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One of the ways in which companies are developed in this new global economy today is through the activities of mergers and acquisitions. The main reasons behind these activities are because the complementarily of organizations helps in improving their financial positions, develop new business opportunities, enable in entering new markets and also increases the competitive advantage. However, it is important to note that the success of any acquisition heavily depends on the ability of the acquirer to be able to manage the acquired company effectively after the completion of the transaction (Cartwright & Cooper, 2012). In addition, after the acquisition it is always challenging to select the right alliance partner for the acquired firm. Some of the main reasons why the creation of strategic alliances is vital is that the expected future benefits may include access to certain technology and markets, sharing of resources and costs, reducing political and financial risk, increasing competitive advantage and reducing competition.
In May 2011, Microsoft announced its acquisition of Skype in an all-cash deal worth $8.5 billion. Microsoft is among the largest American multinational corporations which is a global leader in software, internet, and service technologies for servers, personal and PC computers. The company sells its products in over 70 countries which are translated in over 40 languages with compatibility with most of the platforms in the PC (Cartwright & Cooper, 2012). The acquisition of Skype was one of the largest purchases on the internet and phone service history. Skype is a free software company that provides both voice and video communication with more than 600 million users globally (Cartwright & Cooper, 2012). One of the major benefits that Microsoft gained from this acquisition is that it led to a reduction in the cost of investing and building IP telephony. In addition, it led to an increase in competitive advantage in innovation in the business world of IT. This paper, therefore, seeks to answer the discussion questions that arise from Microsoft’s acquisition of Skype case that offers a deeper insight into the case study.
Case Discussion Questions
Microsoft financed the acquisition of Skype using cash that was held in offshore accounts in foreign subsidiaries that were located in nations that had lower rates of corporate tax such as Singapore, Bermuda, and Ireland. In its annual report for the 2010 financial year, the company reported that it had $ 29.5 billion in “permanently reinvested earnings” that were located outside the US (Bright, 2011). It is important to note that under the law of the US, the company was not entitled to pay taxes on these earnings until when they are repatriated to the US. Therefore, the shareholders of Microsoft would stand to benefit by using cash held overseas since it would attract low or no tax rates. It is important to note that at the end of the first quarter, the company had $50 billion in cash overall, with eye-opening of $42billion that was held in total in foreign countries (Bright, 2011). Therefore, due to the stiff burden of the tax, the company would have encountered in trying to bring this money back to the US, the options of the company were minimal and limited. Therefore, the company had to make acquisitions using overseas cash, grow the business offshore, absorb the huge hit on tax, or hope that the Congress allows for a tax holiday on money that is repatriated and also hope the political climate shifts. However, one of the options that the company could not do is to use this cash for stock repurchases or dividends.
Therefore, from the above analysis, it is evident that one of the major benefit that Microsoft’s shareholders had for using overseas cash to acquire Skype in that it was efficient in terms of tax payment. However, Microsoft was not the only organization that was involved in the deal that reaped the benefits of the tax. Skype also which is based in Luxembourg, which is a country whose corporate tax is 0.4 percent also stood to benefit. Therefore, the company could be able to use some of $42 billion in overseas productively. Additionally, at the time of the acquisition, Silver Lake firm which is a US-based firm owned 39% of Skype (Bright, 2011). In addition, two of the three entities of Silver Lake that owned Skype were based in Caribbean tax heavens, which is also another crucial benefit. Silver Lake also stands to gain from the deal since it will not be paying much in the US due to the capital gain tax on profits that are made from Skype. Therefore, although the price tag of Skype, on the surfaces seems too high but the use of the overseas cash softened the blow of the high valuation. The shareholder of Microsoft stands to benefit from this deal since the company will be able to monetize Skype which has a huge base of users. Therefore, despite the company paying $8.5 billion in cash for Skype, the cash hoard of Microsoft has continued to grow over the years (Edwards et al., 2016).
One of the underreported fact about the deal between Microsoft and Skype is that it was structured by Microsoft in such a way that will keep the taxes at the lowest amount possible. The two companies saved billions of dollars in taxes since Microsoft effected the deal by using foreign profits to purchase Skype. In addition, it happens that Skype had based its headquarters in Luxembourg, which is a major tax haven location (Edwards et al., 2016). Through this deal, Microsoft was able to avoid payment of taxes on their profits where the U.S corporate income tax is 35 percent. This enabled Microsoft to have an effective tax rate of only 4 percent on foreign earnings that were retained overseas (Bright, 2011). This low effective tax rate was made possible due to the fact that although the US corporate tax rate was 35 percent, Microsoft indicated that it would be reduced to 31 percent due to foreign tax credits. This, in turn, implied that Microsoft who have to pay just 4 percent on earnings retained earnings, which was nine times lower the top rate in the US. Therefore, by acquiring Skype using foreign cash, it would be tax-efficient.
In the case study, the 2010 annual report of Microsoft indicated that it had $ 29.5 billion in overseas earnings. In the case, Microsoft notes that repatriating cost of these earnings to the US would cost them an estimate of $9.2 billion. Therefore, the $9.2 billion would have amounted to the 31 percent rate. The missing 4 percent is the foreign tax credits that the company would have paid overseas (Bright, 2011). Therefore, this indicates that Microsoft’s corporate income tax for the profits made overseas is 4 percent paltry which is almost nine times lower compared to the corporate income tax in the US. In addition to this fact, Microsoft is unsurprisingly part of the company’s coalitions that are advocating and requesting tax holiday repatriation. This, in turn, would allow the company to bring back money to the US that they have stashed offshore with tax rates that are dramatically low. Other companies involved in the acquisition such as Skype also will get a sweet deal with the overseas profits. It is clear that one of the groups that do not benefit from this deal are the US taxpayers who will have to watch multinational corporations exploit the set tax codes and tax havens that help them avoid to pay taxes in the country (Edwards et al., 2016).
In the recent reports, it is estimated that over $2.6 trillion in profits for American Corporates is idling in overseas bank accounts with half of it, is in cash. This figure is a remarkably large amount of money that is idling outside the borders of the US to avoid the 35% tax rates on the profits that are earned in other countries (Zenner et al., 2016). It is important to note that this tax is not due until the money has come back to the US. This is the reason why big corporations such as Google, General Electric, Apple and Microsoft are leaving large amounts of cash overseas. This money has also prevented the establishment of new plants or technology in the US. Therefore, the main reason why Microsoft has continued to hold so much money overseas rather than returning it to the US is due to three motives; tax, transaction and the agency motive (Zenner et al., 2016. As pointed above, the main motive is tax since Microsoft seeks to avoid the 35 percent tax charged on all profits gained overseas.
It is estimated that both General Electric and Microsoft have each over $ 100 billion in abroad accounts. However, there is an opportunity cost for holding these huge amounts of money in foreign countries. For instance, there is pessimism or negativity over the impact of repatriation of cash due to different reasons. For example, the last deal led to corporations using a lot of cash to reward their shareholders with stock buybacks and dividends (De Simone et al., 2017). According to the latest Federal Reserve Data, although most companies have held their money overseas, the companies also still hold over $ 1.94 trillion domestically in cash. Therefore, there is a large amount of money lying idle around the country, with money markets that are zero-yielding with investor cash and storing in banks in excess reserves. Therefore, before encouraging any repatriation of cash, it is important to weigh how much productive investment the cash will bring home to avoid distorting the economy with too much cash (De Simone et al., 2017). The figure below indicates the amount of billions that is hoard overseas by different American companies.
There are various potential benefits that might accrue to the shareholders of Microsoft if they decided to return some of the cash to the US. It is important to note that the repatriated cash would most likely benefit the shareholders since it will be distributed in the form of special dividends and share buybacks instead of in the form of investment in equipment and factories (De Simone et al., 2017). Therefore, if the offshore cash of Microsoft is suddenly repatriated without tax, it would most likely be returned to the company’s shareholders. Economists argue that returning this cash to the shareholders would be better for the economy and investors than if the company attempt to invest billions of dollar rapidly in new equipment and plants. Although this might harm the economy, it is healthier to bring money back home rather than let it sit idle in the overseas.
As part of good governance, companies such as Microsoft should seek to minimize their liability on tax through tax planning. Companies should make use of the most mechanisms and tool which the government makes available to them specifically for various purposes such as rebates, exemptions, allowances, and deductions (Zenner et al., 2016). Although tax avoidance is legitimate and legal in the US, most companies have used this as a means for tax advantage. For example companies like Microsoft are using the overseas tax havens to avoid paying taxes. It is important to note, unlike tax evasion, avoiding tax and also bending the system of tax rules is not illegal. Most companies like Microsoft are operating within the set rules but not within the spirit of the law. In my view, it is unethical for Microsoft and other multinational corporations to continue holding their money overseas since in my view tax should be part of a company’s social responsibility. Tax avoidance by the multinational corporations has made the government cut its spending which in turn has a real impact on the lives of many people (Zenner et al., 2016). Therefore, when Microsoft avoids paying tax, it is like avoiding its social obligation. In my view, the practice of holding money overseas does not serve in the best interest of the company’s shareholders since it exposes the company to accusations of selfishness and greed, destroys its public trust and damages the company’s reputation. Therefore, tax avoidance is an unethical and immoral practice that undermines and weakens the integrity of the country’s tax system.
In conclusion, it is evident from the case study that the acquisition of Skype by Microsoft will bring along a lot of benefits. For instance, Microsoft was able to acquire voice and video conferencing capabilities that favored the development and increase the popularity of many programs of Microsoft. The deal also proved to be beneficial and tax-efficient since all the parties involved gained from the tax havens. The involvement of Microsoft helped in inheriting and forming new strategic alliances that enabled the creation of new services, increase in customer base, prevention of competition from major rivals and expansion into new global markets.
- Bright, P. (2011). Microsoft Buys Skype for $8.5 Billion. Why, Exactly? Retrieved April, 12, 2015.
- Cartwright, S., & Cooper, C. L. (2012). Managing mergers acquisitions and strategic alliances. Routledge.
- De Simone, L., Piotroski, J. D., & Tomy, R. E. (2017). Repatriation taxes and foreign cash holdings: The impact of anticipated tax policy (No. 3507).
- Edwards, A., Kravet, T., & Wilson, R. (2016). Trapped cash and the profitability of foreign acquisitions. Contemporary Accounting Research, 33(1), 44-77.
- Zenner, M., Junek, E., & Chivukula, R. (2016). Are US Companies Really Holding That Much Cash—And If So, Why? Journal of Applied Corporate Finance, 28(1), 95-103.
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