Apple (AAPL 0.48%) recently unveiled the new iPhone 7 to mixed reviews, and many analysts are busy debating its impact on the tech giant's earnings this year. But investors should note that another major issue hangs over the company -- the €13 billion ($14.7 billion) tax bill it faces in Ireland.
In late August, the EU ruled that Ireland gave Apple illegal tax benefits which lowered its effective corporate tax rate on its profits from 1% in 2003 to 0.0005% in 2014. In other words, Apple allegedly paid just $55 in tax for every $1.12 million in profits it booked in Ireland. It also ruled that Apple avoided higher taxes in other EU countries by reporting all its European profits in Ireland. Other reports indicate that Apple might have funneled two-thirds of all its overseas profits through the country to reduce its global tax burden.
Apple claims to have regularly paid Ireland's 12.5% corporate tax rate on those profits. CEO Tim Cook condemned the ruling as "total political crap" and claimed that the EU commission "just picked a number." The company vowed to appeal the ruling, but the Irish Department of Finance recently admitted that it would likely need to collect the payment. If that happens, it could hurt Apple and other U.S. tech companies with Irish ties.
How badly would this hurt Apple?
The EU ruling won't cripple the company, since $14.7 billion amounts to just 7% of its overseas cash hoard of $215 billion. Even if Apple paid the full amount, it would likely be written off as a one-time charge and wouldn't be considered a major weight on its long-term growth. The EU also stated that the final amount could be reduced by an agreement, or if Apple agreed to pay back the taxes to individual countries.
However, accepting the tax bill could trap Apple between a rock and a hard place. Back in the U.S., members of Congress have called Apple a "corporate tax dodger" for its refusal to repatriate its overseas profits. Apple gets tax credits for overseas taxes, yet the company isn't taxed unless it brings the cash back home. Apple argues that the U.S. corporate tax rate of 35%, one of the highest in the world, is unfair and discourages it from doing so. That's also why it funds its stock buybacks with debt instead of cash.
But there's a silver lining to this dilemma -- if Apple ends up paying the full amount, it can actually earn a 1-for-1 credit on those overseas payments against its U.S. taxes. This means that if Apple is forced to pay the bill, it could repatriate some cash back to the United States while reducing its U.S. tax bill by $14.7 billion.
How other tech giants could be affected
Microsoft, Alphabet, and Facebook also have major presences in Ireland. Like Apple, all three tech giants have been accused of funneling overseas profits through the country to reduce their taxes. This means that they could be next on the chopping block.
All three companies already face plenty of other headaches in the EU. Three years ago, the EU fined Microsoft over $700 million for failing to respect a previous antitrust settlement. The EU is also hitting Alphabet with various antitrust charges, and Facebook faces a privacy probe in Germany which might expand into an antitrust investigation.
Getting hit by large tax bills could force these companies, as well as many other multinationals, to reevaluate the future of their European operations. If the EU continues to scrutinize Ireland, these companies could move to other regions that are willing to exchange lower tax rates for jobs and economic growth.
The bottom line
The EU ruling against Apple is a thorny issue. Apple claims that it played by the rules, but the industry practice of funneling profits through Irish subsidiaries arguably looks like a shell game. This battle will likely drag on for years, but it could dramatically impact Ireland's relationship with the EU and major tech companies.