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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.

Moreover, the rise of intangibles like intellectual property makes it even easier to relocate income-producing assets at will. Simply by assigning a valuable asset to a subsidiary in a low-tax environment, a company can make a massive shift in where taxable income comes from that has huge implications for total tax liability.

One world, one tax rate?
The best theoretical solution to the stateless income problem is also the most unrealistic one: setting a uniform global tax rate that would remove the incentive for companies to prefer one jurisdiction over another and the barriers to repatriating profits. Without such incentives, companies would presumably pay taxes wherever it made sense to do so rather than to produce tax savings.

Absent that solution, though, the IRS and other tax authorities in high-tax jurisdictions will have no choice but to fight big corporations under broad and somewhat vague laws challenging the true business purpose of tax-motivated moves to create stateless income. That will prove to be an uphill battle for the IRS unless Congress moves to create tighter laws on international tax enforcement. With that being unlikely in the current political environment, shareholders of companies like Apple Inc. (NASDAQ:AAPL), Starbucks Corporation (NASDAQ:SBUX), Forest Laboratories, Inc. (NYSE:FRX), Cisco Systems, Inc. (NASDAQ:CSCO), and Google Inc (NASDAQ:GOOG) probably don’t have much to worry about in the near future.

The article Stateless Income: What It Means for the Stocks You Own originally appeared on is written by Dan Caplinger.

Fool contributor Dan Caplinger owns shares of Apple. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Apple, Cisco Systems, Google, and Starbucks. The Motley Fool owns shares of Apple, Google, and Starbucks.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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