John Shafer, who described himself as “a conservative Republican,” told congressional investigators he sought advice from his boss on how to handle the first Tea Party application he and a lower-level agent came across in February 2010 because it was a new, high-profile issue.

Asked if the lower-level agent sought to elevate the case to Washington because he disagreed with Tea Party politics, Shafer said this was not the case.

“We never, never discussed any political, personal aspirations whatsoever,” he said, according to a transcript of his testimony reviewed by Reuters on Tuesday.

The IRS controversy erupted on May 10 when a Washington IRS official apologized for the handling of applications for tax exemption submitted to the IRS by conservative groups between early 2010 and early 2012.

The furor since then has led to the ousting of the IRS chief by President Barack Obama, an FBI investigation and a congressional investigation.

Leaks from the congressional investigation, now in its sixth week, have neither clearly supported allegations by Republicans of undue influence by Washington officials or the White House, nor ruled this out.

Some material has undermined the allegations by suggesting that the screeners – some of whom were managed by Shafer at the Cincinnati processing hub – acted largely on their own.

Shafer said his screeners knew when a new issue could be difficult and might need to be evaluated by superiors.

“They were folks that had a lot of experience,” he said. “So as they would be reviewing these initial applications, they would be well aware of things that they may not have seen before.”

Shafer said he was in charge of the tax agency’s first look at all tax-exemption applications sent to Cincinnati. Forms that needed a closer look were sent to another unit, he said.

“On an annual basis there would be upwards to 70,000 applications” submitted to the Cincinnati office, he said. “On a monthly basis there would be 4,000 to 5,000 applications that would go through my group.”

(Editing by Kevin Drawbaugh and David Brunnstrom)

(Reuters) – Internal Revenue Service employees in Ohio, who singled out conservative groups applying for tax-exempt status for extra scrutiny, likely did not consider the political implications, an IRS official in Washington has told congressional investigators.

Providing additional details about the worst crisis to hit the IRS in years, tax agency official Holly Paz told investigators she was concerned when she learned that IRS employees were singling out groups with “Tea Party” and other key words in their names.

Paz is the most senior IRS official to be extensively interviewed by investigators. Ousted acting IRS Commissioner Steve Miller was among the top-level Washington officials grilled by Congress in recent weeks. Investigators conducted longer transcribed interviews with IRS employees behind closed doors.

A mid-level official in Washington before she was put on administrative leave, Paz worked for the director of the tax-exempt unit.

Paz said she was worried the practice of flagging certain groups for scrutiny, which she said was not politically motivated, “might give the impression that there was … some bias,” Paz said in the interview last month. Reuters has reviewed the interview transcript.

Some IRS employees in Cincinnati were screening non-profit groups’ applications for tax-exempt status and chose some applications from Tea Party-aligned groups for closer scrutiny.

In doing so, Paz said, the employees likely did not consider that their decisions and practices could be perceived as politically motivated. “They are not as sensitive as we would like them to be as to how things might appear,” she said.

Roel Campos, Paz’s attorney, said his client “has been exemplary. When she discovered a problem in June 2011 she immediately sent it to her superiors.” Paz could not be reached for comment.

The screening carried out in Cincinnati, which Paz said she became aware of in February 2010, drew complaints from conservative groups and Republican politicians. It fully came to light on May 10 when Paz’s boss, Lois Lerner, publicly apologized for the targeting at a legal conference.

A political furor erupted that led to an FBI investigation, the ousting by President Barack Obama of the chief of the IRS and several congressional hearings. Lerner has also been placed on administrative leave.

Darrell Issa, Republican chairman of the House of Representatives oversight committee leading the inquiry, in a statement, said the Paz transcript shows “we still don’t know why everything happened and who is responsible.”

None of the interviews to date suggest any involvement by elected officials in beginning the screening.

Republicans have noted that Paz gave $2,000 to Obama’s campaign in 2008.

Elijah Cummings, the top Democrat on Issa’s panel, said Paz’s comments confirm an earlier inspector general audit. Paz said in the interview she agreed with nearly all of that report.

Issa and Cummings have been squabbling over whether to release full transcripts of the congressional interviews. This continued on Sunday. “It’s time to stop politicizing this investigation,” Cummings said in a statement.

The inquiry by congressional committees is continuing. Republicans are trying, without success so far, to link Obama to the screening, while Democrats are trying to put an end to the controversy, which is headed into its sixth week.

A report last month from the U.S. Treasury Inspector General for Tax Administration, an IRS watchdog, found “inappropriate criteria” were used by IRS agents to select applications for added attention. The report found no political motivations.

20 MORE INTERVIEWS POSSIBLE

Paz is one of more than six IRS employees who have been interviewed in the probe. A congressional aide said last week that investigators may seek interviews with 20 more people.

Paz said front-line IRS employees, such as those who conducted the screening, are unaccustomed to their work being in the spotlight.

“Many of these employees … were used to a world where how they would talk about things internally was not something that would be public or anyone would be interested in,” she said.

The U.S. tax code allows many types of non-profit groups to be tax-exempt, but sets limits on their political activities. The IRS has to ensure that groups apply for tax exemption respect those limits, though they are often vaguely defined.

The Supreme Court’s 2010 “Citizens United” decision unleashed a torrent of new money into politics. Some of it flowed into groups organized under Section 501(c)(4) of the code. Many of these groups were politically conservative.

Campaign finance critics say 501(c)(4) attracts political “dark money” because the law allows such groups to keep donor identities secret. Such groups may be politically active, but under the law, this cannot be their primary purpose.

The IRS has struggled for years with enforcing the law, and related 501(c) tax-exemption statutes for non-profits.

On the issue of balance, Paz told investigators that she knew of some liberal, pro-Democrat groups that had received extra scrutiny in Washington too.

“I had no indication that we were not being balanced in what we were doing,” she said.

(Additional reporting by Patrick Temple-West; Editing by Stacey Joyce)

(Reuters) – A spoof Star Trek video and lavish hotel suites for government workers were singled out on Tuesday by a government watchdog in criticizing the U.S. Internal Revenue Service’s conference planning and budgeting from 2010 through 2012.

In a report that the IRS has already acknowledged as pointing out “inappropriate” spending, the Treasury Inspector General for Tax Administration (TIGTA) faulted the agency specifically for a 2010 conference in Anaheim, California, that cost $4.1 million.

Some of the funding for the conference came from unused monies originally intended for hiring enforcement employees, TIGTA chief J. Russell George said in the report.

“Certain of the IRS’s expenses associated with the Anaheim conference do not appear to be a good use of taxpayer funds,” said George, whose watchdog office has played a key role in the controversy that engulfed the IRS more than three weeks ago.

Amid allegations that it unfairly targeted conservative political activists’ applications for tax-exempt status for extra scrutiny, the IRS has seen its top executive ousted by President Barack Obama and its reputation damaged.

Also Tuesday, conservative political activists told a House of Representatives committee in emotional testimony that their groups were targeted by the IRS over the years.

At the fifth hearing in the past two weeks on the issue, House of Representatives Ways and Means Committee Chairman Dave Camp, a Republican, said the IRS three years ago began targeting taxpayers based on their political beliefs.

“What we still need to find out, is just how widespread this activity was, who ordered it and why it began,” Camp said.

The TIGTA report was slated to be the topic of another hearing scheduled for Thursday. Excerpts of the report were leaked in recent days.

The report found that the IRS spent $50,187 on videos for the Anaheim conference in 2010, including a Star Trek parody that featured IRS executives portraying characters from the television show in a tax-themed skit.

The IRS told TIGTA that the purpose of the video was to highlight issues facing the Small Business/Self Employed Division of the agency, according to the report.

The report said hotel suites were occupied by IRS executives at the conference. The division’s commissioner, for example, stayed five nights in a suite with a private bedroom, living area, conference table, wet bar, and billiard table, it said.

IRS Acting Commissioner Danny Werfel told a congressional panel on Monday he would clean up the agency, including potentially firing those responsible for using terms such as “Tea Party” and “patriot” to help sift through tax-exempt status applications for extra scrutiny.

Congressional committees are in full investigatory mode, with at least three demanding reams of emails, correspondence and other documents from the IRS.

(Editing by Kevin Drawbaugh and Philip Barbara)

Tax lobbyist Ken Kies was not worried. A decade earlier, he had led a fight to preserve a key loophole – known in Treasury Department shorthand as the “check the box” rule – when another Democratic president, Bill Clinton, had tried to kill it.

“I told my clients, ‘Don’t sweat this. This is never going to happen,’” recalled Kies, who has advised corporate giants Microsoft and General Electric on the issue.

Kies was right.

Business groups rose up against Obama’s plan, arguing that it could damage U.S. businesses already threatened by the weak economy. Democrats in Congress balked, Obama dropped the idea and the loophole survived.

The story of the “check the box” loophole, which allows U.S. companies to choose for themselves how to classify their subsidiaries for tax purposes, and a companion policy known as the “look-through” rule, shows how Washington bureaucrats, lobbyists and politicians have worked together — sometimes wittingly – to save money for American corporations and deprive the federal government of billions in tax revenue each year.

What began in 1996 as an effort by the Treasury Department to simplify the U.S. tax code mistakenly ended up as a massive tax loophole for corporate America, which seized upon it and has never let go.

Besides fueling an explosion in earnings that U.S. companies keep abroad – now more than $1.8 trillion, the Commerce Department estimates, double the amount from less than a decade ago – the loophole has become a symbol of how difficult it can be to repeal a tax benefit once it becomes entrenched.

At congressional hearings last week, several lawmakers blasted Apple Inc. for using the “check the box” loophole and other international tax strategies to avoid paying what they estimated as $9 billion in potential U.S. taxes in 2012.

Two of Apple’s most aggressive questioners, Democratic Senator Carl Levin of Michigan and Republican Senator John McCain of Arizona, have called for closing the “check the box” loophole. But even they have voted to keep it alive several times in recent years when it has been inserted into other legislation.

Levin’s office did not respond to requests for a comment. McCain declined to comment for this story.

“Once a policy mistake is made that is favorable to taxpayers, and particularly to big taxpayers, it is extremely difficult to reverse,” said a former Treasury Department official who helped write the “check the box” rule and was involved in Obama’s effort to repeal it.

The former official spoke on condition of anonymity, citing the sensitive nature of the tax break.

The “check the box” loophole – which costs the United States about $10 billion per year, according to the White House – also has been a reflection of Washington’s “revolving door” culture of policy-making and lobbying. Some of the bureaucrats who helped to write the rule went on to work for corporations that used it to lower their tax bills.

They include William Morris, who was Treasury’s associate international tax counsel when the rule was imposed.

Morris, who did not respond to requests for comment on this story, joined GE in 2000 and is now director of the company’s global tax policy. The company, like many other big multinationals, keeps its tax burden well below the official U.S. corporate rate of 35 percent in part by taking advantage of “check the box” and other international tax strategies.

GE’s annual reports indicate that the company does so largely because many of its profits are directed to its vast network of foreign subsidiaries. In a filing with the U.S. Securities and Exchange Commission in February, GE said its overseas affiliates were holding $108 billion in offshore profits, which is more than any other U.S. company.

Morris’s precise role in GE’s tax strategy is unclear. The company declined to comment for this story.

Other former IRS and Treasury officials involved in shaping the tax loophole now hold senior positions at law and accounting firms in Washington and New York.

BIRTH OF A LOOPHOLE

Offshore tax shelters have bedeviled the U.S. government virtually since the inception of the tax code in 1913.

A 1962 compromise between President John Kennedy and Congress imposed U.S. taxes on “passive” income such as royalties and interest earned abroad, but not on “active” income from regular business operations.

That law, known as Subpart F, made the tax code increasingly complex as businesses grew larger and more diverse. The law was revised 10 times between 1969 and 1996 as the U.S. Internal Revenue Service tried to figure out how to classify, and then tax, tens of thousands of corporate units.

In 1996 the Treasury Department moved to simplify matters with a rule that enabled companies to “check the box” on a tax form to describe a given corporate entity – including whether it was, for tax purposes, irrelevant, a so-called “disregarded entity.”

For a company and its subsidiaries that all operate in the United States, the rule streamlined tax filing by allowing the subsidiaries’ income to be reported on the same forms as the parent company’s income.

When applied to U.S.-based multinational companies, however, the “disregarded entities” status could be used to set up high-volume subsidiaries in low-tax jurisdictions such as Luxembourg or Ireland. A key part of Apple’s tax strategy, for example, is having a subsidiary in Ireland that takes in all of the income from Apple’s retail stores in Europe.

Treasury had given little thought to how the “check the box” rule might affect U.S.-based multinational corporations, according to several people involved in the effort.

Treasury officials realized they had created a massive loophole when they noticed a spike in cross-border financing shortly after the rule took effect.

“The mistake was extending it to foreign entities,” Donald Lubick, Treasury’s top tax official at the time, told Reuters. “That was apparent pretty quickly.”

Clinton’s Treasury Department moved to revoke the “check the box” rule in early 1998. But multinational companies such as Hallmark, Coca-Cola, IBM and Philip Morris launched a full-court press to convince Congress to keep the rule in place.

Enter Kies, a former tax specialist for Congress’ Joint Tax Committee who was eager to put his expertise and contacts to work as a tax lobbyist.

Kies’s former Republican bosses – Representative Bill Archer of Texas and Senator William Roth of Delaware – accused the IRS and Treasury of overstepping their authority in trying to take away the loophole.

Kies, meanwhile, says he pursued a strategy that he figured would resonate with businesses, lawmakers and regular citizens: He argued that eliminating the “check the box” loophole would damage U.S.-based multinational companies by forcing them to pay more taxes not only in the United States, but also to high-tax nations such as France.

Roth’s Senate Finance Committee passed a bill in April 1998 to prevent Treasury from making any changes to “check the box.” That language was watered down to a non-binding resolution by the time the measure passed the Senate the next month, but Congress’ message was clear: Don’t mess with the loophole.

Treasury soon gave up its effort to revoke it.

“In light of that reception that this rule got on Capitol Hill, we withdrew the notice,” said Philip West, who was then the top international tax official at Treasury and now advises clients on international tax strategy for the law firm Steptoe & Johnson.

‘CHECK THE BOX’ GROWS UP

By 2004, thanks in part to the “check the box” rule, U.S.-based multinational corporations paid an effective tax rate of about 2.3 percent on $700 billion in foreign earnings, according to the Obama administration.

To make “check the box” tougher to revoke, Kies and other corporate lobbyists urged Congress to turn the rule into a law.

Congress did so in 2006 with legislation that became known as the “look through” rule. It bolstered the “check the box” loophole by giving corporations more latitude to move some types of income from one foreign unit to another without paying a tax.

The “look through” rule became law with little debate, according to congressional records. It was tucked into a broad extension of other tax cuts.

The 2006 law wasn’t permanent, but supporters have managed to extend it repeatedly by embedding it in large and important but unrelated pieces of legislation that were headed toward easy passage in Congress.

That is what happened in 2009, when Obama threatened to cut the loophole.

Congress has extended it temporarily twice since then as part of larger pieces of legislation. Both Levin and McCain voted to extend it in January as part of the legislation that kept the U.S. government from going off the “fiscal cliff,” a package of across-the-board tax hikes and spending cuts that threatened to plunge the U.S. economy into another recession.

Both also voted to extend it in 2010 as part of a broad tax bill.

Obama has not proposed a repeal of the loophole since 2009.

During the Senate hearing last week on Apple’s tax strategy, Mark Mazur, Treasury’s assistant secretary for tax issues, said in written testimony that the Obama administration remained “concerned about the misuse of various income-shifting devices, including misuse of the ‘check the box’ rules.”

Mazur noted that the White House has made proposals to discourage profit-shifting offshore. But it’s unclear whether Obama will try again to have the “check the box” rule revoked.

For perspective, Obama could read the words of another president who also fell short in his assault on tax shelters, this one failing to raise taxes on overseas holding companies.

“We face a challenge to the power of government to collect uniformly and fairly, and without discrimination, taxes based on statutes adopted by Congress,” that president wrote.

The letter was signed by Franklin Roosevelt and dated June 1, 1937.

(Additional reporting by Gabriel Debenedetti, Margaret Chadbourn and Kim Dixon; Editing by David Lindsey and Paul Simao)

Tax lobbyist Ken Kies was not worried. A decade earlier, he
had led a fight to preserve a key loophole – known in Treasury
Department shorthand as the “check the box” rule – when another
Democratic president, Bill Clinton, had tried to kill it.

“I told my clients, ‘Don’t sweat this. This is never going
to happen,’” recalled Kies, who has advised corporate giants
Microsoft and General Electric on the issue.

Kies was right.

Business groups rose up against Obama’s plan, arguing that
it could damage U.S. businesses already threatened by the weak
economy. Democrats in Congress balked, Obama dropped the idea
and the loophole survived.

The story of the “check the box” loophole, which allows U.S.
companies to choose for themselves how to classify their
subsidiaries for tax purposes, and a companion policy known as
the “look-through” rule, shows how Washington bureaucrats,
lobbyists and politicians have worked together – sometimes
wittingly – to save money for American corporations and deprive
the federal government of billions in tax revenue each year.

What began in 1996 as an effort by the Treasury Department
to simplify the U.S. tax code mistakenly ended up as a massive
tax loophole for corporate America, which seized upon it and has
never let go.

Besides fueling an explosion in earnings that U.S. companies
keep abroad – now more than $1.8 trillion, the Commerce
Department estimates, double the amount from less than a decade
ago – the loophole has become a symbol of how difficult it can
be to repeal a tax benefit once it becomes entrenched.

At congressional hearings last week, several lawmakers
blasted Apple Inc. for using the “check the box” loophole and
other international tax strategies to avoid paying what they
estimated as $9 billion in potential U.S. taxes in 2012.

Two of Apple’s most aggressive questioners, Democratic
Senator Carl Levin of Michigan and Republican Senator John
McCain of Arizona, have called for closing the “check the box”
loophole. But even they have voted to keep it alive several
times in recent years when it has been inserted into other
legislation.

Levin’s office did not respond to requests for a comment.
McCain declined to comment for this story.

“Once a policy mistake is made that is favorable to
taxpayers, and particularly to big taxpayers, it is extremely
difficult to reverse,” said a former Treasury Department
official who helped write the “check the box” rule and was
involved in Obama’s effort to repeal it.

The former official spoke on condition of anonymity, citing
the sensitive nature of the tax break.

The “check the box” loophole – which costs the United States
about $10 billion per year, according to the White House – also
has been a reflection of Washington’s “revolving door” culture
of policy-making and lobbying. Some of the bureaucrats who
helped to write the rule went on to work for corporations that
used it to lower their tax bills.

They include William Morris, who was Treasury’s associate
international tax counsel when the rule was imposed.

Morris, who did not respond to requests for comment on this
story, joined GE in 2000 and is now director of the company’s
global tax policy. The company, like many other big
multinationals, keeps its tax burden well below the official
U.S. corporate rate of 35 percent in part by taking advantage of
“check the box” and other international tax strategies.

GE’s annual reports indicate that the company does so
largely because many of its profits are directed to its vast
network of foreign subsidiaries. In a filing with the U.S.
Securities and Exchange Commission in February, GE said its
overseas affiliates were holding $108 billion in offshore
profits, which is more than any other U.S. company.

Morris’s precise role in GE’s tax strategy is unclear. The
company declined to comment for this story.

Other former IRS and Treasury officials involved in shaping
the tax loophole now hold senior positions at law and accounting
firms in Washington and New York.

BIRTH OF A LOOPHOLE

Offshore tax shelters have bedeviled the U.S. government
virtually since the inception of the tax code in 1913.

A 1962 compromise between President John Kennedy and
Congress imposed U.S. taxes on “passive” income such as
royalties and interest earned abroad, but not on “active” income
from regular business operations.

That law, known as Subpart F, made the tax code increasingly
complex as businesses grew larger and more diverse. The law was
revised 10 times between 1969 and 1996 as the U.S. Internal
Revenue Service tried to figure out how to classify, and then
tax, tens of thousands of corporate units.

In 1996 the Treasury Department moved to simplify matters
with a rule that enabled companies to “check the box” on a tax
form to describe a given corporate entity – including whether it
was, for tax purposes, irrelevant, a so-called “disregarded
entity.”

For a company and its subsidiaries that all operate in the
United States, the rule streamlined tax filing by allowing the
subsidiaries’ income to be reported on the same forms as the
parent company’s income.

When applied to U.S.-based multinational companies, however,
the “disregarded entities” status could be used to set up
high-volume subsidiaries in low-tax jurisdictions such as
Luxembourg or Ireland. A key part of Apple’s tax strategy, for
example, is having a subsidiary in Ireland that takes in all of
the income from Apple’s retail stores in Europe.

Treasury had given little thought to how the “check the box”
rule might affect U.S.-based multinational corporations,
according to several people involved in the effort.

Treasury officials realized they had created a massive
loophole when they noticed a spike in cross-border financing
shortly after the rule took effect.

“The mistake was extending it to foreign entities,” Donald
Lubick, Treasury’s top tax official at the time, told Reuters.
“That was apparent pretty quickly.”

Clinton’s Treasury Department moved to revoke the “check the
box” rule in early 1998. But multinational companies such as
Hallmark, Coca-Cola, IBM and Philip Morris launched a full-court
press to convince Congress to keep the rule in place.

Enter Kies, a former tax specialist for Congress’ Joint Tax
Committee who was eager to put his expertise and contacts to
work as a tax lobbyist.

Kies’s former Republican bosses – Representative Bill Archer
of Texas and Senator William Roth of Delaware – accused the IRS
and Treasury of overstepping their authority in trying to take
away the loophole.

Kies, meanwhile, says he pursued a strategy that he figured
would resonate with businesses, lawmakers and regular citizens:
He argued that eliminating the “check the box” loophole would
damage U.S.-based multinational companies by forcing them to pay
more taxes not only in the United States, but also to high-tax
nations such as France.

Roth’s Senate Finance Committee passed a bill in April 1998
to prevent Treasury from making any changes to “check the box.”
That language was watered down to a non-binding resolution by
the time the measure passed the Senate the next month, but
Congress’ message was clear: Don’t mess with the loophole.

Treasury soon gave up its effort to revoke it.

“In light of that reception that this rule got on Capitol
Hill, we withdrew the notice,” said Philip West, who was then
the top international tax official at Treasury and now advises
clients on international tax strategy for the law firm Steptoe &
Johnson.

‘CHECK THE BOX’ GROWS UP

By 2004, thanks in part to the “check the box” rule,
U.S.-based multinational corporations paid an effective tax rate
of about 2.3 percent on $700 billion in foreign earnings,
according to the Obama administration.

To make “check the box” tougher to revoke, Kies and other
corporate lobbyists urged Congress to turn the rule into a law.

Congress did so in 2006 with legislation that became known
as the “look through” rule. It bolstered the “check the box”
loophole by giving corporations more latitude to move some types
of income from one foreign unit to another without paying a tax.

The “look through” rule became law with little debate,
according to congressional records. It was tucked into a broad
extension of other tax cuts.

The 2006 law wasn’t permanent, but supporters have managed
to extend it repeatedly by embedding it in large and important
but unrelated pieces of legislation that were headed toward easy
passage in Congress.

That is what happened in 2009, when Obama threatened to cut
the loophole.

Congress has extended it temporarily twice since then as
part of larger pieces of legislation. Both Levin and McCain
voted to extend it in January as part of the legislation that
kept the U.S. government from going off the “fiscal cliff,” a
package of across-the-board tax hikes and spending cuts that
threatened to plunge the U.S. economy into another recession.

Both also voted to extend it in 2010 as part of a broad tax
bill.

Obama has not proposed a repeal of the loophole since 2009.

During the Senate hearing last week on Apple’s tax strategy,
Mark Mazur, Treasury’s assistant secretary for tax issues, said
in written testimony that the Obama administration remained
“concerned about the misuse of various income-shifting devices,
including misuse of the ‘check the box’ rules.”

Mazur noted that the White House has made proposals to
discourage profit-shifting offshore. But it’s unclear whether
Obama will try again to have the “check the box” rule revoked.

For perspective, Obama could read the words of another
president who also fell short in his assault on tax shelters,
this one failing to raise taxes on overseas holding companies.

“We face a challenge to the power of government to collect
uniformly and fairly, and without discrimination, taxes based on
statutes adopted by Congress,” that president wrote.

The letter was signed by Franklin Roosevelt and dated June
1, 1937.

The Senate Permanent Subcommittee on Investigations has found that Apple in 2012 alone avoided paying $9 billion in U.S. taxes, using a strategy involving three offshore units with no discernible tax home, or “residence.”

Cook, in his first congressional testimony since becoming Apple CEO in 2011, said his company is a major taxpayer, handing over nearly $6 billion in cash to the U.S. government in 2012.

“We expect to pay even more this year,” Cook said. “We pay all the taxes we owe.”

But Senator Carl Levin, chairman of the subcommittee and a veteran tax sleuth, said Apple had sought “the Holy Grail of tax avoidance,” creating one Irish unit that paid no income taxes to any national tax authority for the past five years.

Levin said Apple used Ireland as a base for a web of offshore holding companies and negotiated a deal with the Irish government for a tax rate of less than 2 percent. The top U.S. corporate tax rate is 35 percent, one of the world’s highest.

Cook said Apple did not depend on tax gimmicks. “We don’t move intellectual property offshore and use it to sell our products back to the United States to avoid taxes. We don’t stash money on some Caribbean island,” he said.

In Ireland, where low corporate taxes have been an economic development tool for many years, the government said it had not made a special tax deal with Apple. If Apple’s tax rate was too low, it was the fault of other countries, deputy prime minister Eamon Gilmore told national broadcaster RTE on Tuesday.

HP, MICROSOFT PRECEDED APPLE

Subcommittee staffers said on Monday that Apple was not breaking any laws and had cooperated fully with the inquiry.

Levin’s panel has previously examined what it called tax avoidance by other U.S. technology giants, including Hewlett-Packard Co and Microsoft Corp. The senator said Apple has used similar tax avoidance strategies.

Senator John McCain praised Apple as a success story, but he said the company’s tax strategy reflected a “flawed” tax system.

“For years, Apple has opted to forego fully contributing to the U.S. Treasury and to American society by shifting profits and circumventing U.S. taxes,” McCain said.

Cook said Apple agreed with those in Congress who want to reform corporate taxes and called for changes that include lower corporate income tax rates and a reasonable tax on foreign earnings.

“Apple recognizes these and other improvements in the U.S. corporate tax system may increase the company’s taxes,” he said in prepared testimony.

Many U.S. multinational take advantage of a tax law that allows profits earned abroad to be tax-free as long as they are not brought into the United States, or “repatriated.” Total U.S. corporate profits parked offshore rose 15 percent to $1.9 trillion last year, according to research firm Audit Analytics.

Accounting rules also let the companies avoid recognizing a tax expense if management intends to keep the earnings indefinitely reinvested overseas. Taking advantage of these laws, the offshore earnings of U.S. companies has risen 70 percent in the past five years, Audit Analytics said two weeks ago.

“The baldness of the Apple strategy surprises me more than anything else,” said University of Southern California Law Professor Edward Kleinbard. “European member states are going to be very angry with Apple and very angry with Ireland.”

OFFSHORE MANEUVERS

Offshore profits are typically taxed by the countries in which they are earned, but companies work hard to move offshore profits into countries with lower tax rates, like Ireland.

One way this is done is through “transfer pricing,” or the management of moving goods and services across international borders from one corporate unit to another. Sometimes companies move valuable intellectual property to a low-tax country, then bring profits derived from its use into that country through royalty payments and other structures.

Levin’s panel said Apple used a cost-sharing agreement “to transfer valuable intellectual property assets offshore and shift the resulting profits to a tax haven jurisdiction.”

The panel also said Apple took advantage of loopholes in tax law and regulations known as “check the box” and “look through” that let some offshore units be disregarded for tax purposes, sheltering substantial profits from taxation.

Levin has unsuccessfully called for closing the “check the box” and “look through” provisions of the tax code.

The Levin inquiry comes at a turbulent time in tax circles, with the U.S. Internal Revenue Service under investigation because of the way agents handled conservative political groups’ applications for tax-exempt status.

It is not clear, however, whether that controversy and Levin’s allegations will lead to an overhaul of the U.S. tax code. Tax law writers in Congress had been inching forward on such a project before the IRS scandal erupted earlier this month. Levin’s inquiry has been under way for months.

Shares of Apple closed down 0.7 percent at $439.66 on Tuesday.

(Writing by Kevin Drawbaugh; Editing by Lisa Von Ahn and Tim Dobbyn)

Here are key events in the scandal, based on a report from the Treasury Inspector General for Tax Administration (TIGTA), IRS statements, news reports and interviews:

January 2010 – The Supreme Court’s “Citizens United” ruling lifts government limits on independent political donations by corporations and labor unions in federal elections, opening the door to a surge of political spending.

Tax-exempt “social welfare” groups organized under Section 501(c)(4) of the U.S. tax code become an increasingly popular conduit for increased spending on all parts of the political spectrum, but especially by conservatives.

The number of applications sent to the IRS by groups seeking 501(c)(4) tax-exempt status begins to increase sharply, rising to 3,400 in 2012 from 1,500 in 2010, according to the IRS.

501(c)(4) groups may be exempt from paying taxes and need not disclose the identity of their donors, but only as long as their primary activity is not political advocacy.

March 2010 – The IRS field office in Cincinnati, known as the Determinations Unit, begins picking out applications for tax-exempt status for closer scrutiny, using conservative-sounding key words in groups’ names as a filter. One of the unit’s main jobs is to determine whether applicants obey the political activity limits and deserve tax-exempt status.

The unit targets groups with names such as “We the People” and “Take Back the Country.”

April 2010 – Determinations Unit managers and staff begin assessing the results of the targeting effort, compiling a “Sensitive Case Report” and summary chart. The chart is shared with the director of the exempt organizations unit.

July 2010 – The Determinations Unit tells staffers to be on the lookout for applications including the name of the Tea Party movement, a loose affiliation of groups which oppose President Barack Obama and agitate for lower taxes and smaller government.

October 2010 – Newly assigned IRS specialist in charge of reviewing applications stops work on cases while awaiting guidance from another unit. The TIGTA inspector general’s report points to “a miscommunication about not working the cases while waiting for guidance.”

November 2010 – In mid-term U.S. elections, Republicans win control of the House of Representatives, partly on a wave of support from Tea Party activists.

IRS managers enter a long period of uncertainty about who should review tax-exempt applications for political involvement and how it should be carried out, while reviews are on hold.

June 2011 – Lois Lerner, head of the IRS’s tax-exempt groups unit in Washington, is briefed on the practice of applying extra scrutiny to conservative groups. She instructs “that the criteria be immediately revised,” according to TIGTA.

July 2011 – Determinations Unit filtering criteria for tax-exempt applications are changed to more politically neutral language for “organizations involved with political, lobbying or advocacy for exemption under 501(c)(3) or 501(c)(4).”

August 2011 – A meeting is held between the IRS chief counsel’s office and the office of rulings and agreements, which oversees the Determinations Unit, “so that everyone would have the latest information on the issue,” the TIGTA report said.

September 2011 – U.S. campaign finance watchdogs call for greater IRS scrutiny of certain conservative 501(c)4 groups.

January 2012 – The Cincinnati office of the IRS resumes using politically charged language to filter applications, such as “Political action type organizations involved in limiting/expanding government, educating on the constitution and bill of rights, social economic/reform movement.”

March 2012 – After Tea Party groups complain about lengthy r IRS tax-exempt application reviews, Republican members of Congress question then-IRS commissioner Doug Shulman. In hearings, Shulman denies the IRS is targeting groups based on their politics.

House Republicans contact the U.S. Treasury Inspector General for Tax Administration (TIGTA) with concerns about the IRS.

May 2012 – The IRS again modifies and neutralizes its filtering criteria, this time to “organizations with indicators of significant amounts of political intervention (raising questions as to exempt purpose and/or excess private benefit).

June 2012 – Republican Representative Darrell Issa formally requests a TIGTA inquiry. TIGTA chief J. Russell George informs Issa the following month that it has begun.

August 2012 – Ten Republican senators warn Shulman in a letter not to buckle under to what they call pressure from Democrats as the IRS decides what to do about 501(c)(4) groups.

By now, tax exempted groups are raking in money and spending it on advertising as Obama campaigns for re-election. They include one run by Republican political operative Karl Rove’s Crossroads GPS organization. Obama has one such group under his Priorities USA movement.

July 2012 – The IRS says it “will consider” changing the rules for 501(c)(4) groups, responding to complaints that some of the groups are becoming too politically active.

November 2012 – Obama wins reelection over Republican challenger Mitt Romney.

Shulman steps down when his term as IRS commissioner ends. He is replaced on an acting basis by IRS veteran Steven Miller.

April 2013 – White House General Counsel Kathryn Ruemmler is told about the upcoming TIGTA report on April 24. She briefs White House Chief of Staff Denis McDonough shortly thereafter.

May 2013 – The IRS’s Lerner publicly apologizes for “inappropriate” targeting of conservative groups. Investigations are launched by congressional panels. The White House issues a statement of concern. TIGTA’s report comes out and finds “inappropriate targeting” and poor management at the IRS. The FBI launches a criminal investigation.

Obama fires Miller and names White House budget official Danny Werfel to lead the agency. Joseph Grant, head of the IRS division at the center of the scandal, announces he plans to retire.

(Editing by Kevin Drawbaugh and David Storey)

As the FBI mounted a criminal investigation of the matter, the U.S. Treasury Inspector General for Tax Administration (TIGTA) reported that the IRS used “inappropriate criteria” when it singled out groups for extra scrutiny based on their names.

The report also cited long delays, excessive requests for donor information and general dysfunction in handling cases.

Beginning in 2010, IRS agents in a Cincinnati field office screened thousands of non-profit groups’ applications for tax-exempt status based on the presence of key words in their names such as “Tea Party” and “Patriot.”

This practice was carried out in Cincinnati and other locations by agents responsible for deciding if groups deserved to get tax-exempt status, based on limits imposed on their political activities by Section 501(c)4 of the U.S. tax code.

The IRS responded to the TIGTA report in a short statement late on Tuesday, conceding that “inappropriate shortcuts were used” to screen groups for political activity.

“There was no intent to hide this issue, but rather we waited until TIGTA completed their fact finding, made recommendations, and we reviewed their findings,” the IRS said.

In targeting only conservative groups for closer scrutiny, IRS agents gave “the appearance that the IRS is not impartial in conducting its mission,” the TIGTA report said.

Lois Lerner, a senior IRS official, on Friday apologized for the targeting at a legal conference in Washington. Her remarks triggered a storm of controversy, embarrassing the IRS and giving Republicans a new line of attack on the Obama administration.

Some Republican lawmakers on Capitol Hill have called for the resignations of Lerner, who heads the IRS tax-exempt organizations unit, and IRS Acting Commissioner Steven Miller.

IRS CONFUSION, DELAYS CITED

The TIGTA report points to dysfunction at the agency that employs more than 90,000 people, including a lack of management oversight and political tone deafness by lower-level employees.

IRS agents, who said they used the conservative terms as a shorthand to sift through a flood of applications, “did not consider the public perception of using politically sensitive criteria when identifying these cases,” the report said.

The report also criticized the IRS for inept management.

For example, when Lerner was briefed on the screening in June 2011, she immediately called for changes. This resulted in the dropping of key words such as “Tea Party,” the report said.

But by January 2012, a team of lower-level staffers had changed the screening criteria back to focus on policy positions “without executive approval,” the report said.

The criteria was changed back again in May 2012 to delete “Tea Party” and other conservative references.

“Confusion” and “miscommunication” are cited in descriptions of agency officials attempting to coordinate their work.

For instance, there was a 13-month delay from October 2010 to November 2011 when a team of specialists waited for guidance from another unit because of a miscommunication about the status of 40 cases, the report said.

Overall, during the time period studied, the watchdog found it took 574 calendar days to process applications flagged as potential political cases, compared with 238 days for other applications for tax-exempt status, the report said.

In written responses to the inspector general, the IRS pushed back against two TIGTA recommendations. One urged better IRS documentation to justify how applications are chosen for extra scrutiny. Another called for development of guidance for specialists on how to process requests for tax-exempt status.

The agency said such changes would only cause further delays and proposed alternative actions. TIGTA said those options would not fix the problems, however.

(Additional reporting by Richard Cowan and Patrick Temple-West; Editing by Lisa Shumaker)

The documents show the offices of the IRS’s chief counsel
and deputy commissioner for services and enforcement
communicated about the targeting with lower-level officials on
Aug. 4, 2011, and March 8, 2012, respectively.

The two communications occurred weeks and months before Doug
Shulman, then the commissioner of the IRS, told congressional
panels in late March 2012 that no groups were being targeted for
extra scrutiny by the tax agency.

The IRS has maintained that its senior leadership did not
know for some time that lower-level agents were applying extra
scrutiny to applications for tax-exempt status from groups with
key words in their names, such as “Tea Party” and “Patriot.”

The agency said in a statement on Monday that Steven Miller,
who is now acting IRS commissioner, was first informed in early
May 2012 that some groups seeking tax-exempt status had been
“improperly identified by name” and subjected to extra scrutiny.

Late on Monday, Senate Finance Committee Republicans said
Shulman was briefed on the targeting in May 2012, a date not
previously disclosed. An aide said committee staff learned this
on Monday from the Treasury Inspector General for Tax
Administration (TIGTA), an independent IRS watchdog.

The controversy that has erupted over the IRS’s targeting
practice drew comment on Monday from President Barack Obama, who
said it would be “outrageous” if IRS staff targeted conservative
groups.

He said anyone who did such targeting must be held fully
accountable because the IRS must be neutral and nonpartisan.

The top Republican lawmaker in charge of IRS oversight set a
hearing date for Friday to probe the practice, which burst into
wider view last week at a legal conference where a senior IRS
official apologized for it.

The controversy threatens to tarnish the image of the IRS,
an independent government agency that has long maintained it is
free of political influence.

WATCHDOG REPORT COMING

A report from TIGTA on the targeting of the groups is due to
be made public this week. Portions of it obtained by Reuters
over the weekend listed the meetings that took place between
lower-level staff and the unnamed senior officials.

Miller was IRS deputy commissioner for services and
enforcement at the time of a March 8, 2012, e-mail exchange in
which his office took part, according to the TIGTA documents. No
individuals are names by TIGTA.

The watchdog’s report reads that on March 8, 2012, “The
Deputy Commissioner for Services and Enforcement requested that,
if a taxpayer called about having to provide donor information,
the determinations unit would allow them to not send the donor
names,” but be told they might need to provide them later.

Miller could not be reached for comment.

Miller has been leading the IRS following the November 2012
departure of Shulman, who stepped down as chief of the agency
when his term expired. Miller also remains deputy commissioner
for services and enforcement.

The TIGTA documents also mention an Aug. 4, 2011, meeting
about the targeting between lower-level officials and the office
of the IRS chief counsel, but again, no names are listed.

William Wilkins was then, and is now, the IRS chief counsel.
He could not be reached for comment.

The IRS chief counsel’s office employs about 1,600 lawyers
and it was unclear who among them might have taken part in the
discussions with lower-level officials. The IRS has roughly
90,000 employees.

WHEN DID IRS LEADERS KNOW?

How much the IRS leadership knew about the targeting, and
when, are two of many questions still unanswered in the
controversy.

IRS agents in a Cincinnati field office in 2010 started
using keywords – such as “Tea Party” and “Patriot” – to sift
through thousands of groups’ applications for tax-exempt status
and pick out ones for possible closer scrutiny.

A lawyer for Tea Party groups told Reuters on Monday that
some clients had been contacted from IRS offices not only in
Cincinnati, but also in Washington, D.C., and two offices in
California – Laguna Niguel and El Monte.

The IRS targeting procedure emerged at a time of controversy
about tax-exempt groups organized under U.S. tax law 501(c)4.
Such groups multiplied after the U.S. Supreme Court’s 2010
“Citizens United” ruling that relaxed campaign finance rules.

New applications for tax-exempt status poured into the IRS
in 2010. Most, but not all, were from conservative groups. The
agency came under pressure to deal with the volume and to ensure
that the groups were following the 501(c)4 rules.

These state that 501(c)4 groups need not disclose their
donors and may spend money on advertising around general issues,
but they may not endorse specific candidates or parties.

LERNER APOLOGIZES

Lois Lerner, head of the IRS tax-exempt organizations
office, set off a firestorm at the Washington legal conference
on Friday when she apologized for the targeting, which
conservatives had complained of for years.

Floyd Williams, who was chief of legislative affairs when he
left the IRS in 2012 after serving at the agency for nearly 16
years, said the agency’s decisions are very decentralized.

“I would drop over dead if there were any indication that
the White House was involved and I would say the same with
Treasury,” Williams said. “It is deliberately decentralized
because of the notion that the political people should not be
involved in the day activities.”

The documents show the offices of the IRS’s chief counsel and deputy commissioner for services and enforcement communicated about the targeting with lower-level officials on August 4, 2011, and March 8, 2012, respectively.

The two communications occurred weeks and months before Doug Shulman, then the commissioner of the IRS, told congressional panels in late March 2012 that no groups were being targeted for extra scrutiny by the tax agency.

The IRS has maintained that its senior leadership did not know for some time that lower-level agents were applying extra scrutiny to applications for tax-exempt status from groups with key words in their names, such as “Tea Party” and “Patriot.”

The agency said in a statement on Monday that Steven Miller, who is now acting IRS commissioner, was first informed in early May 2012 that some groups seeking tax-exempt status had been “improperly identified by name” and subjected to extra scrutiny.

The controversy that has erupted over this practice drew comment on Monday from President Barack Obama, who said it would be “outrageous” if IRS staff targeted conservative groups.

He said anyone who did such targeting must be held fully accountable because the IRS must be neutral and nonpartisan.

The top Republican lawmaker in charge of IRS oversight set a hearing date for Friday to probe the practice, which burst into wider view last week at a legal conference where a senior IRS official apologized for it.

The controversy threatens to tarnish the image of the IRS, an independent government agency that has long maintained it is free of political influence.

WATCHDOG REPORT COMING

A report from the Treasury Inspector General for Tax Administration (TIGTA), an independent IRS watchdog, on the targeting of the groups is due to be made public this week.

Portions of it obtained by Reuters over the weekend listed the meetings that took place between lower-level staff and the unnamed senior officials.

Miller was IRS deputy commissioner for services and enforcement at the time of a March 8, 2012, e-mail exchange in which his office took part, according to the TIGTA documents. No individuals are names by TIGTA.

The watchdog’s report reads that on March 8, 2012, “The Deputy Commissioner for Services and Enforcement requested that, if a taxpayer called about having to provide donor information, the determinations unit would allow them to not send the donor names,” but be told they might need to provide them later.

Miller could not be reached for comment.

Miller has been leading the IRS following the November 2012 departure of Shulman, who stepped down as chief of the agency when his term expired. Miller also remains deputy commissioner for services and enforcement.

The TIGTA documents also mention an August 4, 2011, meeting about the targeting between lower-level officials and the office of the IRS chief counsel, but again, no names are listed.

William Wilkins was then, and is now, the IRS chief counsel. He could not be reached for comment.

The IRS chief counsel’s office employs about 1,600 lawyers and it was unclear who among them might have taken part in the discussions with lower-level officials. The IRS has roughly 90,000 employees.

WHEN DID IRS LEADERS KNOW?

How much the IRS leadership knew about the targeting, and when, are two of many questions still unanswered in the controversy.

IRS agents in a Cincinnati field office in 2010 started using keywords – such as “Tea Party” and “Patriot” – to sift through thousands of groups’ applications for tax-exempt status and pick out ones for possible closer scrutiny.

The procedure emerged at a time of controversy about tax-exempt groups organized under U.S. tax law 501(c)4. Such groups multiplied after the U.S. Supreme Court’s 2010 “Citizens United” ruling that relaxed campaign finance rules.

New applications for tax-exempt status poured into the IRS in 2010. Most, but not all, were from conservative groups. The agency came under pressure to deal with the volume and to ensure that the groups were following the 501(c)4 rules.

These state that 501(c)4 groups need not disclose their donors and may spend money on advertising around general issues, but they may not endorse specific candidates or parties.

LERNER APOLOGIZES

Lois Lerner, head of the IRS tax-exempt organizations office, set off a firestorm at the Washington legal conference on Friday when she apologized for the targeting, which conservatives had complained of for years.

Floyd Williams, who was chief of legislative affairs when he left the IRS in 2012 after serving at the agency for nearly 16 years, said the agency’s decisions are very decentralized.

“I would drop over dead if there were any indication that the White House was involved and I would say the same with Treasury,” Williams said. “It is deliberately decentralized because of the notion that the political people should not be involved in the day activities.”

(Editing by Howard Goller and Mohammad Zargham)