Forbidden fruit

Thinking Aloud

There are unusual, even bizarre, aspects to the news that the European Commission has ordered Ireland to claw back €13 billion in back taxes from Apple. The figure represents the difference between Ireland’s standard corporation tax rate and the somewhat smaller figure paid by Apple over the past quarter-century.

First, the Irish Government has decided to appeal the decision. This must be a first – a country being awarded €13 billion against its will. But more seriously, the story – and the decisions around it – does have broader import, and perhaps some lasting investment implications.

It is hard to unravel the rights and wrongs of the Irish government’s actions in the case of Apple. Attracting profitable high-tech companies to locate on an island on the periphery of north-west Europe was a key ingredient that fed the young Celtic Tiger all those years ago. Equally importantly, keeping these sorts of companies in Ireland – creating and maintaining employment – was one way the Irish Government sought to get the older, now sickly tiger off the life support machine after the financial catastrophe of 2007/8. Ireland and the Irish went through hell in that period as wages fell, house prices halved, and emigration spiralled. No doubt, in such an unhealthy climate, mollifying the employer of 5,000 Irish men and women seemed a rather noble aim.

Ireland’s ’competitive’ attitude to corporate taxation has been a constant source of irritation to its European brethren. Undeniably, though, it has been a successful policy, attracting inward investment from far and away. Some might see it as ironic that it is the EU’s Competition Commission kicking up a fuss about this policy. Arguably, Ireland’s methods represent an example of the type of competition that might help navigate a route out of the current Europe-wide economic torpor.

Tax – and the imaginative strategies that companies exploit to avoid paying it – has risen up the political agenda in recent years

From a more broadly European perspective, tax – and the imaginative strategies that companies exploit to avoid paying it – has risen up the political agenda in recent years. Starbucks gained notoriety in the UK earlier this year after it emerged that despite the millions of lattes bought from its ubiquitous coffee shops by Brits in need of a pick-me-up, it failed to sell enough to necessitate the payment of any corporation tax. The rationale for the low profitability was that the UK division had made payments to a Dutch subsidiary for image rights and made premium purchases from a Swiss subsidiary for coffee beans. Unsurprisingly, this explanation did not generate much sympathy from the Great British public. In the end the company “volunteered” to pay £20 million to the UK Exchequer.

So the notion of a ’fair’ rate of tax has now further entered the political (and indeed economic) lexicon. This rate may be unrelated to either a company’s profitability or the tax code of the country in which it operates. It is also far from clear who decides a ’fair’ rate. In Starbucks’ case it was, I suspect, its customers who drove the company to action. Elsewhere, the media, the church and even the very politicians who author the tax code have driven companies to greater largesse to the Exchequer than that code requires.

As a young equity analyst, I was trained to be sceptical of tax charges in company reports that seemed unreasonably low. I was taught to either treat these earnings as lower quality and hence apply a lower valuation multiple, or ’fade’ the tax charge up to a normal level in one’s forecast. Essentially, the guiding principle was: “If it looks too good to be true, it probably is too good to be true.”

The pressure on corporate taxes is upwards, as Ireland has just found out. As an older (and, I hope, wiser) analyst – I believe my teacher’s advice is thus even more relevant today.

By Richard Dunbar Senior Investment Strategist, Investment Solutions at Aberdeen Asset Managers Limited.  This article originally appeared on the Aberdeen Assest Management ‘Thinking Aloud’ blog on 8th September 2016