A Surface-Level Look at Apple’s “Cash-Trapped” Situation

ADVANCE WARNING: I am not an accountant and don’t play one on the Interwebs TV. This post is subject to correction in case of hilariously bad errors. Though this blog post is intended to be generally objective, note my About + Disclaimer section anyway.


I’m a little too proud of myself for that silly “cash-trapped” pun.

Apple’s cash position (and what to do with it) is a recurring discussion in tech/finance circles, because well just look at all them billions (chart is screencap of Apple’s Investor Relations >> Return of Capital website linked here, green rectangle added by me; click all image thumbnails to view at full resolution)

aapl-cash

About $194B cash in hand. $150B net of debt. $22B in the US. $171B held offshore.

Anyway, Neil Cybart of Above Avalon covered what he considers “Apple’s Cash Dilemma” in considerable detail – I won’t be reinventing that wheel. So what brought my post on? I was “inspired” by a recent tweet appearing in my Twitter timeline (but one of many perspectives on “how to unlock the cash”) to take a slightly closer look at the numbers:

What would that actually mean, though? What does Apple think it could mean? Aside from the “why” or “why not”, good, bad or indifferent, what might be the actual cost of repatriating?

Is it even all that clear?

Let’s have a look at some numbers anyway, shall we? 😉 (Advance Note: I don’t subscribe to many newsletters/paid subscriptions out there, sadly, so if I inadvertently “duplicated” work – whoops. Reinventing the wheel isn’t something I’m not known for. 😀 )


Zeroing in on 10-Ks

The bad puns are always free at The AAPL Tree. For better or for – never mind.

We know that in the US, corporate tax rates go as high as 35%. They don’t get much higher in the entire world than 35% (at the country level). And since Apple nets mega-billions in pretax income each year, let’s just presume its effective US tax bracket would be 35%. 😉

Which is exactly what Apple assumes every year. Where, specifically? As of this year:

aapl-tax-reconciliation

I’ll get back to this screencap in a bit (I added those three “text rectangles” after all), but first, in case you were wondering, this income tax reconciliation isn’t new:

aapl-tax-reconciliation-2000

Remember when Apple didn’t have “much” of a cash hoard to speak of? It had something like $4B in cash (you’d never have guessed what was just around the corner, by the way) and had, from FY 1998 through 2000 combined, a cute widdle $142M in “indefinitely invested earnings of foreign subsidiaries”.

Which, by the way, is a big part of this (beta) post.


Unpatriated 

Part One of Apple’s Judgment Call: “Permanently” Offshore Foreign Earnings

Well, some people think it’s unpatriotic, but let’s not go there. Instead, let’s go back to that 2014 10-K. As I presume every other US-based BigCo does, Apple starts with the US 35% of pre-tax earnings and includes a reconciliation line called “indefinitely invested foreign [subsidiaries] earnings” – apparently, those earnings it has decided/intends never to repatriate (the process by which the intent is established isn’t simple, see PricewaterhouseCoopers PDF link a ways down the post if you like). As of late, these permanently invested foreign subsidiaries earnings predominantly account for the difference between the “default” 35% tax rate (if all earnings were brought home to Cupertino, which isn’t ever happening for obvious reasons such as these) and what it actually provisions for income taxes each fiscal quarter/year. That’s that lowest green rectangle highlight, if you’ll pardon the image re-link.

aapl-tax-reconciliation

Apple calculates its “unrecognized deferred tax liability” at $23.3B as of FY 2014-end. If Apple repatriated all of that ~$70B (at the time) in undistributed international earnings “generated” by its Irish subsidiaries (which it wouldn’t), then the estimated cash repatriation hit would be $23.3B. That sounds about right when adding up the indefinitely invested earnings of foreign subsidiaries balances from the last 10 fiscal years (as you can see, it wasn’t until FY 2010 that outside-US profits really started ramping up):

aapl-indef-invested

Obviously, Apple made the judgment call to indefinitely invest (cynical read: stash away, not to be US-deployed) $69.7B in “offshore”, non-US-taxed income, partly because of Congressional gridlock (no corporate tax reform), and perhaps-more-likely because of Apple’s ready ability to leverage its foreign cash balances for far less than the theoretical repatriation expense, slightly-imperfect S&P debt rating aside. Note Apple’s debt interest payments of a “mere” half billion or so on a debt balance reaching around $35B at the end of FY 2014. Based on page 64 of the 10-K, it seems Apple would have to pay that same amount to Uncle Sam after repatriating “only” around $1.5B.

Cost of borrowing? Probably around 1.1% or so per year right now (2014 10-K, page 34). Cost of repatriation? My wild guess, much higher than 15% tax on average. Hm, I wonder what a rational multinational would do given those two options.

As a bit of an aside, while Apple probably employed almost all $35B raised to fund its can-only-be-domestically-funded capital return program (at ridiculously cheap borrowing costs), that $35B supplemented $59.4B in non-borrowed domestic cash used by Apple to achieve an eye-opening $94.4B in total capital return by FQ4 2014 (with $84.4B returned in just six fiscal quarters). So if Apple didn’t have a capital return program, its domestic cash balance would probably be closer to an eye-watering $110B as of FY 2014-end. And over $125B a mere 6 months later. Wow.

Part Two of the Apple’s Judgment Call: “Temporarily” Offshore Foreign Earnings 

To quickly recap, you have Apple “not recognizing”, though acknowledging, a theoretical (until there’s a change in the tax laws or whatever) deferred tax liability of $23.3B based on those Irish subsidiaries that certain people/groups seem to take issue with. (Yes, I’m an impossibly biased shareholder/fanboy, but you knew that already.)

(Here’s where I get a little theoretical, by the way, and where my non-accounting background “shines through”. Note BETA POST label, you have been warned, CPAs/accountants in the audience feel free to tweet/comment, etc.)

There’s also deferred tax liability which Apple does recognize. Deferred tax liabilities could arise from any number of sources, but let’s focus on a rather significant one in Apple’s case.

That’s right…undistributed foreign earnings which Apple does “intend” to reinvest (repatriate) within the US.

Huh?! Apple? Alleged pioneer of the Double Irish with a Dutch Sandwich manuever whatever? Really?!

Well, yes. Check out page 65 of the 2014 10-K:

aapl-net-deferred-tax

Those deferred tax liabilities don’t have an “unrecognized” label on them. And yet, there’s a “unremitted earnings of foreign subsidiaries” section with a FY 2014-end balance of $21.5B. Which, according to Apple (as audited by Ernst & Young, as will be almost certainly be audited by the IRS, which probably has an advance satellite team embedded at One Infinite Loop looking at every SEC filing), is counterbalanced by various deferred tax assets. Resulting in net deferred tax liabilities of $15.12B as of that time. (Ahem, WIRED article from 2013 that doesn’t look at net deferred tax liability for whatever reason.)

But didn’t we just “establish” that Apple, the rational multinational, will borrow rather than take a big tax hit on remitting foreign earnings to the US? We did. My wild guess is that given Apple’s famous conservatism (you see it in their guidance all the time), it decided that it couldn’t make a blanket declaration that 100% of unremitted offshore earnings would always and forever stay unremitted (NOTE: links to PricewaterhouseCoopers PDF “pamphlet”, “Deferred taxes on foreign earnings: A road map“). Ah, but there’s (apparently) nothing in the US tax code that says not-indefinitely invested offshore earnings must be remitted to the US within any given time limit.

So, what do we end up with? Yep, more of that tax avoidance/planning/strategy.

Now it doesn’t explain everything, and multinational tax accounting is impossible to…well…fully account for within the “confines” of an 88-page 10-K (before exhibits), but in this non-accountant’s exceedingly humble opinion, it’s visible in two “places”:

First, Apple’s income tax provision breakout.

Second, Apple’s cash tax payments.

Income Tax Provision Breakout

Notice anything interesting in Note 5 to Apple’s Consolidated Financial Statements?

aapl-provision-breakdown

Huh, hasn’t Apple gotten the majority of its revenues outside the US for the past several years? Yep. So why exactly is the provision for federal (US, national level) taxes such a huge portion of the overall provision for FY 2012-2014?

It’s not something explainable by relative revenue region profitability. Yes, I’m massively oversimplifying, but post-corporate expenses, Apple operating income in the Americas was probably in the low-$20B range, give or take a few billion :D, in FY 2012-2014. Considering also that the Americas revenue geography includes Canada, Mexico and, well, the entire continent of South America…carry the 5…uh…how is it possible that Apple’s provisioning taxes at well over a 50% rate at the “federal” level? And probably over 35% for all three fiscal years even isolating “current” income taxes?

Well, aside from “multinational tax accounting maths is complicated” (for whatever reason, Apple for GAAP purposes “allocates” most tax provision to the US), let’s look at Apple’s cash tax payments, and possibly semi-solve a mystery/additional tax controversy along the way.

Apple’s Cash Tax Payments

Various articles, with varying degrees of hyperventilation, have pointed out the disparity between Apple’s provisioned income taxes and those it actually pays. Looking at the fiscal period from FY 2007 through 2014, there’s no denying the disparity exists. Based on my hopefully-correct math and skimming through the relevant 10-Ks, Apple provisioned a total of $62.1B those eight fiscal years, but, based on its “Supplemental cash flow disclosure”, “only” paid about $38B in taxes, leaving a differential of $24.1B.

Scandal! (?)

Well, your opinion on US corporate taxation aside…considering Ernst & Young and the IRS looking over Apple and most other megacorporations constantly…I’m guessing “no”. Recall that Apple, as of FY 2014, had an unremitted foreign subsidiaries earnings balance of about $21.5B. Note also that Apple, from FY 2007-2014, reported combined “Federal” tax deferral of $16.4B in its tax provisioning. Finally, recall Apple’s basically “under oath” calculation of its net (recognized) deferred tax liability to be about $15.1B as of FY 2014. When you add in timing differences and other deferred taxes unrelated to unremitted foreign earnings, that $24.1B “gap” suddenly doesn’t seem quite so suspicious.

Provisional Wrap-Up

So, trying to keep opinion mostly off to the side, what takeaways are there given the scope of this post? I humbly submit:

1) Apple, the rational multinational (last time I’ll type this in this post, promise), saves big on repatriation taxes by borrowing to fund its humongous capital return program (which is now up to an ionospheric (up-to) $200B by March 2017). As of now the savings from borrowing the $44B in FQ2 2015-end cumulative debt vs. repatriating would approach $15B. But that’s not the only way to look at it nor should it be in my opinion. Consider beyond theoretical “temporary” savings (a) accelerated share repurchases, (b) reducing shareholder liability via massive buyback at a depressed valuation, (c) dividend payout savings, (d) immense corporate flexibility via alternate “access” to otherwise “frozen” overseas capital while supplementing Apple’s critical US cash supply, and so on.

2) Averaging the past eight fiscal years, Apple’s cash effective tax rate worldwide is roughly 60% of its declared tax rate based on the GAAP-recognized provision for income taxes. It varies by year, though, so it’s probably more useful to track/average over multi-year periods. Also, c’mon, people. The numbers aren’t that hard to find. But I guess sensation over fact-checking, per usual.

3) Apple’s reporting “conservatism” lowers its GAAP-reported net income (eh, Wall Street always worries about gross margins anyway), and also “explains” how Apple’s cash balance can grow more quickly than its GAAP-reported net income suggests it can. Yes, the cash flow statement watchers knew this already.

Well, maybe one opinion. Apparently (link to Deloitte US PDF tax brief on China), China’s corporate tax rate is 25% – though given Apple’s immense investments, PPE, etc. in the fast-growing revenue region, there’s likely a decent amount of deductible expenses. Unless its tax structure forces it to, I wouldn’t assume that Apple, considering everything, will get all that “tax avoidance fancy” with the Chinese taxation authorities.


* Yes, for now, Fiscal 2012 remains Apple’s most profitable year in GAAP terms, though it’s important to note the increased per-device revenue/gross margin deferrals instituted in Fiscal 2014.


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