Is it possible to be too good at minimizing your taxes?
That's the question many H.J Heinz (HNZ +0.00%) investors must be asking after the company announced Q3 earnings this week. On the same day that fellow food producer Campbell Soup (CPB +2.48%) reported its own effective tax rate for the quarter of 31%, Heinz said it ended up forking over less than a third of that figure to the taxman. Heinz's tax rate for Q3 was an enviable 9.6%.
That's a low rate even for Heinz, which routinely makes use of foreign tax benefits to minimize its liabilities. The company paid almost twice that rate in last year's Q3 and projects its full-year liability to come in at a still-low 20 %. While it's a worthy goal to keep tax expenses as low as possible, a rate that's so far from competitors can't last forever. And a great rate like that comes loaded with its own risks.
Unprofitable profits
Just ask Starbucks (SBUX 0.13%).
Members of the U.K. government called the company to task earlier this month after a Reuters report found that it paid no income tax in Britain for the past three years despite hefty sales in the country. Starbucks was grilled, along with executives from Google (GOOG +1.28%) and Amazon.com (AMZN 0.21%), for not paying more taxes in Britain.
For their part, Amazon and Google executives had to answer pointed questions on their corporate structures, and on how profits are channeled through different countries. All three multinationals say they follow applicable laws and did nothing wrong.
Still, the costs of this extra tax attention can be counted in more than just negative publicity. The French government, for example, recently served Amazon a tax claim for $250 million tied to back taxes, interest, and penalties.
Not just ketchup
So Heinz isn't alone in benefiting from a flexible international presence. For a profitable company that sets the bar in terms of tax expenses, Heinz's strategies can be described as aggressive. But there's no reason to think they're anything but above-board. Heinz booked a 22% tax rate last year, and 27% the year before. The company says the savings it benefited from this quarter are a result of "foreign tax planning initiatives" that should help keep its tax liability at around 20% for this fiscal year and next.
But a rate that low does raise questions. In fact, the first question CEO William Johnson was asked in the company's earnings conference call was on that very topic.
An analyst from JPMorgan Chase opened the call's Q&A session with what he called "the obvious question ... can you just help us understand how sustainable a [tax] rate of about 20% is going forward?" Johnson said he expects the rate to be achievable at least through the next fiscal year:
I'm not going to say anything beyond next fiscal year because I have no idea what's going to happen to tax regimes around the world. But certainly, for the next six quarters, the two this year and next year -- the four next year -- we should be in pretty good shape.
Even without the tax benefits, Heinz is in pretty good shape. The company managed to grow sales and profits in Q3 and kept up its impressive streak of organic sales growth. That no-hitter of consecutive quarterly sales growth now stands at 30 quarters.
On top of that good news, Heinz's major brands grew sales by nearly 5% in the quarter, and emerging markets look set to keep on powering growth in the years ahead. As for the near term, the company stood by its forecast for sales growth of about 4% and for strong free cash flow of more than $1 billion next year.
Foolish bottom line
But the low tax rate that allowed the company to plow investment into marketing while still boosting earnings by 11% looks like a much riskier long-term bet. As governments around the world shore up their tax bases, investors can expect the issue of local taxation to come up more and more. And Heinz shareholders shouldn't bank on anything like a 9.6% tax rate to be a sustainable competitive advantage. It's a solid benefit for now. But, as with most good things, it's possible to have too much of it.
