The Tax Man's Piece Of The Apple Pie

| About: Apple Inc. (AAPL)

Something that hasn't received enough attention is Apple's (NASDAQ:AAPL), (as is a similar case with many U.S. multinationals), possibly precarious tax position. As has been widely reported, Apple paid approximately 1.9 percent in tax on its foreign earnings in FY2012.

US$ billions






Tax Rate


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Source: 10-K

The incredibly low rate of tax paid on its foreign earnings has been likely achieved mostly through clever tax structuring, involving transfer pricing and low tax jurisdictions. Transfer pricing is, in a nutshell, the way multinationals structure the pricing of their internal transactions that occur across borders.

The most important aspects of Apple's business that make it so profitable are clearly its brand name/marketing and technology. As such, these intangible assets are likely owned in low tax jurisdictions and AAPL sees to it a significant proportion of its profits earned in foreign markets are paid out in the form of royalty type transactions to these low tax jurisdictions for license of the technology and marketing intangibles. This is one of the major ways AAPL is managing to lower its tax bill in foreign markets.

As the U.S. uses a worldwide taxing system, AAPL should be paying the additional tax on these foreign profits in the U.S. that are not fully taxed at U.S. rates in the foreign jurisdictions. There has been much consternation and discussion in the media over just what AAPL has been paying in taxes. Truth is, it is quite hard to tell exactly. Nevertheless, what we can tell is Apple reported the following for 2012:

US$ billions


Expected tax


State Taxes


Indefinitely invested earnings of foreign subs


R&D Credits


Domestic production deductions




Provision for income taxes


Effective tax rate


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Source: 10-K

So what does the above tell us? It tells us that AAPL, based on the U.S. tax rate of 35% should expect a $19.5 billion tax bill on its 2012 worldwide earnings. However, based on various adjustments this came down to $14 billion in taxes being reported. The important line here relating to foreign income is the "indefinitely invested earnings of foreign subs", totaling to $5.9 billion. This is the portion of taxes that is earned abroad and left abroad that AAPL is not repatriating to the U.S. and therefore left untaxed. The IRS cannot get a hold of this owed tax at this stage, until repatriated to the U.S. This unrealized deferred tax liability is stated in AAPL's FY2012 10-K as totaling to $13.8 billion from FY2012 and all previous years.

So what does it mean for AAPL?

It means the IRS and thereby, the U.S. government is missing out on a considerable amount of additional tax revenue. With the U.S. government's finances looking like they are, there is no doubt the IRS will come after AAPL for these deferred taxes should it not be in the process of this already. Another possibility is tax reforms taking place to change the current regulations.

The fact is, most of Apple's intangible development takes place in the U.S. and therefore, the U.S. division of Apple should have a greater share of the group's profits. This indicates that there would be a decent chance the IRS could win a case if brought against AAPL for additional tax payments. Note also, if AAPL has current advance agreements in place with IRS regarding its transfer pricing, when these come to an end is the more likely date for such a profit shift to the U.S. to occur.

Additionally, as in these overseas jurisdictions, many countries are earning very low tax revenues from AAPL, which is making significant sales in these markets. Therefore, there is also a good chance we may see more foreign tax authorities attacking Apple to get its piece of the Apple pie that they feel they are missing out on. This would not increase AAPL's tax burden to the U.S., but would mean they would be taxed now by foreign jurisdictions.

If AAPL's taxes that are declared as "indefinitely invested earnings of foreign subs" (these are the taxes described above as being able to avoid U.S. taxation) were added to the income tax expense due to IRS winning a case brought against AAPL or a regulation change, it would have a considerable consequence on AAPL's EPS. If we take 2012 as an example, AAPL's EPS would reduce from $44.15 to $37.91, a 14% reduction in EPS.

US$ billions
(except EPS)


Net Income


Additional Tax


Net Income After Adjustment


Earnings Per Share


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For firms wishing to show EPS growth to shareholders, AAPL will want to avoid this happening.

So what does it mean for investors?

For investors it means one of two things:

  1. Investors believe that the IRS will never get hold of these profits, and therefore continue business as usual.
  2. Investors see a possibility that the IRS will get a hold of these delayed taxes. If this is the case, investors should possibly put a discount into the determined valuation of AAPL, as going forward this will affect its EPS and cash flows. Further, they should be on the lookout for similar cases brought by the IRS against other multinationals and the outcomes. As well as this, investors should be aware of possible regulation changes regarding U.S. tax rules.

Key Takeaways

AAPL is at risk of having its EPS lowered should the IRS or other jurisdictions go after its foreign earnings, or should there be any significant tax regulation changes. This is not meant to be alarmist, as AAPL is still seen by many as a solid growing business, but it is nevertheless still something for investors to keep in mind.

AAPL investors should take note should the IRS win cases against other multinationals in similar situations, and act accordingly. Furthermore, any significant talk of tax regulation change in the U.S. regarding foreign earnings is also something investors should take note of.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.