As you probably know, about two-thirds of the $145 billion in cash on Apple’s books is held in overseas subsidiaries, and Apple would have to pay U.S. income tax if it used that money in the United States. So instead of bringing back money from overseas to pay for its stepped-up stock buybacks and higher cash dividend, Apple will borrow money instead.
It’s a perfect tax arbitrage. Let’s say Apple borrows money at an interest rate of 3 percent a year (which is more than it would probably pay), and uses it to buy back stock at the current price of about $410 a share. Each share that Apple buys back will reduce its annual dividend obligation by $12.20 a share, at the company’s current dividend rate. The interest on the borrowed money would be $12.30 a share — about the same as the dividend. But interest is tax-deductible, and dividends aren’t.
At a 35 percent tax rate, the borrowed money would cost Apple $8 after taxes for each share it bought back. That’s significantly less than the $12.20 after-tax cost of its $12.20 dividend. At a 25 percent tax rate, the borrowing would cost $9.23 after taxes—but that’s still less than $12.20. So lowering the tax rate to 25 percent from 35 percent doesn’t remove Apple’s incentive to play the deduct-interest-to-retire-stock tax game. It would be less lucrative than it is at 35 percent — but it’s still lucrative. And, by the way, the borrowing-to-buy-back maneuver would not only reduce Apple’s taxes but also increase its earnings per share.
With tax rates at 35 percent, it’s considerably cheaper for Apple to borrow money in the United States than it would be for it to repatriate cash held in foreign subsidiaries. But even if the tax rate were only 25 percent, it would still be cheaper for it to borrow than to repatriate.
Besides, history shows that lowering the corporate tax rate doesn’t reduce companies’ desire to play games. The 1986 tax reform act reduced the corporate rate to 34 percent from the previous 46 percent. So what happened? After a brief period, probably measured in nanoseconds, companies began trying to get around the 34 percent (now 35 percent) rate the same way they had tried to get around the 46 percent rate.
Reuters published a wonderful series last year detailing the efforts by European subsidiaries of such U.S. multinationals as Starbucks, Amazon and eBay to move taxable income out of countries such as England, Germany and France, which have corporate rates in the mid-20s, to places such as Luxembourg, where rates are considerably lower.
These games are familiar to those of us who follow U.S. tax policy, such as it is. You set up a subsidiary in a low-tax area that owns “intellectual property,” and that collects royalties that subsidiaries in higher-tax areas get to deduct. You have all sorts of intra-corporate loans, with tax-deductible interest paid in higher-tax areas and collected in low-tax and no-tax areas. And on and on and on. Except that instead of moving income from the United States to low-tax countries, you move income from higher-tax European countries to lower-tax European countries.
The bottom line: Even if Washington’s gridlock is broken long enough to cut the corporate rate to 25 percent, there will always be a Luxembourg or a Cayman Islands or some other low-tax Shangri-La that will offer rates low enough to keep tax lawyers gainfully employed. You can take it to the bank. An offshore bank, of course.
Sloan is Fortune magazine’s senior editor at large.