) Transitional modification of applicable (the 1995 regulations in 26 CFR part 1 existing as
provisions. For purposes of this paragraph of January 1, 1996). If one instead mistakenly
(m), conformity and substantial substituted the colloquial meaning of the term,
compliance with the provisions of this “former” would have been interpreted to mean
section shall be determined with the the regulation in effect just before the January 5,
following modifications: (i) CSTs and PCTs 2009, effective date of these December 2008
occurring prior to January 5, 2009, shall be temporary regulations. This is an important point
subject to the provisions of former section because some advisers may not have recognized
1.482-7 rather than this section. (ii) Except to this, as demonstrated by the loose language in
the extent provided in paragraph (m)(3) of some of their published guidance that substituted
this section, PCTs that occur under a CSA other words such as “old” in place of “former”
that was a qualified cost sharing with no definition or qualification, or that
arrangement under the provisions of mistakenly attached the colloquial meaning to
former section 1.482-7 and remained in “former.” Here are two examples:
effect on January 5, 2009, shall be subject to • “A CSA in existence on 5 January 2009 may
the periodic adjustment rules of section be grandfathered, in part, if, prior to this
1.482-4(f)(2) rather than the rules of date, it was a qualified CSA under section
74
paragraph (i)(6) of this section. [This is not 1.482-7 (the old regulations).”
applicable to Apple because it was never • “Transition for pre-existing CSAs. An
subject to the former reg. section 1.482-7 — arrangement in existence on January 5, 2009,
see discussion below.] will be considered a qualifying CSA, if it
For a preexisting CSA to successfully was a qualified CSA under the provisions of
transition to the 2008 regulations and become former regulation section 1.482-7.”75
exempt from the reg. section 1.482-7(i)(6) periodic Given these loose readings of “former” by
adjustment rules in those regulations for PCTs some commentators, it seems likely that some
that occurred before January 5, 2009, and taxpayers believed their preexisting CSAs would
afterward, the taxpayer would have had to do the be grandfathered automatically. It appears that
following (described here as parts 1 and 2): the primary reason the drafters of the 2008 reg.
1. establish that the CSA before January 5, section 1.482-7(m) transition regulations
2009, was a qualified CSA meeting all the specifically chose the 1995 regulations and the
requirements of “former” reg. section fixed date of January 1, 1996, as the primary
1.482-7 (26 CFR part 1 edition revised as of compliance requirement for transition was the
January 1, 1996); and participation requirements in paragraphs (c)(1)-
2. amend by July 6, 2009, the existing CSA in (3). This is critical because compliance with these
effect on January 5, 2009, to meet the new regulations is mandatory for taxpayers seeking to
requirements of the 2008 temporary avoid exposing their past and future PCTs to a
regulations, except for specific periodic adjustment under reg. section 1.482-
requirements as described in reg. section 7(i)(6). The facts in Apple’s situation show just
1.482-7(m)(2). how costly such an oversight could be.
The remainder of this section focuses on what
appears to be noncompliance with the reg. section
1.482-7T(m)(1) and (2) rules that subject Apple’s
preexisting and post-2008 PCTs to the reg. section
1.482-7(i)(6) periodic adjustment rules.
C. What Does ‘Former’ Mean?

Note that the word “former” in the 2008 74
temporary regulations is not used colloquially; NERA Economic Consulting, “The New Temporary Cost Sharing
Regulations: What Needs to be Done?” (Spring 2009).
this is a highly defined use, designating a 75
Ropes & Gray LLP, “IRS Issues Temporary and Proposed Cost
particular regulation in effect on a particular date Sharing Regulations” (Jan. 6, 2009).
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D. Apple CSA Transition Failure wanted its preexisting CSAs to successfully
transition to the 2008 regulations) had to ensure
The January 1, 1996, “former” version of the
that the January 2009 facts concerning their CSAs
CSA regulations (referenced by the 2008
met the requirements for CSAs as those
temporary cost-sharing regulations in reg. section
requirements existed on January 1, 1996. Factual
1.482-7T(m)(1)) had been issued in final form on
conditions can change significantly over a 13-year
December 20, 1995, in T.D. 8632, and was effective
period. What might have been reasonably, or even
for tax years beginning on or after January 1, 1996,
clearly, within the requirements in 1996 may no
for taxpayers without preexisting CSAs.76
longer be true in 2009.
Taxpayers such as Apple with a preexisting CSA
would continue to have a qualified CSA only if The paragraph (c) participant guidance reads
the CSA was a “bona fide CSA” under the prior in part:
regulation (as that regulation was in effect on (c) Participant —
April 1, 1995), and if that CSA was conformed to
(1) . . . A controlled taxpayer may be a
meet the requirements of the new regulation by
controlled participant only if it — (i)
December 31, 1996. This regulation had been
Uses or reasonably expects to use covered
proposed in 1992 and was issued with some
intangibles in the active conduct of a
changes after Treasury received numerous
trade or business, under the rules of
comments.
paragraphs (c)(2) . . . of this section. . . .
The new regulations promulgated in T.D. 8632
presented two particularly troubling provisions (2) Active conduct of a trade or
for taxpayers like Apple. First, they made the business — . . . (ii) Active conduct. In
explicit point in paragraph (a)(1) that a CSA must general, a controlled taxpayer actively
involve parties that “agree to share the costs of conducts a trade or business only if it
development of one or more intangibles in carries out substantial managerial and
proportion to their shares of reasonably operational activities. For purposes only
anticipated benefits from their individual of this paragraph (c)(2), activities
exploitation of the interests in the intangibles carried out on behalf of a controlled
assigned to them under the arrangement” taxpayer by another person may be
(emphasis added). The narrow explanation attributed to the controlled taxpayer,
accompanying the original proposed regulation but only if the controlled taxpayer
released in 1992 indicated that this was intended exercises substantial managerial and
to restrict “membership in a cost sharing operational control over those activities.
arrangement to those in a position to exploit [Emphasis added.]
developed intangibles by means of the Notably, these participant requirements were
manufacture of products.” Second, the new removed approximately five months later
regulations included guidance, found in reg. through an amendment to the cost-sharing
section 1.482-7(c), for determining when a regulations issued in T.D. 8670 on May 13, 1996.
controlled entity could be a participant in a CSA. However, this amendment is irrelevant to the 2008
In considering this individual exploitation regulation transition rules of reg. section 1.482-
requirement and the participant rules, keep in 7T(m)(1) because this provision cites these earlier
mind what was discussed in Section III.B above regulations as they existed as of January 1, 1996,
that taxpayers such as Apple (which, of course, which, of course, ignores later amendments, such
as those in T.D. 8670.
Treasury clearly sought to make it difficult if
not impossible for taxpayers with low-substance/
tax shelter-type CSAs to be grandfathered under
the 2008 regulations. The IRS, however, appears to
76 have never enforced these regulations.
60 F.R. 65553-65566 (Dec. 20, 1995). Note also that the reference to
these regulations was later changed from reg. section 1.482-7 to reg.
section 2.482-7A in T.D. 9441 (Jan. 5, 2009).
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Solely for purposes of this discussion, it is Apple Inc., which, on AOI’s behalf, conducts all
conservatively assumed that in 1996, which was production activities short of physical
before the issuance of the entity classification production. That AOI does not meet this
check-the-box rules, Apple’s CSA with AOE or its individual exploitation requirement is fully
applicable predecessor (it is understood that ASI consistent with the earlier-mentioned explanation
did not join the CSA until 1999) met all applicable accompanying the regulation when originally
requirements, including both the individual proposed in 1992.
exploitation requirement and the reg. section Regarding the participant requirement, a
1.482-7(c) participant requirement (after controlled taxpayer must carry out substantial
amendment by T.D. 8670). As of January 2009, managerial and operational activities. There is no
however, the manner in which Apple conducted question that disregarded entity subsidiaries of
its international business had significantly AOI conduct substantial operational activities.
changed, both factually and structurally. Both ASI These activities include functions such as sales
and AOE were now disregarded entity and marketing, customer support, retail stores,
subsidiaries of AOI, meaning that AOI and all its and limited manufacturing in Ireland. There will,
disregarded entity subsidiaries must be treated as of course, be some localized and regional
one CFC conducting business through branches management for these various functions.
in Ireland and various other countries around the However, with the information provided in the
world. Further, whereas in 1996 many of the European Commission’s 2016 decision, the 2013
Apple products distributed into Europe and other Senate report, and the 2020 GCEU opinion —
foreign markets may have been manufactured in which include Apple’s representations about the
its Cork, Ireland facility, by January 2009 the bulk conduct of its business in Ireland — it is clear that
of products “manufactured” by AOI and sold to AOI in January 2009 did not conduct substantial
customers in its defined territory were sourced by managerial activities over critical portions of its
engaging Asian contract manufacturers that were own business, including, for example,
arranged for, directed, and controlled by Apple management over component purchasing and
Inc. personnel in the United States. It appears contract manufacturers; management of the
factually that no AOI personnel in Ireland or provision of cloud services and the various
elsewhere conducted “substantial managerial and internet-based platforms through which AOI sells
operational control” over these Apple Inc. to customers and provides them with cloud
personnel. (Specific evidence of some of these services; and sales management, particularly for
facts are set out in Section III.E below.) key customers such as cellular networks and
With this changed situation by January 2009, it major resellers.
seems certain that AOI could not in any manner It is also important to note the sentence in
be seen to meet either the individual exploitation paragraph (c)(2) requiring that “activities carried
requirement or the participant requirement as in out on behalf of a controlled taxpayer by another
effect on January 1, 1996, before the T.D. 8670 person may be attributed to the controlled
amendment. taxpayer, but only if the controlled taxpayer exercises
Regarding the individual exploitation substantial managerial and operational control over
requirement, although AOI and its disregarded those activities.” (Emphasis added.) Clearly, AOI
entity subsidiaries do have thousands of exercises no such managerial or operational
employees and considerable operations, control over Apple Inc. and its U.S. affiliates in the
including limited manufacturing in its Irish activities they conduct on AOI’s behalf. The
facilities, AOI in no sense conducts its business in reality is that AOI’s substantial managerial
the independent manner that individual activities were conducted in Cupertino and not by
exploitation would require. AOI itself neither AOI.
manufactures the vast majority of the products it It is worth saying more about the above
sells nor manages and directs in any way the comment that AOI disregarded entity
contract manufacturers that physically produce subsidiaries conduct some localized and regional
its products. It also in no way manages or controls management for some functions. Of course, these
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AOI subsidiaries do have appropriate European Commission decision. The commission
management personnel responsible for the requested that Ireland provide information on the
localized portions of Apple’s business that they ASI and AOE activities represented by the
manage. However, these personnel do not have functions and risks presented in figures 8 and 9, as
broad authority over all of AOI’s worldwide well as concrete examples of those activities.
business, and they operate only under the close Ireland and Apple responded to that request with
77
direction and supervision of Cupertino a letter from Apple dated April 22, 2016. The
management, who direct and participate in the European Commission described the content of
conduct of AOI’s business. The Cupertino-based that letter as follows (with one footnote omitted
management and operations go far beyond just and emphasis added):
group policy direction and the mere oversight
Ireland and Apple indicated that the tables
and stewardship functions that a parent company
from the CSA of 2009 . . . do not purport to
normally conducts for its independently run
show activities actually performed by the
subsidiaries. Further, some AOI business and
parties to the CSA but merely summarise the
operational functions (in particular, the
activities that each party is authorised to
production functions and the operation of
perform under that agreement. Apple further
worldwide internet-based app stores and other
explained that the tables . . . were added to the
platforms through which AOI sells products and
CSA to satisfy the requirements under
provides cloud services) are conducted mostly or
temporary regulations issued by the US
wholly by Cupertino-based personnel on behalf
Treasury Department, effective 5 January
of AOI. In no way may it be said that in January
2009, that a cost sharing agreement among
2009 AOI was “exercis[ing] substantial
related parties reflect the parties’
managerial and operational control over those 78
functions and risks.
activities” conducted on its behalf by Apple Inc.
and other U.S. group members as required by Apple further indicated that the . . .
former reg. section 1.482-7(c)(2) as in effect on activities listed in the table reproduced in
January 1, 1996. Figure 8 . . . were performed almost entirely by
Apple Inc. employees in the US.79
E. CSA and Evidence of Transition Failure
Apple further stated that ASI and AOE do
Although Treasury later defended Apple’s not have any role in the management of
transfer pricing and claimed that it was unable to Apple’s IP and that they have only a
examine assertions of tax violations by the limited role, within the strict parameters
European Commission, the Senate did take issue set by Apple Inc. executives in the US, in
with Apple’s tax structure and transfer pricing commercial contract negotiations. . . . All
and tried to investigate it, as did the commission. the functions that drive Apple’s profits are
These two investigations each disclosed portions directed by Apple Inc. executives in the
of Apple’s restated CSA, shown below in Figure 2, US and performed largely in the US.80
reconstructed from the Senate and commission
disclosures.
This document was prepared by Apple and
signed in June 2009 to meet the 2008 reg. section
1.482-7T(k)(1) and (m)(1) requirement that
taxpayers execute written contracts that reflect the
new 2008 regulation requirements by July 6, 2009.
Apple would have also presumably provided the
IRS with a CSA statement under reg. section 77
Although no copy of this April 22, 2016, letter was released, its
1.482-7T(k)(3) and (m)(2)(viii) no later than existence was disclosed in the commission decision, supra note 4, at 39
n.96.
September 2, 2009. 78
Id. at para. 124 and n.96.
Figures 8 and 9 shown below in Apple’s 79
Id. at para. 125.
restated CSA contract were disclosed in the 2016 80
Id. at para. 126.
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A plain reading of Apple’s disclosure to the directors, either directly or by power of
European Commission would indicate that its attorney. . . .84
June 25, 2009, restated CSA contract was simply
Apple Inc., ASI and AOE submitted, in the
false. Many of the activities Apple told the IRS
context of both the administrative
that ASI and AOE factually perform were actually
procedure and the present action,
performed by Apple Inc.
evidence demonstrating that the
The July 15, 2020, decision of the GCEU81 framework agreements with the
provides further evidence of Apple’s manufacturers of Apple-branded products (or
representations: OEMs) had been concluded centrally in
It is also apparent from that evidence that respect of the Apple Group as a whole by Apple
the strategies relating to new product launches Inc. and ASI in the United States.85
and, in particular, the organisation of Recall from Section III.D above that the
distribution on the European markets in the regulation in effect on January 1, 1996, required
months leading up to the proposed launch date that each participant conduct “individual
had been managed at the Apple-Group level by, exploitation of the interests in the intangibles
inter alia, the Executive Team under the assigned to them under the arrangement.” Based
direction of the Chief Executive Officer in on the above, Apple has emphasized in its defense
82
Cupertino. to the European Commission that “all the
In addition, it is apparent from the file that functions that drive Apple’s profits are directed
contracts with third-party original equipment by Apple Inc. executives in the US and performed
manufacturers (“OEMs”), which were largely in the US.” This is not just top-level
responsible for the manufacture of a large management direction. Rather, as the above
proportion of the products sold by ASI, shows, the GCEU accepted as fact Apple’s
were negotiated and signed by the parent representations that two of the most critically
company, Apple Inc., and ASI through their major aspects of AOI’s business were conducted
respective [U.S.-based] directors,83 either from Cupertino: (1) the negotiations and the
directly or by power of attorney. ASI and signing of contracts with major
AOE also submitted evidence regarding telecommunications customers, and (2) the
the negotiations and the signing of negotiations and signing of contracts with third-
contracts with customers, such as party OEMs (that is, the Asian contract
telecommunications operators, which manufacturers that produced iPhones and other
were responsible for a significant products for Apple’s worldwide needs). This is
proportion of the retail sales of Apple- not the picture of a subsidiary that conducts
branded products, in particular mobile individual exploitation of its share of IP. Instead,
phones. It is apparent from that evidence it looks as if the Irish CSA participants are not
that the negotiations in question were led involved in exploitation at all, and the entire
by directors of the Apple Group and that structure is a sham.
the contracts were signed on behalf of the Also recall that to be eligible to be
Apple Group by Apple Inc. and ASI grandfathered under the reg. section 1.482-7(m)
through their respective [U.S. based] transition rule, AOI must conduct substantial
managerial and operational activities. Yes, AOI
through its disregarded entity subsidiaries does
81
Judgment of the General Court, supra note 25. have some thousands of employees in Ireland and
82
Id. at para 300. in many other countries. It does perform
83
With few exceptions, in most years the ASI and AOE board substantial operational activities. However, it is
members resident in the United States held legal, accounting, treasury,
and other financial positions within Apple Inc. For example, Elizabeth
Rafael was the Apple Inc. vice president and corporate controller and
principal accounting officer. Mark Stevens worked in finance during his
career with Apple Inc. These ASI and AOE directors would have signed 84
Judgment of the General Court, supra note 25, at para 301.
any commercial agreements on ASI or AOE’s behalf when the Apple Inc. 85
Cupertino operational personnel told them to sign. Id. at para 381.
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clear from these representations to the European AOI may have exceeded the commensurate-with-
Commission and to the GCEU that in January income limitations of reg. section 1.482-7(i)(6)
2009 AOI in no way conducted substantial since 2009 by substantial margins. That result and
managerial activities within the meaning of reg. the calculations behind it are discussed in Part 2 of
section 1.482-7(c) as in effect on January 1, 1996, this report.  
related to exploitation of CSA-covered IP.
F. Effect of Transition Failure

The discussion in the prior two sections shows
that the two Apple CSAs were ineligible to be
grandfathered on January 5, 2009, under the reg.
section 1.482-7(m)(1) transition rule. As such, on
the surface, the Apple Inc./AOI relationship is not
governed by reg. section 1.482-7 and is instead to
be subject to other applicable section 482
regulations.
Interestingly, Apple affixed the following
label to its revised CSA (highlighting by the
authors), purporting that its CSA was indeed
grandfathered, though clearly it did not meet the
86
requirements to be so :
Despite this “surface result” of being covered

not by reg. section 1.482-7 but by other applicable
section 482 regulations, it is clear that Apple has
treated the Apple Inc./AOI CSAs as being valid
for several years and that the IRS has not
challenged their purported validity. With this
being the case, Apple’s clear failure to meet the
reg. section 1.482-7(m)(1) transition rule can only
mean that the Apple Inc./AOI CSA must be
considered a new CSA covered by the 2008 regulations
with effect from January 5, 2009. As a result of this and
earlier analyses, all of Apple’s PCTs, including those in
prior years, are subject to the periodic adjustment
regulations of reg. section 1.482-7T(i)(6). This is
critically important because the profits booked by
86
This document was included as Exhibit 3 in the exhibits to the May
2013 PSI report.
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tax notes federal
Apple’s Cost-Sharing Arrangement: Frankenstein’s Monster,

Part 2
by Stephen L. Curtis and David G. Chamberlain

E. Exceptions to Periodic
Adjustments . . . . . . . . . . . . . . . . . . . . 1225
F. Periodic Trigger Calculation . . . . . . 1225
G. Periodic Adjustment Calculations . 1229
H. Impact of Deemed Repatriation
Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1231
V. Alternative Adjustments to AOI. . . . . 1231
A. ECI Taxation and Subpart F
Branch Rule . . . . . . . . . . . . . . . . . . . . 1232
B. Recharacterization. . . . . . . . . . . . . . . 1233
VI. Conclusion . . . . . . . . . . . . . . . . . . . . . . . 1233
VII. Appendix 1: Apple Acquisitions. . . . . 1235
VIII. Appendix 2: Periodic Adjustment. . . . 1246
Stephen L. Curtis is a transfer pricing
economist and the president of Cross Border Part 1 of this report broke down Apple’s cost-
Analytics Inc. David G. Chamberlain is an sharing arrangement and explained how
assistant professor of accounting and tax at corporate taxpayers have been able to exploit the
California Polytechnic State University in San cost-sharing regulations to shift hundreds of
Luis Obispo. billions of dollars or even trillions of dollars in
In this final installment of their two-part U.S. profits offshore with little or no IRS detection
report, Curtis and Chamberlain apply the or enforcement.1 In this report, we undertake a
periodic adjustment rules to Apple’s cost- forensic transfer pricing analysis of the evidence
sharing arrangement, and they propose disclosed in the U.S. Senate and European
alternative ways to tax some of the U.S. profit Commission investigations of Apple — or
that Apple has been able to shift offshore by provided by the company in filings with those
exploiting the cost-sharing regulations and bodies, the SEC, courts, and other sources —
other U.S. taxation mechanisms. regarding its compliance with U.S. transfer
Copyright 2021 Stephen L. Curtis and pricing laws. We find that Apple could be subject
David G. Chamberlain. to a U.S. tax adjustment under reg. section 1.482-
All rights reserved. 7(i)(6) that could exceed by several multiples the
amount of taxes at issue in the European
Table of Contents Commission state aid case (now under appeal)
and Apple’s reserves for uncertain tax positions.
IV. Apple’s Periodic Adjustment . . . . . . . 1218
In this final installment of the report, we discuss
A. No Statute of Limitations . . . . . . . . . 1219
that result and the calculations behind it.
B. Key Assumptions Regarding I
nputs . . . . . . . . . . . . . . . . . . . . . . . . . . 1220
C. Estimates for 2009 Initial PCTs . . . . 1221 1
Stephen L. Curtis and David G. Chamberlain, “Apple’s Cost-Sharing
D. Estimated 2009 PCT Payments . . . . 1222 Arrangement: Frankenstein’s Monster,” Tax Notes Federal, Aug. 16, 2021,
p. 1049.
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IV. Apple’s Periodic Adjustment guidance is not very specific, and it has rarely, if
ever, been applied in practice. Rules for periodic
Congress adopted the commensurate-with-
adjustments in the context of cost-sharing
income standard in 1986 by adding the following
agreements (CSAs) were promulgated in 2008, in
sentence to section 482:
reg. section 1.482-7(i)(6). Those rules, which are
In the case of any transfer (or license) of the subject of the following sections, are detailed
intangible property (within the meaning and specific. Although the rules do not appear to
of [section 367(d)(4)]), the income with have been applied in practice yet, CSAs that
respect to such transfer or license shall be began in 2009 or later are just now reaching a level
commensurate with the income of maturity that makes implementation of the
2
attributable to the intangible. rules practical.
Obviously, profits that are expected at the In a CSA, periodic adjustments may apply if
time of the transfer or license of intellectual there have been any contributions of IP to the
property would be taken into account in research program. These contributions are known
determining the price or royalty rate. The relevant as platform contribution transactions (PCTs).
question is what happens when actual profits are Platform contributions are broadly defined by
greater or less than expected profits. It is reg. section 1.482-7(c)(1) as “any resource,
indisputable that actual profits can be used by any capability, or right that a controlled participant
tax authority worldwide as evidence of what has developed, maintained, or acquired
profits should have been forecast at the time of the externally to the [CSA] . . . that is reasonably
initial transfer or license. There is strong evidence anticipated to contribute to developing cost
that Congress intended that material future shared intangibles.” Consistent with the broad
changes (or “major variations”) in the profits mandate of the committee report,4 Treasury
attributable to transferred IP away from the adopted this broad definition to ensure that
projections used to value this IP also give rise to valuable contributions are covered by the
adjustments to taxable income (periodic regulations even if the taxpayer would argue that
adjustments).
3 they are technically not within the definition of
Treasury regulations have implemented the intangible. The calculation of periodic
concept of periodic adjustments. Notably, as adjustments will also take into account so-called
shown in the next section, the IRS can make operating contributions, which are defined
periodic adjustments to taxable income in any similarly to platform contributions in reg. section
later year, even if the statute of limitations has run 1.482-7(j)(1)(i) (“any resource, capability, or
out on the year of the original transfer. In 1993 right”), but which contribute to operating the
Treasury promulgated reg. section 1.482-4(f)(2), ongoing business rather than being used
providing guidance for the application of periodic specifically in the research program.
adjustments in any type of IP transaction. That For periodic adjustments to apply to the
profits of Apple Operations International (AOI),
there must be PCTs attributable to Apple Inc. The
case is complicated by the fact that AOI (or its
2
The only change to this sentence since 1986 is the cross-reference for predecessors) and Apple Inc. had preexisting
the definition of intangible property. The current language is shown for
readability.
CSAs that dated back to 1980 that we are
3
See, e.g., H.R. Rep. No. 99-426 at 423 et seq. (1985) (“The committee assuming, for purposes of this report, were valid
does not intend, however, that the inquiry as to the appropriate
compensation for the intangible be limited to the question of whether it
was appropriate considering only the facts in existence at the time of the
transfer. The committee intends that consideration also be given the
actual profit experience realized as a consequence of the transfer. Thus,
the committee intends to require that the payments made for the
intangible be adjusted over time to reflect changes in the income
attributable to the intangible. The bill is not intended to require annual
adjustments when there are only minor variations in revenues. However,
it will not be sufficient to consider only the evidence of value at the time
of the transfer. Adjustments will be required when there are major
variations in the annual amounts of revenue attributable to the 4
intangible.”). Id.
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until the January 5, 2009, effective date of the 2008 substantial periodic adjustments can be made. It is
cost-sharing regulations.5 AOI therefore owned in the second step (the calculation of the periodic
exclusive rights to legacy Apple product IP in the adjustments) that AOI’s ownership of rest-of-the-
rest of the world other than the Americas. world rights to legacy Apple product IP is taken
In Part 1, based on our analysis of the into account as a PCT attributable to AOI. This is
transition rules of the 2008 cost-sharing regulation achieved through the mandatory application of a
and Apple’s restated 2009 CSA, we determined residual profit-split method (RPSM) that gives
that AOI and Apple Inc. entered into a new CSA AOI a ratable share of the profits in its territory
on January 5, 2009. The question that arises is that exceed the routine return that it properly
whether Apple Inc. made any platform earned for its actual activities (for example,
contributions to the new CSA, given that AOI routine sales and marketing, customer support,
already owned rest-of-the-world rights to product logistics, etc.).
IP. The answer is a definitive yes. Apple Inc. A final note is warranted. Reg. section 1.482-
contributed (1) exclusive rights to use legacy 7(i)(6) gives the IRS discretion in whether to apply
Apple product IP in the Americas, which would periodic adjustments. We conclude that it is
include the rights to use them in the research appropriate for the IRS to impose periodic
program (which required undivided rights to the adjustments in this case because (1) Apple Inc.
global product IP); (2) IP related to workforce in makes nearly all the valuable contributions to
place and facilities (which are part of going both the research program and the ongoing global
concern value) that are used in the research and business, while AOI makes only financial
development program; and (3) IP that it acquired contributions (PCT payments and cost-sharing
in connection with corporate acquisitions in 2009 payments) and performs some routine activities;
and later years. Further, all the IP used in the and (2) Apple’s representations to the Senate and
global business other than in the R&D program the commission are contradictory and
(that is, operating contributions), including IP demonstrate an abusive mind-set. In the
related to the world’s best supply chain, belongs following sections, we use publicly available
exclusively to Apple Inc., as was shown in Part 1, information to show that there has been a periodic
in our analysis of the investigations by the Senate trigger and to estimate the magnitude of the
and the European Commission. periodic adjustments that would apply.
There are two overarching steps in
determining the amount of the periodic A. No Statute of Limitations
adjustments that the IRS can make. First, the IRS The 2008 CSA regulations provide the
must determine whether there is a periodic following guidance regarding a periodic trigger:
trigger, which would result from AOI earning
more than an investor’s return on investments it Determination of periodic adjustments. In
has made in the CSA (that is, cost-sharing the event of a Periodic Trigger, subject to
payments and PCT payments). Second, the paragraph (i)(6)(vi) of this section, the
periodic adjustment itself must be calculated by Commissioner may make periodic
applying the detailed rules in the regulations. The adjustments with respect to all PCT
analysis in the following sections clearly shows Payments between all PCT Payors and
that there have been periodic triggers and that PCT Payees for the Adjustment Year and
all subsequent years for the duration of the
CSA Activity pursuant to the residual
5 profit split method as provided in
This assumption that Apple Inc. and AOI had a valid CSA in effect
from 1996 until January 5, 2009, was made to apply conservative paragraph (g)(7) of this section, subject to
assumptions that are the most favorable to the Apple group. See sections the further modifications in this
III.D, E, and F of Part 1 of this report, and Appendix 2, subsection B, item
3, for a discussion of why we believe there was no valid CSA during that paragraph (i)(6)(v). A periodic adjustment
period, which in short explained why AOI did not meet the individual may be made for a particular taxable year
exploitation requirement of reg. section 1.482-7A(a)(1). With AOI’s
dependence on Apple Inc. for the performance of so many exploitation without regard to whether the taxable years of
functions that AOI is incapable of performing itself or incapable of
directing a true independent contractor to perform on its behalf, it is
the Trigger PCT or other PCTs remain open for
quite reasonable to see the pre-2009 CSA as a sham arrangement.
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6 7
statute of limitation purposes. [Emphasis buy-in payment was made for this IP transfer,
added.] which was allowed under then-applicable law.
Since 1980, with the continued existence of CSAs
Note that in general, according to reg. section
that were amended from time to time, AOI (or its
1.482-7(i)(6)(i), there is no statute of limitations for
predecessors) would presumably have made
the application of a periodic adjustment in an
appropriate payments for its share of intangible
open year pertaining to a PCT in a closed year:
development costs.
Subject to the exceptions in paragraph Although Apple undoubtedly made other
(i)(6)(vi) of this section, the Commissioner acquisitions before January 2009, in hindsight, the
may make periodic adjustments for an 1997 acquisition of NeXT Software is notable for
open taxable year (the Adjustment Year) its size and importance to the future of the
and for all subsequent taxable years for the company. In December 1997 Apple was having
duration of the CSA Activity. . . . The difficulty financially, and its share price was
failure of the Commissioner to determine equivalent to that on its IPO date 17 years earlier.
for an earlier taxable year that a PCT The NeXT acquisition brought Steve Jobs back to
Payment was not arm’s length will not the company. And with the NeXT design team he
preclude the Commissioner from making had assembled, Jobs began restructuring the
a periodic adjustment for a subsequent company, eliminating 11 of its 15 product lines
year. A periodic adjustment under this while seeking a $150 million investment from
paragraph (i)(6) may be made without 8
Microsoft Corp. The value of Apple’s IP in 1997
regard to whether the taxable year of the appeared tenuous, which is highlighted by the
Trigger PCT or any other PCT remains different direction that Apple took after the NeXT
open for statute of limitations purposes or acquisition:
whether a periodic adjustment has
previously been made with respect to any Most college students today have only
PCT Payment. known Apple as the fashionable, popular,
commercially competent, and trend
B. Key Assumptions Regarding Inputs setting global technology giant it is today.
However, 23 years ago Apple Computer,
We explained in Part 1 that the Apple Inc./AOI Inc. was struggling to survive while trying
CSA should be treated as a new CSA as of January to sell Macs in a PC world centered around
5, 2009. Because of this, it is necessary to consider Microsoft Windows. Things began to
what each of Apple Inc. and AOI brought to the change after Apple acquired NeXT . . . on
table in the way of platform contributions as of February 7, 1997. . . . Apple’s acquisition of
that date. This information is important because NeXT Software 23 years ago most
the reg. section 1.482-7(i)(6) calculations require obviously provided the company with a
the application of an RPSM that is based in part on modern operating system foundation. . . .
the platform contributions provided by each CSA Apple cracked open the highly
participant. proprietary worlds of audio streaming,
From a conservative perspective, the video encoding and distribution . . . video
calculations in this report assume that at the playback streaming on the Internet. . . . In
initiation of the December 1980 CSA, Apple Inc. the same way that Jobs’ NeXT built its own
transferred to its then-Irish subsidiaries the development frameworks and operating
applicable foreign rights that would allow them to environment, Apple has built its own
manufacture Apple products and then sell those
products within the company’s defined
geographic territory, which is understood to be
7
the rest of the world other than the Americas. No See European Commission, “Commission Decision of 30 August
2016 on State Aid Implemented by Ireland to Apple,” SA.38373 (2014/C)
(ex 2014/NN) (ex 2014/CP) implemented by Ireland to Apple, C(2016)
5605 final, at para. 117 (Aug. 30, 2016).
8
6 See John C. Abell, “Aug. 6, 1997: Apple Rescued — by Microsoft,”
Reg. section 1.482-7(i)(6)(v). Wired, Aug. 6, 2009.
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technology for iMessages, for Siri, Maps, rights related to the global business (known as
for new technologies.9 operating contributions).
Relevant here is whether AOI made any buy- To calculate periodic adjustments, the relative
in payment to Apple Inc. for the PCTs that became values of Apple Inc.’s and AOI’s platform and
available to the CSA’s intangible development operating contributions must be determined.
activity. With the NeXT acquisition would have These relative values are used to determine for
come both important intangibles and personnel AOI the portion of the profits related to its
(for example, Jobs and many other territory that are properly allocated to AOI in a
knowledgeable and skillful team members) who residual profit-split analysis. One valuation
would have contributed significantly to the method that would produce a maximum (and
development team within Apple Inc. It is therefore conservative) value for AOI’s platform
unknown whether Apple’s Irish CSA participants contribution of legacy IP existing on January 5,
made PCT payments for the NeXT acquisition or 2009, would be based on an allocation of Apple’s
for later or prior acquisitions related to Apple’s global market capitalization among the various IP
new strategy. The important point is that if there assets owned by Apple Inc. and AOI.
were in fact no PCT payments by AOI for those Apple’s market capitalization on January 5,
11
pre-2009 acquisitions, especially the NeXT 2009, was $80.7 billion. The value of Apple’s
acquisition, that would substantially reduce AOI’s tangible assets on December 27, 2008, reported in
relative share of the PCTs and legacy IP as of SEC filings was $39.1 billion, so the market value
January 5, 2009.10 For purposes of this report, it is of Apple’s intangible assets was $41.6 billion.
conservatively assumed that AOI made Importantly, this value represents all of the Apple
appropriate PCT payments and therefore legally group’s IP — including both technology IP and
owns the rest-of-the-world rights to the associated exploitation IP, the latter of which belonged solely
IP. to Apple Inc. The allocation of this value among
the various IP assets is discussed here and is
C. Estimates for 2009 Initial PCTs further documented in Appendix 2 (including
Table A2.1).
All the examples in reg. section 1.482-
Economic research has shown that
7(i)(6)(vii) assume that there is a new CSA where
exploitation attracts as much as 80 percent of
only one participant owns preexisting IP, and an
system profits.12 The preponderance of this value
initial PCT payment is therefore due exclusively
would be attributable to Apple’s exploitation
from the other (usually foreign) participant. In
capability, including the world’s best supply
Apple’s case, as previously explained, the rest-of-
chain. Relatively speaking, AOI has few
the-world rights to the existing IP were already
exploitation capabilities and relies on Apple U.S.
owned by AOI because of its legacy participation
to conduct virtually all nonroutine critical
in the CSAs that were in place before January 5,
business functions through which its IP is
2009. As a result, on the January 5, 2009,
exploited. We must therefore exclude the IP value
commencement of the new CSA, AOI would be
of that exploitation capability conducted by
deemed to have made a platform contribution
Apple U.S. from AOI’s legacy IP value. For this
consisting of those rights. For its part, Apple Inc.
exercise, the calculations conservatively assume
would be deemed to have made a platform
that exploitation IP represents only 50 percent
contribution of all other rights to legacy IP related
(well under the above-noted 80 percent) of the
to the CSA, in addition to owning all other IP
$41.6 billion of intangible assets, or $20.8 billion.
9
Daniel Eran Dilger, “Apple Officially Acquired NeXT 23 Years Ago,
Changing Everything,” AppleInsider.com, Feb 7, 2020.
10
Of course, there must have been many acquisitions in addition to
the NeXT Software transaction. A full analysis to determine the relative 11
Macrotrends, “Apple Market Cap 2006-2021|AAPL.”
portions of the PCTs as of January 5, 2009, would need to consider all 12
pre-January 5, 2009, acquisitions and whether AOI had made any buy-in For a detailed overview of this research, see Curtis, “Forensic
payments for acquired intangibles and personnel who would take part Approaches to Transfer Pricing Compliance and Enforcement,” 8 J.
in the intangible development activity. Forensic & Investigative Acct. 359 (2016).
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The remaining $20.8 billion represents the adjustment calculations any actual PCT payments
value of all technology-related IP. Technology- that it made in connection with the contribution
related IP must be further allocated between by the other participants at the initiation of that
product IP (including the Apple trademark and CSA. Because Apple Inc. and AOI treated their
any similar IP assets), which both Apple Inc. and CSA under the 2008 regulations as being
AOI own, and other IP related to the development grandfathered, they would not have made any
program, which belongs solely to Apple Inc. This actual PCT payments. Although alternatives may
development program IP includes R&D employee be possible, this exercise is more than sufficient to
workforce in place and the going concern value of conservatively analyze AOI’s position at the
research facilities. Although there is some debate commencement of the new CSA on January 5,
about whether these items are truly “intangible 2009.
property” as defined in the tax code, the cost-
sharing regulations broadly define platform D. Estimated 2009 PCT Payments
contributions to include them. Specifically, Apple disclosed to the Senate Homeland
platform contributions include any “resource or Security and Governmental Affairs Permanent
capability” that a cost-sharing participant has Subcommittee on Investigations (PSI) that Apple
developed, maintained, or acquired that is Sales International (ASI) and Apple Operations
reasonably anticipated to contribute to Europe (AOE) paid Apple Inc. for their respective
developing cost-shared intangibles. As has been shares of PCTs, consisting of (1) their shares of
clearly stated in the various documents from the third-party technology acquisitions and (2) their
European Commission and the General Court of shares of other contributed IP (such as IP covered
the European Union (GCEU), only Apple Inc. has by reg. section 1.482-4). For some years, Apple
the personnel and facilities through which the also disclosed the actual amounts of those PCT
intangible development activity is conducted. It is payments, together with actual cost-sharing
therefore necessary to establish a PCT value for payments and information on actual RAB shares,
these Apple Inc. research teams and facilities as total CSA-related payments, and payments from
they existed on January 5, 2009.13 We have ASI. Several of those inputs are shown below in
estimated that one-third of the $20.8 billion value figures 4 and 5:
of technology-related IP should be allocated to
development program IP and two-thirds to
product IP.
The amount allocated to product IP is $13.874
billion (two-thirds of $20.8 billion). Because both
Apple Inc. and AOI own rights to Apple’s legacy
product IP in their respective territories, this value
is multiplied by AOI’s estimated 2008 year-end
reasonably anticipated benefit (RAB) territory
share of 34.5 percent to yield a value of
approximately $4.8 billion for AOI’s legacy IP.
Because AOI owns no other IP, this is AOI’s entire
IP contribution.
Under the applicable rules, each participant in
a CSA must also take into account in the periodic
13
See reg. section 1.482-7(c)(5), Example 2.
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Moreover, Apple reports other key any tangible assets would be the adjusted
information in SEC filings, including U.S. and acquisition value. Although this acquisition price
foreign pretax earnings and revenues. method is rarely used, it may be helpful for many
Information on acquisitions is available from Apple acquisitions because Apple often acquires
public sources, including Apple’s websites. Those small independent enterprises for their intangible
public sources were used to estimate the cost- properties and knowledgeable employees.
sharing payments and PCT payments, which The approach taken here is to account for all
were then calibrated against actual results publicly known acquisitions since January 5, 2009,
reported by Apple to the Senate PSI. The resulting at their reported or estimated full acquisition
adjustments were then applied to all years in the price (because the amounts of liabilities, tangible
periodic adjustment calculations. assets, or portions of acquisition values
Perhaps the most important input to be constituting PCT values are unknown). When an
estimated for this calculation involves acquisition is disclosed but its value isn’t, the
14
acquisitions from January 5, 2009, by Apple Inc. value to be substituted in this computation is the
that include intangibles or personnel and facilities average of all the disclosed acquisition values for
that will contribute to the cost-shared intangibles acquisitions from January 5, 2009. The average
under the CSA. This is a difficult exercise using was determined after removing the two highest-
only public information because Apple acquires a and lowest-value acquisitions from the
company every few weeks, according to its CEO,15 calculation to reduce bias.
and few of those acquisitions are publicly This approach may conservatively overvalue
announced. It is unknown whether, or to what the PCTs to some extent because (1) it is almost a
extent, any of the acquisitions include intangibles certainty that not all acquisitions will include
that would be within the scope of the Apple Inc./ intangibles that will contribute to CSA cost-
AOI CSA and thus contribute as PCTs to cost- shared intangibles at a partial or full acquisition
shared intangibles. However, because Apple price; and (2) most, if not all, of the publicly
makes so many acquisitions, these acquisitions announced acquisitions are expected to be among
cannot be ignored. For example, in April 2010 the largest ones, so the use of the average of these
Apple acquired Siri. Soon after, in October 2011, larger acquisition values is expected to capture or
Siri was included in the Apple iPhone 4S.16 exceed the value of the omitted acquisition values.
Generally, an acquisition or portions thereof We were able to benchmark our estimates for
would give rise to a PCT only if it involved PCTs with one year of actual PCTs reported by
capabilities, resources, or rights that were Apple to the Senate PSI for 2012. Our calculations
“reasonably anticipated to contribute to the to estimate the PCTs for all years matched very
intangible development activities.” The value of closely (within +$277 million to actual, or 11
the platform contribution would be estimated percent overestimation) the actual PCT payments
according to methods in reg. section 1.482- in 2012 that Apple reported to the Senate, shown
7(g)(1)(i) through (vi) (which include unspecified in Table 5.
methods). However, under appropriate
circumstances, the foreign share of the entire
adjusted acquisition value would be the PCT
value according to reg. section 1.482-7(g)(5)(iii).
Under that method, the full acquisition price plus
any assumed liabilities and minus the value of
14
As Appendix 1 shows, there are many foreign acquisitions. While it
seems likely that all U.S. acquisitions would have been made by Apple
Inc., Apple might have arranged for some or all foreign acquisitions to
be made by AOI. If so, the analysis here would change to some degree.
15
Lauren Feiner, “Apple Buys a Company Every Few Weeks, Says
CEO Tim Cook,” CNBC, May 6, 2019.
16
SRI International, “Siri.”
Electronic
SPECIAL REPORT
Table 5. Estimated Cost-Sharing and PCT Payments by AOI Since 2009
($ million)
Total
Estimated Estimated Estimated
Cost-Sharing Acquisition- Estimated CSA 2012 Actual Difference
Year Payments Related PCTs Other PCTs Investments Payments (Est. - Actual)
2009 $489 $85 $65 $639
2010 $758 $407 $131 $1,297
2011 $1,400 $132 $173 $1,705
2012 $1,658 $609 $255 $2,522 $2,245 $277
2013 $2,207 $83 $258 $2,548
2014 $3,061 $2,694 $649 $6,404
2015 $4,376 $600 $561 $5,536
2016 $5,433 $743 $696 $6,872
2017 $6,006 $554 $739 $7,299
2018 $7,358 $915 $932 $9,206
2019 $7,876 $1,350 $1,040 $10,265
2020 $8,992 $835 $1,107 $10,934
The calculations here assume that all entitled to earn an appropriate return. By
acquisitions were made by Apple Inc. and assuming that AOI made required PCT payments
contributed to the CSA cost pool as PCTs, and by using an estimation method that likely
requiring payment by AOI, consistent with overvalues the amount of the PCT payments, the
information provided in Figure 4. The European total investment amount is increased. If PCT
Commission documents allege that AOI (that is, payments were not made or were smaller in
ASI and AOE) has made payments to Apple Inc. amount, the size of the periodic adjustments we
for only intangible development cost and some calculate would be larger.
17
marketing services. The Senate PSI documents, A summary of Apple’s acquisitions is shown
however, disclosed that AOI made substantial in Appendix 1, together with the references for
PCT payments for both U.S. and foreign these acquisitions and their values, if disclosed.
acquisitions and other IP covered by reg. section Combining the PCT payments for these
1.482-4, at least in 2012. It seems likely that these acquisitions with the totals for other PCT
PCT payments were included in the cost-sharing payments and cost-sharing payments (as
payments in the commission’s report. The calibrated using actuals reported for 2012, shown
calculations therefore assume that AOI has in Figure 4), the payments shown in Table 5 were
contributed through buy-in payments to PCTs estimated as the basis for the periodic adjustment
acquired through acquisitions made by the U.S. calculations. In general, these results are expected
company. to provide a fairly accurate, if not slightly
Our method for estimating AOI’s PCT overstated, value of identified PCTs in each year
payments is conservative. This is because the on average. This is because we use the acquisition
periodic adjustment calculations treat PCT price method for acquisitions and assume
payments as investments on which AOI would be generous “other IP” contributions in every year
(when those contributions would be anticipated
for only some years), combined with the
17
Commission decision, supra note 7, at paras. 181, 313, 316, and 450.
referenced calibrations and adjustments (for
Electronic
SPECIAL REPORT
instance, adjusting the foreign pretax income platform contributions add significantly to AOI’s
reported in SEC filings to the Americas and rest- extremely high profits, this exception would not
of-the-world pretax income based on ratios apply.
determined from Senate PSI disclosures). The The fourth exception would apply if a
calculations conservatively assume that the 2012 periodic trigger would not have occurred if
PCT results shown in Figure 4 above are anticipated profit and losses in future years were
indicative of all the years between 2009 and 2020, taken into account in the current year. Our
which may not be the case. analysis shows that AOI’s profits increase year
after year, which indicates that the periodic
E. Exceptions to Periodic Adjustments trigger would occur no matter how many future
Reg. section 1.482-7(i)(6)(vi)(A)(1)-(4) years were considered.
identifies four exceptions that could prevent a In addition to these four exceptions, there are
periodic adjustment. In Apple’s case, the five- and 10-year safe harbors. The five-year safe
applicable period when these exceptions could harbor states that if AOI’s CSA-related results are
apply would start on January 5, 2009. This is a so low that they fall below the periodic trigger
result of Apple’s earlier-described lack of range, no periodic trigger will be allowed to exist
compliance with the 2008 regulation transition for the first five years of the CSA (which, in our
rule of reg. section 1.482-7(m)(1), which caused a analysis, is from January 5, 2009). Under the 10-
new CSA as of that date. year safe harbor, if the taxpayer has no periodic
The first exception concerns when a taxpayer trigger in the first 10 years of its CSA under the
has transferred the cost-shared IP to an unrelated 2008 regulations, the taxpayer will be exempt
party under conditions that are similar to the from a periodic adjustment for the remaining life
contribution to the controlled CSA participant, of the CSA arrangement. Apple Inc. qualifies for
and the unrelated transfer price was used as the neither of these safe harbors because it appears to
basis for pricing the PCT. No instances of this can trigger a periodic adjustment in every year since
be found in the public domain, and it seems 2009.
doubtful that those situations would exist. In summary, Apple does not appear to qualify
The second exception occurs when the for any of these exceptions or safe harbors that
indicated periodic trigger was the result of would prevent a periodic adjustment under reg.
extraordinary events, beyond the control of the section 1.482-7(i)(6).
controlled participants, that could not reasonably
have been anticipated at the time of the trigger F. Periodic Trigger Calculation
PCT. Note that this exception assumes that the Having concluded thus far that Apple did not
taxpayer otherwise complied with the CSA meet the transition rules or grandfathering
regulations. One might suggest that the incredible requirements to be exempt from a periodic
success of the iPhone could not have been adjustment under reg. section 1.482-7(i)(6) and
reasonably anticipated, but actually the opposite would not meet any of the exceptions or safe
occurred — the unexpected rise of Google’s harbors, the next step in this analysis is to perform
Android-based smartphones, which competed a periodic trigger calculation. If the calculation
directly with Apple’s iPhone, ensured that Apple shows that a periodic adjustment is triggered, the
would not become a monopolist in the adjustment is calculated.
smartphone market. In fact, Android’s rise
relegated Apple’s market share to second place.
No facts appear to support this exception.
The third exception is difficult to understand,
even after reviewing the IRS’s discussion of it in
the preambles to the regulations. It appears to
apply when the periodic trigger occurs as the
result of contributions other than platform
contributions. Because it is quite clear that
Electronic
Table 6. Key Inputs to AOI Periodic Trigger and Periodic Adjustment Calculations
1226
($ million)
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j) = e - h (k) = j/e (l) (m) = k * l (n) (o) = k * n (p)
SPECIAL REPORT
Rev. per
Year
Discount
Term
ADR
Discount
Factors
Total Apple
SEC Filings
U.S.
Rev. per
SEC Filings
Foreign
Rev. per
SEC Filings
Est. Americas
Territory
Revenues
Est. AOI
Pretax Income
Est. Apple Ireland
CSA-Related
Territory Revenues per
SEC Filings
Est. AOI RAB %
Based on Territory
Rev. Share
Total R&D Costs
Reported in
SEC Filings
Est. AOI RAB
Share of
R&D Costs
Est. Total Tech
Acquisitions
Est. AOI Share of
Tech Acquisitions =
PCT Payments
Est. AOI Share of
“Other” U.S.
Contributed PCTs
FY2009 0.73 12.23% 0.92 $30,892 $16,074 $14,818 $15,144 $2,880 $15,748 51% $960 $489 $168 $85 $65
Electronic
FY2010 1.73 12.23% 0.82 $65,225 $28,633 $36,592 $37,466 $12,000 $27,759 43% $1,782 $758 $957 $407 $131
For morecopy
FY2011 2.73 12.23% 0.73 $108,249 $41,812 $66,437 $54,711 $22,000 $53,538 49% $2,429 $1,201 $267 $132 $150
FY2012 3.73 12.23% 0.65 $156,508 $60,949 $95,559 $79,752 $36,000 $76,756 49% $3,381 $1,658 $1,241 $609 $255
Tax Notes ®
FY2013 4.73 12.23% 0.58 $170,910 $66,197 $104,713 $86,619 $28,500 $84,291 49% $4,475 $2,207 $168 $83 $258
available
FY2014 5.73 12.23% 0.52 $182,795 $68,909 $113,886 $90,167 $31,600 $92,628 51% $6,041 $3,061 $5,316 $2,694 $649
Federal
FY2015 6.73 12.23% 0.46 $233,715 $81,732 $151,983 $106,946 $45,600 $126,769 54% $8,067 $4,376 $1,106 $600 $561
at:content,
FY2016 7.73 12.23% 0.41 $215,639 $75,667 $139,972 $99,010 $39,100 $116,629 54% $10,045 $5,433 $1,373 $743 $696
FY2017 8.73 12.23% 0.37 $229,234 $84,339 $144,895 $110,358 $42,700 $118,876 52% $11,581 $6,006 $1,068 $554 $739
FY2018 9.73 12.23% 0.33 $265,595 $98,061 $167,534 $128,313 $46,000 $137,282 52% $14,236 $7,358 $1,771 $915 $932
FY2019 10.73 12.23% 0.29 $260,174 $102,266 $157,908 $133,815 $42,300 $126,359 49% $16,217 $7,876 $2,779 $1,350 $1,040
FY2020 11.73 12.23% 0.26 $274,515 $109,197 $165,318 $142,884 $36,347 $131,631 48% $18,752 $8,992 $1,741 $835 $1,107
WACC 12.23% Sum $2,193,451 $833,836 $1,359,615 $1,085,185 $385,027 $1,108,265 n/a $97,966 $49,416 $17,953 $9,006 $6,584

https://ssrn.com/abstract=3931424
TAX NOTES FEDERAL, VOLUME 172, AUGUST 23, 2021
Table 7. Estimated AOI Periodic Trigger Calculation
Periodic Trigger Calculation per Reg. Section 1.482-7(i)(6) for All PCTs
($ million)
(a) (b) (c) (d) (e) (f) = d + e (g) = b - c (h) = g/f (i) (j) = h - 1.25
Apple Ireland Non-CC/ PVI = Est. Total PVTP = Est. “Excess” AERR
Territory CSA- Non-IDC Costs CC/IDCs Current Year Investment Divisional AERR = PVTP/ AERR > 1.5 OR (versus 1.25
Year Year No. Related Sales (Est.) (Est.) PCTs Costs Profit (Loss) PVI 1.25* limitation)
FY2009 1 $15,748 $12,293 $489 $150 $639 $3,455
FY2010 2 $27,759 $14,593 $758 $539 $1,297 $13,166
FY2011 3 $53,538 $30,205 $1,201 $282 $1,484 $23,333
FY2012 4 $76,756 $38,489 $1,658 $864 $2,522 $38,267
Electronic
FY2013 5 $84,291 $53,502 $2,207 $341 $2,548 $30,790
For morecopy
FY2014 6 $92,628 $55,273 $3,061 $3,342 $6,404 $37,355
Tax Notes ®
FY2015 7 $126,769 $76,193 $4,376 $1,160 $5,536 $50,575
available
FY2016 8 $116,629 $71,353 $5,433 $1,439 $6,872 $45,276
Federal
FY2017 9 $118,876 $69,617 $6,006 $1,293 $7,299 $49,260
Yr 0 NPV Thru Yr 1 $14,476 $11,300 $450 $138 $588 $3,176 5.40 Yes 415%
at:content,
Yr 0 NPV Thru Yr 2 $37,212 $23,253 $1,071 $579 $1,650 $13,959 8.46 Yes 721%
Yr 0 NPV Thru Yr 3 $76,284 $45,296 $1,948 $785 $2,733 $30,988 11.3 Yes 1009%
Yr 0 NPV Thru Yr 4 $126,196 $70,324 $3,026 $1,347 $4,373 $55,871 12.8 Yes 1153%
Yr 0 NPV Thru Yr 5 $175,035 $101,324 $4,305 $1,545 $5,849 $73,711 12.6 Yes 1135%
Yr 0 NPV Thru Yr 6 $222,856 $129,859 $5,885 $3,270 $9,155 $92,996 10.2 Yes 891%
Yr 0 NPV Thru Yr 7 $281,170 $164,909 $7,898 $3,804 $11,702 $116,261 9.9 Yes 865%
Yr 0 NPV Thru Yr 8 $328,974 $194,155 $10,125 $4,394 $14,518 $134,819 9.3 Yes 804%

Yr 0 NPV Thru Yr 9 $372,390 $219,580 $12,318 $4,866 $17,184 $152,809 8.9 Yes 764%
1227
SPECIAL REPORT
SPECIAL REPORT
Table 8. Estimated AOI Periodic Adjustment Calculations
With a 66.7% Residual Profit Split to Apple US in Adjustment Year 2017
Periodic Adjustment per Reg. Section 1.482-7(i)(6)
($ million)
(g) = f /
(a) (b) (c) (d) = b * c (e) (f) = d - e (Det Year ADR)
Nominal
Royalty Nominal Present Value of
Divisional Royalty Rate Due Under Payments The Owed PCT
Year Profit and Adjusted Made Additional In 2017
Year No. Loss RPSM (PCTs) PCT Owed
FY2009 1 $3,455 50% $1,732 $150 $1,582 Convert Year 0

Amounts to PV in
FY2010 2 $13,166 50% $6,601 $539 $6,062 2017
FY2011 3 $23,333 50% $11,699 $282 $11,416
FY2012 4 $38,267 50% $19,186 $864 $18,321
FY2013 5 $30,790 50% $15,437 $341 $15,096
FY2014 6 $37,355 50% $18,728 $3,342 $15,386
FY2015 7 $50,575 50% $25,357 $1,160 $24,196
FY2016 8 $45,276 50% $22,700 $1,439 $21,261
FY2017 9 $49,260 50% $24,697 $1,293 $23,404
Yr 0 NPV Thru Yr 9 $152,809 $76,613 $4,866 $71,747 $196,452
The periodic trigger calculation, which is should qualify as noncompliance.) Because Apple
described in reg. section 1.482-7(i)(6)(i) through is publicly traded, the applicable discount rate is
(iv), triggers a periodic adjustment if the foreign Apple’s weighted average cost of capital in the
participant’s actually experienced return ratio is year in which the trigger PCT occurs, according to
above the periodic return ratio range. The actually reg. section 1.482-7(i)(6)(iv)(B).
experienced return ratio is the present value of the The calculations that follow use Apple’s 2017
total profits of the foreign CSA participants fiscal year as the adjustment year (which is not yet
divided by the present value of the CSA-related under examination according to the most recent
investments (the sum of PCTs and cost-sharing annual SEC filing). The trigger PCT occurred in
payments), known as PVI. The upper bound of 2009, and Apple’s applicable discount rate in 2009
the periodic return ratio range is 1.5. However, if is reported on a financial website to have been
the taxpayer has not substantially complied with 12.23 percent.19 All the tables in the appendix use
the documentation requirements referenced in that applicable discount rate.
reg. section 1.482-7(k), that threshold is reduced to The calculations of the periodic trigger for
1.25. (Note that preparing a CSA contract that Apple are based on SEC filings and other
includes intentionally misleading and false information and may differ to some extent from
information on the functions and risks that each tax information. First, the information used as
18
CSA participant undertakes — information inputs to the periodic trigger calculation is shown
required by reg. section 1.482-7(k)(1)(ii)(C) — below. Note that Apple has a September 30 year-
end, and the CSA start date for this exercise is
18
See Curtis and Chamberlain, supra note 1, at Section III (discussing 19
the disclosures in the 2016 commission decision regarding false See GuruFocus’s website. This website provides all calculations and
information contained in figures 8 and 9 included in Apple’s restated inputs to the weighted average cost of capital determination and is
CSA contract). considered a reliable source for this information.
Electronic
SPECIAL REPORT
January 5, 2009. Therefore, year 1 in this exercise routine returns. Say, for example, that one
is a partial year, from January 5, 2009, to participant has existing product IP that will
September 30, 2009, and year 2 and onward are contribute to the intangible development
12-month periods from October 1 to September 30 activity and has personnel and facilities that
of the following year. The year 1 financial inputs will conduct the joint development of the
were estimated based on the proportion of annual cost-shared intangibles. The other
revenues that occurred between the second and participant holds different IP that will also
fourth quarters. The discount term was based on contribute to the intangible development
the number of days between January 5, 2009, and activity. Their relative values are 75 percent
September 30, 2009. (Note that Apple Inc. uses a for the first participant and 25 percent for
52/53 week fiscal year in its SEC filings. For the the second participant. These relative values
convenience of the reader, we refer herein to are used by applying the RPSM in the
September 30 year-ends.) periodic adjustment calculation to place
The periodic trigger calculation is shown appropriate levels of nonroutine profits in
below in Table 7, and it follows the process and the hands of each participant.
formatting shown in reg. section 1.482-7(i)(6)(vii), The five formulaic steps to calculate the
Example 1. periodic adjustment are set out in reg. section
As can be seen, a periodic trigger is indicated 1.482-7(i)(6)(v) as follows.
by this calculation beginning in year 1 of the As of the date of the trigger PCT, determine
January 5, 2009, CSA. the present value of the PCT payments using the
adjusted RPSM as described in paragraph
G. Periodic Adjustment Calculations
(i)(6)(v)(B) of the CSA regulations. (Note that for
The five steps laid out below are formulaic. this purpose, these PCT payments are mostly
The background to them, though, is the those related to the Apple Inc. acquisitions.)
commensurate-with-income concept that was Convert the present value of the PCT
inserted into section 482 (and section 367(d)) in payments determined in the first step into a level
the Tax Reform Act of 1986. In short, the concept royalty rate as a percentage of the reasonably
behind these formulaic steps is to allow a CSA anticipated divisional profits or losses over the
participant to earn a return only to the extent of entire duration of the CSA activity.
two factors: Multiply the second-step royalty rate by the
• The first factor is the routine exploitation actual divisional profit or loss for tax years
functions performed. Normal transfer preceding and including the adjustment year to
pricing concepts and applicable regulations yield a stream of contingent payments in each
under section 482 will determine the return year, and convert these payments to a present
for these functions. For AOI, these functions value as of the CSA start date. In the event of a loss
include the sales and marketing, customer in a year, the result will be a negative contingent
support, logistics, and other functions payment for that year.
performed by AOI’s disregarded entity First, convert any actual PCT payments
subsidiaries around the world. Because through the adjustment year to a present value as
Apple U.S. performs all production of the CSA start date (January 5, 2009). Second,
functions, AOI’s routine exploitation returns subtract this present value from the present value
would exclude any return for those result determined in the previous step. This
functions. difference is the amount in present value terms of
• The second factor is the platform the participant’s deficiency in PCT payments.
contributions that each CSA participant Third, convert this present value payment to a
brought to the table at the initiation of the nominal amount in the adjustment year. This
CSA. Thus, the RPSM is used by applying nominal amount is the periodic adjustment to be
the relative value of each participant’s PCTs recognized by the U.S. taxpayer as additional
to determine that participant’s share of taxable income in the adjustment year.
actual profits that exceed the calculated
Electronic
SPECIAL REPORT
Table 9. Estimated AOI Periodic Adjustment Calculations for
Years Between Adjustment Year and 2020 Determination Date
($ million)
(a) (b) (c) (d) = b * c (e) (f) = d - e
Nominal
Royalty Due Additional
Divisional Royalty Rate Under Nominal Periodic
Profit and In Adjustment Adjusted Payments Adjustment to
Year Year No. Loss Year RPSM Made (PCTs) Be Made
FY2018 10 $54,274 50% $27,211 $1,848 $25,363
FY2019 11 $51,526 50% $25,833 $2,389 $23,444
FY2020 12 $46,174 50% $23,150 $1,942 $21,208
Table 10. Estimated Federal Taxes for a Periodic Adjustment Covering the
Adjustment Year and Through the Determination Date
($ million)
Periodic Statutory Federal Estimated
Description Applicable Year Adjustment Rate Federal Taxes
Initial Periodic Adjustment 2017 $196,452 35% $68,758
Subsequent Periodic Adjustment 2018 $25,363 24.5% $6,214
Subsequent Periodic Adjustment 2019 $23,444 21% $4,923
Subsequent Periodic Adjustment 2020 $21,208 21% $4,454
Total $84,349
Importantly, step 4 actually includes three for what otherwise were the projected
substeps as noted. In Appendix 2, step 4 is results over such period, as reasonably
separated into steps 4a, 4b, and 4c for clarity. After anticipated as of the date of the Trigger
a periodic adjustment has been calculated for an PCT.
adjustment year, every subsequent year will
The detailed guidance, as reflected in reg.
automatically be subject to a periodic adjustment
section 1.482-7(i)(6)(vii), Example 1, paragraphs
in accordance with the following guidance.
(v) through (vii), requires that the entire projected
Apply the second-step royalty rate to the life of a CSA be included in the calculation of the
actual divisional profit or loss for each tax year level royalty rate. As a result, in making
after the adjustment year to calculate amounts for calculations for the Apple Inc./AOI CSA, which
each year. Then subtract from each year’s amount presumably is intended to have a perpetual life,
any actual PCT payment made for the same year. our calculation of the level royalty rate in Table
The differences are the periodic adjustment for A2.3 includes a terminal value. (This is described
each post-adjustment tax year. in Appendix 2, section C.3.)
Reg. section 1.482-7(i)(6)(v)(B)(2) contains the The calculation steps described above as
following guidance regarding the determination applied to Apple’s CSA, together with relevant
of the applicable royalty: assumptions, are shown in Appendix 2. Tables 9
Projected results for the balance of the and 10 show the results of steps 4 and 5,
CSA Activity after the Determination representing the periodic adjustment calculations
Date, as reasonably anticipated as of the through the fiscal 2017 adjustment year.
Determination Date, shall be substituted
Electronic
SPECIAL REPORT
Once the adjustment year result is obtained, last three years to 15 percent, 20 percent, and 25
step 5 computes the periodic adjustment due for percent, respectively. No interest element is
the remaining years for which information is added to these installments. This means that as of
available (the last year representing the mid-2021, Apple has presumably paid two of
determination date), using the adjustment year these installments, or $5.9 billion, which would
royalty rate. Because Apple has reported book reduce to some extent the amount of any taxes
financial results through 2020, Table 9 shows resulting from a periodic adjustment assessed for
results for fiscal 2018 through fiscal 2020, in which the 2017 tax year.
the 2020 tax year is the determination date. Apple reported in its 2018 Form 10-K that it
The total estimated taxes that the IRS could had established a deferred tax liability for the
impose on an audit cycle covering years through expected deemed repatriation taxes of $37.3
the determination date based on this analysis are billion arising from the TCJA. If that is combined
shown below. with Apple’s unrecognized tax benefits as of
September 30, 2020, of $16.5 billion, the result is
H. Impact of Deemed Repatriation Tax $53.8 billion, which is about 64 percent of the $84
Importantly, Apple stated in its fiscal 2018 billion in taxes that would be associated with the
Form 10-K the following regarding its deemed periodic adjustment estimated here based on
21
repatriation taxes as part of the Tax Cuts and Jobs public information. It is expected that Apple’s
20
Act. Beginning with its fiscal 2018 tax return, internal accounting information will differ,
Apple was required to pay these taxes on all perhaps significantly, from the estimates
accumulated unrepatriated foreign income since established here, which are based on publicly
1986, measured as of approximately November available information and on factual assumptions
2017, because of the U.S. implementation of a made when public information is unavailable. For
territorial tax system in 2017: instance, this analysis intentionally seeks to apply
maximum possible values for acquisition and
As of September 30, 2017, the Company other PCTs and routine returns, and minimum
had a U.S. deferred tax liability of $36.4 values for projected CSA returns, to produce a
billion for deferred foreign income. “lower bound” conservative periodic adjustment
During 2018, the Company replaced $36.1 estimate. An actual calculation based on Apple’s
billion of its U.S. deferred tax liability with proprietary tax and accounting results could
a deemed repatriation tax payable of $37.3 determine periodic adjustments significantly
billion, which was based on the Company’s higher than the $84 billion estimated here.
cumulative post-1986 deferred foreign
income. . . . The Company plans to pay the tax V. Alternative Adjustments to AOI
in installments in accordance with the Act.
Regardless of whether the IRS chooses to
[Emphasis added.]
apply a periodic adjustment under reg. section
The $37.3 billion appears to represent, for the 1.482-7(i)(6), the publicly available facts strongly
most part, the 15.5 percent special repatriation tax support two additional approaches for the IRS to
rate applied to Apple’s unrepatriated foreign consider. One of them — the application of
income as of the 2017 measurement date, net of effectively connected income taxation and the
foreign tax credits. Secondly, Apple stated that it subpart F branch rule to AOI — can be pursued
elected to pay this sum in installments over eight simultaneously with transfer pricing adjustments,
years, consistent with the TCJA. According to the including the periodic adjustment and
law, the first five of those payments are 8 percent adjustments under other transfer pricing
of the repatriation tax amount and escalate in the regulations.
20
Because a periodic adjustment will increase the income of Apple
Inc., there will be a corresponding reduction in the accumulated 21
earnings within AOI. See reg. section 1.482-1(g)(2) concerning correlative Note that this additional $84 billion in taxes does not include any
adjustments. state taxes that may be due.
Electronic
SPECIAL REPORT
A. ECI Taxation and Subpart F Branch Rule
24
business of the Apple group, AOI will be treated
by statute (section 875) as being engaged in a
ECI taxation is applied to foreign persons,
trade or business within the United States.
including controlled foreign corporations, such as
AOI. This taxation requires that the foreign Once AOI is found to be engaged in a trade or
person factually conduct a trade or business business in the United States (whether directly or
within the United States. Part 1 of this report through a partnership), each item of gross income
documented how AOI conducts much of its must be considered under the applicable sourcing
business through the actions of U.S.-based and ECI rules to determine the ECI that will be
22
personnel, whether its own personnel or Apple directly taxable in the hands of AOI. Given the
Inc. personnel who are making decisions and active participation of personnel in the United
conducting commercial sales and production States in both the sales and production of tangible
activities on behalf of AOI. These activities, and intangible products, as well as in managing
conducted regularly and continuously, are more and operating the internet-based platforms
than enough to cause AOI to be engaged in a trade through which cloud services income is earned, it
or business within the United States. seems certain that there will be significant U.S.-
source income that will be treated as ECI under
The application of ECI taxation is 25
section 864(c)(3).
procedurally easier when there is a partnership.
Accordingly, how Apple Inc. and AOI conduct the It is important to note that ECI taxation may
Apple group’s worldwide business must be be applied in conjunction with transfer pricing
examined in light of the reg. section 301.7701-1 adjustments. Assume that the IRS chooses to
and -3 entity classification rules. In short, with one apply and eventually sustains periodic
management and operational structure that adjustments under reg. section 1.482-7(i)(6) or
conducts the business of both Apple Inc. and AOI, other transfer pricing adjustments, such as
there is clearly a joint business that constitutes an intercompany service fee adjustments under reg.
entity for federal tax purposes and will be treated section 1.482-9. Following those adjustments,
as a partnership under the entity classification AOI’s profits will have been reduced under the
default rule in the absence of an active election.
23 correlative adjustment rules of reg. section 1.482-
With AOI thereby being treated as a partner in a 1(g)(2). ECI taxation will be applied to the post-
partnership that conducts the joint worldwide correlative adjustment profits of AOI.
The status of open and closed years for the
application of ECI taxation to a CFC, such as AOI,
does not follow the status of the Apple U.S.
affiliated group’s open and closed years. This is
22
because any CFC is a separate taxpayer with its
Recall that AOI has employees within the United States regularly
acting for its disregarded entity subsidiaries. This is because ASI and
own filing requirements on Form 1120-F, “U.S.
AOE (disregarded entity subsidiaries treated as AOI branches or Income Tax Return of a Foreign Corporation.” If
divisions for federal tax purposes) have U.S.-located directors who,
Apple has admitted to the European Commission and the GCEU, are
AOI hasn’t filed Form 1120-F for a prior year, then
conducting ASI and AOE’s businesses. While those persons may under section 6501(c)(3), that year will still be
factually be directors of ASI and AOE, the branch-division status of the
companies for federal tax purposes under the check-the-box rules means open for adjustment. Further, the above-described
that they are AOI employees who have management responsibility for facts show how Apple Inc. has conducted major
AOI’s ASI and AOE divisions. The regular conduct of management and
other functions by these AOI employees creates a trade or business portions of AOI’s business and show the
within the United States for AOI.
23
See Jeffery M. Kadet and David L. Koontz, “Profit-Shifting
Structures and Unexpected Partnership Status,” Tax Notes, Apr. 18, 2016,
p. 335. As indicated in that article (id. at 340), even just joint production 24
See LTR 201305006.
activities will create a separate entity (reg. section 301.7701-1(a)(2)) that 25
will be treated as a partnership for tax purposes under the default rule of See H. David Rosenbloom, “Kumquat: The U.S. International Tax
reg. section 301.7701-3(b). The production functions (short of the Issues,” Tax Notes Int’l, June 25, 2018, p. 1521; Lee A. Sheppard, “What
physical manufacturing carried out by third-party contract About Cupertino?” Tax Notes Federal, July 27, 2020, p. 565; Thomas J.
manufacturers) conducted by Apple Inc. on behalf of both its own and Kelley, Koontz, and Kadet, “Profit Shifting: Effectively Connected
AOI’s product needs are more than sufficient to create the separate entity Income and Financial Statement Risks,” 221 J. Acct. 48 (Feb. 2016); Kadet
and thus a partnership for tax purposes. The additional joint and Koontz, “Internet Platform Companies and Base Erosion — Issue
management and joint participation in sales to major customers and the and Solution,” Tax Notes, Dec. 4, 2017, p. 1435; and Kadet and Koontz, “A
management and conduct of the internet-based platforms used by both Case Study: Effectively Connected Income,” Tax Notes Federal, Apr. 13,
companies just cement this separate-entity and partnership status. 2020, p. 217.
Electronic
SPECIAL REPORT
conflicting information that the group has B. Recharacterization
provided to different authorities, including the
The second possible approach that the IRS
GCEU. Considering this, even if AOI has filed
could consider is recharacterization. Although the
protective Forms 1120-F for all prior years going
above ECI and subpart F branch rule approach
back to its predecessor’s 1980 formation claiming
can be applied on its own or in conjunction with
that it had no trade or business in the United
periodic adjustments, recharacterization would
States, many of those years should still be open
be appropriate only if the IRS were to decline to
under either section 6501(c)(1) or (2), which
initiate periodic adjustments.
respectively deal with the filing of a false or
Any in-depth discussion of recharacterization
fraudulent return and the willful attempt to evade
is beyond the scope of this report. Suffice it to say
tax.
that the background facts of how Apple Inc.
The Form 10-K filed by Apple Inc. for its year
manages the entire business of AOI and conducts
that ended in September 2020 disclosed that all
major portions of its business on its behalf (for
prior years through 2015 are closed for further
example, sales to major customers, full conduct of
adjustment by the IRS. Despite this, many or all of
AOI’s supply chain, and operation of the internet-
those prior years will likely still be open for ECI
based platforms through which AOI makes sales
taxation of AOI.
and earns cloud services revenues) strongly
ECI taxation includes not only the normal support a position that AOI is nothing more than
corporate tax at the rate applicable for the tax year an agent of Apple Inc. That position is consistent
26
but also the section 884 branch profits tax. with the factual situation that Apple has
27
Further, if a tax return has not been timely filed, presented to the European Commission and the
the amount of ECI will be increased by the section GCEU.
28
882(c)(2) denial of deductions and credits.
Note that a recharacterization approach could
To the extent that AOI’s income from sales is be applied only to Apple Inc.’s open years, which
foreign-source and escapes ECI taxation, it will are 2016 through the present. In contrast, both
still be potentially subject to U.S. taxation in the periodic adjustments and ECI taxation allow
hands of its U.S. shareholder under subpart F. In some taxation of AOI income earned in earlier
short, the branch rule of section 954(d)(2) and reg. years.
section 1.954-3(b) should apply to some portion of
AOI’s sales transactions.29 Because subpart F VI. Conclusion
results in taxation in the hands of the U.S.
shareholder and not the applicable CFC, this The conclusions of this report are based on
additional tax should apply only to Apple Inc.’s reliable public information, including disclosures
2016 tax year and later, unless some exception related to investigations conducted by the Senate
were to apply. For example, section 6501(c)(8) PSI and the European Commission, which
could potentially apply depending on what include information provided by Apple Inc. to
disclosures Apple Inc. has made or not made in its these organizations and to the GCEU. Our
U.S. tax filings. findings include that Apple Inc. did not comply
with the transition rules in the 2008 temporary
cost-sharing regulations (in particular, reg.
section 1.482-7(m)(1)). Although this would
disqualify the Apple Inc./AOI CSA from being a
valid CSA from January 5, 2009, the IRS’s
26
Because AOI is not tax resident in any country with which the apparent acceptance of the CSA in now-closed tax
United States maintains a tax treaty, the 30 percent rate in section 884(a) years from 2009 through 2015 means that Apple
would apply to the dividend equivalent amount.
27
See reg. section 1.882-4(a)(3).
Inc. and AOI’s CSA must be considered to be a
28
There is no need to go into details. Suffice it to say that in addition
new CSA effective from January 5, 2009, with no
to interest, there could be various penalties, including penalties for benefit of any grandfathering provisions in reg.
nonfiling of partnership returns and non-withholding of tax under section 1.482-7(m)(2). As a result, Apple would
section 1446.
29
Rosenbloom, supra note 25, at 1523 et seq.; and Sheppard, supra not qualify for exemption from compliance with
note 25, at 565 et seq. the 2008 periodic adjustment regulations in reg.
Electronic
SPECIAL REPORT
section 1.482-7(i)(6). An indicative calculation of Importantly, the apparent recognition within
this periodic adjustment according to these AOI of significant profits that should have been
regulations and based on conservative reflected within the United States, as
assumptions shows that Apple Inc. appears to be demonstrated in this report, affects state taxes,
subject to a substantial periodic adjustment, the especially for any states that apply their state
tax payments for which would exceed the income taxes on a water’s-edge or other approach
amounts of tax underpayments reserved in that excludes AOI’s profits from the allocable tax
Apple’s UTPs combined with its deferred tax base. In addition, these findings should provide a
liabilities for the TCJA deemed repatriation taxes. basis for state tax audits to recoup significant
In conjunction with, or as an alternative to, amounts of underpaid taxes where a state has
making periodic adjustments, the IRS has a applicable transfer pricing rules in place.
particularly strong basis for assessing ECI That so many code sections appear to have
taxation directly on AOI and treating some been violated by Apple Inc.’s potentially sham,
portion of AOI’s transactions as creating subpart F and almost certainly nonqualifying, CSA without
income within Apple Inc. under the foreign base IRS detection or enforcement, despite a plethora
company income branch rule. Further, as an of publicly available evidence and information,
alternative to making periodic adjustments, the raises possibly the most spectacular enforcement
IRS could consider recharacterizing the Apple failure yet produced by this Frankenstein
Inc./AOI relationship to treat AOI as nothing regulation. It does appear that Frankenstein’s
more than an agent of Apple Inc. monster is alive and well, and on the rampage at
Apple Inc.
Electronic
VII. Appendix 1: Apple Acquisitions
Publicly known acquisitions are shown in Table A1.1. All references for these acquisitions were retrieved in May 2021 and are shown in
Table A1.2. The years shown are September year-end.
Table A1.1
Public PCT
Value Value Used
No. Date Acquisition Technology Location ($ mil) Application Reference ($ mil)
1 2-Mar-88 Network Innovations Software United States — Data Access Language (DAL) [1] $70.8
2 7-Jun-88 Orion Network Sys. Computer Software United States — SNA*ps [2] $70.8
3 27-Jun-88 Styleware Computer software United States — AppleWorks GS, iWork, iLife [3] $70.8
Electronic
4 11-Jul-88 Nashoba Systems Computer software United States — FileMaker [4] $70.8
For morecopy
5 3-Jan-89 Coral Software YE United States — Macintosh Common Lisp [5] $70.8
6 7-Feb-97 NeXT Unix-like hardw./softw. platform United States $404.0 Mac OS X/macOS, iOS [6] $404.0
Tax Notes ®
7 2-Sep-97 Power Computing Corp. Macintosh clones United States $110.0 — [7] $110.0
available
8 8-Jan-99 Xemplar Education Software United Kingdom $4.9 — [8] $4.9
Federal
9 3-Nov-99 Raycer Graphics Computer graphic chips United States $15.0 — [9] $15.0
at:content,
10 7-Jan-00 NetSelector Internet software United States — — [10] $70.8
11 11-Apr-00 Astarte-DVD Software Software Germany — DVD Studio Pro, iDVD [11] $70.8
12 1-Nov-00 SoundJam MP Software United States — iTunes [12] $70.8
13 1-Mar-01 Bluefish Labs Productivity software United States — iWork [13] $70.8
14 11-May-01 bluebuzz Internet service provider (ISP) United States — — [14] $70.8
15 9-Jul-01 Spruce Technologies Graphics software United States $14.9 DVD Studio Pro [15] $14.9
16 31-Dec-01 PowerSchool Online info systems services United States $66.1 PowerSchool [16] $66.1

17 1-Feb-02 Nothing Real Special effects software United States $15.0 Shake [17] $15.0
18 4-Apr-02 Zayante FireWire chips and software United States $13.0 FireWire [18] $13.0
19 11-Jun-02 Silicon Grail Corp Digital effects software United States $20.0 Motion [19] $20.0
20 20-Jun-02 Propel Software Internet & network wireless opt. United States — Safari [20] $70.8
21 21-Jun-02 Prismo Graphics Film/video special-effects softw. United States $20.0 LiveType (Final Cut Studio) [21] $20.0
22 1-Jul-02 Emagic Music production software Germany $30.0 Logic Pro, GarageBand [22] $30.0
23 1-Mar-05 SchemaSoft Software Canada — iWork [23] $70.8
1235
SPECIAL REPORT
Table A1.1 (Continued)
1236
Public PCT
Value Value Used
24 1-Apr-05 FingerWorks Gesture recognition company United States — iOS [24] $70.8
SPECIAL REPORT
25 16-Oct-06 Silicon Color Software United States — Color (Final Cut Studio) [25] $70.8
26 4-Dec-06 Proximity Software Australia — Final Cut Server [26] $70.8
27 24-Apr-08 P.A. Semi Semiconductors United States $278.0 Apple SoC [27] $278.0
28 7-Jul-09 Placebase Maps United States — Apple Maps [28] $167.6
29 4-Dec-09 Lala.com Music streaming United States $17.0 iCloud, iTunes Match [29] $17.0
Electronic
30 5-Jan-10 Quattro Wireless Mobile advertising United States $275.0 iAd [30] $275.0
For morecopy
31 27-Apr-10 Intrinsity Semiconductors United States $121.0 Apple SoC [31] $121.0
32 27-Apr-10 Siri Voice control software United States — Siri [32] $167.6
Tax Notes ®
33 10-May-10 Gipsy Moth Studios Application Regionalization Firm — $12.0 iPod, iPhone, iPad [33] $12.0
available
34 14-Jul-10 Poly9 Web-based mapping Canada — Apple Maps [34] $167.6
Federal
36 14-Sep-10 IMSense High-dynamic-range photography United Kingdom — iOS [35] $167.6
at:content,
35 20-Sep-10 Polar Rose Facial recognition Sweden $29.0 iOS [36] $29.0
37 1-Aug-11 C3 Technologies 3D mapping Sweden $267.0 Maps [37] $267.0
38 20-Dec-11 Anobit Flash memory Israel $500.0 iPod, iPhone, iPad [38] $500.0
39 23-Feb-12 Chomp App search engine United States $50.0 App Store [39] $50.0
40 2-Jun-12 Redmatica Audio Italy — Logic Pro, GarageBand [40] $167.6
41 27-Jul-12 AuthenTec PC and mobile security products United States $356.0 Touch ID [41] $356.0
42 27-Sep-12 Particle HTML5 Web app firm United States — iCloud, iAd [42] $167.6

43 3-Apr-13 Novauris Tech. Speech recognition United Kingdom — Siri [43,44] $167.6
44 Oct-13 OttoCat Search engine United States — App Store [45] $167.6
45 23-Mar-13 WiFiSlam Indoor location United States $20.0 Apple Maps [46] $20.0
46 19-Jul-13 Locationary Maps Canada — Apple Maps [47] $167.6
47 19-Jul-13 HopStop.com Maps United States — Apple Maps [48] $167.6
48 1-Aug-13 Passif Semiconductor Semiconductors United States — Apple SoC [49] $167.6
49 13-Aug-13 Matcha Media discovery app United States — TV app — Apple TV & iOS [50] $167.6

Public PCT
Value Value Used
50 22-Aug-13 Embark Maps United States — Apple Maps [51] $167.6
51 28-Aug-13 AlgoTrim Mobile data compression Sweden — iOS [52,53] $167.6
52 3-Oct-13 Cue Personal assistant United States $50.0 Siri [54] $50.0
53 24-Nov-13 PrimeSense Structured-light 3D scanners Israel $360.0 Face ID, TrueDepth [55] $360.0
54 2-Dec-13 Topsy Analytics United States $200.0 App Store, Music, iTunes [56] $200.0
55 23-Dec-13 BroadMap Maps United States — Apple Maps [57] $167.6
Electronic
56 23-Dec-13 Catch.com Software United States — Siri [58] $167.6
For morecopy
57 Dec-13 Acunu Database analytics United States — iCloud [59] $167.6
58 4-Jan-14 SnappyLabs Photography software United States — Camera [60] $167.6
Tax Notes ®
59 21-Feb-14 Burstly Software testing United States — TestFlight, App Store [61] $167.6
available
60 2-May-14 LuxVue Technology microLED displays United States — — [62] $167.6
Federal
61 6-Jun-14 Spotsetter Social search engine United States — Apple Maps [63] $167.6
at:content,
62 29-Jun-14 Swell Music streaming United States $30.0 Apple Music [64] $30.0
63 29-Jun-14 BookLamp Book analytics United States — iBooks [65,66] $167.6
64 1-Aug-14 Beats Electronics Headphones, music streaming United States $3,000 iPhone, iTunes, Music [67] $3,000
65 23-Sep-14 Prss Digital magazine Netherlands — Apple News[85] [68,69] $167.6
66 Sept-14 Dryft On-Screen Keyboard United States — iOS Keyboard [70] $167.6
67 Jan-15 Camel Audio Audio plug-ins/sound libraries United Kingdom — Logic Pro [71] $167.6
68 21-Jan-15 Semetric Music analytics United Kingdom $50.0 Apple Music, iTunes [72,73] $50.0

69 24-Mar-15 FoundationDB Database United States — iMessage Backend [74] $167.6
70 14-Apr-15 LinX Camera Israel $20.0 iPhone Camera [75] $20.0
71 Apr-15 Coherent Navigation GPS United States — Apple Maps [76] $167.6
72 May-15 Metaio Augmented reality Germany — ARKit [77] $167.6
73 Sep-15 Mapsense Mapping visualization United States $30.0 Apple Maps [78] $30.0
74 Sep-15 VocalIQ Speech technology United Kingdom — Siri [79] $167.6
75 Sep-15 Perceptio Mach. Learning, Image recogn. United States — Face ID, Animoji, Photos [80] $167.6
1237
SPECIAL REPORT
1238
Public PCT
Value Value Used
76 Nov-15 Faceshift Realtime Motion Capture Switzerland — Animoji [81] $167.6

SPECIAL REPORT
77 7-Jan-16 Emotient Emotion recognition United States — Face ID, Animoji[103] [82] $167.6
78 28-Jan-16 LearnSprout Education technology United States — Classroom iPad App [83] $167.6
79 29-Jan-16 Flyby Media Augmented reality United States — ARKit [84] $167.6
80 3-Feb-16 LegbaCore Platform security United States — Apple computers [85] $167.6
81 5-Aug-16 Turi Machine learning United States $200.0 Xcode, Core ML [86] $200.0
Electronic
82 22-Aug-16 Gliimpse Personal health info collection United States — HealthKit, CareKit [87] $167.6
For morecopy
83 22-Sep-16 Tuplejump Machine learning India — Siri, CoreML [88,89] $167.6
84 1-Dec-16 Indoor.io Indoor mapping and navigation Finland — Maps, Project Titan [90] $167.6
Tax Notes ®
85 23-Mar-17 Workflow Automation and scripting app United States — Shortcuts (iOS 12)[119] [91,92] $167.6
available
86 8-May-17 Beddit Sleep tracking hardware Finland — iOS, watchOS [93.94] $167.6
Federal
87 13-May-17 Lattice Data Artificial intelligence United States $200.0 Photos [95] $200.0
at:content,
88 16-Jun-17 SensoMotoric Instr. Eye tracking hardware/software Germany — ARKit [96] $167.6
89 22-Sep-17 Vrvana Augmented reality Canada $30.0 ARKit [97] $30.0
90 29-Sep-17 Regaind Computer vision France — Photos [98] $167.6
91 Oct-17 init.ai Messaging assistant United States — Siri [99] $167.6
92 Oct-17 PowerbyProxi Wireless charging New Zealand — iPhone, AirPower [100,101] $167.6
93 9-Nov-17 InVisage Technologies Quantum dot-based image sens. United States — iPhone, iPad [102] $167.6
94 5-Dec-17 Pop Up Archive Search tools for digital speech United States — iTunes, Apple Music [103] $167.6

95 Dec-17 Spektral Computer vision, real-time editing Denmark $30.0 Photos, iOS [104] $30.0
96 10-Dec-17 Silicon Valley Data Sci. Data science, data engineering United States — Digital Advertising [105,106] $167.6
100 2-Jan-18 Buddybuild Integration/debugging/mobile Canada — Xcode, TestFlight [107] $167.6

testing
101 12-Mar-18 Texture Digital magazine subscription svc. United States — Apple News+ [108] $167.6
102 29-Aug-18 Akonia Holographics Augmented reality glasses lenses United States — — [109,110] $167.6
103 24-Sep-18 Shazam Music and Image recognition United Kingdom $400.0 iTunes, Siri, Apple Music [111] $400.0
104 11-Oct-18 Dialog Semi. (parts) Chip development United Kingdom $600.0 — [112,113] $600.0

Public PCT
Value Value Used
105 14-Oct-18 Asaii Music analytics United States — [114] $167.6
98 Oct-2018 Silk Labs Artificial Intelligence, home monitor United States — — [115] $167.6
99 Nov 2018 Tueo Health Asthma monitoring United States — — [116,117] $167.6
106 7-Dec-18 Platoon Artist development United Kingdom — — [118,119] $167.6
97 Dec-2018 Laserlike Machine learning United States — AI, Siri [120] $167.6
107 15-Feb-19 PullString Speech technology United States — Siri [121] $167.6
Electronic
108 21-Mar-19 Stamplay Backend workflow development Italy $5.6 — [122,123] $5.6
For morecopy
109 25-Jun-19 Drive.ai Autonomous vehicles United States — — [124] $167.6
110 25-Jul-19 Intel smartph. modem Smartphone modems United Kingdom $1,000 Apple SoC [125] $1,000
Tax Notes ®
111 3-Oct-19 IKinema Motion capture United Kingdom — — [126] $167.6
available
112 12-Dec-19 Spectral Edge Low-light photography United Kingdom — — [127] $167.6
Federal
113 15-Jan-20 Xnor.ai Edge comp., artificial intelligence United States $200.0 — [128] $200.0
at:content,
114 Early 2020 Scout FM Podcast A.I. — — Apple Music, ITunes [129] $167.6
115 31-Mar-20 Dark Sky Weather forecasting and app United States — — [130] $167.6
116 3-Apr-20 Voysis Artificial intelligence/voice assistant Ireland — Siri [131,132] $167.6
117 14-May-20 NextVR Virtual reality events USA $100.0 [133] $100.0
118 24-Jun-20 Fleetsmith Mobile device management USA — iPhone, iPad, iOS [134] $167.6
119 31-Jul-20 Mobeewave Payments startup Canada $100.0 iPhone [135] $100.0
120 20-Aug-20 Camerai AR Israel — [136] $167.6

121 25-Aug-20 Spaces VR startup USA — [137] $167.6
122 15-Jan-21 Curious AI Core AI startup Finland — [138] $167.6
Total $9,244 Total $21,367
Mean $225.5 Trimmed $70.8

Mean to
2006
Trimmed means were calculated after removing the two highest and two lowest disclosed acquisition values Trimmed $167.6
Mean
after 2006
1239
SPECIAL REPORT
Table A1.2. List of References for Apple Acquisitions Included in Periodic Adjustment Calculations
1240
[1] “Apple Computer Inc acquires Network Innovations Corp.” Thomson Financial. Archived from the original on Apr 17, 2009. Retrieved May 24, 2021.
[2] “Apple Computer Inc acquires Orion Network Systems Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021
[3] “Claris Corp (Apple Computer) acquires Styleware Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
SPECIAL REPORT
[4] “Claris Corp (Apple Computer) acquires Nashoba Systems In..” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[5] “Apple Computer Inc acquires Coral Software Corp.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[6] “Apple Computer Inc acquires NeXT Computer Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[7] “Apple Computer Inc acquires Power Computing-Clone-Making from Power Computing Corp.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[8] “Apple Computer Inc acquires remaining interest in Xemplar Education Ltd from Morgan Stanley.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
Electronic
[9] “Apple Computer Inc acquires Raycer Graphics.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
For morecopy
[10] “Apple Computer Inc acquires NetSelector.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
Tax Notes
[11] “Apple Computer Inc acquires Astarte-DVD Authoring Software from Astarte GmbH.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
®
[12] Jade, Casper. “Apple Acquires SoundJam, Programmer for iMusic.” AppleInsider. January 8, 2001. Archived from the original on January 19, 2012. Retrieved May 24, 2021.
available
Federal
[13] “We’ve been acquired!.” Bluefish Labs. Archived from the original on November 29, 2001. Retrieved May 24, 2021.
[14] “Network Innovations Corp acquires bluebuzz.com Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
at:content,
[15] “Apple Computer Inc acquires Spruce Technologies Inc from JBIS Holdings Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[16] “Apple Computer Inc acquires PowerSchool Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[17] “Apple Computer Inc acquires Nothing Real LLC.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[18] “Apple Computer Inc acquires Zayante Inc.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[19] “Apple Computer Inc acquires Silicon Grail Corp-Chalice from Silicon Grail Corp.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[20] “Apple Computer Inc acquires Propel Software Corp.” Thomson Financial. Archived from the original on December 20, 2008. Retrieved May 24, 2021.
[21] Loli, Eugenia. “Apple Purchases Prismo Graphics.” OSNews. Jun 21, 2002. Retreived May 24, 2021.

[22] “Apple Computer Inc acquires Emagic Soft-und Hardware GmbH.” Thomson Financial. Archived from the original on May 11, 2009. Retrieved May 24, 2021.
[23] Freid, Ina. “Apple swallows SchemaSoft.” CNET. March 23, 2005. Retrieved May 24, 2021.
[24] Khaney, Leander. “Birth of the iPhone: How Apple turned clunky prototypes into a truly magical device.” June 26, 2017. Retreived May 24, 2021.
[25] Cohen, Peter. “Apple acquires Silicon Color.” MacWorld. October 15, 2006. Retrieved May 24, 2021.
[26] “Apple Acquires Proximity.” Mac Observer. December 5, 2006. Retrieved May 24, 2021.
[27] Krazit, Tom. “Apple acquires low-power chip designer PA Semi.” CNet. Sept. 18, 2009. Retrieved May 24, 2021.
[28] Weintraub, Seth. “Apple purchased Placebase in July to replace Google Maps?.” ComputerWorld. Archived from the original on October 2, 2009. Retrieved May 8, 2021.

Table A1.2. List of References for Apple Acquisitions Included in Periodic Adjustment Calculations (Continued)
[29] Kincaid, Jason. “Apple has acquired LaLa.com.” TechCrunch. December 4, 2009. Retrieved May 8, 2021.
[30] McCarthy, Caroline. “Apple acquires Quattro Wireless.” Cnet. January 5, 2010. Retrieved May 8, 2021.
[31] Vance, Ashlee and Brad Stone. “Apple Buys Intrinsity.” New York Times. April 27, 2010. Retrieved May 8, 2021.
[32] Hay, Timothy. “Apple Moves Deeper Into Voice-Activated Search With Siri Buy.” Wall Street Journal. April 28, 2010. Retrieved May 8, 2021.
[33] “Gipsy Moth Studios acquired by Apple.” AcquiredBy.co. Retrieved Retrieved May 8, 2021.
[34] Marsal, Katie. “Apple acquires online mapping company Poly9 — report.” AppleInsider. July 14, 2010. Retrieved May 8, 2021.
[35] “Apple Buys Imsense Ltd.” Silicon Tap. September 14, 2010. Retrieved May 8, 2021.
[36] Takahashi, Dean. “Apple acquires face-recognition firm Polar Rose.” VentureBeat. September 20, 2010. Retrieved May 8, 2021.
Electronic
[37] Gurman, Mark. “Apple acquired mind-blowing 3D mapping company C3 Technologies, looking to take iOS Maps to the next level.” 9to5Mac. October 29, 2011. Retrieved May 8, 2021.
For morecopy
[38] Burns, Chris. “Apple picks up Anobit for Flash Memory.” SlashGear. December 20, 2011. Retrieved May 8, 2021.
Tax Notes
[39] Satariano, Adam and Douglas MacMillan. “Apple Is Said to Pay About $50 Million for Search Startup Chomp.” Bloomberg Businessweek. Archived from the original on February 25, 2012. Retrieved May 8,
®
2021.
available
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SPECIAL REPORT
Table A1.3. Estimated ASI/AOE Acquisition-Related PCT Values
Between September 30, 1996, and September 30, 2020
Est. Value of Acquisitions Apple Ireland Est. RAB Apple Ireland Est. PCT
Year ($ mil) Share of Acquisition Price Payments ($ mil)
1997 $514 40% $207.5
1998 $- 36% $-
1999 $5 36% $1.8
2000 $157 38% $60.2
2001 $227 36% $82.3
2002 $235 34% $80.8
2003 $- 33% $-
2004 $- 33% $-
2005 $142 33% $46.7
2006 $- 32% $45.9
2007 $142 33% $46.6
2008 $278 35% $95.9
2009 $168 51% $85
2010 $957 43% $407
2011 $267 49% $132
2012 $1,241 49% $609
2013 $168 49% $83
2014 $5,316 51% $2,694
2015 $1,106 54% $600
2016 $1,373 54% $743
2017 $1,068 52% $554
2018 $1,771 52% $915
2019 $2,779 49% $1,350
2020 $1,741 48% $835
Sum $17,953 $9,673
Electronic
SPECIAL REPORT
VIII. Appendix 2: Periodic Adjustment is one example of an undocumented transaction
that would help explain the significant periodic
A. Assumptions Made adjustment result.
In preparing this analysis, the following One reason the commensurate-with-income
assumptions underlie the calculations. standard is necessary is that it is often impossible
for the IRS to sufficiently identify all current and
1. Apple Inc. made all U.S. and foreign future PCTs, operating contributions, and non-
acquisitions that constitute platform CSA-related intercompany transactions to
contributions. adequately explain all future CSA outcomes in a
Apple disclosed to the Senate PSI a detailed way that can reliably value platform contributions
accounting of the PCTs paid by its Irish affiliates made at the outset of the CSA or throughout the
in 2012, which showed that they made payments CSA’s existence. Only through a periodic
to Apple U.S. for their share of PCTs for adjustment analysis in future years can the IRS be
acquisitions of both foreign and U.S. companies in confident that the CSA has properly accounted for
that year that were deemed to contribute to the IP the value of all PCTs and other intercompany
development activity, as well as for “other” IP transactions. The periodic adjustment
consisting of IP that was covered by reg. section calculations do not try to identify these missing
1.482-4. The information did not disclose any PCT transactions but merely confirm that they exist.
obligations of Apple U.S. to the Irish participants. Taxpayers can, of course, avoid a periodic
Therefore, we have extended these facts to all the adjustment by performing the periodic trigger
years since January 5, 2009. If 2012 was not calculations themselves and revising their
reflective of the facts in other years, those results transfer pricing to ensure that the periodic trigger
may be inaccurate. limitations are not breached for the applicable
2. There are undisclosed and underpriced period.
PCTs and other uncompensated transactions.
B. Alternative Assumptions
This periodic adjustment analysis assumes
that AOI paid an arm’s-length price under If any of the alternative assumptions below
applicable regulations (in fact, the maximum occurred, the results of this analysis could change
value for acquisitions of intangible assets and significantly.
personnel that would contribute to the 1. AOI made material technology acquisitions
development of cost-shared intangibles) for all using its own funds.
identified PCTs. Therefore, to the extent that a
If Apple’s 2012 year was not representative of
periodic adjustment is calculated, it would be the
other years and, for instance, AOI made
result of unidentified PCTs, identified PCTs for
acquisitions with its own funds in other years, this
which no payment was made, non-CSA-related
could change the amount of the periodic
controlled transactions, or other factors that
adjustment, which assumes that AOI made no
inflate the divisional profits of AOI. For instance,
acquisitions with its own funds from 2009 but
our analysis has shown, and Apple has
paid Apple U.S. AOI’s share of PCTs for all
represented to the GCEU, that AOI did not pay for
acquisitions that contributed to the cost-sharing
any U.S. commercialization activities that in fact
activity. If AOI made its own acquisitions, there
generated the Irish participants’ CSA-related
could be some amount of PCT payments due by
income (a violation that could technically
Apple Inc. to AOI, and AOI would have to be
invalidate Apple’s CSA under reg. section 1.482-
given credit for any acquired intangibles in the
7(m)(1) in combination with reg. section 1.482-
RPSM analysis.
7(a)(3)(iii)). Apple further testified that all its
stateless income was attributable to these Apple 2. Exceptions apply under reg. section 1.482-
U.S. exploitation services and activities. Whether 7(i)(6)(vi).
this is an Apple U.S. operating contribution or an If any of the exceptions to a periodic
activity that contributes to the IP development adjustment listed in reg. section 1.482-7(i)(6)(vi)
activity in a way that requires a PCT payment, it apply, that could alter or reverse these results.
Electronic
SPECIAL REPORT
These exceptions are explained in Section V.E of calculations in this appendix are based on the
our report. These exceptions would include if AOI following assumptions, as mentioned earlier:
provided intangible development activities that 1. AOI, through its disregarded entity
have not been otherwise accounted for. That subsidiaries, performs only routine
would reduce the value of any periodic activities.
adjustments once these contributions were 2. The arm’s-length return for AOI’s routine
accounted for. activities is an 8 percent markup on its
3. Apple did not have a qualified CSA under associated expenses. Based on our
the 1996 regulations. experience, we deemed this to likely be a
generous arm’s-length profit for what are
The January 1996 regulation, reg. section
clearly routine back-office functions,
1.482-7A(a)(1), required for a valid CSA that there
marketing and sales activities,
be “individual exploitation of the interests in the
manufacturing, customer service, and
intangibles assigned to them under the
other disaggregated and essentially
arrangement.” Based on testimony by Apple Inc.
subcontracted services performed mostly
to the GCEU, and the results of the state aid
for the local Irish markets.30
investigation by the European Commission, AOI
3. Future years are included in accordance
(or ASI and AOE) neither conducted its business
with reg. section 1.482-7(i)(6)(v)(B)(2).
in any truly independent manner nor exploited
They are reflected in a “terminal value”
the CSA-covered IP. Rather, Apple Inc. performed
that was modeled as a finite life of 10
these activities on behalf of AOI, apparently
years, in which each year replicated the
without compensation. As such, if AOI were
fiscal 2020 result with no growth or
considered to not be conducting individual
decline, with the nominal amount
exploitation, there would be no valid CSA in place
representing the discounted result in 2020,
from 1996 through January 5, 2009. This means
using the 2017 applicable discount rate
that all internally created intangibles (putatively
(these assumptions of zero growth and
created within the preexisting CSAs from the
finite life of the CSA are anticipated to be
January 1, 1996, effective date of the applicable
very conservative estimates of Apple’s
regulations until January 5, 2009) should be
projected results).
treated as solely owned by Apple Inc. for
4. The residual profit split shown in column
purposes of the relative platform and operating
(g) provides 66.7 percent of the residual
contributions as of January 5, 2009, that each of
profits to Apple U.S. and 33.3 percent to
Apple Inc. and AOI contributed to the new CSA.
AOI, based on the analyses shown in Table
For conservatism, this alternative assumption was
A2.1. These calculations are further
not made in the periodic adjustment calculations,
described below.
but it appears to be realistic. If the IRS pursues the
periodic adjustments suggested in this report, it D. Residual Profit-Split
should consider whether to adopt this lack of any
effective CSA from 1996 through the January 5, The first step of the periodic adjustment
2009, commencement date of the new CSA. calculation is to determine the present value of the
PCT payments using the adjusted RPSM, as
C. Periodic Adjustment Step 1 described in paragraph (i)(6)(v)(B) of the CSA
regulations. Reg. section 1.482-7(g)(7)(iii)(C)(1)
Table A2.1 below calculates the residual profit
provides that profits must be split “based upon
for each year, based on the difference between the
foreign affiliate revenues and the non-CSA-
related expenses as marked up by the routine
return. This difference is the nonroutine return. 30
Note that the 8 percent markup on total costs used in this report is
The nonroutine return is additive by year, and the lower than the 10 to 15 percent margins that Apple negotiated with
sum of each year and prior years is determined Ireland for the same activities. Apple’s negotiated margin did not
involve a transfer pricing study and was deemed by the European
and converted to a net present value as of the CSA Commission to be excessive and to “deviate from the arm’s-length
start date (January 5, 2009). Importantly, the principle.” See commission decision, supra note 7, at paras. 149 and 150.
Electronic
SPECIAL REPORT
the relative values, determined as of the date of assumed to be equally valuable. Platform
the PCTs, of the PCT Payor’s [AOI] as compared to contributions are contributions that are
the PCT Payee’s [Apple U.S.] nonroutine related to the development program
contributions to the PCT Payor’s division.” The under the CSA. These are further broken
regulation continues with further guidance that down between the value of product IP
would clearly not give the correct economic result (which also includes the value of
in Apple’s case. Among other faults, the guidance trademarks) and the value of IP related to
fails to consider a circumstance in which the PCT workforce in place and research facilities.
payee (Apple Inc.) makes operating contributions Considering the world-class nature of
to the business of the PCT payer (AOI) (much less Apple’s research program, which is
an egregious case like Apple’s in which only the conducted wholly by Apple Inc., we
PCT payee makes operating contributions) estimate that it constitutes one-third of the
because it refers only to the PCT payer’s operating total platform contributions. (Note that
contributions. Notably, Example 2 in reg. section these IP values, which could also be
1.482-7(g)(7)(v) applies the general rule but does identified as part of Apple’s going concern
not apply any of the further guidance. We have value, are in addition to (1) the routine
done likewise in Table A2.1.31 For this purpose, all values of the group’s tangible assets,
platform and operating contributions are taken which are captured by using their book
into account, but the initial platform contributions value and (2) the routine value of all
at the outset of the new CSA that are deemed to activities conducted by AOI and its
occur on January 5, 2009, are particularly disregarded entity subsidiaries, which is
important. (All later PCTs have already been captured by the 8 percent markup on
accounted for in Appendix 1.) expense.) Nonroutine operating
As noted above, the applicable profit-split contributions are all IP contributions to the
factor must be calculated for the above group’s ongoing business that are
calculations. The derivation of the factor is unrelated to the research program but
documented in Table A2.1. The factor is equal to primarily related to Apple’s world-class
the ratio of nonroutine contributions by each supply chain and its marketing strategies,
party as of January 5, 2009. Nonroutine which are directed and conducted by
contributions include both platform contributions Apple Inc.
and operating contributions. The top portion of The next two portions of the table split these
the table below calculates worldwide values of worldwide intangible property values between
each type of nonroutine contribution: AOI and Apple Inc.:
1. First, the worldwide value of all IP is 3. AOI contributes only one of the three
calculated. This is the market types of IP identified. That is, AOI is
capitalization of Apple Inc. as of January 5, treated as owning all the product-related
2009, minus the book value of assets. The IP applicable to AOI’s territory (identified
worldwide value of all IP equals $41.6 as AOI’s 34.5 percent RAB share as of the
billion. end of fiscal 2008). This is because even
2. Second, the worldwide IP value is divided though a new CSA is deemed to begin on
between platform contributions and January 5, 2009, as a result of the final
operating contributions, which are regulations’ transition rules, the original
CSA that commenced in 1980 and later
restatements are conservatively assumed
31 to have been valid through January 5,
It is appropriate to ignore the regulation’s further guidance rather
than to apply it mechanically because it provides a result that is not 2009.
correct economically. Since independent parties would not use an 4. It is indisputable that the R&D workforce
approach that is economically irrational, following the mechanical rule
would violate the overarching requirement in reg. section 1.482-1(b)(1) in place and research facilities are located
that the arm’s-length standard be applied “in every case.” (See Xilinx Inc. within Apple Inc. and that no portion of
v. Commissioner, 598 F.3d 1191 (9th Cir. 2010) (holding that reg. section
1.482-1(b)(1) trumps conflicting language elsewhere in the section 482 their IP value should be allocated to AOI.
regulations).)
Electronic
SPECIAL REPORT
5. For purposes of the analysis, it is assumed subsidiaries would be compensated only with
that AOI should not be allocated any routine returns under Apple’s global transfer
portion of the operating contributions, pricing policies. It is therefore reasonable and
either. While this conclusion is not appropriate to assign a nonroutine operating
indisputable, it cannot be denied that contribution value of zero to AOI.
Apple Inc. owns the lion’s share of that IP. In light of the above, the worldwide value of
Attributing some small proportion (say, 3 the Apple group’s IP of $41.6 billion must be
percent) of this IP to AOI would make only allocated between the Apple Inc. and AOI
a very minor change to the periodic territories. Under the guidance of reg. section
adjustment calculation. 1.482-7(g)(7)(iii)(C)(1), with only profits
This report has demonstrated very clearly that attributable to AOI’s territory being subject to the
almost all activities related to Apple’s unmatched RPSM analysis, the final section in the table below
supply chain, and all direction and much of the determines the profit split between AOI and
implementation of marketing strategies, are Apple Inc. based on AOI’s RAB share of legacy
conducted by Apple Inc. and in fact have been product IP ($4.8 billion) and Apple Inc.’s
compensated by AOI through service fees only to contribution to AOI’s business from its R&D
a very small extent (if at all). Apple has admitted workforce and facilities ($2.4 billion) and its
as much in its filings with the European supply chain, marketing, and other exploitation
Commission. To the extent there may be Apple ($7.2 billion). This results in a profit split for AOI
group personnel located in China or elsewhere in of 33.3 percent and for Apple Inc. of 66.7 percent.
Asia who are part of the supply chain support and These relative percentages are carried to Table
quality control functions who are employed by A2.2, which allocates to Apple Inc. a 66.7 percent
AOI’s disregarded entity subsidiaries, those share of AOI’s residual nonroutine profit.
personnel take their directions solely from Apple
Inc. and not from AOI or any of its disregarded
entity subsidiaries. Further, all indications
suggest that those AOI disregarded entity
Electronic
SPECIAL REPORT
a
Table A2.1. Residual Profit-Split Calculation
Inputs to Residual Profit-Split Method Calculation
(Reg. Section 1.482-7(g)(7)(iii)(C)(1) [first sentence])
($ million)
Worldwide Intangible Assets
(a) $41,600 Market Capitalization of Apple Inc. Consolidated Intangible

Assets (Market Cap - BV of Tangible Assets)
(b) 50% Apple US RAB Share in Jan 2009 (Use FYE 2009)
(c) 50% AOI RAB Share in Jan 2009 (Use FYE 2009)
(d) = 0.5 * a $20,800 2009 Market Value of Platform Contribution IP (Product IP,
Trademarks, etc.)
(e) = 0.5 * a $20,800 2009 Market Value of Operating Contribution IP (Supply

Chain/Exploitation IP)
(f) = 0.667 * d $13,874 2009 Market Value of Legacy Product IP (2/3 of platform
contribution IP)
(g) = 0.333 * d $6,926 2009 Market Value of Workforce/R&D Facilities IP (1/3 of

platform contribution IP)
AOI Intangible Assets and Operating Contributions (allocable solely to AOI territory)
(h) = c * f $6,937 AOI Legacy Product IP (RAB share of worldwide product IP)
Apple US Intangible Assets
Worldwide Values
(i) = b * f $6,937 Apple US Legacy Product IP (allocable solely to Apple US

territory)
(j) = (g) $6,926 Apple US Workforce/R&D Facilities IP (worldwide)
(k) = (e) $20,800 Apple US Operating Contribution IP (Supply Chain/

Exploitation IP) (worldwide)
Allocable to AOI Territory
(l) = 0% * i $- Apple US Legacy Product IP (allocable to AOI territory)
(m) = c * j $3,463 Apple US Workforce/R&D Facilities IP (allocable to AOI

territory)
(n) = c * k $10,400 Apple US Operating Contribution IP (Supply Chain/

Exploitation IP) (AOI territory)
Residual Profit-Split Calculation per Reg. Section 1.482-7(g)(7)(iii)(C)(1)
h AOI Contributions to Nonroutine $6,937 33.3%

Profits (AOI territory)
l+m+n Apple US Contributions to $13,863 66.7%

Nonroutine Profits (AOI territory)
a
Note that we have used some hindsight to apply 2009 year-end RAB shares for entry (b) and (c) in the interest of reliability
instead of the year-end 2008 figure.
Electronic
SPECIAL REPORT
Table A2.2 below calculates the nonroutine arms-length return for these routine functions.
residual profit for each year, 66.7 percent of which This difference is the nonroutine residual return,
is credited to Apple U.S. This residual profit is which is then split between AOI and Apple Inc.
based on the difference between AOI’s revenues based on the profit split calculated in Table A2.1
(column (b)) and the sum of (1) AOI’s intangible above. The nonroutine residual return is additive
development costs (that is, cost-sharing by year, and the sum of each year and prior years
payments) (included in column (e)); (2) AOI’s PCT is determined and converted to a net present
payments to Apple Inc. (also included in column value as of the CSA start date of January 5, 2009
(e)); and (3) AOI’s non-CSA-related expenses ($132.4 billion in column (g)).
(included in column (c)) marked up by an
assumed routine return of 8 percent (included in
column (f)), which is intended to approximate an
Table A2.2. Step 1 Results

Periodic Adjustment Calculation per Reg. Section 1.482-7(i)(6) for All PCTs
($ million)
(g) = (d - e -
(a) (b) (c) (d) (e) - (f) f) * 0.667
Apple Routine
Ireland Return Residual
Territory Non-CC/ Est. (MUTC) = Profit
CSA- Non-IDC Divisional Reported (c) x (66.7% =
Related Costs Profit CC/IDCs Routine Routine Share to
Year Year No. Sales (Est.) (Loss) (Est.) Return % Return Apple US)
FY2009 1 $15,748 $12,293 $3,455 $489 8% $983 $1,321
FY2010 2 $27,759 $14,593 $13,166 $758 8% $1,167 $7,491
FY2011 3 $53,538 $30,205 $23,333 $1,201 8% $2,416 $13,141
FY2012 4 $76,756 $38,489 $38,267 $1,658 8% $3,079 $22,347
FY2013 5 $84,291 $53,502 $30,790 $2,207 8% $4,280 $16,198
FY2014 6 $92,628 $55,273 $37,355 $3,061 8% $4,422 $19,910
FY2015 7 $126,769 $76,193 $50,575 $4,376 8% $6,095 $26,729
FY2016 8 $116,629 $71,353 $45,276 $5,433 8% $5,708 $22,751
FY2017 9 $118,876 $69,617 $49,260 $6,006 8% $5,569 $25,117
FY2018 10 $137,282 $83,009 $54,274 $7,358 8% $6,641 $26,843
FY2019 11 $126,359 $74,833 $51,526 $7,876 8% $5,987 $25,102
FY2020 12 $131,631 $85,457 $46,174 $8,992 8% $6,837 $20,225
Terminal 12 $736,793 $478,339 $258,454 $50,330 8% $38,267 $113,210

Value
Yr 0 NPV Thru Yr 12 $678,066 $413,952 $264,114 $32,323 $33,116 $132,417
Electronic
SPECIAL REPORT
E. Periodic Adjustment Step 2
Table A2.3 is used to calculate the residual
return to Apple Inc. for AOI’s exploitation of the
cost-shared intangibles as a level royalty rate.
Table A2.3. Step 2 Royalty Rate Determination

Periodic Adjustment Calculation per Reg. Section 1.482-7(i)(6) for All PCTs
($ million)
(e) = (b - c - d) *
(a) (b) (c) (d) 0.667 (f) = e/b
Routine
Return Residual
(MUTC) = (c) * Profit (66.7%
Est. Divisional Reported CC/ Routine Share to
Year Year No. Profit (Loss) IDCs (Est.) Return Apple US) Royalty Calc
FY2009 1 $3,455 $489 $983 $1,321
FY2010 2 $13,166 $758 $1,167 $7,491
FY2011 3 $23,333 $1,201 $2,416 $13,141
FY2012 4 $38,267 $1,658 $3,079 $22,347
FY2013 5 $30,790 $2,207 $4,280 $16,198
FY2014 6 $37,355 $3,061 $4,422 $19,910
FY2015 7 $50,575 $4,376 $6,095 $26,729
FY2016 8 $45,276 $5,433 $5,708 $22,751
FY2017 9 $49,260 $6,006 $5,569 $25,117
FY2018 10 $54,274 $7,358 $6,641 $26,843
FY2019 11 $51,526 $7,876 $5,987 $25,102
FY2020 12 $46,174 $8,992 $6,837 $20,225
Terminal Value 12 $258,454 $50,330 $38,267 $113,210
Yr 0 NPV Thru Yr 12 $264,114 $32,323 $33,116 $132,417 50%
Electronic
SPECIAL REPORT
F. Periodic Adjustment Step 3 Apple has disclosed that the IRS is examining
its tax years through 2016, and we assume that the
Table A2.4 calculates the nominal value of the
IRS has not applied a periodic adjustment to
royalty payment representing the residual profit
Apple Inc. in the current examination cycle or any
as calculated in the prior table, on a rolling basis
previous examination cycle. This table therefore
from the beginning of the CSA to the adjustment
uses a royalty rate applicable to adjustment year
date. The table calculates the nominal royalty in
2017.
the adjustment year, based on the sum of the net
present value of the payments in each year and
the years before it.
Table A2.4. Nominal Royalty Calculation

($ million)
(a) (b) (c) (d) = b * c
Nominal Royalty
Divisional Royalty Rate Due Under Adjusted
Year Year No. Profit and Loss RPSM
FY2009 1 $3,455 50% $1,732
FY2010 2 $13,166 50% $6,601
FY2011 3 $23,333 50% $11,699
FY2012 4 $38,267 50% $19,186
FY2013 5 $30,790 50% $15,437
FY2014 6 $37,355 50% $18,728
FY2015 7 $50,575 50% $25,357
FY2016 8 $45,276 50% $22,700
FY2017 9 $49,260 50% $24,697
FY2018 10 $54,274 50% $27,211
FY2019 11 $51,526 50% $25,833
FY2020 12 $304,628 50% $152,729
Yr 0 NPV Thru Yr 9 $152,809 $76,613
Note: The divisional profit figure shown in the last row of Table A2.4 above adds the two sums for 2020 (the $258,454 terminal
value measured in 2020 and the 2020 divisional profit and loss of $46,174) shown in Table A2.3 together for a single entry in
2020.
Electronic
SPECIAL REPORT
G. Periodic Adjustment Steps 4a-c table. Step 4b converts these results to a net
present value payment at the beginning of the first
Table A2.5 combines several steps. Step 4a
year of the CSA (year 0). Step 4c takes the step 4b
calculates a series of nominal adjustments by
amount and, through compounding, converts it to
subtracting the nominal PCT payments from the
a nominal payment in the adjustment year (2017).
nominal royalty payments calculated in the prior
Table A2.5. Periodic Adjustment Calculation

($ million)
(g) = f/(Det Year
(a) (b) (c) (d) = b * c (e) (f) = d - e ADR)
Nominal
Royalty Present Value
Due Nominal of the Owed
Divisional Royalty Rate Under Payments PCT in 2017
Profit and Adjusted Made Additional
Year Year No. Loss RPSM (PCTs) PCT Owed
FY2009 1 $3,455 50% $1,732 $150 $1,582
FY2010 2 $13,166 50% $6,601 $539 $6,062
FY2011 3 $23,333 50% $11,699 $282 $11,416

Convert Year 0
FY2012 4 $38,267 50% $19,186 $864 $18,321 Amounts to PV
in 2017
FY2013 5 $30,790 50% $15,437 $341 $15,096
FY2014 6 $37,355 50% $18,728 $3,342 $15,386
FY2015 7 $50,575 50% $25,357 $1,160 $24,196
FY2016 8 $45,276 50% $22,700 $1,439 $21,261
FY2017 9 $49,260 50% $24,697 $1,293 $23,404
Yr 0 NPV Thru Yr 9 $152,809 $76,613 $4,866 $71,747 $196,452
Electronic
SPECIAL REPORT
H. Periodic Adjustment Step 5 due to Apple Inc., net of the nominal PCT
payments made in those years. These figures are
Table A2.6 applies the royalty rate established
not discounted, because these adjustments are for
for the adjustment year to the years after the
examination cycles after the 2017 examination
adjustment year for which information is
and pertain only to the nominal results year-by-
available (fiscal 2018, 2019, and 2020) to calculate
year.
the periodic adjustments for each of those years
Table A2.6. Periodic Adjustment Calculation for Years Through the Determination Date
($ million)
Nominal
Royalty Due Additional
Divisional Royalty Rate Under Nominal Periodic
Profit and in Adjustment Adjusted Payments Adjustment to
Year Year No. Loss Year RPSM Made (PCTs) Be Made
FY2018 10 $54,274 50% $27,211 $1,848 $25,363
FY2019 11 $51,526 50% $25,833 $2,389 $23,444
FY2020 12 $46,174 50% $23,150 $1,942 $21,208
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Apple’s Cost-Sharing Arrangement: Frankenstein’s Monster

by Stephen L. Curtis and David G. Chamberlain

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1049

1050 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1051

1052 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1053

Americas and Retail:

Net Sales 52,442 34,296 25,637 105%

Operating Income 16,882 9,954 8,335 103%

Operating Margin 32% 29% 33% 0%

% Change in Income Minus % Change in Sales -2.0%

Net Sales 27,778 18,692 11,810 135%

Operating Income 11,528 7,524 4,296 168%

Operating Margin 42% 40% 36% 14%

% Change in Income Minus % Change in Sales 33%

Net Sales 5,437 3,981 2,279 139%

Operating Income 2,481 1,846 961 158%

Operating Margin 46% 46% 42% 8%

% Change in Income Minus % Change in Sales 20%

Net Sales 22,592 8,256 3,179 611%

Operating Income 9,587 3,647 1,100 772%

Operating Margin 42% 44% 35% 23%

% Change in Income Minus % Change in Sales 161%

2011 2010 2009 Sum

Sum of Non-Americas $23,596 $13,017 $6,357 $42,970

Foreign Pretax Income $24,000 $13,000 $6,600 $43,600

Difference (Non- $404 ($17) $243 $630

Difference as % of Non-Americas Op. Profit 1.5%

1054 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1055

2008 $27 $85 $81 $-

2009 $847 $151 $24 $-

2010 $61 $240 $227 $102

2011 $49 $425 $42 $-

2012 $340 $467 $117 $3

2013 $745 $626 $127 $592

2014 $1,295 $882 $284 $574

2015 $2,056 $1,278 $358 $109

2016 $1,121 $1,578 $257 $1,618

2017 $333 $1,880 $991 $539

2018 $2,431 $1,824 $2,212 $756

2019 $5,845 $1,697 $765 $852

2020 $454 $1,347 $860 $85

Totals $15,604 $12,480 $6,345 $5,230

1056 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1057

1058 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1059

1060 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1061

1062 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1063

1064 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1065

1066 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1067

1068 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1069

C. What Does ‘Former’ Mean?

1070 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021

TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021 1071

1072 TAX NOTES FEDERAL, VOLUME 172, AUGUST 16, 2021