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As China Becomes The iPhone’s Largest Market Look For Apple’s Tax Charge To Rise


sagsdgfgsgaThe general assumption is that Apple AAPL +0.95% is going to have a smashing quarter to report tomorrow and also that China will overtake the US as the largest market for the iPhone. Both of these could be true. But there’s an interesting little implication of that second, that China is becoming a larger market for Apple. Which is that we may well see Apple’s foreign tax bill rise as a result. In recent years that bill has been as small as 2% of profits declared and my opinion is that it’s unlikely that they’ll be able to continue that. The reason being that while Apple are very good indeed at organising matters so that profits end up being booked in offshore locations it’s a great deal more difficult to do that if you’re manufacturing and selling in the same one tax and legal jurisdiction. I do not mean to be categorical about this: but it is much more difficult. Thus I’d expect to see, along with the importance of China as a market, a rise in the tax bill.

The results for the quarter are expected to be pretty darn good:

According to different estimates and consensus Apple Inc. (NASDAQ:AAPL) should be able to bring in sales worth $68.3 billion in the first quarter of its fiscal year 2015; this would be a 21% up on the year-over-year basis. This figure was gathered by a consensus by 35 analysts both amateurs and professionals; whereas Credit Sussie predicts that Apple Inc. (NASDAQ:AAPL) will post figures of $72.8 billion in revenue with earnings of $2.97.

It’s the Financial Times which reports the increasing importance of China:

Tim Cook, chief executive, had said in 2013 that he expected China to eventually overtake the US as Apple’s single largest source of revenue. The iPhone already accounts for more than half of Apple’s total sales and an even larger share of its profits.

Analysts at UBS estimate that China accounted for 36 per cent of iPhone shipments in the most recent quarter, compared with 24 per cent for the US. During the same period last year, 29 per cent of units were sold in the US and 22 per cent were in China, UBS said.

Here’s the basic economic flows within Apple. It’s easiest to think of it as two separate structures really, there’s Apple N America and then Apple everywhere else. Please note, this isn’t an organisational structure, a management one or even a legal one. But it is a rough approximation of the economic one. Each of them organises the purchase of all the pieces that go into making the company’s various machines, iPads, iPhones, Macs and so on (this may well be the same unit doing both but again, we’re talking about economic flows here). These then go to China, get assembled and shipped off to the various markets where they are sold.

Apple N America then reports to the IRS how much it spent on all those components, how much it received in sales revenue, the profits it made and then pays the corporate income tax due on those profits. Simple and Tim Cook has made it very clear that Apple just does do this, play it straight by the book, with its N American sales. This is what makes it, by some counts, the largest payer of the US corporate income tax.

Apple everywhere else is a little different. It’s a company in Ireland that does this. This company then sells that complete kit to the various national companies that retail it. Apple UK, Apple DE and so on. But it does this at quite high prices. Those local Apple subsidiaries never make more than a token profit. All of the real profit is in Eire, where in a series of complex transactions (that Double Irish and Dutch Sandwich stuff) it becomes royalties for the brand and the tech and ends up near entirely untaxed in Bermuda. Where, because it is not taken into the US, it is not subject to the US corporate income tax.

People can and do mutter about whether this is all quite fair but there’s no doubt that it’s currently all entirely legal (the EU’s recent declaration about this was on a trivial point involving a minor amount of money and doesn’t change the basic situation). However, it’s really very difficult indeed to do this trick if you’re manufacturing and also selling in the same tax jurisdiction.

It’s easy enough to avoid the UK or German tax systems as all that happens there is the retail part of the process. So, you import iKit at some price and that’s just the price it is imported at. However, in China, the Chinese authorities are seeing the true value of all of those components. Either because they’re of Chinese manufacture (the cheaper stuff) of because they can see the import manifestos (for the more expensive items like the processing chips, screens and so on). So the Chinese tax authorities are seeing all of the information necessary to know what Apple’s real gross margins are.

Sure, Apple’s allowed to charge a royalty for the brand, for the technology, just like they do elsewhere. But they’re not going to be allowed to claim that entire net margin as such, not when there’s a tax authority that does get to see all of the numbers. The end result of this is that, in my opinion at least, we’re likely to see Apple’s foreign tax rate paid creep up as China becomes an ever more important part of their market. Simply because they will be, more and more, both assembling and also selling in that same one tax jurisdiction.

My latest book is “23 Things We Are Telling You About Capitalism” At Amazon or Amazon UK. A critical (highly critical) re-appraisal of Ha Joon Chang’s “23 Things They Don’t Tell You About Capitalism”.

Culled From Forbes