Tax Reforms are Coming, Who is Most at Risk? (Round 2)

Let me reiterate my disclaimer: I am neither a tax expert nor a financial analyst. I am not even close to being either one. I am simply writing about tax avoidance in the context of sustainability. Therefore, the analysis here is to contribute to the discussion on tax avoidance as a sustainability risk to companies and should not be taken as investment advice.  If you decide to use this piece for entertainment purposes only, I will not be offended. 

TL;DR: Ebay, Priceline and Google face the highest tax-related risks due to consistently lower tax rates for the last 10 years. 


Image: Ace Finance & Markets News


Plotting the 10-year effective tax rates of the eight companies I am tracking (thank you, Morningstar), Priceline Group (PCLN) and Alphabet / Google (GOOGL) may face the biggest impacts on its profitability if they are made to pay the US statutory rate of 35%. From 2006 to 2014, the three companies’ effective tax rates (ETR) have consistently been below 35% and tax rates have declined despite increases in operating income.

Most at Risk

Ebay: Except for 2014 when Ebay’s ETR was at 98.7%, Ebay’s tax rate has consistently been lower than 20% since 2008. Between 2008 and 2013, its ETR range was between a low of 14% and a high of 18.5%. In 2015, it was 19.08%, down from 98.7% recorded in 2014. The 2014 ETR was an outlier and was due “primarily to the recognition during the year of deferred tax liabilities of approximately $3.0 billion of U.S. income and applicable foreign withholding taxes on $9.0 billion of undistributed foreign earnings of certain of our foreign subsidiaries for 2013 and prior years, partially offset by the release of the valuation allowance on our capital loss carryover.” Note that low tax rates were recorded even as the company’s operating income steadily increased.

Priceline Group: Priceline’s highest ETR was 33.29% in FY2008, against an operating income of $289 million. The ETR started dropping annually in FY2010 from 29.23% to 18.44% in FY2015. This while its operating income grew from $787 million in FY2010 to $3.3 billion in FY2015.

Alphabet: The company formerly known as Google has also seen a steady decline in its ETR since 2006. The company’s median ETR from FY2006 to FY2015 is 21%, with the highest ETR recorded in FY2008 at 27.79%. The tax rate steadily declined from then on, with the latest fiscal year ETR recorded at 16.81%. Meanwhile, the company’s operating income has grown from $3.6 billion in FY2006 to $19.4 billion in FY2015.

Declines in the ETR are explained by increases in income from foreign operations, which of course makes sense off-hand. It remains to be seen if foreign taxes paid reflect the surge in foreign income. It is worth noting, however, that Google agreed to pay back taxes in the UK, and early this year, French authorities were reportedly demanding payment of more than EUR 1 billion in back taxes. These indicate that foreign taxes have not been commensurate to the increase in foreign income. But we’ll get back to that in the next posts.

Consistently Above 35% 

In contrast, Facebook’s ETR has consistently been above 35% since FY2010, the first year for which ETR was recorded for Facebook by Morningstar. Its ETR has hovered around 40% with a sudden spike in FY2012 at 89.27%. The company explained that its ETR increased in FY2012 “primarily due to the impact of non-deductible share-based compensation and the losses arising outside the United States in jurisdictions where we do not receive a tax benefit. Our effective tax rate in 2012 was also higher due to the expiration of the federal tax credit for research and development activities.” Facebook, however, has not been spared from criticism abroad. In March 2016, it agreed to reform its tax structure in the UK and will pay higher taxes there starting 2017.

Wild Swings and Fluctuations

Tripadvisor: Its ETR was 34.61% in FY2011 but dropped to 17.15% in FY2015. The declining trend of its ETR reflects the company’s fluctuating operating income during that period. There are no obvious inconsistencies based on the numbers, so the company may just get away with its lower rates.

Amazon: Amazon’s ETR has seen wild fluctuations in the last 10 years. It had a 49.6% ETR in 2006, which went down to between 21% and 31% between 2007 and 2011. In 2012, its ETR jumped to 78.68% due to “the lower level of pre-tax income generated during the year, relative to our tax expense. Our effective tax rate in 2012 was also adversely impacted by acquisitions (including integrations) and investments, audit developments, nondeductible expenses, and changes in tax law such as the expiration of the U.S. federal research and development credit at the end of 2011. These items collectively caused our annual effective tax rate to be higher than both the 35% U.S. federal statutory rate and our effective tax rates in 2011 and 2010.” In 2015, the company’s ETR was 60.59% “due to losses of foreign subsidiaries, reduce our pre-tax income without a corresponding reduction in our tax expense.” The company’s European operations are based in Luxembourg, known as a “secrecy jurisdiction”.

Apple: Apple’s ETR hovered between 24% and 32% with no outliers over the last 10 years. This range has been stable, although still lower than the US federal statutory rate, and amidst a rapid increase in its operating income. Interestingly, Apple’s lowest ETR over the 10-year period was recorded in 2011, the year its operating income by 54%.

What is the Data Telling Us? 

Well, this tiny experiment shows that the world’s biggest companies have effective tax rates that are below the US federal statutory rate, while their revenues continue to rise. The more money they make, the less taxes they pay, is the simplistic explanation. Is this legal? Yes it is. But is it ethical?

This simple experiment also shows that the companies that have consistently paid the lowest tax rates are the companies that may be hit the most if the US tax regime follows the OECD recommendations. The hit will be in the form of payment of back taxes, possibly spread out over a number of years. Not to mention the reputational damage of being known as a tax cheat. Ebay’s case shows that impact of deferred tax liabilities on a year’s ETR. The number isn’t pretty.

More next time.


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