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Google Inc (GOOG), Apple Inc. (AAPL)- Stateless Income: What It Means for the Stocks You Own

With taxes having risen for most people at the beginning of 2013, ordinary Americans are increasingly angry about the steps that many well-known U.S. companies have used to minimize or eliminate their tax bills. By creating what’s become known as stateless income, companies have navigated the complexities of international tax law to earn more money free of tax than many Americans believe reflects their fair share of the nation’s overall tax burden.

Google Inc (NASDAQ:GOOG)

Now, though, the IRS has said that it plans to clamp down on companies using stateless income strategies, with the intent to pursue enforcement claims against users of the controversial techniques. Let’s take a closer look at how companies create stateless income and whether IRS moves will hurt them in the near future.

Who’s earning stateless income?
Two months ago, Congressional hearings focused on tax strategies that many multinational corporations have successfully used to minimize their corporate tax liability. A Senate subcommittee report found that Apple Inc. (NASDAQ:AAPL) successfully saved billions of dollars in potential U.S. tax liability by using foreign business entities. Because those units didn’t have any legally determinable country of origin for tax purposes, the earnings they generated became stateless income.

Several other companies use similar strategies to cut their tax bills in high-tax jurisdictions. Google Inc (NASDAQ:GOOG) has used units based in Ireland and the Netherlands to help greatly reduce taxation on the money it earns, while Professor Edward Kleinbard’s recent paper “Through a Latte, Darkly” goes into great detail about the methods that Starbucks Corporation (NASDAQ:SBUX) used to minimize tax payments to the U.K. through the use of affiliates in the U.S., the Netherlands, and Switzerland. A Bloomberg article from 2011 cited Forest Laboratories, Inc. (NYSE:FRX) as using a strategy similar to Google Inc (NASDAQ:GOOG)’s involving an Irish unit headquartered in Bermuda, while the same article said Cisco Systems, Inc. (NASDAQ:CSCO) attributed half its profits to a unit in Rolle, Switzerland.

The unsolvable problem
The problem that countries have in collecting taxes from multinational corporations is that it’s increasingly difficult in the global economy to attribute income to particular business units accurately. When global divisions of large corporations used to act largely autonomously and separately, it was reasonable to assume that reported revenue and earnings reflected actual sales and profits that each country’s business division brought in. Now, though, with global commerce having become commonplace, it’s much easier for companies to manipulate their tax liability with intra-company transactions that produce huge tax savings by shifting income to lower-tax jurisdictions.