NEW YORK (TheStreet) - Maybe, in light of eBay's (EBAY) earnings-wrecking $3 billion repatriation charge, investors should focus a bit more on the hundreds of billions of dollars in unrecognized tax liabilities that Apple (AAPL), Google (GOOG), Microsoft (MSFT), Hewlett-Packard (HPQ), and Cisco (CSCO) have created by keeping foreign profits abroad.
There are two ways of looking at eBay's repatriation.
For tech start-ups, the move to bring $9 billion of the company's about $14 billion in foreign earnings to the U.S., creating a $3 billion charge, may be fodder for the next mega deal in the Silicon Valley as eBay looks to bolster its portfolio. On the other hand, the repatriation may be a sign eBay cannot invest all its foreign earnings abroad. If the latter proves true, it could mean a wave of similar charges for U.S. tech giants who've stockpiled over a quarter trillion of dollars' worth of foreign profits in low tax jurisdictions.
Repatriating foreign earnings to U.S. shores, as eBay has now shown, can create quite the tax bill. On a GAAP basis, the company lost $1.82 a share in the quarter as a result of the repatriation. But it is unclear what eBay's intent is in bringing those earnings to the U.S.
If eBay is taking a tax hit in order to make a large acquisition then that might be a silver lining for the tech sector. Alternatively, eBay said on a conference call with analysts on Tuesday no acquisition is imminent and it may use foreign cash to reinvest in its U.S. business or support stock buybacks.
So pick how you interpret the repatriation. eBay was decidedly vague about its rationale, which at first glance appears to be a dramatic change in strategy from what the company disclosed in its annual 10-k filing with the Securities and Exchange Commission.
The $6 billion in net foreign earnings that eBay is looking to repatriate, after tax charges, is an amount that seems enough to help the company finance an acquisition of Square, Etsy, Pinterest or Airbnb were the company to combine its cash with stock or debt financing.
"Just to be clear, we are not announcing any large U.S.-based acquisition, nor are we committing to finance our share buyback with offshore cash," eBay CFO Robert Swan said on a conference call, of eBay's foreign earnings repatriation
It wouldn't be a surprise if, on the heels of those comments, VC's are busy this morning sprucing up their eBay pitch books given the repatriation. To be clear, eBay's PayPal division recently denied a Wall Street Journal report that it was pursuing a bid for mobile payments startup Square. Maybe that will change.
"The company denied having a specific acquisition target(s) in mind, but we believe this move sends up a bright flare over Silicon Valley that it is looking for deals (and it would be an expensive way to finance the buyback)," Wells Fargo analysts said of the repatriation.
That's the optimistic read.
A Repatriation Trend as a Threat?
The negative way to read eBay's move is to view it as an early indicator of similar risks at the company's larger competitors, be it Apple, Microsoft, or Google. If eBay is taken at its word and no acquisition emerges imminently, then the company may see a better ability to invest its earnings domestically, creating a big tax bill.
Here's what CFO Swan said on Tuesday:
[H]istorically we've assumed that the significant majority of our international earnings would be permanently be deployed internationally... I think what's changed is, the opportunities in the U.S., while we have a strong balance sheet and our cash balance continues to grow, the opportunities in the U.S. are even bigger... [Our] historical election was no longer valid, so that resulted in the accounting change.
That is a big change from February, when discussing its foreign earnings in its annual 10-k filing, eBay stated "we currently have no plans to repatriate those funds."
In 2013, eBay provided U.S. tax on approximately $450 million of non-U.S. earnings that the company expected to repatriate in the future, but kept $14 billion held abroad. It's planned repatriation grew twenty-fold in the first quarter, leading to the $3 billion non-cash charge.
"[If] and when we repatriate the cash, we will have a cash obligation to the IRS. So we've provided the non-cash charge in terms of the earnings implications, but when we bring that money back, we'll have to actually write a check," CFO Swan added on Tuesday.
On the same week that Apple tapped debt markets for $12 billion, adding to the $17 billion of debt on its balance sheet to help finance a fast rising $3.29 a share quarterly dividend and $90 billion in share buybacks, it might be time for investors to pay more attention to repatriation risks across Silicon Valley. Maybe U.S. cash balances and debt offerings won't suffice, in the long-term, for the amount of buybacks and dividends investors' expect.
Consensus also minimizes the prospect repatriation becomes an issue for the tech sector. When Yahoo! does eventually exit its 24% stake in e-commerce giant Alibaba, investors will see evidence of whether or not they have properly anticipated corporate tax bills.
For now, here's a look at what the tech sector's biggest names said about the scope of their undistributed foreign earnings in recent annual 10-k filings with the SEC.
The foreign provision for income taxes is based on foreign pre-tax earnings of $30.5 billion, $36.8 billion and $24.0 billion in 2013, 2012 and 2011, respectively. The Company's consolidated financial statements provide for any related tax liability on undistributed earnings that the Company does not intend to be indefinitely reinvested outside the U.S. Substantially all of the Company's undistributed international earnings intended to be indefinitely reinvested in operations outside the U.S. were generated by subsidiaries organized in Ireland, which has a statutory tax rate of 12.5%. As of September 28, 2013, U.S. income taxes have not been provided on a cumulative total of $54.4 billion of such earnings. The amount of unrecognized deferred tax liability related to these temporary differences is estimated to be approximately $18.4 billion.
As of September 28, 2013 and September 29, 2012, $111.3 billion and $82.6 billion, respectively, of the Company's cash, cash equivalents and marketable securities were held by foreign subsidiaries and are generally based in U.S. dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S.
The Company's other non-current liabilities in the Condensed Consolidated Balance Sheets consist primarily of deferred tax liabilities, gross unrecognized tax benefits and the related gross interest and penalties. As of March 29, 2014, the Company had non-current deferred tax liabilities of $19.5 billion. Additionally, as of March 29, 2014, the Company had gross unrecognized tax benefits of $3.0 billion and an additional $590 million for gross interest and penalties classified as non-current liabilities. At this time, the Company is unable to make a reasonably reliable estimate of the timing of payments due to uncertainties in the timing of tax audit outcomes.
In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of GAAP and complex tax laws. Resolution of these uncertainties in a manner inconsistent with management's expectations could have a material impact on the Company's financial condition and operating results.
The Company is subject to taxes in the U.S. and numerous foreign jurisdictions, including Ireland, where a number of the Company's subsidiaries are organized. Due to economic and political conditions, tax rates in various jurisdictions may be subject to significant change. The Company's future effective tax rates could be affected by changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, or changes in tax laws or their interpretation, including in the U.S. and Ireland. The Company is also subject to the examination of its tax returns and other tax matters by the Internal Revenue Service and other tax authorities and governmental bodies. The Company regularly assesses the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of its provision for taxes. There can be no assurance as to the outcome of these examinations. If the Company's effective tax rates were to increase, particularly in the U.S. or Ireland, or if the ultimate determination of the Company's taxes owed is for an amount in excess of amounts previously accrued, the Company's operating results, cash flows, and financial condition could be adversely affected.
In 2013, 2012, and 2011 we recorded net tax provisions of $161 million, $428 million, and $291 million. Except as required under U.S. tax law, we do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries that have not been previously taxed since we intend to invest such undistributed earnings indefinitely outside of the U.S. If our intent changes or if these funds are needed for our U.S. operations, we would be required to accrue or pay U.S. taxes on some or all of these undistributed earnings.
As of December 31, 2013, cash held by foreign subsidiaries was $4.6 billion, which include undistributed earnings of foreign subsidiaries indefinitely invested outside of the U.S. of $2.5 billion. We have tax benefits relating to excess stock-based compensation deductions and accelerated depreciation deductions that are being utilized to reduce our U.S. taxable income. Accelerated depreciation deductions on qualifying property were a result of U.S. legislation that expired in December 2013. As such, cash taxes paid (net of refunds) were $169 million, $112 million, and $33 million for 2013, 2012, and 2011.
As of December 31, 2013, our federal net operating loss carryforward was approximately $275 million and we had approximately $295 million of federal tax credits potentially available to offset future tax liabilities. The U.S. federal research and development credit expired in December 2013. As we utilize our federal net operating losses and tax credits, we expect cash paid for taxes to significantly increase. We endeavor to optimize our global taxes on a cash basis, rather than on a financial reporting basis.
U.S. income taxes and foreign withholding taxes associated with the repatriation of earnings of foreign subsidiaries were not provided for on a cumulative total of $48.0 billion of undistributed earnings for certain foreign subsidiaries as of the end of fiscal 2013. The Company intends to reinvest these earnings indefinitely in its foreign subsidiaries. If these earnings were distributed to the United States in the form of dividends or otherwise, or if the shares of the relevant foreign subsidiaries were sold or otherwise transferred, the Company would be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. Determination of the amount of unrecognized deferred income tax liability related to these earnings is not practicable.
As a result of certain employment and capital investment actions, the Company's income in certain foreign countries is subject to reduced tax rates and in some cases is wholly exempt from taxes. A portion of these tax incentives will expire during the second half of fiscal 2015, and the majority of the remaining balance will expire at the end of fiscal 2025. The gross income tax benefit attributable to tax incentives were estimated to be $1.4 billion ($0.26 per diluted share) in fiscal 2013, of which approximately $0.5 billion ($0.10 per diluted share) is based on tax incentives that will expire during the second half of fiscal 2015. As of the end of fiscal 2012 and fiscal 2011, the gross income tax benefits attributable to tax incentives were estimated to be $1.3 billion ($0.24 per diluted share) for each of the respective years. The gross income tax benefits were partially offset by accruals of U.S. income taxes on undistributed earnings.
As of July 27, 2013, $1.5 billion of the unrecognized tax benefits would affect the effective tax rate if realized. During fiscal 2013, the Company recognized $115 million of net interest expense and $2 million of penalties. During fiscal 2012, the Company recognized $146 million of net interest expense and $21 million of penalties. During fiscal 2011, the Company recognized $38 million of net interest expense and $9 million of penalties. The Company's total accrual for interest and penalties was $268 million, $381 million, and $214 million as of the end of fiscal 2013, 2012, and 2011, respectively. The Company is no longer subject to U.S. federal income tax audit for returns covering tax years through fiscal 2007. With limited exceptions, the Company is no longer subject to foreign, state, or local income tax audits for returns covering tax years through fiscal 2001.
The Company regularly engages in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. The Company believes it is reasonably possible that certain federal, foreign, and state tax matters may be concluded in the next 12 months. Specific positions that may be resolved include issues involving transfer pricing and various other matters. The Company estimates that the unrecognized tax benefits at July 27, 2013 could be reduced by approximately $200 million in the next 12 months.
We have not provided for U.S. federal or foreign income taxes, including withholding taxes on $14.0 billion of our non-U.S. subsidiaries' undistributed earnings as of December 31, 2013. We intend to indefinitely reinvest the $14.0 billion of our non-U.S. subsidiaries' undistributed earnings in our international operations. Accordingly, we currently have no plans to repatriate those funds. As such, we do not know the time or manner in which we would repatriate those funds. Because the time or manner of repatriation is uncertain, we cannot determine the impact of local taxes, withholding taxes and foreign tax credits associated with the future repatriation of such earnings and therefore cannot quantify the tax liability. In cases where we intend to repatriate a portion of our foreign subsidiaries' undistributed earnings, we provide U.S. and applicable foreign taxes on such earnings and such taxes are included in our deferred taxes or tax payable liabilities depending upon the planned timing and manner of such repatriation. During 2013, we provided U.S. tax on approximately $450 million of our non-U.S. earnings which we expect to repatriate in the future.
On a regular basis, we develop cash forecasts to estimate our cash needs internationally and domestically. We consider projected cash needs for, among other things, investments in our existing businesses, potential acquisitions and capital transactions, including repurchases of our common stock and debt repayments. We estimate the amount of cash available or needed in the jurisdictions where these investments are expected, as well as our ability to generate cash in those jurisdictions and our access to capital markets.
This analysis enables us to conclude whether or not we will indefinitely reinvest the current period's foreign earnings. We benefit from tax rulings concluded in several different jurisdictions, most significantly Switzerland, Singapore and Luxembourg. These rulings provide for significantly lower rates of taxation on certain classes of income and require various thresholds of investment and employment in those jurisdictions. These rulings resulted in a tax savings of $540 million and $439 million in 2013 and 2012, respectively, which increased earnings per share (diluted) by approximately $0.41 and $0.33 in 2013 and 2012, respectively. These tax rulings are currently in effect and expire over periods ranging from 2020 to the duration of business operations in the respective jurisdictions. We evaluate compliance with our tax ruling agreements annually.
The determination of our worldwide provision for income taxes and other tax liabilities requires estimation and significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain. Like many other multinational corporations, we are subject to tax in multiple U.S. and foreign tax jurisdictions and have structured our operations to reduce our effective tax rate. Our determination of our tax liability is always subject to audit and review by applicable domestic and foreign tax authorities, and we are currently undergoing a number of investigations, audits and reviews by taxing authorities throughout the world, including with respect to our tax structure. Governments are increasingly focused on ways to increase revenues, which has contributed to an increase in audit activity and harsher stances taken by tax authorities. Any adverse outcome of any such audit or review could have a negative effect on our business, operating results and financial condition, and the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made. While we have established reserves based on assumptions and estimates that we believe are reasonable to cover such eventualities, these reserves may prove to be insufficient in the event that any taxing authority is successful in asserting tax positions that are contrary to our positions.
In light of serious ongoing fiscal challenges in the U.S. and many countries in Europe, various levels of government are also increasingly focused on tax reform and other legislative action to increase tax revenue, including corporate income taxes. For example, the economic downturn reduced tax revenues for U.S. federal and state governments, and a number of proposals to increase taxes from corporate entities have been implemented or are being considered at various levels of government. Among the options have been a range of proposals included in the tax and budget policies recommended to the U.S. Congress by the U.S. Department of the Treasury to modify the federal tax rules related to the imposition of U.S. federal corporate income taxes for companies operating in multiple U.S. and foreign tax jurisdictions.
If such proposals are enacted into law, this could increase our effective tax rate. A number of U.S. states have likewise attempted to increase corporate tax revenues by taking an expansive view of corporate presence to attempt to impose corporate income taxes and other direct business taxes on companies that have no physical presence in their state, and taxing authorities in foreign jurisdictions may take similar actions. Many U.S. states are also altering their apportionment formulas to increase the amount of taxable income/loss attributable to their state from certain out-of-state businesses. Companies that operate over the Internet, such as eBay, are a target of some of these efforts. If more taxing authorities are successful in applying direct taxes to Internet companies that do not have a physical presence in the jurisdiction, this could increase our effective tax rate.
As of December 31, 2013, we had $58.7 billion of cash, cash equivalents, and marketable securities. Cash equivalents and marketable securities are comprised of time deposits, money market and other funds, including cash collateral received related to our securities lending program, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate securities, mortgage-backed securities and asset-backed securities.
As of December 31, 2013, $33.6 billion of the $58.7 billion of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations.
Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. At December 31, 2013, we had unused letters of credit for approximately $173 million. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months. Our liquidity could be negatively affected by a decrease in demand for our products and services. In addition, we may make acquisitions or license products and technologies complementary to our business and may need to raise additional capital through future debt or equity financing to provide for greater flexibility to fund any such acquisitions and licensing activities. Additional financing may not be available at all or on terms favorable to us.
HP has not provided for U.S. federal income and foreign withholding taxes on $38.2 billion of undistributed earnings from non-U.S. operations as of October 31, 2013 because HP intends to reinvest such earnings indefinitely outside of the United States. If HP were to distribute these earnings, foreign tax credits may become available under current law to reduce the resulting U.S. income tax liability. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable. HP will remit non-indefinitely reinvested earnings of its non-U.S. subsidiaries for which deferred U.S. federal and withholding taxes have been provided where excess cash has accumulated and it determines that it is advantageous for business operations, tax or cash management reasons.
As of October 31, 2013, HP had $1.4 billion, $5.6 billion and $30.8 billion of federal, state and foreign net operating loss carryforwards, respectively. Amounts included in each of these respective totals will begin to expire in fiscal 2014. HP also has a capital loss carryforward of approximately $272 million which will expire in fiscal 2015. HP has provided a valuation allowance of $162 million for deferred tax assets related to state net operating losses, $104 million for deferred tax assets related to capital loss carryforwards and $8.9 billion for deferred tax assets related to foreign net operating loss carryforwards that HP does not expect to realize.
Our cash balances are held in numerous locations throughout the world, with substantially all of those amounts held outside of the United States. We utilize a variety of planning and financing strategies in an effort to ensure that our worldwide cash is available when and where it is needed. Our cash position remains strong, and we expect that our cash balances, anticipated cash flow generated from operations and access to capital markets will be sufficient to cover our expected near-term cash outlays.
Amounts held outside of the United States are generally utilized to support non-U.S. liquidity needs, although a portion of those amounts may from time to time be subject to short-term intercompany loans into the United States. Most of the amounts held outside of the United States could be repatriated to the United States but, under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits.
Repatriation of some foreign balances is restricted by local laws. Except for foreign earnings that are considered indefinitely reinvested outside of the United States, we have provided for the U.S. federal tax liability on these earnings for financial statement purposes. Repatriation could result in additional income tax payments in future years. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is that cash balances would remain outside of the United States and we would meet liquidity needs through ongoing cash flows, external borrowings, or both. We do not expect restrictions or potential taxes incurred on repatriation of amounts held outside of the United States to have a material effect on our overall liquidity, financial condition or results of operations.
As of June 30, 2013, we have not provided deferred U.S. income taxes or foreign withholding taxes on temporary differences of approximately $76.4 billion resulting from earnings for certain non-U.S. subsidiaries which are permanently reinvested outside the U.S. The unrecognized deferred tax liability associated with these temporary differences was approximately $24.4 billion at June 30, 2013.
We earn a significant amount of our operating income outside the U.S., which is deemed to be permanently reinvested in foreign jurisdictions. As a result, as discussed above under Cash, Cash Equivalents, and Investments, the majority of our cash, cash equivalents, and short-term investments are held by foreign subsidiaries. We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt repayment schedules, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, such as business acquisitions and share repurchases, we could elect to repatriate future earnings from foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. These alternatives could result in higher effective tax rates, increased interest expense, or dilution of our earnings. We have borrowed funds domestically and continue to believe we have the ability to do so at reasonable interest rates.
Our effective tax rates were approximately 19% and 20% for the three months ended March 31, 2014 and 2013, respectively, and 18% and 19% for the nine months ended March 31, 2014 and 2013, respectively. Our effective tax rate was lower than the U.S. federal statutory rate primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.
The current quarter's effective tax rate was lower than the prior year's third quarter effective tax rate, primarily due to nonrecurring items in the prior year's third quarter effective tax rate, such as the non-deductible EU fine and transfer pricing developments related to Denmark and India which were offset by adjustments to prior year tax provision estimates and unfavorable changes in the proportion of earnings taxed at lower rates in foreign jurisdictions. The current year's effective tax rate was lower than the prior year's effective tax rate, primarily due to additional U.S. tax relief determined to be available with respect to transfer pricing developments in certain foreign tax jurisdictions, primarily Denmark.
Tax contingencies and other tax liabilities were $9.4 billion as of March 31, 2014 and June 30, 2013, and were included in other long-term liabilities. While we settled a portion of the U.S. Internal Revenue Service ("I.R.S.") audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for these years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of March 31, 2014, the primary unresolved issue related to transfer pricing which could have a significant impact on our financial statements if not resolved favorably. We do not believe it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within the next 12 months, as we do not believe the remaining open issues will be resolved within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2013.
We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2013, some of which are currently under audit by local tax authorities. The resolutions of these audits are not expected to be material to our financial statements.
We are subject to income taxes in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly are under audit by tax authorities. Economic and political pressures to increase tax revenues in various jurisdictions may make resolving tax disputes more difficult. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our financial statements in the period or periods for which that determination is made.
We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds currently held in foreign jurisdictions to the U.S. may result in higher effective tax rates for the company. In addition, there have been proposals from Congress to change U.S. tax laws that would significantly impact how U.S. multinational corporations are taxed on foreign earnings. Although we cannot predict whether or in what form any proposed legislation may pass, if enacted it could have a material adverse impact on our tax expense and cash flows.