They say there is no such thing as bad publicity. Ireland might beg to differ, having been at the center of a U.S. Senate hearing on Apple Inc.’s tax accounting practices at a time when the European Union is working hard to crack down on tax evasion.

On May 21, the Senate Permanent Subcommittee for Investigations dug into Apple’s tax activities in deep and gory detail. Their findings show that Ireland has been at the very center of Apple’s success in tax avoidance.

Using information provided by Apple, the subcommittee found that the company used subsidiaries in Ireland to funnel about $74 billion in worldwide income away from the U.S. The three units involved ― Apple Sales International, Apple Operations Europe and Apple Operations International ― were incorporated in Ireland but not tax resident anywhere.

The structure allowed Apple to pay an effective tax rate of 2 percent or less since 2003, well below Ireland’s corporate tax rate of 12.5 percent. Perhaps the most damning part for Ireland came in the explanation of the low rate in the subcommittee’s report: “Apple told the Subcommittee that, for many years, Ireland has provided Apple affiliates with a special tax rate through negotiations with the Irish government.”

This is serious. It would be hugely awkward ― to say the least ― to have the Irish government cutting special deals with large multinational companies while also, as the current holder of the EU presidency, presiding over a push for greater transparency in corporate tax dealings. Irish Prime Minister Enda Kenny immediately rebutted Apple’s version of events, insisting that Ireland doesn’t make special deals with companies.

Is there another explanation for why Apple pays such a low tax rate? Seamus Coffey offers a convincing one on the Irish Economy blog: Apple benefited from a perfectly legal loophole in the way Ireland defines taxable income. The country’s 12.5 percent tax rate applies to income after subtracting expenses such as royalty payments for intellectual property licenses. In Apple’s case, these payments are very large, significantly reducing taxable income.

The royalties are paid to another Apple subsidiary in a different tax jurisdiction. This is sometimes referred to as a “Dutch sandwich,” because the payments are typically funneled through the Netherlands on their way to Bermuda, where there is no corporate tax. In Apple’s case, the subsidiaries are strangely not resident anywhere. This is an issue indeed ― but for Apple, not Ireland.

Whether Ireland really is a tax haven, the perception could be just as damaging as the reality. The countries calling the shots in the EU (namely, Germany) aren’t favorably disposed to countries that lure away their tax revenue. Just ask Cyprus, which received very little sympathy for its banking troubles. Ireland will almost certainly succeed in exiting its bailout program in the next year, but it may need assistance from its euro-area partners in the future.

Ireland should use the Apple drama as an opportunity to consider whether the benefits of an attractive tax regime are worth the costs. Many multinational corporations have set up headquarters in Ireland for access to the greater European market. The low corporate tax is clearly a draw, but so is the skilled, English-speaking talent pool.

Multinational companies have helped to keep Ireland’s exports buoyant throughout the crisis, with pharmaceuticals, chemicals and business services performing relatively well over the past few years. As of 2012, multinational companies employed about 150,000 people in Ireland.

Some analysts, however, question how much Ireland really benefits from the presence of multinationals. Most of their profits flow back to shareholders outside the country. This is reflected in the difference of almost 30 billion euros ($39 billion) between gross national product and gross domestic product in Ireland. The latter includes exports by multinationals based in Dublin, while the former does not.

Without multinational companies, Ireland would have struggled to achieve the export-led growth it posted last year. In the longer term, however, a sustainable growth model must involve Ireland weaning itself from exports and fostering domestic demand. Perhaps the Apple embarrassment will awaken Ireland to that reality. 

By Megan Greene

Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. She is also a senior fellow at the Atlantic Council in Washington. The opinions expressed are her own. ― Ed.

(Bloomberg)