On Monday evening, Senators Carl Levin and John McCain addressed the media about Apple (AAPL), alleging tax avoidance by means of offshore entities. This issue could affect Apple in a meaningful manner. Before it's all over, Apple could theoretically be forced to pay reparation, but it is far more likely that the company will have to pay more taxes in the future, which should result in some sort of cut to earnings estimates and the stock's valuation, bringing down the already barraged stock even further. Furthermore, because of its high profile, this issue will be amplified to the American audience. If Apple is then viewed as un-American by some of its patriotic clientele here at home, it could see market share bleed as well, which favors its rivals Samsung (OTC:SSNLF), Nokia (NOK) and BlackBerry (BBRY), but especially its American rivals, Google (GOOG), Amazon.com (AMZN) and Microsoft (MSFT). By the way, many of these companies do not have clean hands either, but Apple is the one being dragged through the mud at the moment.
Therefore, on Tuesday, Apple's CEO Tim Cook will have one of those defining moments in a man's life; the sort that a man comes out of branded by society as either a winner or a loser. He will appear before the Senate Permanent Subcommittee on Investigations along with other Apple executives, two professors, and Mark Mazur, Treasury Assistant Secretary for Tax Policy, and Samuel Maruca, IRS Director of Transfer Pricing Operations. At issue is Apple's alleged avoidance of taxes on what seems to be more than a hundred billion dollars worth of revenue from 2009 through 2012 (the Senate statement refers to "revenue" from one subsidiary and "income" from another, so it is unclear). What is really at stake is Apple's massive brand value and reputation.
Here's how Apple has managed to avoid paying taxes, and mind you, everything seems perfectly kosher and quite cunning. Still, these are monies that would be helpful to our government today. The company has two subsidiaries that are incorporated in Ireland, Apple Operations International (AOI) and Apple Sales International (ASI). Because the firms are incorporated in Ireland, American law holds no right over their taxable income. However, as Senator Levin stated on Monday evening:
"Apple wasn't satisfied with shifting its profits to a low-tax offshore tax haven. Apple sought the Holy Grail of tax avoidance. It has created offshore entities holding tens of billions of dollars, while claiming to be tax resident nowhere. We intend to highlight that gimmick and other Apple offshore tax avoidance tactics so that American working families who pay their share of taxes understand how offshore tax loopholes raise their tax burden, add to the federal deficit and ought to be closed."
Because Irish tax law asserts jurisdiction only over entities that are managed and controlled in Ireland, these subsidiaries also do not pay significant taxes to Ireland, and so pay relatively no tax to any country. It would seem that they have legally exploited a gap between the two nations' tax laws in order to do so. The senators also claim that Apple's third subsidiary, Apple Operations Europe (AOE), also has no tax residency.
Ouch! It looks to me like the Senators know where to strike at Apple for maximum pain. Branding the company as a sort of tax renegade will do it no favors with its core customer base here in the United States. I believe the U.S. representatives are painting the picture this way for a reason. As I see it currently, the best they could do otherwise is force Apple to pay more taxes to Ireland. Only by painting this image could they possibly get Apple to volunteer to pay something more to the United States. However, they will also push Apple to gain the favor of the nation in order to close the current tax loopholes and better ensure American companies pay more taxes to the United States in the future. In a previous hearing, the subcommittee heard from Microsoft and Hewlett-Packard (HPQ) on similar tax avoidance questions, so Apple is not the only alleged culprit. For more details about Tuesday's hearing and what is at issue, I refer you to the Senate release on the subject.
As far as the stock is concerned, in my view, this issue adds more risk near-term to an already stagnant story, and so I suggest investors avoid the risk and sell Apple, or hedge against short-term downside by employing option strategies. In that regard, I invite option strategy experts to add their insights hereunder. If Apple's competitors seize upon this opportunity to rebrand Apple products in the hearts and minds of Americans, serious damage could be done, in my view. But let him with no sin cast the first stone…