Apple Inc. (AAPL) Sitting On $187 Billion To Avoid U.S. Tax
The source for this piece is Michael Faulkender, associate professor of finance at the University of Maryland’s Smith School of Business and co-author of the working paper Taxes and Leverage at Multinational Companies.
He has commented on financial topics for the likes of PBS Newshour and the Globe and Mail and in a Baltimore Sun op-ed, ‘To keep corporations here, fix the tax code.’ He can be reached at 301-405-1064 or [email protected]
Apple sitting on $187 billion to avoid U.S. tax; economic distortion not clear: UMD finance prof
SMITH BRAIN TRUST — Feb. 5, 2016 – U.S corporations are sitting on some $3 trillion in cash, which some commentators view as an economic mystery. Why aren’t they investing that money productively — in factories or in R&D? And would the economy see a positive bump if they did?
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The amount of cash companies are amassing is unprecedented. Apple’s 2015 annual report showed that it was holding $187 billion in cash, an amount equivalent to fully 88 percent of the company’s sales for a year. Alphabet Inc.’s (aka Google’s) $73 billion in cash holdings, in 2015, represented 97.3 percent of a year’s revenue. These companies are holding so much cash that when you invest in them you are effectively investing partly in tech companies, partly in mutual funds.
Every company needs ready cash to handle unpredictable expenditures, but the debate in economics today is over whether companies are amassing all that cash for “precautionary” reasons, or because of peculiarities in the international tax system. Michael Faulkender, an associate professor of finance at the University of Maryland’s Robert H. Smith School of Business, leans strongly toward the tax-avoidance side of the argument.
First, the logic behind precautionary cash. Companies, if they don’t have cash on hand, are dependent on capital and debt markets for funding their ventures. Pharmaceutical and tech companies, in particular, can find it difficult to make the case to Wall Street that their intellectual property will lead to a productive return. A classic case study occurred in the late 1970s when Intel was trying to raise equity to finance develop its 8088 chip, which it was rightly convinced would help lead to the personal computer revolution, and ran into skepticism. IBM eventually took an equity stake, but extracted a heavy price. “The lesson Silicon Valley took from that experience,” Faulkender says, “is that you never again want to be in a situation where you are creating innovative technologies that are going to fundamentally alter the structure of the markets, and be reliant on external capital markets to fund it.”
Other types of businesses, such as utilities and railroads, rarely face quite the same challenge, because their investments tend to be straightforward and tangible, and lenders can put liens on their assets if things don’t work out as planned. As a result, CSX and Pepco’s cash holdings are minuscule in comparison with Google’s and Apple’s.
But is Apple worried about the Intel-in-1979 scenario? “Does anybody believe if Apple needed money it couldn’t issue debt?” Faulkender asks. To the contrary, he points out, Apple is in the midst of a $100 billion bond offering that it is using to fund stock repurchases and to issue dividends. “Is Apple holding on to cash for precautionary reasons?” he asks. “No.”
Rather, Faulkender argues, a substantial fraction of the cash U.S. companies are sitting on is being used to get around the unusually high corporate taxes of the United States: 35 percent. When companies earn profits abroad, they pay taxes at the local rate — 12.5 percent in Ireland, to choose a famously low example. At that point, the companies can “repatriate” the money right away, and the U.S. Treasury will collect the U.S. tax minus a credit for the amount paid overseas.
Or they can defer taxation by keeping the money abroad. And they can earn interest on those profits during the deferral. “The longer you defer repatriating the profits, the greater the benefit,” Faulkender says.
What’s more, if the U.S. should declare a tax “holiday,” as it did in 2004, or if it lowers the corporate tax — something both political parties say they want to do — then the benefits of keeping cash abroad indefinitely grow even larger. The international corporate-tax-rate discrepancy has existed for many years, but companies have been honing their tax-management strategies, which may help to explain the increased cash holdings
Some commentators believe the piles of corporate cash are holding back U.S. productivity and growth. But Faulkender believes that’s unlikely. First of all, much of the foreign cash is already held in U.S. securities, he points out. “Let’s say you ‘fix’ the system,” he says — that is, lower U.S. tax rates. “What would happen is that Apple would liquidate its holding of U.S. securities and then issue a big dividend in the U.S. capital market.”
“If Apple simultaneously sells U.S. securities, but then puts money back in so that investors can buy U.S. securities, that has zero net effect on the amount of capital in the U.S. financial sector. Therefore, there is no stimulative effect.”
Despite all of the financial machinations, “It’s not clear that there are real distortions resulting from this state of affairs,” Faulkender says. “The problem is that politicians see the figure ‘$3 trillion’ and they salivate.”