Why Tim Cook is the genius Apple needs

By Felix Salmon | September 7, 2016 | 1:00pm

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Later this morning, Apple CEO Tim Cook is going to unveil the iPhone 7, and when he does, the familiar litany of complaints will almost certainly be aired. “This new phone is evolutionary, not revolutionary.” “Apple’s very good at making money, but its spark has gone.” “Why can’t it innovate any more?”

Some people will come out and say it explicitly: Why can’t Tim Cook be more like Steve Jobs?

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The real answer is that only Steve Jobs could be Steve Jobs, and even Steve Jobs took many decades and quite a lot of failure to become what he became.

But Tim Cook, it turns out, has different skills. Cook’s skills aren’t the kind that make for flashy keynotes and whiz-bang product launches. But they’re the kind that, in many ways, are even more valuable when you’re running Apple—which, at this point, is more akin to a sovereign nation-state than a technology company.

Apple’s revenues today are more than double what they were when Jobs died in 2011, and leading a company that size is about much more than innovation. You need to manage insanely complex global supply chains, as well as a set of cashflows of a magnitude all but unprecedented in the history of modern capitalism. Most importantly, your future relies on a set of relationships, with suppliers and tax authorities all over the world, all of which must be delicately massaged and cared for. Managing those relationships was Tim Cook’s job when he worked for Steve Jobs, and it was his astonishing success in that position which propelled him into the CEO’s office upon Jobs’s death.

If you want to see Cook at his strongest, don’t look to this morning’s keynote in San Francisco. Instead, look 5,500 miles east, to Brussels, where Apple is currently fighting the European Union over its corporate tax liabilities.

Last week, the EU ruled that Apple owes €13 billion (more than $14 billion) in taxes to Ireland. In response, Cook angrily replied that it follows the law and pays all the taxes it owes. You might think that Cook was angry because the EU just increased Apple’s tax liability by €13 billion, but in fact the size of Apple’s tax liability has gone up by exactly zero.

It’s worth backing up a little here, because this isn’t a normal corporate tax dispute, and it shows why Cook’s talents for corporate statesmanship are so incredibly value to today’s Apple.

As a US company, Apple owes US taxes on its global income, but it doesn’t need to pay those taxes unless and until it brings those offshore dollars back to the U.S. (or “repatriates” them, in accountant-speak). As of September 2015, Apple showed a whopping $24.1 billion in “non-current deferred tax liabilities” on its balance sheet: that is, taxes which it owes to the U.S. but has (legally) not yet paid.

If Apple paid Ireland €13 billion tomorrow, then its $24 billion in deferred tax liabilities would simply decrease by an identical amount. That’s because the U.S. and Ireland have a dual-taxation treaty, under which companies (and individuals) are only taxed once on any given income. However much money Apple pays in Irish taxes, it can go ahead and deduct from the amount it owes the U.S.

In other words, this is not a fight about whether Apple owes €13 billion in taxes—it’s about where Apple owes €13 billion in taxes. The EU says Apple owes that money in the EU, while Apple says it only owes the money in the US.

As Apple itself says:

At its root, the Commission’s case is not about how much Apple pays in taxes. It is about which government collects the money.

Taxes for multinational companies are complex, yet a fundamental principle is recognized around the world: A company’s profits should be taxed in the country where the value is created. Apple, Ireland and the United States all agree on this principle.

This also explains why American politicians, including the Treasury secretary, have been complaining loudly that the EU ruling is “an attempt to reach into the U.S. tax base to tax income that ought to be taxed in the United States”. If you’re in charge of U.S. fiscal policy, then you look at that $24 billion and you consider it to be, basically, yours. It might not have been paid yet, but you’re patient. So to U.S. eyes, Europe is dipping into a pool of money which rightfully belongs not to Apple, but rather to the U.S. government.

But here’s the thing. If Apple wanted to pay the U.S. the $24 billion in taxes that it owes in this country, it could have done that years ago. The whole point of Europe’s ruling was that Apple was booking billions of dollars of income and paying tax on that income nowhere at all.

An enormous proportion of Apple’s European income was funneled into something called Apple Operations International, or AOI, which was extremely good at getting out of having to pay taxes. Take it away Adam Davidson:

Phillip Bullock, the head of tax operations for Apple, told a U.S. Senate committee in 2013 that “A.O.I. is incorporated in Ireland; thus, under U.S. law it is not tax resident in the U.S.” That seemed clear enough until his next sentence. “A.O.I. is also not tax resident in Ireland because it does not meet the fact-specific residency requirements of Irish law.” It’s Irish, according to American law; not Irish, according to the Irish. A.O.I., in fact, does not legally exist anywhere, even as it takes in much of the profits from Apple sales outside of the United States.

It’s therefore a bit rich for Cook to start wrapping himself in the American flag, complaining that the EU is snatching away money which rightfully belongs to U.S. taxpayers. If Cook wanted U.S. taxpayers to have that money, he could have given it to them whenever he wanted – and the EU would have had no case against him. They just wanted Apple to pay tax somewhere, and if it wasn’t paying its taxes in the U.S., then they were going to force the company to pay its taxes in Europe, instead.

But Cook didn’t want to pay those taxes, because paid taxes have no strategic value, and give Apple no leverage with the U.S. government. To remix an old saying, if you owe the government a million dollars, you have a problem. If you owe the government 24 billion dollars, the government has a problem. Specifically, in order to get its hands on that money, the government might be willing to cut some kind of a deal: announce a one-off window, say, whereby corporations would be allowed to repatriate their offshore profits at a discounted tax rate.

No one knows such tactics better than the U.S. government, which sat on money it owed to Iran for 35 years before finally agreeing to release that money as part of a much broader deal including Iran releasing certain political prisoners. No one disputed that the money rightfully belonged to Iran, but the U.S., which had control over when the money was paid, managed to leverage that control so as to achieve broader political goals.

Most big companies spend money on Washington lobbyists—a few million dollars can go a long way, if spent smartly. But if you’re in the business of dangling carrots in front of the government in an attempt to get them to do what you want them to do, then pointing at a stockpile of 24 billion carrots, just sitting there ripe for the munching, can be incredibly effective. And when the EU effectively sticks a lien on 14 billion of those carrots, reserving them for itself—well, then your power in Washington diminishes.

This is not the Apple we think of when we think of Steve Jobs, inventing “insanely great” products and shipping them to delighted consumers. Tim Cook’s Apple, by contrast, is more akin to a mid-sized country, constantly embroiled in tricky negotiations with its various allies around the world. Apple might not be technologically innovative any more, but it has become peerless in its ability to leverage its enormous balance sheet—both its assets and its liabilities—with governments around the world.

Jobs never cared much about the practical utility of Apple’s cash. He was famously dismissive of his shareholders, never paid a dividend, and was happy to simply let huge amounts of money pile up on his balance sheet, doing nothing in particular.

Cook, by contrast, understands that Apple’s enormous wealth is an asset to be used strategically, in furtherance of the company’s broader goals. He has famously spent billions of dollars on stock buybacks, which have helped support the share price and thereby made recruitment and retention much easier in a world built on stock-based compensation. Even after all that expenditure, however, he still has more than $200 billion sitting offshore—a cash pile which, it turns out, makes for a very effective bargaining chip.

The EU’s ruling doesn’t make Apple any poorer, but it does hurt the company’s leverage. That’s why Cook hates it so much. Negotiating with governments isn’t sexy: you can’t do it while wearing a black turtleneck and being live-streamed around the world. But it’s what Cook is good at, and it’s one of the reasons why Apple is worth much more now than it ever was while Jobs was alive. Innovation is all well and good. But not all innovation comes in the form of user-friendly technology. Sometimes, it looks more like geopolitical strategy.