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Sprint's Tax Problems And Investment Risk

Stephen D. Simpson, CFA

Just in the wake of the due date for American individual tax returns for 2011, Wall Street is still processing the news that came out April 19 that Sprint is under fire in New York for alleged tax fraud. What makes the Sprint case unusual is how rarely corporations are publicly prosecuted for tax fraud, but it should serve as an invaluable reminder of just how convoluted the corporate tax world can be.

SEE: How To Report A Tax Cheat

The Accusations Against Sprint
Sprint has been accused and sued by the New York State Attorney General for at least $300 million in a case that alleges that Sprint fraudulently failed to collect and remit sales taxes to the state of New York on flat-rate access charges for certain wireless plans.

In essence, then, this is a sales tax case. Sprint has denied the allegations and claimed that the company has paid the taxes it owes; the debate seems to center around a portion of the taxes that the company treated as non-taxable and withheld. Others, however, claim that Sprint withheld these taxes as a means of competing on price with rivals Verizon Wireless (co-owned by Verizon and AT&T).

Where Are the Other Stories?
What's a little remarkable is how relatively few high-profile corporate tax fraud prosecutions there have been. It takes almost no effort to find recent examples of celebrity tax fraud cases (Wesley Snipes perhaps being the most serious, but Leona Helmsley certainly merits mention), but corporate cases are less common. Deutsche Bank had some issues in recent years, and Cisco has been accused in some overseas matters, but more often than not corporate tax fraud cases involve an individual attempting to mask their own shady individual dealings.

In fact, most investors have to look to the developing world to find any extensive catalog of tax fraud accusations. While not necessarily common, more than a few countries have seized assets from foreign companies (most especially mining and petroleum companies) under the guise of tax fraud when those companies refused to surrender ownership of assets in the country. Suffice it to say, these moves often reek of underhanded dealings.

Still Plenty of Controversy
Certainly there is no shortage of outrage and debate about whether corporations pay their fair share in taxes. The issue of corporate tax rates has become a talking point again in the latest American political season, as many companies pay effective tax rates that are well below many individual income tax rates.

Moreover, many large companies like Apple are amassing large cash balances overseas that they do not wish to repatriate to America because of the large tax bill they would owe. Along similar lines, many major companies (including Exxon Mobil and General Electric) have come under fire for low effective tax rates that are often the byproduct of a bewildering array of offsets, credits and deductions that come with multinational operations.

While these low effective tax rates often offend the sensibility of those who claim to want a fair playing field for all, they don't meet the standard of fraud. The fact is that tax law is incredibly complicated and corporations pay accountants and lawyers to find and implement the most advantageous and tax-efficient strategies permitted by law. The Internal Revenue Service doesn't always agree and will take companies to court (sometimes winning penalties and interest), but this still doesn't meet the standard for fraud. Simply put, nobody wants to pay more taxes than necessary and investors rightly expect companies to manage their tax obligations as efficiently as possible.

SEE: The Impact Of U.S. Corporate Taxation On Investment Decisions And CFC Transfer Pricing

Sales Tax Is a New Battleground
There have been plenty of battles in years past over the tax treatment of depreciation, options and leases and there is now more or less established case law on how those rules work. More recently, many states have opened a new battle line over the issue of sales tax. As the Sprint case shows, though, even sales tax can be a more complicated issue.

Sales tax law is actually more complicated than many people realize, as most states require shoppers to pay a "use tax" on items they buy from out of state (as in the case of online purchases). Likewise, companies with physical operations within a state are generally required to charge sales tax to shoppers in those states.

As online shopping becomes more significant, an increasing number of states are trying to find ways to compel retailers to collect and remit sales tax for purchases made by residents of their respective states. While this matter is fairly cut-and-dried in cases of retailers like Best Buy with extensive nationwide store networks, it's becoming increasingly complicated and contentious for companies like Amazon and eBay.

With sales tax rates climbing, this debate is not likely to vanish. Finding legal ways to avoid sales tax can effectively allow a company to charge 13% less for a good or service depending upon the state, and customers will certainly direct their business for marginal savings like these. In the case of online retailers, then, investors may be looking at a less competitive Amazon in future years if the company has to start collecting and remitting sales tax.

SEE: "Temporary" Taxes That Stuck

The Bottom Line
Although $300 million is not a trifling sum, the New York case is likely to be significant to Sprint only if other states review the issue and decide to pursue similar charges against the company. Frankly, Sprint has bigger worries, including its ability to fund its next-gen needs and compete effectively with Verizon Wireless and AT&T.

More interesting, though, is the wider issue of corporate taxation. Right now companies are highly incentivized to minimize their tax bill, but the process is murky to say the least. While investors can usually get a rather thorough discussion of the cost of goods sold or sales and marketing expenses, taxes represent 30% or more of corporate earnings, but investors can scarcely "play along at home" because of the complexities that go into the calculations. That, then, is something for investors to consider and remember as a risk factor in their stock holdings.

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