Dodging The International Tax Liability Bullet

by: George Kesarios

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Reuters reported a while ago:

Over the past three years, Starbucks has reported no profit, and paid no income tax, on sales of 1.2 billion pounds in the UK. McDonald's, by comparison, had a tax bill of over 80 million pounds on 3.6 billion pounds of UK sales. Kentucky Fried Chicken, part of Yum Brands Inc., the no. 3 global restaurant or cafe chain by market capitalization, incurred taxes of 36 million pounds on 1.1 billion pounds in UK sales, according to the accounts of their UK units.

Yet transcripts of investor and analyst calls over 12 years show Starbucks officials regularly talked about the UK business as "profitable," said they were very pleased with it, or even cited it as an example to follow for operations back home in the United States.

In fact Reuters says that Starbucks (NASDAQ:SBUX) paid about 13% on average on its overseas income, one of the lowest in the consumer goods sector. There is nothing Illegal in all of this, but many countries around the world are trying to find ways to plug the loopholes that permit many companies to be able to do whatever Starbucks is doing.

Apple (NASDAQ:AAPL) is another company that has been in the tax spotlight for some time now. As explains, Apple paid an income tax rate of only 1.9 percent on its earnings outside the U.S. in its 2012 fiscal year. More specifically, it paid $713 million in tax on foreign earnings of $36.8 billion in the fiscal year ended Sept. 29, 2012.

Apple does this by setting up subsidiaries and subsidiaries of subsidiaries in countries with low corporate taxes, and it shuttles funds between them in order to minimize its liabilities, using a tax technique call the Double Irish with a Dutch Sandwich.

There is nothing illegal about all this. Like other big companies, Apple leaves its cash overseas, because if it brought it to the U.S., it would have to pay U.S. corporate taxes on that money. Apple however sets aside a portion of its foreign profits making them subject to U.S. taxes in the future. Apple then simply records that portion of the tax as a liability, and then subtracts it from its profits even though it didn't pay tax on that amount.

So while everything is on order as far as the IRS is concerned, if Apple were to bring this money to the U.S. it would actually have to pay that money in taxes. According to the most recent Apple filling, total non-current deferred tax liabilities stand at $15.7 billion.

Although Amazon (NASDAQ:AMZN) has not officially done anything wrong, some people in the U.K. feel they are not treated fair tax-wise. Several days ago France24 reported:

British booksellers Frances and Keith Smith are reaching out to the UK government with this message: "We pay our taxes and so should Amazon." They launched an online petition condemning the American online retailing giant's tax avoidance. They have now reached the 100,000 signatures required to present the petition to British Prime Minister David Cameron.

UK booksellers have been on Amazon's case for several months now. They say the well-known ecommerce website has an unfair advantage because as its headquarters are based in Luxembourg it does not pay any UK tax on any UK earnings. Although this is not illegal practice, it has fueled anger in austerity hit Britain, where residents have decided to boycott the brand in favor of small businesses, which do pay their fair share of taxes.

Whether anything negative for Amazon arises out of all this is not clear, but what is clear is that more and more governments around the world are pressing international companies to leave more local tax revenue on the table. And this pressure is mounting from all sides.

Also let's not forget Google (NASDAQ:GOOG). A popular story a while ago in Businessweek explains how Google uses a complicated legal structure that has saved it billions since 2007 and boosted overall earnings. In fact Google has managed to lower its overseas tax rate more than its peers in the technology sector. Bloomberg says Google currently has about $10 billion stashed in Bermuda.

And just yesterday Reuters reported a bombshell about Nokia (NYSE:NOK):

Indian tax officials demanded Nokia pay 20.8 billion rupees ($383 million) in unpaid taxes, stepping up claims against foreign companies, although the Delhi High Court issued a stay on the demand.

The order from the Indian tax officials covered five fiscal years starting from 2006/07, according to a March 22 notice on an Indian court's website.

The tax order, if enforced, would add to pressure on Nokia's finances, which are already being strained by falling sales. The company axed its annual dividend payment for the first time in its history to shore up its cash position.

But it's not only Nokia the Indian Government is going after. According to Reuters, last month Indian tax authorities accused Cadbury Plc of misleading them about production from a new factory to avoid about $46 million in taxes. The Indian government is also after Royal Dutch Shell, Vodafone and LG Electronics.

Bottom line

I am not exactly sure where all this is leading. But I see evidence that many governments around the world are trying to close many price transfer loopholes or are looking very close at multinational company accounts in order to get more taxes.

And if governments around the world figure a way on how to cancel out many of these techniques that companies are using, it will mean less after tax earnings for many companies. For the time being however I don't see much evidence of countries being successful, but it never hurts to keep this scenario in mind.

Because if what is happening in India escalates, then investors have to be warned to dodge the bullet that is coming their way.

As you know, you really can't see a bullet coming until it hits you. However if you know it's coming your way, at least you can prepare for it, even though you have no idea when the gun will be fired or from what direction.

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.

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