MarketWatch First Take: Microsoft rides huge tax benefit from failing at smartphones to big earnings beat
Microsoft Corp. beat Wall Street’s earnings estimates by a wide margin in its biggest quarter of the year, and it has a huge failure to thank for it.
On Thursday, Microsoft reported a better-than-expected fiscal fourth quarter, thanks mostly to a $ 1.8 billion tax write-down from Microsoft’s MSFT, +0.49% money-losing Windows Phone business. This gain added 23 cents a share to earnings, boosting Microsoft’s non-GAAP earnings per share to 98 cents a share, while analysts were looking for an average of 71 cents a share, according to FactSet.
That is not to say that Microsoft’s business was off, mostly because it has been able to latch onto the cloud after missing on smartphones. The company revealed substantial revenue growth of 21% in the segment that includes its cloud software, such as its Office 365 and Dynamics 365 businesses, as well as $ 1.1 billion of revenue from LinkedIn. Microsoft saw 11% sales growth in its cloud-infrastructure business, as its Azure cloud-computing business nearly doubled yet again, growing 97%.
While Microsoft’s cloud gains pushed the company to a slight beat, it was the big tax benefit that pushed it to profits that were 38% higher than analysts expected. And Microsoft is not alone; in fact, it is the second tech giant this week to ride this type of big tax benefit to an earnings beat. IBM Corp. IBM, +0.09% beat Wall Street estimates Tuesday because of a tax benefit that added 18 cents a share to its earnings.
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IBM was not rewarded Wednesday after its earnings beat, but Microsoft’s results led shares to rise in late trading from prices that were already at record highs. The stock has gained 13.3% in the past three months and 32.8% in the past year as Chief Executive Satya Nadella’s cloud focus has taken hold, while the S&P 500 index SPX, -0.02% has increased 5% and 13.8% in those periods.
Microsoft and IBM are instructive as President Donald Trump promises to lower the overall corporate tax rate while complaining about the costs of operating in the U.S. The actual tax rates that many companies actually pay, especially tech giants in the U.S. that make creative use of segment losses and other creative loopholes, are much lower than the 35% rate that CEOs and politicians decry.
The standard U.S. corporate tax rate is one of the highest in the world, but most companies don’t pay near that rate thanks to write-offs, loopholes and more. A report in April by the Center on Budget and Policy Priorities, a nonpartisan research and policy institute in Washington, concluded that the average corporate tax rate on profits from new investments made in the U.S. is 24% and the share of world-wide profits that U.S. multinational firms pay in U.S. and foreign income taxes is about 28%.
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Microsoft said that its effective tax rate in the 2018 fiscal year was 8% and 14% in GAAP and non-GAAP terms, and it forecast a tax rate of approximately 19% and 20%, respectively, for fiscal 2018. IBM, meanwhile, had a negative effective tax rate in the first six months of 2017.
Credit Suisse analyst Kulbinder Garcha noted in a report earlier this week that IBM’s tax rate had helped the company’s earnings materially on average about 7% over the last three years, and called the tax gains unsustainable. The company’s first quarter 2017 negative tax rate was helped by booking intracompany asset transfers, which were one-time in nature.
Trump has promised to get rid of some loopholes and create a more straightforward system in his tax-reform effort, even though he is believed to have taken advantage of similar rules himself. Until and unless the U.S. tax system changes, companies will be able to continue capitalizing on their failures and using other tricks to boost their profits well beyond what is expected.