This article was written by Idan Levitov, head analyst for anyoption.com.
Taxes have been all the rage in 2016, with governments globally working to close loopholes and improve their revenue collection mechanisms amid growing concerns about multinational corporations not paying their fair share. Many of the largest companies that have a worldwide presence have come under fire for using special vehicles to reduce if not evade taxes entirely in an effort to deliver better value to shareholders.
However, since the release of the Panama papers and several failed tax inversions, governments are seen fighting back and rapidly cracking down on what they view as outright fraud. The first warning shot was fired today by the European Commission in its efforts to collect taxes from Apple which exploited its Irish incorporation and tax benefits granted by the government to avoid paying €13 billion in taxes between 2003 and 2014.
The European Union handed down a landmark ruling on Apple’s tax strategies on August 30th, calling the use of an Irish tax benefit illegal under EU ‘state aid’ rules. Suspicions were raised when it was determined that Apple was paying an effective tax rate of 0.005% on European profits from sales of Apple consumer technology products and services across the political union.
The US holding company for Apple claims ownership over these Irish entities which were designed to reduce the taxable income from European operations by effectively licensing technology and building a cost-sharing agreement whereby the subsidiaries would pay the parent company for research and development services.
By domiciling these subsidiary businesses in Ireland, Apple recorded all sales in Europe based on the effective tax rate paid in Ireland, which began as low as 1.00% in 2003 before dropping even further throughout the next decade.
For years Apple has engaged in all sorts of crafty measures to go ahead and limit its tax exposure globally. Besides determining that revenues generated outside the United States would remain outside the auspices of the US Internal Revenue Service, Apple has even gone about setting up a fund manager subsidiary called Braeburn Capital in Nevada to invest its cash pile that currently numbers north of $200 billion worth of cash and marketable securities.
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Although the company has turned to debt capital markets in order to raise funds to pay shareholder dividends, it does in fact have the largest cash hoard of any multinational company.
However, when it comes to taxes, the effective rate on this cash is nil. Instead of repatriating that money and paying US corporate taxes that number 35.00% annually, Apple keeps this cash abroad knowing that it can continue maneuvering around tax authorities.
The Political Component
Companies like Apple have long exploited these legal loopholes by creating subsidiaries in foreign countries or even offshore to handle cash flow in an effort to reduce taxes. However, the authorities are catching on as evidenced by the European Commission ruling which effectively forces Apple to come up with a €13 billion payment.
Now that increased populist rhetoric is taking off in the United States with political candidates calling for companies to produce goods and services domestically while paying their fair share of taxes, the latest ruling from the EU might lead to greater challenges for companies like Apple as they fight the charges. The US Treasury has also gotten involved, effectively calling the European ruling a transfer of revenues from the US Treasury to the European Treasury in a move that might spark further trade protectionism, tariffs, and regulatory scrutiny.
For Apple, this first move by the European Union could create a precedent which forces the company to be more transparent with its cash and force it to repatriate its substantial cash pile back to the United States. Over the last two years, there has been growing pressure against US multinationals seeking tax inversions, which basically enabled companies to setup headquarters in lower tax jurisdictions while most operations were carried out in a higher tax jurisdiction.
Considering Apple already faces abundant scrutiny for its business practices, falling revenues from disappointing iPhone unit sales and forward guidance coming in weaker than anticipated sets the stage for more downside in shares. Now that taxes have come back on the radar, the company may face further headwinds as it tries to regain its composure and lift shareholder value.
The Unfolding Impact
Since the announcement, Apple shares have already retreated, falling -0.32% during Tuesday’s session to $106.48 per share, well below 52-week highs of $123.82. Although Apple will likely take the opportunity to appeal the European Commission ruling, it brings unwanted attention upon the firm at a time when it is facing declining revenues from its key product.
While investors might view the company as fairly valued considering its 12.48 price-to-earnings ratio and 2.13% dividend yield, the question remains as to whether other countries will soon follow suit in closing loopholes, forcing Apple to repatriate its cash for what could be a massive tax liability.
If the political conditions become more favorable for Apple after the elections, they could conceivably repatriate the cash. However, in light of the current environment, expect more pressure on shares as investigations into their tax avoidance practices mount.