Source: Microsoft
Tax policy has been in the news lately. On a global level, a leak of 11.5 million confidential documents from Panamanian law firm (and alleged tax-evasion enabler) Mossack Fonseca has ignited a firestorm. In the United States, a move by the Obama administration essentially forced U.S. drug firm Pfizer to call off its planned merger with Irish firm Allergan by eliminating the transaction's tax benefits.
While it's technically true that the United States has one of the highest corporate tax rates in the world, many multinational firms pay far less than the stated rate through a combination of legal maneuvers. Some, most famously Apple (AAPL 1.27%), keep their profits stashed in offshore subsidiaries, e.g. Ireland, in order to delay paying U.S. taxes on these profits.
Unfortunately for U.S. shareholders, this money is essentially locked overseas, preventing the company using it to buy back shares or pay dividends. But while Apple is the most noted offender, Microsoft (MSFT 0.37%) appears to stash even more of its cash abroad.
What percentage of iCash is stashed abroad?
Apple's legendary cash pile continues to grow. In Apple's most recent earnings release, the company boasted $216 billion in cash, cash equivalents, and marketable securities. However, $200 billion, nearly 93%, is held by foreign subsidiaries and is "generally subject to U.S. income taxation on repatriation to the U.S." Currently, U.S.-domiciled cash will be unable to pay Apple's dividend commitment for 1.5 years at the current run rate of $12 billion per year.
However, I'm virtually certain Apple can continue to pay its dividend. So far, the company has been paying for its dividends and buybacks through debt issuance and has increased its long-term debt from nothing in 2012 to approximately $55 billion last quarter. In addition to that method, there's nothing stopping the company from domiciling the 93% of its cash held abroad and paying the taxes that would require, and the company produced $27 billion in operating cash last quarter alone.
Microsoft is worse
It's hard to beat 93%, but Microsoft managed to do so. In the company's last quarterly earnings release, it reported $102.6 billion in cash, cash equivalents, and short-term investments. Of that total, $96.3 billion, or 94%, is held by foreign subsidiaries and is subject to "material repatriation effects." The $9 billion in domestic cash would pay less than 1 year of the company's dividend payout at the projected run rate of $11.4 billion. Not surprisingly, the company has also increased its long-term obligations over the last four years, nearly doubling the $22 billion in 2012 to $40.7 billion last quarter.
Under the current system, it makes sense for Microsoft and Apple to turn to the debt markets to fund dividends rather than domiciling cash. Instead of paying taxes to domicile foreign cash to pay a dividend investors are taxed again on, borrowing to pay dividends actually lowers future tax outlays because cash paid for debt service is tax-deductible. Unfortunately, there's a limit to this strategy as high debt levels require higher interest rates and tend to depress stock valuations. Neither Apple nor Microsoft have problems servicing their debt, but it's hard to imagine both continuing their debt binge at the same levels they've recently done.
Fixing the tax code would be a good first step
The corporate tax issue is a multifaceted problem that has unfortunately been reduced to inane sound bites like "war on business" or claiming corporations are "destroying the moral fabric" of our country.
Many corporations have already shown their commitment to opt out of paying the United States' high tax rates if at all possible. On the other hand, United States national debt now tops $19 trillion, with many calling for further investments in infrastructure, education, and national defense. At the current 35% tax rate, Apple and Microsoft would have to pay $104 billion if their entire foreign cash holding were subject to repatriation taxes. If multinationals continue to stash cash abroad, the tax burden or forgone investments will disproportionally fall on individual taxpayers.
There's been a broad consensus forming among both Democrats and Republicans that the fairest way to address corporate taxes would be to lower the tax rate and eliminate many of the special interest deductions, but the parties have been unable to work together to enact legislation. Additionally, there's no guarantee that such a plan would find broad consensus in the business community if the tax rate remains higher than the current effective rates, once carve outs, industry-specific and company-specific tax exemptions, and deductions are eliminated.
