Apple and Microsoft might be new poster children for tax reform

Published in The Hill

This month’s big news for tech addicts was the unveiling of the next generation iPhone 7. Apple hopes that, like earlier updates, this will be another success for its bottom line. However, no new success comes without a headache. For Apple, that may mean more money stashed overseas and the increased risk of facing the backlash of various tax authorities.

Several news stories this summer demonstrate what many of us already know to be true: Our outdated tax code is keeping much-needed investment money overseas instead of here in the United States.

First, just recently, the European Commission’s Competition Commissioner Margrethe Vestager levied a record tax bill on Apple. The commission accused Apple of owing up to 17 billion euros in reportedly illegal back taxes for revenue parked in Ireland. Ireland has Europe’s lowest corporate tax rate at 12.5 percent, in contrast with America’s 39 percent combined corporate tax rate.

Second, in a wide-ranging interview with The Washington Post last month, Apple CEO Tim Cook defended the company’s tax strategy, including the decision to keep money overseas. Apple is, of course, not alone in leaving money in more tax-friendly jurisdictions.

Third, software giant Microsoft made news in June when it agreed to purchase LinkedIn for $26.2 billion. The rub: Microsoft borrowed the money to complete the deal even though it has roughly $100 billion sitting outside the country, beyond the tax collector’s reach.

Before the chorus condemning both technology giants grows any louder, it’s worth examining why they made their respective decisions.

It’s true that Microsoft has more than enough cash to buy LinkedIn. But bringing back that money from overseas would trigger a hefty tax levy of 39 percent. Not only is that the highest combined corporate tax rate in the developed world, but the United States is also one of only six countries in the Organization for Economic Cooperation and Development (OECD) to tax corporate income earned overseas when it is repatriated.

The standard among our major competitors is to tax earnings only in the country in which they were earned — the so-called “territorial system.” Twenty-eight of 34 OECD countries have some form of territorial taxation.

That is reason enough for Microsoft to keep its foreign earnings overseas.

Also factoring into its decision is the added tax benefit of borrowing in the form of interest deductions. This not only decreases the company’s current year tax bill, but also future taxes for as long as Microsoft pays interest on the loan.

When these two factors are combined, it becomes clear that Microsoft and Apple made rational decisions. They chose a path that maximizes profits and benefits shareholders — exactly what a corporation is supposed to do.

That is not to say that there isn’t a lesson to be learned here about taxes. What might be best for a business is not always best for American tax revenues. Our country’s antiquated tax code prevents companies such as Microsoft and Apple from bringing home their overseas earnings and reinvesting here, which could boost tax revenues and create jobs in the long run.

Worse, the U.S. Treasury Department has proposed far-reaching new regulations under Section 385 of the Internal Revenue Code that would reclassify inter-company debt as equity, tax such transactions under the U.S. corporate tax rate and thereby penalize U.S. companies for daily business transactions. This development threatens to discourage much-needed foreign investment into the United States.

Given the drawbacks of our current system and renewed scrutiny American companies face overseas, the sensible move would be to reform the U.S. tax code to allow businesses to bring money home, spur investment and keep American companies in America. But such reforms seem unlikely in the current political climate. What is preventing the federal government from taking this crucial step?

There is broad bipartisan agreement that the tax code needs to be changed. President Obama’s annual budget has long recognized the problem and Congress has released multiple tax reform proposals that address either the full tax code or portions of it.

Unfortunately, the holdup is in the business community, which disagrees over the best path for reform. High-capital businesses value certain provisions — like the Section 199 deduction — in the tax code more than less capital-intensive businesses. And they have a valid case as there has been a significant shift in the U.S. economy from manufacturing to the service sector. For these businesses, reducing the corporate tax rate is preferred, even if it means cutting other tax provisions to finance lower overall rates.

In light of these competing business interests, it is important to strike the right balance for tax reform. And while we’re still some ways off from finding that balance, one thing is already certain: We should be attacking the antiquated tax code rather than companies like Microsoft and Apple who are doing their best to deal the hand they’ve been dealt.