Senate hearings about Apple’s alleged tax avoidance have been in the news the last few weeks. News stories abound, describing how Apple generates billions of dollars in profits overseas, using a chain of entities set up in Ireland, pays no U.S. income taxes on those profits and pays almost no income taxes in Ireland. The alleged scandal is so delicious, few reporters passed it up.

I have diligently searched most available news sources and have not found a single article that actually explains the tax mechanics of the alleged tax avoidance. All the articles I read describe the structure used by Apple, some with a great deal of specificity, use interesting sounding tax terminology like “an Irish sandwich” and then magically conclude that the structure allows Apple to escape income taxation. Oh, I forgot, the word “loophole” gets mentioned quite often. Let us examine the alleged loophole and see if Apple is actually doing anything unseemly.

About four years after Apple was created, it moved its intellectual property (“IP”) to Ireland, when its IP had a fairly low value. The IP was moved to an Irish company AOI (I will use acronyms in the interest of brevity). AOI in turn owns a slew of other subsidiaries. One such subsidiary, ASI, purchases computers from Apple’s supplier in China and resells to other subsidiaries at a profit. The other subsidiaries sell Apple computers throughout the world. The profit captured by ASI is then sent up to AOI in the form of a dividend. Ordinarily, profits earned by ASI should be currently taxed to Apple as they constitute so-called Subpart F income (income from sales involving related parties – all the subsidiaries are related to each other). Similarly, dividends sent up the corporate chain should also be taxed as Subpart F income (passive income). However, Apple made a check-the-box election to treat its subsidiaries as disregarded entities, and only AOI is deemed to exist for U.S. tax purposes. Due to the application of the disregarded entity status and the look-through rule (extended through end of 2013) all subsidiary level transactions are disregarded. Because all transactions and all entities below AOI are disregarded, AOI is now deemed to be selling computers throughout the world directly to customers. The computers are not acquired from a related party nor are they sold to a related party. Consequently, income generated by AOI does not constitute Subpart F income.

All the tears shed by Congress and parroted by the media suggest that Apple is a bad company. After all, how can an American company use U.S. tax laws to avoid paying U.S. taxes? Even ignoring the obvious politics behind these Congressional hearings, the attack on Apple fails. Suppose Apple did not set up a slew of subsidiaries, but set up only one – AOI. It would then not need the use of the check-the-box rules, the look-through rule and the lesser known but much loved same country exception. Subpart F would simply not apply because AOI would not be transacting business between related parties. Why should Apple’s U.S. tax results be different when it is uses disregarded entities? There are thousands of disregarded entities used throughout the United States, without any attack on their tax status. Why should a foreign disregarded entity be treated differently?

Apple is not subject to Subpart F because Subpart F was not designed to apply to Apple. Subpart F was enacted to capture offshore corporate structures that are tax motivated. Apple actually carries on an active business overseas. It did not set up offshore subsidiaries purely for tax avoidance. Once one accepts the argument that Apple’s tax treatment should be the same whether it has one level of foreign subsidiaries or twenty five levels, it becomes clear that Apple appropriately deferred its U.S. taxes. By the way, Apple only deferred its income taxes, it did not avoid them entirely.

What really irks Congress is not Apple, it is Ireland. If Apple was set up in a high-tax jurisdiction, the hearings would have never taken place. These hearings were never intended as a spotlight on Apple, or Google or any other U.S. company that is using a structure similar to the one described above. These hearings are designs to push sovereign nations from making attractive offers to U.S. businesses. Could it be that Congress does not consider its own tax policies to be business friendly?