MorningWord 11/18/16: Home for the Tax Holidays

by Dan November 18, 2016 10:46 am • FREE ACCESS

Apple (AAPL) has been at the forefront of technological innovation for the last three decades. But this past Summer, European Union competition commissioner Margrethe Vestager claimed that their financial innovation shielded profits from taxes over the last decade to the tune of $14.5 billion, per NYT:

Vestager, the European Union’s competition commissioner, said Apple’s sweetheart deals with the Irish government allowed the company to sidestep taxes by moving profits to a “head office” with “no employees, no premises, no real activities.” The company paid just 50 euros, or $56 at current exchange rates, in taxes for every million euros in profit in 2014, she said.

AAPL’s CEO Tim Cook did not hold back in his response tot he claim, calling the ruling “maddening and disappointing” Cook said of the figure of 14.5 billion, “It’s total political crap,”  “They just picked a number from I don’t know where.”

The EU probably has a legitimate gripe, maybe not a $14.5 billion one, but make no mistake, the cash is sitting in Ireland and has benefited from a sweetheart tax deal because the company does not want to bring it back at the U.S. current corporate tax rate.

In September 2012, about a year into Cook’s tenure and month’s after the company and the board announced its first ever share repurchase program and annual dividend, the company had $121 billion in cash, no debt and a then record high market capitalization of $626 billion. Flash forward to today, AAPL’s market cap is $586 billion, they have a whopping $238 billion in cash and have raised $87 billion in debt. The company has raised the debt to fund the buyback and dividend because 90% of their cash is overseas.

In the fiscal year just ended, AAPL had its first annual sales and eps decline (8% and 10% respectively) since 2001. With rates rising, debt raises will be less attractive, and interests rates are far lower globally than they are here. AAPL desperately needs this cash back in the U.S. to fund cash return, get a better return on their cash and offer flexibility on m&a.

Which brings us to some hot button issues in the current political environment, foreign cash repatriation, free trade, immigration and a desire to bring back skilled labor jobs to the U.S. lost over the last couple decades due to globalization.


First let’s look at the foreign cash issue. In 2004, George Bush and Congress passed a repatriation tax holiday, per WSJ:

the legislation specified that the funds should be earmarked for activities like hiring workers or conducting research and prohibited using the money for executive compensation or buying back stock. Companies that brought back profits earned abroad saw them taxed at roughly 5%, instead of the top 35% corporate tax rate.

Postmortems on the results showed we got played, per WSJ:

The 15 companies that repatriated the most after the 2004 tax break on the return of overseas profits later cut a net 20,931 jobs between 2004 and 2007 and slightly decreased the pace of their spending on research and development, found the report surveying 19 companies’ activity.


Meanwhile, the top 15 repatriating companies also accelerated their spending on stock buybacks and executive compensation after the tax break. The top five executives at those 15 companies saw their compensation rise 27% from 2004 to 2005 and then another 30% between 2005 to 2006.


Or free trade. If the president elect slaps a 45% tariffs on Apple products made in China, it’s not like the company will suddenly move production back to the U.S., it will simply move to a different, cheaper place. I am not going to get into detail, but here are a few good reads on the topic (here, here and here).

But tariffs do matter. At a time where smartphone growth has ground to a halt in the developed world, with the market becoming commoditized, and future growth coming from emerging markets where selling prices will be much less, companies like AAPL would have to give up a good deal of profits to adjust for much higher production costs, per WSJ:


Jobs & Immigration

Reports like the one from Nikkei yesterday that Apple could make iPhones in the US in future, should be viewed with some skepticism. It could merely be posturing by the company to affect public opinion and help the company on its tax amnesty goals. Why the skepticism? First things first, the factories that assemble iPhones in China view their employees like robots. And in the not so distant future, those workers doing most smartphone assembly will literally be robots. It’s all window-dressing.

But don’t take my word for it. Back in 2010, at a dinner hosted to discuss such issues with with other tech luminaries and President Obama, Steve Jobs told Obama “Those jobs aren’t coming back,” He then tried to explain why the majority of Apple’s production is overseas (From Walter Isaacson’s biography on Jobs (per WSJ)) :

Jobs told Mr. Obama that Apple employs 700,000 factory workers in China because it can’t find the 30,000 engineers in the U.S. that it needs on site at its plants. “If you could educate these engineers”… “we could move more manufacturing jobs here.”

One of the benefits of free trade, including in the movement of labor, is that skills would go where they are most valued. Jobs made the point that Silicon Valley is mystified by a policy that instead educates foreigner engineers at top U.S. universities, then sends them home immediately.

Some of that may be true, but let’s not pretend that anything goes into Apple’s thinking other than the bottom line. Apple is unlikely to build factories that employ hundreds of thousands of workers in the U.S., because it makes no sense. It makes no sense because the supply chain of millions of workers and thousands of factories are in Asia for cost reasons, and most will be replaced by robots anyway.


My guess is that Trump’s tough talk regarding Apple is just that. But it could be used as leverage versus the tax amnesty issue. And Apple is out there trying to turn public opinion on that already. Their goal is to bring back all that money from overseas and pay next to nothing in taxes on it.

Chances are that AAPL will eventually win because something has to give. And the president-elect is on record complaining about the U.S. corporate tax code, rate and will need companies like AAPL to do their part to deliver on the promise of his infrastructure rebuild. So AAPL will negotiate its EU tax liability down, and that will look like a rounding error compared to the savings from a one time tax amnesty. And much like the last major tax amnesty in 2004 unfortunately, there will be a lot of promises made, and few kept. Because there’s just not a ton of leverage when it’s the U.S. taxpayer versus multinational behemoths.