Tuesday, June 11, 2013

Apple's Effective Federal Tax Rate is NOT 25% - it's likely less than 10%

Apple Computer was in the news recently as their CEO Tim Cook took some heat while testifying in front of Congress about the US Federal Corporate Income Tax.  The controversy around Apple revolves around how it is that Apple's "effective tax rate" is roughly just 25% when the US Federal Corporate Income Tax Rate is supposed to be 35%.  What I find shocking, is that Apple is able to get away with claiming they pay an "effective tax rate" of 25% when it is actually closer to 9.5%.

On pages 36-37 of Apple's 2012 Annual Report (SEC Form 10-K) the company states:

"The Company’s effective tax rates were approximately 25.2%, 24.2%, and 24.4% for 2012, 2011, and 2010, respectively. The Company’s effective rates for these periods differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S."
The second sentence above attempts to imply
that the lower "effective tax rate" is somehow due to the firm earning income in other countries that are taxed at much lower rates.  The company further attempts to explain its low "effective tax rate" on page 61 of Apple's annual report, where they go as far as to provide a table that seemingly reconciles how it is they don't pay 35% income taxes.  In this table, Apple actually includes State Income Taxes as part of their reconciliation.  Huh?

If Apple is going to provide a reconciliation that includes state income taxes, then they shouldn't be reconciling from 25% to 35% (the federal tax rate), they should be reconciling from 25% to 44% (to account for the 9% State Corporate Income Tax Rate in Apple's home state of California).

However, a quick peek into Apple's Annual Report shows that the 25.2% "effective tax rate" is complete mythology in the first place.  Apple touts this "effective tax rate" based on a calculation that utilizes something called "Provision" for income taxes.  On page 43 of Apple's Annual Report one will find the firm's "Consolidated Statement of Operations" commonly known as a company's Income Statement.  For fiscal year 2012 Apple reports:

Income before provision for income taxes = $55.7 billion
Provision for income taxes = $14.0 billion

Thus, the 25.2% rate is simply the calculation of 14.0 / 55.7 = 0.252 or 25.2%

However, "Provision" for income taxes is very different than income taxes "paid."  For you and me, the IRS (Internal Revenue Service or the US tax authority for my foreign readers) does not allow us to merely report a "provision" for income taxes do they?  No, the IRS actually requires us to pay our tax bill.  If you want to know how much income tax Apple actual "paid" one would need to look at Apple's Statements of Cash Flows on page 46 of the annual report.  On page 46 you will see that Apple did not pay $14.0 billion of income taxes but instead paid about half that or just $7.7 billion.

This $7.7 billion amount of income taxes "paid" would suggest an effective tax rate of just 13.8%.  But, we still need to whittle that down a bit.  Recall, that Apple is actually including State and Foreign income taxes paid in that figure and in all their false reconciliations to the 35% US Federal Corporate Income Tax Rate.  At this point, Apple really needs to provide a reconciliation for how they pay a total tax rate of just 13.8% versus a combined State and Federal income tax rate of 44%.  Now that would be a really helpful table.

To get a true rate for Apple's US Federal Corporate Taxes "paid" we need to subtract State and Foreign income taxes from the $7.7 billion.  Provision for State and Foreign income taxes can be found in Footnote #5 of the financial statements on page 61 of the annual report.  On page 61 you will see Apple's current provision for 2012 State Income taxes was $1.2 billion and Foreign Income Taxes was another $1.2 billion.  We can now estimate Apple "PAID" just $5.3 billion in US Federal Income Taxes in fiscal 2012 (7.7 - 1.2 -1.2 = 5.3).

Thus, Apple's true US Federal Income Tax Rate is only 9.5% ( 5.3 billion taxes / $55.7 billion income).

I'm hoping next year Apple will provide a reconciliation of how they paid just 9.5% US Federal Corporate Income Tax Rate versus the statutory rate of 35%.  If not, maybe someone in Congress will ask their CEO this question.  The answer to that question involves something called Transfer Pricing, Intellectual Property, and the country of Ireland, but I will save that for another blog.

You might be wondering if 2012 was an aberration?  Perhaps the GAAP (Generally Accepted Accounting Principles) accounting methods required by the SEC (Securities and Exchange Commission) in Apple's Form 10-K result in some sort of clumping of taxes paid from one year to the next?  So, I did the same analysis described above and discovered Apple actually "paid" an even lower rate in 2011.  In fact, if you bought an iPod, iPhone, or iPad in 2011, you likely paid a higher sales tax rate than Apple's income tax rate.

Apple Computer, Inc.

Stated Actual Estimated
Mythical Paid Real
Effective Total Federal
Year Tax Rate Tax Rate Tax Rate
2012 25.2% 13.8% 9.5%
2011 24.2% 9.8% 5.3%
2010 24.4% 14.5% 9.5%
2009 31.8% 24.8% 19.7%
2008 31.6% 14.2% 8.7%
2007 30.2% 17.2% 12.9%
2006 29.4% 6.9% 1.3%

And to think, not long ago, we were all upset that Mitt Romney's tax rate was just 14.1%. 

Note: Full disclosure, my effective Federal Income Tax Rate was 18.2% and North Carolina State Income tax was another 7.3% for a combined effective income tax rate PAID of 25.5%. (For my foreign readers, that does NOT include payroll taxes and retail sales taxes, among others).

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