Tax Analysts Blog

Apple's Financial Disclosure: The Lockout Effect at Work

Posted on Nov 6, 2014

Apple Inc. has been in the news lately, and for reasons unrelated to CEO Tim Cook's personal revelations. The disclosures we're focused on are of an economic nature.

Last week Apple submitted its latest filing to the SEC, SEC Form 10-K, detailing the company’s financial profile for the fiscal year ending September 27, 2014. Much of what's contained in the 118-page document is not new. Apple sells a lot of computers, smartphones, and music downloads, and in the process it makes a lot of money. If you're an Apple shareholder, that makes for good reading.

What's not so enjoyable -- from a purely neutral tax policy perspective -- is the size of Apple's offshore stockpile of undistributed earnings. That stash grew by another $16 billion over the last year, and now totals $137 billion. That's some serious coin. Bear in mind these are billions of dollars, not millions.

I'm confident the geniuses in Cupertino could put those funds to good use, preferably in a manner that benefits both shareholder value and the U.S. economy. But don't hold your breath waiting for that to happen. The way our tax code functions, Apple would face a massive tax hit if it were to get its hands on that cash.

Here's why. Other countries can tax Apple's foreign profits in the same year the income is earned. That's called corporate taxation on an accrual basis. Most of the jurisdictions where Apple has placed subsidiaries (think Ireland) impose little corporate tax, so the firm's foreign tax exposure is very low.

Back in America, the IRS generally can’t tax Apple's foreign profits until its non-U.S. subsidiaries distribute the funds to the U.S. parent company via an inbound dividend. That dividend might not happen for many years, if at all. That's called corporate taxation on a deferral basis.

Deferral is often categorized as a loophole, but in truth it's more of a purposeful design feature of the tax code. Deferral is no accident.

So if Apple were to bring those profits back home, how large a tax hit are we talking about? We need not guess. Apple’s SEC filing estimates the incremental U.S. tax rate on a hypothetical repatriation would be about 33 percent. Let's do the math: 33 percent of $137 billion is about $45 billion. Since Apple doesn't want to unnecessarily fork over an extra $45 billion to the IRS, it chooses to leave the money right where it is -- offshore. Thus, the profits are said to be locked out of the U.S. economy.

How badly does Apple want to avoid the tax consequences of repatriating foreign profits? Well, would you be willing to pay $45 billion in taxes that you didn't have to? Of course not. There is no moral or patriotic duty to unnecessarily pay more tax than is legally due -- even if you're a large profitable corporation.

Here's a case in point. When Apple recently needed cash for a share buy-back, it chose to borrow the money and pay interest charges rather than tap into its own stockpile of tax-deferred foreign profits. Frankly, that decision was a no-brainer. If you were Apple's tax director, you surely would have done the same thing -- otherwise you should be fired for incompetence. Some pundits see fit to drag Apple over the coals for this maneuver, as if it were financial treason. That's nonsense. Perhaps they miss the point that interest rates are historically low and that the finance costs of borrowing were significantly less than the tax costs triggered by repatriation. Do these critics genuinely expect companies to pay more tax than they're legally obligated to do? Would you forgo a perfectly legitimate tax position, say the deductibility of your mortgage interest, for the sake of perceived morality or social justice?

At this point I should offer you a succinct policy justification for the lockout effect. But I can't -- because one doesn't exist. As I see it, the lockout effect benefits nobody. Not Apple. Not its shareholders or employees. Not consumers or the public at large. And definitely not the U.S. government. It's a symptom of an ill-conceived corporate tax regime.

There are several methods by which Congress could eliminate the lockout effect, but sadly none seem able to gain political traction in Washington. So in another 12 months, when Apple releases its SEC filing for fiscal 2015 odds are it will show the company’s hoard of offshore cash has grown even larger.

Of course, Apple is not alone. Other multinationals are in the same boat. Looking at the corporate sector in aggregate, the total amount of locked-out profits is staggering. I've seen estimates ranging between $1 trillion and $4 trillion. This is a problem that will not fix itself.

Read Comments (6)

bob kammanNov 6, 2014

Apple's balance sheet shows about $14 billion in cash and cash equivalents,
down from $19 billion two quarters ago. But its cash, short-term investments
and long-term investments, excluding inventory, are about $196 billion. If
$137 billion of that is offshore, what would they do with it that they can't
already do with the $59 billion already here?

Ask Apple if they would agree to move jobs from China to American factories
built with tax-free repatriated profits. I think what they want is offshore
jobs, onshore profits.

vivian darkbloomNov 6, 2014


It seems to me that you are confusing "cash, cash equivalents and marketable
securities" of $137 billion for "foreign earnings" (if so, not at all the same
thing). And, if you are comparing the "cash, cash equivalents and marketable
securities of $137 billion from 2014 billion from $111 billion in 2013, the
difference is $26 billion, not $16 billion.

It is not clear to me where you get your numbers.

edmund dantesNov 6, 2014

Having major U.S. corporations leave giant amounts of capital offshore is
actually the new foreign aid, a policy that never needs to get an approval from
Congress. We don't ship food to China, we ship jobs instead.

Apple has moved the assembly of its top-of-the-line Mac Pro to American
factories. I'm sure they sacrificed some margin to take this "patriotic" step,
but it was on their lowest volume product.

The U.S. needs to modernize its corporate tax code pronto, and get in step with
the rest of the world.

robert goulderNov 6, 2014

BK & VD: Thank you for the input - always appreciated! Some clarification is

Yes, I'm using Cash-CashEquiv-MarktSec. The figure ($137B) is taken from the
section on "Liquidity & Capital Resources" page 35, 3rd paragraph from bottom,
and the section "Note 5 / Income Taxes" on page 64, 2nd paragraph from the top.

I didn't mention it in my post, for the sake of brevity, but Apple's pre-tax
foreign earnings for FY 2014 were $33.6B (also p.64). Next sentence goes on to
say that substantially all the undistributed foreign profits are intended to be
indefinitely invested outside the U.S., and attributable to the Irish subs.

There's a reference on that same page to cumulative foreign profits of $69.7B
for which no U.S. tax has been provided in Apple's financials. My
interpretation is that pool of foreign earnings remaining offshore (per Lockout
Effect) is not identical to the pool of foreign earnings for which no U.S. tax
has been been provided. That former exceeds the latter. In other words, Apple
has a track record of booking the tax liability without actually repatriating
the profits. That is consistent with Marty Sullivan's prior reporting on
Apple's foreign tax profile.

I welcome input from all parties on differing interpretations here. Also, at a
minimum, yes -- the difference between FY 2013 and FY 2014 should have $26B not
$16B. That is my error.

Hope that helps. Let me know your thinking on the matter. Best, RG

robert goulderNov 6, 2014

E.D.: I can remember when foreign aid went to places like Bangladesh or
Ethiopia. Now (to follow on your thought) our capital goes to Ireland and
Luxembourg. I guess times have changed. Thank you for commenting.

vivian darkbloomNov 6, 2014


That is somewhat better.

Without looking at Apple's actual tax filings, you probably cannot know exactly
how much their un-repatriated "earnings and profits" are, but one might come
very close with a lot of work (so, yes, there is likely some need to "guess" or
at least approximate).

Since you are looking at Apple's financial statements and not tax returns,
there are two numbers to concentrate on.

First, as you (partly) noted, they have $69.7 billion of foreign earnings
mostly attributable to their Irish subs for which no deferred tax liability
provision has been made. This is because they don't have to if they represent
these earnings are "indefinitely" reinvested abroad. This is somewhat
self-serving, but obviously any US multinational will have historical earnings
they *can't* feasibly bring back because they are already re-invested in plant,
equipment, new foreign acquisitions, etc). While Apple states the *statutory*
Irish rate is 12.5 percent; the effective rate on those earnings must be much,
much lower. Apple, like everyone else, tends to re-invest low-taxed foreign
earnings and take a deferred tax liability for higher-taxed foreign earnings.
*If* they were to have taken a deferred tax liability in the actual financial
statement for those Irish earnings, the notes indicate it would have been $23.3
billion (reflecting, on that pool, obviously, a much lower effective tax rate
than the 12.5 statutory Irish rate)..

Apple has actually taken a deferred foreign tax liability of $21.6 billion to
account for other accumulated foreign earnings that they represent are *not*
indefinitely reinvested. Presumably, this is for much of the rest of the
foreign Apple world which has a higher effective tax rate. If we take Apple
and their auditors at their word (that all other earnings mentioned previously
really are indefinitely reinvested) then that would be the US tax liability if
all such non-indefinitely reinvested earnings were repatriated. How much in
terms of earnings does that $21.6 billion liability relate to? That depends on
the effective tax rate on those earnings. I would have to guess (or do a lot
more work digging into past filings), but I'm pretty sure the effective foreign
tax rate is a lot more for that than the 2 percent you seem to have assumed and
the amount they would potentially repatriate would not necessarily relate to
the $137 billion "cash, etc" you have stated. (If their foreign tax rate were
*zero* that deferred tax liability would equate with $61.7 of un-repatriated,
non-indefinitely reinvested earnings ($21.6/.35). *If* it were 25% (probably
more realistic), it would equate with $216 billion ($21.6/(.35-.25)). Etc.
Your $137 billion may be within a very big ballpark, but it's not like you
pointed to a seat in the bleachers and hit the ball there, and if you did, it
would have been pure luck.

I've been through many of these same issues (and problems) with David Cay
Johnston earlier in this space.

Your general point that our current tax system is locking out substantial
foreign earnings from repatriation is valid, but your numbers and assumptions
much less so.

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