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S&P 500 IT sector's effective tax rates drop since 2017 tax reform

Effective tax rates for companies in the S&P 500 information technology sector have dropped in the last two years since tax reforms passed in 2017, internally compiled data showed.

The legislation dropped the statutory corporate tax rate, the percentage set by federal law that designates how much of a company's income is taxable, to 21% from 35%. Effective tax rates, or the rate companies actually pay in taxes after taking tax breaks into account, can vary from the statutory rate. Since the tax reform was enacted, the median effective tax rates for information technology companies in the S&P 500 index dropped from 21.1% in the first quarter of 2017 to 15.5% in the same period of 2019.

Companies such as Adobe Inc., Arista Networks Inc. and Fortinet Inc. had lower effective tax rates in the first quarter of 2019 than the median 15.5%. These companies generally reported lower taxes on foreign earnings as a reason for their low effective tax rates. Those with a significantly higher effective tax rate, such as Symantec Corp. and Juniper Networks Inc., generally cited one-time effects, including changes in the tax code or unrecognized tax benefits, as the reason for the rate.

The reform also altered the policy for taxing U.S. multinationals' foreign-held funds. Previously, a 35% tax had been placed on repatriated cash with a tax credit for foreign income taxes, and foreign-held funds would only be taxed if and when companies opted to repatriate them.

As a result, many firms left their cash overseas. Tech companies including Alphabet Inc. and Intel Corp. held over 50% of their cash overseas. Others, like Apple Inc. and Microsoft Corp., had more than 90% of their cash assets in foreign holdings.

The 2017 legislation shifted the U.S. tax statute toward a territorial system, removing the 35% tax on repatriated dividends and instituting a one-time repatriation tax on previously accrued foreign-held funds. The one-time tax charges 10.5% on cash and 8% on noncash assets, payable over an 8-year period.

The peak median effective tax rate of 52.9% that occurred in the fourth quarter of 2017 largely resulted from companies opting to repatriate accumulated earnings of foreign subsidiaries and therefore incurring the one-time repatriation tax.

Even prior to the tax reform's passage, tech companies had plenty of cash to spend. Corporate cash hit an all-time high in the third quarter of 2017, just before the tax code change. With the new statutes in place, some had expected expenditures to rise with corporate earnings. However, that has not been the case.

"Companies took in a lot more money, but they did not spend proportionately that much more," said Howard Silverblatt, a senior industry analyst at S&P Global Dow Jones Indices. "There's the potential for spending, but the economy is still uncertain."

Instead, the tech industry has turned to issuing shareholder returns with repatriated cash and tax savings, outspending any other industry in share repurchases. Apple, specifically, has made a push to buy back shares from its shareholders since its foreign-held funds were repatriated. The company, which held $246 billion of its cash overseas before the tax reform passed, delivered over $27 billion in shareholder returns in the first quarter of 2019, compared to over $10 billion in the same period of 2017. Microsoft, which held $127.9 billion of its cash overseas before the tax code change, similarly jumped in shareholder returns, moving from $4.6 billion in returns in the March quarter of 2017 to $7.4 billion in the March quarter of 2019.

While not all businesses that had held cash overseas have made the same buyback efforts as Apple, Jarrad Harford, a finance professor at the University of Washington who has studied corporate cash, said there is a "slow change" toward deploying more cash among U.S. tech companies.

Looking forward, Harford expects tech companies to continue this trend and hold onto less cash because there is no longer a tax on repatriating foreign funds.

"The repatriation tax created this bizarre distortion in the way companies could use their internal resources," Harford said. "Now that that distortion is gone, I would expect to see— and I think Apple has been clear about this, as well— lower targeted cash holdings."

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