I have to be honest, I didn't expect the issue to become a mainstream issue this fast. But yesterday's Senate sub-committee hearing on tax avoidance tactics, more or less brings to the forefront this very important issue, which can have negative investment implications in the future.
The issue is the tactics that many U.S. and foreign multinational companies use to pay less taxes. As a reminder, I have written two articles on this subject in the past. Please consider, "Dodging The International Tax Liability Bullet" and "Google And Several Other Tech Heavyweights Might Have Tax Problems."
While yesterday's U.S. Senate hearing was all about Apple (NASDAQ:AAPL), I think the Senate missed the elephant in the room, and that is Google (NASDAQ:GOOG). While Apple and many other companies are using techniques to lower their tax bill totally legal, Google has turned this into an art.
According to a story in Bloomberg a while ago, Google's total tax rate was just 2.4%, despite the fact that Google operates in jurisdictions where the tax rate on average is 20%, with a 35% tax rate in the U.S. and 28% in the U.K.
Google's chairman, Eric Schmidt has said:
We pay lots of taxes; we pay them in the legally prescribed ways. I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate.
And if Bloomberg is correct, looking at Google's 12 months income statement, Google claims to pay a whole lot more taxes than they actually do.
So the question is, since Google and many other companies are technically not doing something against the law, does it mean they actually don't pay taxes they claim? Also, does it mean they are defrauding investors?
As for the first question, yes they are not paying the taxes they claim on their balance sheet, but at the same time they are not doing anything illegal, since the countries where they operate in, permit them to pay such a low rate as Google's Eric Schmidt said.
As far as defrauding investors, the answer here is also negative.
Technically, companies who use techniques to lower their tax expense set up a deferred tax liability, offsetting the tax that would have to be paid in the U.S. if the money would be repatriated to the U.S. So theoretically speaking, the balance sheets of Apple, Google, Cisco (NASDAQ:CSCO), Oracle (NYSE:ORCL) and Microsoft (NASDAQ:MSFT) are fine, and in no way are investors being not told the truth as far as the assets and the liabilities are concerned.
However, if this money were to be brought to the U.S. and all deferred taxes payed, then the amount of cash on the balance sheet would indeed go down, but the differed tax liability would also disappear. So nothing would really change on the balance sheet as far as assets and liabilities, except that the cash position would decrease.
As per the latest 12 month data from yahoo, Cisco's total tax bill was 20.7% of earnings, Microsoft paid 23.7%, Oracle 23% and Apple 25%. However, since Cisco keeps 80% of the $46 in cash the company has overseas, it is unlikely their total tax bill was 20.7% of earnings.
The bottom line is that the issue of multinational corporate tax avoidance and off-shore loopholes is gaining momentum. Currently this is a very big issue in Europe. On a daily basis politicians and commentators battle it out on television, on how to deal with the issue and how to bring more of this money to national governments.
With the OECD in on the game and the fact that yesterday's Senate sub-committee was to some extent a show of force, I think investors have to be prepared for some kind of a global understanding between countries that will eliminate many of these tax loopholes. I am not exactly sure how this will unfold, but from an investment perspective, paying more money in taxes is never bullish.