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Apple Inc. (Nasdaq: AAPL) CEO Tim Cook was summoned to Congress last week to face outraged legislators over his company’s failure to pay corporate income taxes to any national government on more than $74 billion in overseas earnings.
This is a perfect example of a situation that is simply the tip of the “offshoring” iceberg. Below, I’ll address what it means for your money and why the outcome may not end up at the “obvious” solution.
According to a Congressional investigation, the Cupertino giant paid no taxes whatsoever to any national government on more than $74 billion in revenues – a fact that Apple doesn’t dispute.
As galling as this is, what Apple did was perfectly legal. Using well-documented and well-known loopholes in the U.S. and Irish tax codes, Apple set up Irish shell corporations that allowed them to funnel dividends and earnings from offshore investments in such a way as to not incur tax liabilities…in any country.
Interestingly, Senate aides associated with the investigation said they’ve never seen companies use subsidiaries that didn’t owe taxes. Evidently, they haven’t looked very hard.
What Apple’s doing is nothing new or unique. Almost every multinational corporation operates in the same shady territory. Most have thousands of accountants and lawyers on staff whose sole job is to make sure everything those companies do is tax “efficient.”
Foreign subsidiaries are just the beginning. There’s transfer costing, loans between subsidiaries, options-based compensation, tax deductions for malfeasance, and intellectual property offshoring — just to name a few of the favorite tax dodges in widespread use today around the world, quite literally.
For example, Microsoft Corp. (Nasdaq: MSFT) sends an estimated $0.46 cents on every dollar through Puerto Rico to pay for patent costs associated with discoveries that are “mostly” made inside the United States, according to the Institute for Policy Studies or “IPS” for short.
Microsoft CEO Steve Ballmer’s crew stashed $60.8 billion offshore last year alone and didn’t pay a dime in U.S. taxes. That’s an estimated $19.4 billion it’d owe Uncle Sam if brought home.
Pfizer Inc. (NYSE: PFE) sells 35%-45% of its drugs inside the United States but has reported no U.S. profits in five years. The IPS estimates the pharma giant booked $73 billion in profits offshore last year.
Like Microsoft, it paid no taxes on that money whatsoever. And you’ll love this…the company earned $43 billion from 2010-2012 yet still was so tax “efficient” it received $2.2 billion in federal refunds over the same time period.
Verizon Communications (NYSE :VZ), Merck & Co. (NYSE: MRK), Citigroup Inc. (NYSE: C), JPMorgan Chase (NYSE: JPM), Hewlett-Packard Co. (NYSE: HPQ), General Electric Co. (NYSE: GE), Exxon Mobil Corp. (NYSE :XOM), FedEx Corp. (NYSE: FDX), and Bank of America Corp. (NYSE: BAC)…they’re all in on it. So are dozens of other big companies.
Never mind what Apple owes. In my mind the far bigger problem is that Congress has known about this for years and failed to do anything about it.
They’ve Seen the Enemy…And It Is Them
Which brings me to Congress.
Don’t let the histrionics fool you. They’re a smoke screen.
Like a bunch of spoiled kindergarteners, what Congress is really mad about is that somebody figured out how to game the system in a way that they didn’t anticipate.
If I were Tim Cook, I would have hauled a huge mirror into the chambers, held it up and encouraged every member of the inquisition to take a good hard look at what they see.
The reality of what’s happening is that the United States runs a punitive, worldwide taxation system very poorly. As morally appalling as this situation may be, holding a corporation to task for legal behavior enabled by decades of bad policymaking is wrong.
Our regulators and our Congress are outclassed, outmaneuvered and out negotiated at every turn because they don’t understand how real money works. They never have and, in today’s complicated financial markets, it’s likely they never will.
Worse, they cannot grasp the concept of responsibility for their own actions. Nor, evidently, do they understand the “law of unintended consequences” or basic economics, for that matter.
If anything, Congress ought to turn on itself and keelhaul every member who voted to implement the policies that created this mess. Demonstrate some real leadership by looking introspectively first. Then go about actually fixing the issue and doing something that engenders the public’s trust instead of tromping all over it.
What This Means to Your Bottom Line
And that brings me to the American public, and to investors in particular.
As tempting as it is to go along with the witch hunt, investors better be careful what they wish for.
CEOs have one job and one job only…to maximize profits. That means they not only need to develop, design, build and sell products and services, but create tax-efficient organizations, too. Individuals have the same job, albeit on a very different scale.
More importantly, both have the right to pay the minimum amounts of taxes allowed by law.
Let’s not forget that Apple’s margins are obscenely high and that those same profit margins were being lauded as the stock rose to $705.07 per share last September.
If Congress decides to close down these loopholes, chances are good that they’re going to do it in such a way that what comes to the bottom line is going to change Apple’s bottom line dramatically. Not to mention the bottom line of every other Fortune 500 firm.
Take proposals from Sen. Carl Levin, D-MT, and Sen. Bernie Sanders, I-VT, for example.
The former is championing the Cut Unjustified Tax Loopholes Act, which would nail down executive options compensation pay, end several oil and gas subsidies and treat foreign subsidiaries controlled from the United States as U.S. entities for tax purposes.
The latter has put the Corporate Tax Dodging Prevention Act on the table. Sanders’ proposal would end tax deferrals on offshore profits while also taxing global profits for U.S. corporations.
While both bills are expected to raise nearly half a trillion dollars in additional taxes or more over the next 10 years, I figure they’re good for at least a 30%-45% reduction in bottom line profits if they pass. That likely translates into a buzz cut of at least the same amount in stock prices.
Never forget that stock prices are a function of earnings and profits. Take those away through punitive legislation and guess what…prices will fall.
Debt markets could implode, too. Our entire equity pricing system is built upon the efficient use of debt. If you force cash reserves to be used for taxes, debt to equity ratios go haywire, as does operating leverage.
Return on equity ratios, return on cash, and price to earnings ratios…they’ll all change. Longer term, the effects would probably be good, but the short-term adjustment will be a bear – pun absolutely intended.
And finally, if you think offshoring or the practice of moving businesses to other jurisdictions is galling now, wait till Congress starts fixing things.
Money Has No Borders
Money is mobile and those who control it are, too. I can think of no better way to eviscerate what’s left of the American industrial machine than to punitively change the tax code in response to misplaced social pressure applied retrospectively. Fixing it is another matter entirely (and badly needed).
And any time there are big changes, new winners and losers emerge. You lose the dinosaurs and you end up with homo sapiens.
Don’t be surprised to see a number of corporations give up their U.S. status as the situation develops.
Regardless of the legislation they manage to pass, the best CEOs will already be well out ahead of any legislation Congress can dream up.
So will their profits, which I expect to actually grow as sophisticated tax-minimization becomes an even more important element of quarterly performance.
If a Man Can Dream
In case you’re wondering how I would fix all this…I would do the same thing many CEOs would. I’d implement “single company accounting,” so everything is rolled up worldwide. No more fancy engineering and transferring assets from one pocket to the next to avoid taxes.
I’d also change corporate reporting so that anybody could verify how much corporations are actually paying in taxes every year. As obnoxious as Apple’s situation is, people don’t understand that corporations are not required to disclose their actual tax bill.
So for all the hullabaloo, nobody really knows what corporate tax rates are or aren’t. Not you, not me and not the government. The 10-Ks everybody looks to as a proxy reflect only the current portion of taxes due. If the government wants a real handle on this they need to require disclosure of federal taxes paid for a given year. Congress could legislate this overnight if it wanted to.
And finally, I’d cut all the tax expenditures. According to the GAO, the U.S. government spends as much as it takes in. Repealing things like accelerated depreciation, perpetual income deferrals for foreign profits, research credits, and special exemptions for low-income housing could put nearly $200 billion back on the books. Every year. Immediately.
At the end of the day, if we’re going to go after individuals for higher taxes (which I don’t agree with by the way), then it’s only fair we go after corporations, too.
Just do it the right way.
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