The Problem
Let's keep it simple – no need to get into the details to understand what this and other international corporate income tax disputes are all about.
Apple's CEO Tim Cook said: “A company's profits should be taxed in the country where the value is created.” He is right. And that is the rub. Lawyers will argue. But it is not really possible to locate where value is added if a company produces in one location and sells in another. Why? Because you need both production and sales for value/profits to be generated.
This is not a new problem. States in the US have been dealing with it for many years. 44 US states have corporate income taxes. When a good is produced in North Carolina (corporate tax rate – 4%) and sold in Iowa (corporate tax rate – 12%), what should happen? What is the corporate tax base for each state?
Back in the ‘sixties, I took a summer job working for the Special Subcommittee of State Taxation of Interstate Commerce of the US House Judiciary Committee. My Ph.D. dissertation ended up being “A Study of How Corporate Income Should Be Apportioned for Taxation by States.” Efforts by US states to tax corporate profits face the same problems nations face when trying to tax the profits of global companies. Many corporations do business in all 50 US states, so there is an issue as to how their profits should be divided among states for taxation. The Subcommittee tried to get states to adopt a uniform formula to allocate profits among states. If they had succeeded, all corporate profits would have at least been taxable in one or another state.
The Subcommittee favored a three-factor formula: the average of the shares of a corporation's payrolls, property, and sales within the state. If P = Payrolls, A = Property, and S = Sales with subscripts S and T designating state and total, a state's share of a company's tax base would be (Ps/Pt + As/At + Ss/St)/3. Does it sound simple? It is not. Definitions for payrolls and property located in a state can be worked out. But the sales factor is a very different story. When I did my dissertation in 1961, the sales factor definitions being used by states included: “origin (manufactured in state)”, “destination (shipped into state)”, “sales activities”, “sales office”, “receiving office”, “acceptance office”, “location of goods”, and “shipments from warehouse(s) within the state”.
