I've heard it explained this way, not sure if it is entirely accurate, could someone else confirm?
John is headquartered in the US, and sells apples around the world for $1. His cost to produce the apples is $0.20 in China. If he sells an apple to Mary in France, he would owe tax on his profit of $0.80 in France. For simplicity, let's assume the tax rate is 20% in France. Of John's $0.80 profit, he pays France $0.16, leaving him with $0.64 of his original $0.80 profit. If John tries to bring his profit back to the US, it will be taxed again at 20% and he will end up with about $0.51 of his original $0.80 profit.
Now if John gets crafty, he sets up a subsidiary (which he controls) in Ireland to purchase apples from his Chinese supplier for $0.20, from which John buys the apples from at a price of $0.90. When Mary in France purchases an apple from John for $1.00, John has now only made a profit of $0.10 in France, while his subsidiary has made a profit of $0.70 in Ireland. Because the corporate tax rate in Ireland is only 3%, John's subsidiary only ends up paying $0.02 in tax on his $0.70 profit, and $0.02 in tax on his $0.10 profit in France. As of now, with the funds still in the EU John has saved $0.12 in tax on every apple sold, and effectively reduced his tax burden by 75% ($0.04 vs $0.16). Now John knows if he tries to bring his profit of $0.76 back to the US, they're going to tax it at 20%, so instead John just leaves it in Ireland (really a bank in NYC), and the cash piles up.
I think that is right. See this below. The U.S. is a residential tax treatment country. Most of the rest of the world is territorial. When Apple sells an iPhone in France it is very justifiable to say that the Apple store in France didn't produce the lion share of the profit. Instead the majority of the Profit is allocated to the intellectual property which happens to be owned by the Apple Irish Holding company.
Countries that tax income generally use one of two systems: territorial or residential. In the territorial system, only local income – income from a source inside the country – is taxed. In the residential system, residents of the country are taxed on their worldwide (local and foreign) income, while nonresidents are taxed only on their local income. In addition, a very small number of countries, notably the
United States, also tax their nonresident citizens on worldwide income.
Countries with a residential system of taxation usually allow deductions or credits for the tax that residents already pay to other countries on their foreign income. Many countries also sign
tax treaties with each other to eliminate or reduce
double taxation. In the case of corporate income tax, some countries allow an exclusion or deferment of specific items of foreign income from the base of taxation.
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No, they would have to pay tax there and then again in the US (of course not if there was an amnesty)
That money stays where it is or goes to another country,
Yes, the money stays there. But generally I think the U.S. company gets a foreign tax credit. There are treaties to avoid double taxation. The issue is that often companies don't find it very hard to structure around paying the initial taxes in the foreign company. Or they at least pay a very low tax (like Apple does through its Irish structure). But there is a credit even though the initial tax stays in the foreign company.
From wikipedia:
A
foreign tax credit (FTC) is generally offered by income tax systems that tax residents on worldwide income, to mitigate the potential for
double taxation. The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction. The credit generally applies only to taxes of a nature similar to the tax being reduced by the credit (taxes based on income) and is often limited to the amount of tax attributable to foreign source income. The limitation may be computed by country, class of income, overall, and/or another manner.
Most income tax systems therefore contain rules defining source of income (domestic, foreign, or by country) and timing of recognition of income, deductions, and taxes, as well as rules for associating deductions with income. For systems that separately tax business entities and their members, a deemed paid credit may be offered to entities receiving income (such as dividends) from other entities, with respect to taxes paid by the payor entities with respect to the income underlying the income recognized by the member. Systems with
controlled foreign corporation rules may provide deemed paid credits with respect to deemed income inclusions under such rules. Some variations on the credit provide for a credit for hypothetical tax to encourage foreign investment (sometimes known as tax sparing).
