For a long time, companies have been able to pad their profits in the U.K. without paying any corporate taxes. According to the New York Times, Ms. Hodge and other lawmakers are upset that Google Inc (NASDAQ:GOOG) paid only £6 million in corporate taxes in Britain in 2011 despite generating more than £3 billion in revenue there. Google Inc (NASDAQ:GOOG), which reduces its tax bill in Britain and other European countries by routing sales via Ireland, where corporate taxes are lower, insists that the practice is perfectly legal.
In fact, the Prime Minister wants to send a clear message to international companies. “The prime minister has made it very clear that having strong international standards to make sure that global companies, like anyone else, pay the taxes they owe is a priority for the G-8 summit,” Mr. Cameron’s office said in a statement.
The ramifications for technology companies could be enormous if the U.K was to close the tax loop holes that technology companies have been taking advantage of.
Analyzing the effects of taxation against five technology empires
The corporate tax rate in the United Kingdom is approximately 28%. Assuming the immediate impact on taxes in the United Kingdom would involve the analysis of operating income after depreciation (as governments generally do recognize depreciation as a legitimate business expense, however, GAAP recognized depreciation is different than the government tax codes).
My analysis of the potential tax effects does not take into an exact consideration the difference between the cash-basis accounting of taxation versus the accrual basis accounting of GAAP. What I will focus on strictly is the sudden rate increase and the potential impact it would have on a company’s income statement.
Also, I will be making estimates using the financial data, meaning that the exact figures are not exact, and assuming that if these laws were to change, these companies will end-up paying the full taxes on operations internationally.
Analysis using British tax rates
Apple Inc. (NASDAQ:AAPL), in its full-year annual report, stated that its jurisdiction of incorporation is Ireland. Apple Inc. (NASDAQ:AAPL) also takes full advantage of Europe’s favorite tax-shelter, Ireland, which has allowed it to cut-down the cost of taxation in foreign jurisdictions by a hefty margin.
Apple Inc. (NASDAQ:AAPL) currently generates $36.32 billion in sales in the European market. It generates a pre-tax margin off 31.54%. Assuming the pre-tax margin is accurate, it can be assumed that Apple’s pre-tax operating income is $11.45 billion. Assuming a 28% tax rate on that amount of operating income, Apple Inc. (NASDAQ:AAPL) would wind up paying up $3.61 billion in taxes in a fiscal year. Apple generated $41.73 billion in net income in fiscal year 2012.
Closing Apple Inc. (NASDAQ:AAPL)’s favorite European tax-shelter could reduce Apple’s net income by up to 10% in the next fiscal year.
Google Inc (NASDAQ:GOOG) uses the Irish tax shelter generously. Taking advantage of the laws, Google had been able to avoid paying taxes internationally. I’m going to focus specifically on its European operations, and how it could potentially be affected rather than focusing on every international operation. As it is only the European Union that is making any attempt to close tax loop holes, so therefore, I will limit the effect to European business segments.
Google Inc (NASDAQ:GOOG), similar to Apple, has a pre-tax margin of 25.14%. Google discloses the revenue it generates from the United Kingdom separately from the rest of Europe. I am willing to assume that all of Europe will, at some point, adopt measure to reduce the effectiveness of the Irish tax shelter. I don’t have an exact break-down of Google Inc (NASDAQ:GOOG)’s European segment, but if Google has a similar pre-tax margin to Apple, it would mean that net income will decline anywhere from 7%-10%, assuming a 28% tax rate.
Research In Motion Ltd (NASDAQ:BBRY) BlackBerry generates approximately $4.5 billion from Europe (including the Middle East). Now, the segment data doesn’t specifically break-down Europe separately from the Middle East, so what I’m about to do is make an estimate on the full tax effect that Research In Motion Ltd (NASDAQ:BBRY) BlackBerry could experience from closure of the Irish tax loop hole.
Currently, Research In Motion Ltd (NASDAQ:BBRY) BlackBerry operates at a (11)% pre-tax margin. This implies that levying an additional tax on a company that technically generates no operating income would imply that the tax will not have any immediate effect.
BlackBerry avoids the effects of taxation, but it did so by not being able to remain profitable.
Facebook Inc (NASDAQ:FB) currently generates $374 million in revenue from Europe in the fourth quarter, which is approximately 23% of its overall revenue. Since Facebook Inc (NASDAQ:FB) generated $5 billion in revenue in the past fiscal year, it can be assumed that Facebook currently generates approximately $1.15 billion in revenue from Europe.
It is projected to earn $6.72 billion in sales in fiscal year 2013. Back in 2011, the company had an operating margin of 47.32%. In 2012, the operating margin declined substantially as the company had paid out $1.1 billion in share-based compensation in the June quarter. As a result, we would be better off assuming that 47.32% of the revenue that Facebook Inc (NASDAQ:FB) earns in Europe is taxable.
That being the case, assuming the European division generates $1.54 billion in revenue, the company would be paying taxes on $731 million in pre-tax income. Assuming a 28% tax rate, Facebook Inc (NASDAQ:FB) will be paying out $205 million in additional tax-related expenses.
Analyst’s project that Facebook Inc (NASDAQ:FB) will generate $1.37 billion in net income. Assuming the $205 million reduction in net income from taxes, and it can be assumed that Facebook’s net income could be negative affected by 15%.
Conclusion
The higher a company’s net operating margin, the larger the effect of closing tax loop holes. Companies like BlackBerry, which are unprofitable, may not experience a negative effect. The tax effect can reduce a technology company’s net income by 5%-15% as we just saw.
Remember these are just estimates, but even if these are estimates. It’s good to know that if Europe wins a major reform on corporate taxation, it could impair earnings by a large margin to cause major technology names to tumble on the stock market.
The article These Technology Titans Will Face Tough Times If Tax Loop Holes Are Closed originally appeared on Fool.com and is written by Alexander Cho.
Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited
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