Funding U.S. Acquisitions with Foreign Cash in Light of Current Tax Legislative Uncertainties

By Stuart E. Leblang, Michael J. Kliegman  and Amy S. Elliott

Apple Inc. (AAPL) just reported that, as of April 1, 2017, its foreign subsidiaries were sitting on $239.6 billion ¹of cash and marketable securities.  While the company continues its commitment to return cash to shareholders through dividends and share repurchases, there is speculation about a more big-bang event in which Apple accesses its offshore cash to fund one or more large-scale acquisitions.  Some names that have been mentioned include Netflix Inc. (NFLX), Tesla Inc. (TSLA) and Walt Disney Co. (DIS), with current market prices of about $70 billion, $50 billion and $170 billion, respectively.²

What is notable about the names being considered for acquisition candidates is that they are predominantly U.S. companies.  While Apple might well decide that there is a strategic necessity to acquire any of these companies, insofar as it might wish to fund the deal with cash on its balance sheet, it seems unlikely that such a move would occur under current tax law.

Apple’s Deferred Taxes on Offshore Earnings

Before discussing the funding of domestic acquisitions, let’s spend a moment on U.S. tax and Apple’s offshore cash.  First, it is always important to keep in mind the distinction between cash taxes paid and tax expense reported in financial statements. The difference between these two is generally reflected in deferred income tax assets or liabilities.  A U.S. multinational company generating earnings overseas ordinarily is required to provide deferred tax expense for unrepatriated earnings based on the assumption that it will eventually have to bear that tax cost to fully realize the benefit of those earnings.  Accounting rules allow a company to avoid bearing that book expense if it consistently asserts its intention to permanently reinvest those earnings overseas.  Particularly where the company has managed to arrange for the overseas earnings to attract a very low rate of taxation, it is quite common for such an assertion to be made.

One could be excused for assuming that Apple has not provided deferred taxes for its unrepatriated overseas earnings.  A look at the company’s financial statements indicates, however, that Apple has already taken the earnings and balance sheet hit for U.S. tax on as much as half of its overseas cash.  On its last full-year audited financial statement for the fiscal year ended September 24, 2016, Apple reported $216 billion of unrepatriated overseas earnings, of which $110 billion were treated as permanently reinvested overseas and, thus, to which no deferred tax liability was established.^[3]

To be clear, even though the company has provided a book expense for the tax, no cash tax has yet been paid to the Internal Revenue Service.  Only an actual repatriation or deemed repatriation (such as that currently under consideration by lawmakers) would trigger an actual tax outlay.

M&A Prospects

There have been some recent large-scale cash acquisitions involving U.S. companies purchasing foreign companies, presumably using offshore cash on their balance sheets.  Johnson & Johnson (JNJ) recently announced an agreement to acquire Swiss-based biotech Actelion (ATLN) for $30 billion cash. ⁴Another pending transaction is the acquisition by Qualcomm Inc. (QCOM) of Dutch company NXP Semiconductors NV (NXPI) for $47 billion cash.⁵

Current tax law allows for a U.S. multinational group to fund the purchase of a non-U.S. company with offshore cash.  Indeed, funding such an acquisition is quite consistent with the assertion made for accounting purposes that earnings generated overseas are to be permanently reinvested overseas, and, therefore, the company need not provide deferred tax expense for an eventual repatriation.

Using untaxed offshore cash to fund the acquisition of a U.S. target is a different ball game.  While “impossible” is almost never the right word to use when talking about tax planning, strenuous effort has been expended by U.S. companies and their tax advisors to devise structures to use offshore earnings to fund U.S. acquisitions without a repatriation tax, and it is not generally achievable without very unusual circumstances, significant complexity and increased tax risk.

In other words, Apple is unlikely to use offshore cash on its balance sheet to fund a U.S. acquisition before it has legal assurance that the resulting earnings repatriation will be taxed at a reduced rate.⁶

Changes to the Tax Landscape

That brings us to prospects for changes in the U.S. taxation of overseas earnings.  While President Trump’s recently released tax reform outline was sparse on details, it is noteworthy how much broad consensus there is about the necessity for, and direction of, changes to the U.S. system of international taxation, something even Democrats have clamored for in recent years.⁷Under the House Republicans’ “A Better Way” tax reform proposal, ⁸ as well as under President Trump’s outline, ⁹ earnings of foreign subsidiaries of U.S. corporations would generally not be taxed under a so-called territorial system similar to that of most industrialized countries.¹⁰

Along with the shift to a territorial tax system, each plan is accompanied by a one-time mandatory repatriation, which would likely involve subjecting all previously untaxed post-1986 foreign earnings (whether held as cash or cash equivalents or reinvested in property, plant and equipment and generally measured as accumulated earnings and profits) to a special, lower rate of tax.  The House Republican proposal has a rate of 8.75 percent for liquid earnings and 3.5 percent for illiquid earnings, while candidate Trump proposed a deemed repatriation rate of 10 percent.  The outline put forth by the Trump administration declined to specify a repatriation tax rate.

Whatever may be the likelihood for a full-scale reform of the U.S. tax system during the next year or so, we think the probability is higher for a shift to a territorial system of international taxation and especially for the one-time, low tax rate on repatriation.  Even if Congress and the White House are not able to agree on a comprehensive reworking of the tax code, rule changes targeted at the foreign earnings of U.S. multinationals that would provide for repatriation at a reduced rate could be achievable, potentially even attracting Democratic support.  This is especially the case if the funds are used to pay for increased investment in infrastructure. ¹¹ House Republicans’ deemed repatriation provision was scored to bring in anywhere from $138 billion to $185 billion over 10 years.¹²

In light of the high degree of current legislative uncertainty, we would be surprised if Apple or a similarly situated company would jump the gun on repatriation at this point by risking billions of dollars in tax to pull off a large cash acquisition of a U.S. company.  When we get clarity about the chances for, and timing of, a reduced tax rate on repatriation, this picture could change radically.  In the meantime, Apple seems likely to continue to access debt markets to supplement U.S. cash flow to fund its capital return program.

Finally, an observation about U.S. companies, such as Johnson & Johnson and Qualcomm, using their offshore cash to purchase foreign targets.  Yes, under current U.S. tax law, this is, to a large degree, swimming with the current.  At the same time, the more overseas profits that are generated from these acquisitions, the greater the problem they will have under our current tax system.  However, if we do see the United States shift to a territorial tax system, then these acquisitions could prove to be the best of both worlds:  funded with untaxed earnings and resulting in foreign operations that will not be subject to U.S. tax going forward.

^{[1] According to comments made by Apple CFO Luca Maestri on the company’s May 2 earnings call, Apple “ended the quarter with $256.8 billion in cash plus marketable securities, a sequential increase of $10.8 billion.  $239.6 billion of this cash, or 93 percent of the total, was outside the United States.” https://seekingalpha.com/article/4068153-apple-aapl-q2-2017-results- earnings-call-transcript?part=single, see also https://www.sec.gov/cgi- bin/viewer?action=view&cik=320193&accession_number=0001628280-16-020309&xbrl_type=v# .}

^{[2] Liedtka, Michael, May 3, 2017, “Apple ‘set to buy huge company’ with Disney, Netflix and Tesla Motors possible targets,” The Irish News (http://www.irishnews.com/business/businessnews/2017/05/03/news/apple-set-to-buy-huge-company-with- disney-netflix-and-tesla-motors-possible-targets-1015819/)  ; Tiernan Ray, April 13, 2017, “Apple:  A $237B Bid for Disney Not a Bad Idea, Says RBC,” Barron’s (http://www.barrons.com/articles/apple-could-pay-157-sh-for-disney-or-237b-in-theory-says- rbc-1492088081 )  .}

^{[3] 3 https://www.sec.gov/Archives/edgar/data/320193/000162828016020309/a201610-k9242016.htm; according to its most recent disclosure, the tech giant has taken a charge of $31 billion for U.S. taxes on its foreign earnings.}

^{[4] https://www.jnj.com/media-center/press-releases/johnson-johnson-to-acquire-actelion.}

^{[5] https://www.qualcomm.com/news/releases/2016/10/27/qualcomm-acquire-nxp.}

^{[6] Two caveats here:  One, we do not purport to know what Apple executives will do strategically with the company’s offshore cash.  Two, especially with a now-recovered stock price, it is possible that Apple could pay for a large acquisition with its stock.}

^{[7] Lawler, Joseph, April 26, 2016, “Democrats seek international tax reform,” Washington Examiner (http://www.washingtonexaminer.com/democrats-seek-international-tax-reform/article/2589615).}

^{[8] http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf.}

^{[9] https://www.whitehouse.gov/the-press-office/2017/04/26/briefing-secretary-treasury-steven-mnuchin-and-director- national.}

^{[10] http://www.taxpolicycenter.org/publications/lessons-united-states-can-learn-other-countries-territorial-systems-taxing- income/full .}

^{[11] Melanie Zanona, March 24, 2017, “Lawmakers want infrastructure funded by offshore tax reform,” The Hill (http://thehill.com/policy/transportation/infrastructure/325555-lawmakers-want-infrastructure-funded-by-offshore-tax).}

^{[12] https://taxfoundation.org/details-and-analysis-2016-house-republican-tax-reform-plan and http://www.taxpolicycenter.org/publications/analysis-house-gop-tax-plan/full).}