Looming Tax Changes Could Be Dragging Down Tech Stocks, Experts Say

As Apple (AAPL) led a broader market tumble earlier this week, many investors pinned the drop on a host of pessimistic iPhone forecasts.

But according to Radu Tunaru, a professor of finance at the University of Kent, there may be a much more mundane explanation for investors' anxiety -- in particular for investors in big tech companies including Apple, Alphabet (GOOGL) or Amazon (AMZN) .

"The answer is very simple -- tax," he said, suggesting that shifts in international tax policy run the risk of spooking investors -- and forcing them to stay on their toes.

Both inside and outside of the U.S., policy discussions are underway that could change the game to multinational tech firms, in particular those such as Apple that have parked significant sums overseas. 

Recently, British Chancellor Philip Hammond announced a new 'digital services tax' aimed squarely at the likes of tech giants like Amazon, Alphabet and Facebook (FB) . Described as a narrowly targeted tax, Hammond said that the new tax would be levied on profitable companies that generate at least 500 million pounds per year ($650 million USD) "in global revenues on the business lines in scope."

The tax would go into effect in April 2020, although there's a possibility that the proposal could wind up failing amid negotiations for Britain's exit from the European Union due for March 2019. 

"This step shows we are serious about this reform," Hammond said in announcing the measure. The European Union has proposed a similar tax on digital services, and intergovernmental groups The Organisation for Economic Co-operation and Development (OECD) and Group of Twenty (G20) have been working to develop an international consensus on tax reform.

Meanwhile, in the U.S., tech giants have been enjoying a favorable tax environment owing to the Trump administration's tax cuts, which lowered the corporate tax rate to 21% in addition to luring corporations to repatriate billions in overseas cash at a lower tax rate, dubbed a "toll charge", of 15.5%. Corporations like Apple, which had an estimated $252 billion parked overseas prior to the tax bill, are taking the bargain: The tech giant said it would would repatriate much of the funds, and settle up a bill equivalent to a whopping $38 billion under the repatriation deal. 

But there's a detail in the deal that could trip up investors over time, Moody's cautioned in a recent report studying the effects of the tax cuts on corporations. The bill can be paid over a period of eight years, on an adjusted schedule that shifts 45% of the liability to the last two years. Although companies have the option of paying it in a lump sum, "substantially all" corporations studied in the report -- including Apple, which has the largest tax liability by a wide margin -- opted for the 8-year repayment plan because there's no interest associated with the liability, said Moody's David Gonzales. And he warned that could translate into a drag on future cash flows.

"Disclosures that we have reviewed to date indicate that tax liabilities relating to unrepatriated overseas earnings can be a significant drain on reported operating cash flows in future years," he said. "Investors should scrutinize income tax disclosures because the notes to financial statements may not contain all of the pieces to a company's income tax puzzle."

Meanwhile, Tunaru suggested that the tax changes in the U.S., over time, could have other unforeseen consequences for investors: Namely, by strengthening other countries' resolve to impose their own taxes on these companies. And that's in addition to other regulatory efforts, such as GDPR, that impose fines on mishandling user data.

"Because of President Trump's international commercial protective nationalistic battle, all other large economies are insisting that the tech giants will pay their fair share of tax," Tunaru added. "Hence, technology company stockholders are looking at a reduction in future revenues plus possible large fines for the past behavior of these companies."

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