Tech regulatory and tax threats are overstated

The global tech sector has been one of the main beneficiaries of the COVID-19 pandemic, supported by the shift to a “stay-at-home” economy and lower rates. This year, rising rates and the prospect of economic reopening driven by vaccination programs have added to volatility in tech stocks. The sector must now also contend with the prospect of tighter regulation and the potential for higher taxes.

China’s regulators this week imposed a record USD 2.75bn fine on Alibaba for anti-competitive behavior. News reports also suggested that more than 100 small Chinese tech start-ups have suspended plans to list their stocks on concerns they may draw regulatory scrutiny similar to Alibaba’s stalled IPO. Meanwhile, Apple has agreed to testify before the US Senate on anti-trust and competition issues related to mobile app stores, days after receiving criticism for refusing to appear before the Senate Judiciary panel. Google has already agreed previously to testify at the hearings.

Meanwhile, President Joe Biden has proposed increasing the US corporate tax rate from 21% to 28% and the tax on global intangible low-taxed income (GILTI) from 10.5% to 21%. Separately, the US administration, through Treasury Secretary Janet Yellen, is pushing for a global minimum corporate tax rate.

Pressure for greater scrutiny and taxation of big tech companies is likely to continue, but it is important not to overstate the likely impact on the sector.

• Regulators don’t want to stifle their countries’ chances in the global tech race. In our view, the authorities don’t want to curb progress, innovation and development. The global tech race is increasingly bipolar, with the US and China competing to lead the digital world. China has stressed in its Five-Year Plan that it wants to become self-sufficient in technology against the backdrop of US-China tensions. Meanwhile, part of President Biden’s USD 2.25tr infrastructure plan focuses on bolstering US competitiveness against China, with USD 50bn earmarked for domestic semiconductor manufacturing, new funds for research and development, and billions of dollars to upgrade high-speed broadband infrastructure.
• Regulatory action has its own constraints. In 2017, China established a centralized online payment clearing platform to level the playing field for smaller competitors. Four years later, the two incumbents still dominate the market and we remain skeptical that regulatory action alone can shift users or institutions away from the dominant platforms. In the US the 16-month-long House antitrust investigation into the big four tech firms which ended last October stopped short of any radical solutions, such as company break-ups.
• Global agreement on minimum tax is a long way off. Depending on how it was constructed, a global minimum corporate tax rate could impact mega-cap tech firms. For example, both Google and Apple take advantage of the low tax regime offered by Ireland. But negotiations, which would have to take place through the OECD, have not yet started. It would be a very long process, and they are not guaranteed to succeed.
• Biden’s proposals will have a limited impact on corporate earnings. In the US, domestic companies would be hit by the higher domestic rate, but more multinational corporates would be hit by the GILTI increase. But overall, with a compromise 25% corporate tax rate already under discussion, the hit to company profits would not be large. In our base case we assume a domestic tax rate of 25% that would lead to a 4% reduction in 2022 earnings. This is already incorporated into our forecast for 13% earnings-per-share growth for next year.

So, while tax and regulatory headlines could continue to add to near-term volatility for the tech sector, we believe the structural growth story remains solid and investors should use volatility to add long-term exposures. Over the medium term, clarity over anti-trust regulations should help stabilize sentiment. Investors can also consider areas less sensitive to regulatory action such as the digital subscription economy. Read more here on positioning for structural growth.

Mark Haefele

UBS AG