How Will Changes in the Tax Code Affect the Biggest Tech Companies?

While the details of the likely-to-pass tax plan have not fully been decided -- at least as of when this was taped -- the revised tax rates are going to have a big impact on the technology industry. The changes in the tax code, while not final, are expected to do two things. First, companies will pay a lower rate than the current 35% charged on corporate profits. Second, companies would be able to bring money into the country or repatriate it at a lower tax rate, somewhere between 10% and 14%.

On this episode of Industry Focus: Tech, Dylan Lewis is joined by Motley Fool contributor, Daniel Kline, to talk about what these potential tax code changes mean to the technology industry. Specifically, the two discuss the huge $250 billion-plus war chest Apple (AAPL -0.35%) has along with the roughly $100 billion Microsoft (MSFT 1.82%) has overseas. They examine what the company's might do with the cash and whom any potential moves might be good for.

A full transcript follows the video.

This video was recorded on Dec. 15, 2017.

Dylan Lewis: One of the big things that is currently in the news and has an outsize impact on the tech space itself is tax reform. We're getting some hints on what that might look like. I believe that lawmakers will unveil a final bill today, actually, and hopefully vote on legislation sometime next week. We'll see what that picture looks like, and it might be a little bit clearer next week. We're going to be doing some more predictive crystal ball-type conversation today. I guess, to start, Dan, why don't we talk about why this is so important?

Dan Kline: There's two major things that are going to happen. Assuming this bill passes, and there's some doubt about that at the moment, the corporate tax rate is going to get cut from about 35% to somewhere between 20% and 23%. There's still some negotiation going on there. The other issue that's going to happen is, it's going to cost companies much less to repatriate money. Repatriate means take money that they made overseas, which they don't have to pay taxes on until they bring it back to the U.S., and bring it back to the U.S. They're going to drop that tax rate, again, somewhere in the 20% range from 30% to 20%, though, again, the numbers are not final in any way.

Lewis: Maybe a little bit of a refresher for folks who aren't super-familiar with the corporate tax code: Companies can currently defer paying that income tax, like you mentioned, on money earned abroad until it's brought back to the United States. And because current conditions say that they would be paying a higher tax rate than the current tax rate on those profits, a lot of companies have basically said, "Nope, we're not going to do it. We're just going to keep it offshore, keep it overseas, and wait." And they've been waiting with the hope that they would either get tax reform, in terms of a sweeping tax bill, or maybe a tax holiday. So, presently, it seems like there's roughly $2.5 [trillion]-$3.1 trillion in profits generated by U.S. companies sitting overseas in this limbo.

Kline: The tax code creates sort of a weird disincentive. You have all this money, but it's actually cheaper to borrow money in the United States than it is to bring money that's already yours back. So there has to be some level of reconciling this, because if you have a bunch of money sitting in foreign banks, it makes sense to open foreign factories, to invest in other countries, to spend some of this money. So, however the tax changes go down, ideally there will be either this tax cut or a one-time repatriation deal. Something has to happen, which in theory should be good for investors and probably employees of a lot of tech companies.

Lewis: And the rate that we've seen, or at least I've seen floated in a lot of these reports, for repatriation would be somewhere in the neighborhood of 10%-14% for money held in cash. I've seen that the rate might be a little bit lower if it's held in certain securities. Again, we're speculating a little bit here because we don't know the firm details of the bill at this point. But, the reason this is so relevant to the tech space is because when you look at the heavy hitters that really contribute to that $2.5 [trillion]-$3 trillion in profit overseas, they're all tech firms.

Kline: The big ones are really Apple and Microsoft. Apple has over $250 billion sitting in overseas banks, piggy banks, under some mattresses in a couple of countries. You look at it, Apple has $100 million in debt in the U.S. that they borrowed, sort of what I was talking about before, and $250 million. So in theory, if they brought that back, paid $25 [million]-$50 million in taxes, they could wipe out all of their debt and have $100 billion to play with. To give you a perspective, the recent Disney (DIS -0.04%)-Fox (FOXA) (FOX) deal was a $52 [billion]-$54 billion deal. Apple could buy all of that and still have a lot of money left.

Lewis: And it's funny, because for a long time, we've seen people speculate about, these are the things that Apple could do with its massive cash hoard. It's been these crazy, outsize contextual things. Talking about the number of Ferraris they could buy, or what have you. The point is, there's a lot of money that's been sitting overseas for a lot of these companies. You mentioned Microsoft. They're second right now with just over $100 billion held abroad. Other major tech players, Oracle, Cisco, Alphabet, I think they have roughly $50 billion overseas. But, that money has largely been just sitting there; it hasn't really been put to use. So what you hope to see with a lot of this and what investors will be watching is, if they're able to bring back this money and they're not going to take a huge haircut on it with the taxes they will be paying, what will they do with it? Some folks believe it'll lead to companies investing in growth in the United States, building out jobs, maybe building out factories and things like that. Others think the companies will be using money to buy back shares, possibly raise dividends. You mentioned the possibility of merger-and-acquisition activity. There's so many different things that this amount of capital can enable.

Kline: I think realistically, the biggest impact is going to be increasing dividends and buying back shares. The reality is, if Apple and Microsoft had companies they wanted to purchase, they could make those deals happen. Especially because many of the companies they'd want to purchase, some of that deal could be financed with money that was outside the United States. The other advantage to having all this money is, it makes it very easy to borrow at low rates. Even if you factor in the current tax code, you still have the cash, that makes you the best kind of debt any company could have -- someone who can pay it back but just wants to keep the cash, or for this reason has to keep the cash in another location.

Lewis: Yeah. No one has any problems buying up bonds from the likes of Apple because they know there's all this money sitting overseas. So even though they have that $100 billion in term debt, they've had coupons between 3.5%-4.5% to maintain their capital return program, pay those dividends and buy back shares, and they haven't had any trouble raising that money because the assumption has been they're going to be able to bring that money back eventually.

Kline: I think what you're not going to see is massive investment in U.S. factories. All of the economics that make that not work -- the cost of workers, all of those negatives -- if you could make those numbers make sense, they would be doing it now. You might see an increase in research and development. This makes it easier for Apple to spend a few billion dollars on driverless cars or whatever their next fancy might be, spaceships, who knows, but that's not going to result in tens of thousands of jobs.

Lewis: I mentioned before, we're looking at preliminary reports of the bill. We'll find out more in the coming days. I think one thing that's particularly worth watching is what the bill dictates about future foreign profits. I've seen some reports that the repatriation tax would apply to past profits only. I've seen other reports that the 10% tax or roughly 12% tax, whatever it winds up being, would apply to foreign profits moving forward under certain circumstances. That's something that will largely determine how companies treat their foreign profits going forward. If it's something that it doesn't really matter how they bring things back, what they're taxed at, that's going to dramatically change what balance sheets look like.

Kline: It's a moving target, and not to get too into the politics, but even the bill we see this afternoon, there's still only the thinnest of Republican majority in the Senate. So, exactly what we see on Friday and what gets voted on next week or the week after or whenever it gets voted on, that could all look very different.

Lewis: And the reason I specifically mentioned that future-looking element of foreign profits is, that's kind of the situation that got us here. The reason that all these companies were stockpiling cash abroad was, they hoped that at a certain point, they could force policymakers' hands and say, "We want to have some sort of cash repatriation, or we want some sort of tax reform that allows us to bring it back at a rate that makes sense for us." For the longest time, Tim Cook has said, it's irresponsible for me to my shareholders to bring it back at the rate it would currently be taxed at. So if there's wiggle room in whatever they set up for the tax code, it would not shock me to see tech companies go about building up the same war chests, again, overseas. So it's all about what policymakers decide to create.

Kline: I think the best thing for shareholders is stability. If you really look at this, and they come out and it's a one-time deal, that'll have a nice benefit over the next couple of years in spending, and give back some dividends. But the reality is, if they do set a lower long-term rate, even if it's not as low as 10%-14%, as long as it seems stable and it doesn't look like you're going to have Congress, the Senate, and the presidency flip to the Democrats. So, whatever gets voted on is almost certainly going to be in place for a while. That makes it a lot easier for a company to plan long-term investment.

Lewis: That's what you want to be able to see, is this understanding of where things are going.

Kline: Yeah. When your tax rate could change by 20%, that's not a small number.