Apple (AAPL) made headlines today after the European Commission ruled that Ireland granted it illegal tax breaks in order to lure its business to Dublin. While the stock dipped on the news, I’m not too concerned here and expect it to rebound fairly quickly as the news cycle shifts to the back-to-school iPhone 7 launch and the holidays beyond.
Although Ireland now needs to claw back approximately $14.5 billion in uncollected tax, neither the national authorities nor AAPL are rushing the process. Working through the appeal system will take years, during which time the company will simply keep the cash in escrow drawing interest.
In addition, the ruling reveals the limit of what the European regulators say AAPL owes in tax and penalties for 2003-2013. Even a failed appeal is unlikely to increase that liability; the only direction the number can go from here is down.
And lastly, every dollar of tax AAPL pays on that cash will earn it an IRS credit when and if it finally repatriates it where it can return to U.S. shareholders. Up until today the company had treated its Irish earnings as subject to full U.S. tax because its debt to Dublin never rose above 1% of annual profit. Since foreign corporate taxes are subtracted from the effective U.S. rate a company pays, AAPL was looking at paying to the IRS up to 34.5% to move that money back home.
Assuming that the $14.5 billion brings AAPL’s total Irish tax bill close to compliance with the posted 25% corporate rate, it now needs to pay at most an additional 10% toll on every dollar it sends back. The overall impact on the balance sheet doesn’t really change—as CEO Tim Cook has pointed out—but with up to 70% of the benefit of keeping the money in place evaporating, the operational math changes.
In effect, the European Commission just accelerated the strategic choice of whether to get all or most of that money moving again. The 1% loophole has closed. AAPL and other companies exploited it to the best of their ability, even though it left the bulk of their liquid assets stranded overseas for years in order to defer the inevitable IRS bill. Paradoxically, the IRS will not get a much smaller cut of that money once Dublin takes it regulator-mandated fair share. But that’s not AAPL’s problem.
That money won’t move before the appeals process is over. By that point, of course, we’ll have a new occupant in the White House. Ironically, Donald Trump’s current plan doesn’t give AAPL anything because the company is probably looking at a 10% net IRS bill either way. There’s no additional incentive there and depending on the accounting wizardry Tim Cook can whip up, Trump may actually make repatriating the assets look less attractive. Likewise, under Hillary Clinton’s proposals, the incentives for AAPL don’t really change one way or the other—the only new policy card on the table is that it would be harder for the company to permanently migrate its headquarters offshore some day.
My point here is that despite the ruling this looks like business as usual for AAPL. The biggest near-term impacts revolve around sentiment and flexibility: both are mildly positive. On the one hand, the long overhand of the European Commission moves closer to resolution, so investors no longer need to worry about nebulous risk factors on the wind. And that knowledge brings management incrementally closer to the moment where they can justify liberating their offshore cash to engage in transformative research and development (R&D), mergers and acquisitions (M&A) or simple shareholder rewards programs.
Ultimately, I think this will be a watershed moment for AAPL. The decade when this company could rest on massive cushions of cash instead of relying on its tradition of innovation is winding down fast.
And as AAPL goes, the rest of the U.S. corporate landscape follows. Alphabet (GOOGL) and Facebook (FB) have big offices in Ireland as part of their global tax management activities. Companies like Amazon (AMZN) and McDonald’s (MCD) have similar arrangements with Luxembourg. Clarifying their tax status may create short-term liabilities like what we’re seeing with AAPL today, but it’ll also force them to get that money working.
We’re talking apparently $2 trillion in U.S. capital stranded overseas waiting to get back to work when it becomes clear that the tax situation isn’t going to get any better. When that happens, they’ll take the IRS hit and start investing. For an economy that’s been starving for corporate investment, that’s a good thing.