Infosys has announced an Advanced Pricing Agreement (APA) with the US Internal Revenue Service (IRS), under which both companies have agreed on a methodology to allocate revenues and compute taxable income of the company’s US operations.
Infosys has announced an Advanced Pricing Agreement (APA) with the US Internal Revenue Service (IRS), under which both companies have agreed on a methodology to allocate revenues and compute taxable income of the company’s US operations. The agreement covers a 10-year period from FY11-21. Infosys will reverse tax provisions of $225 million that were made in the previous period and are no longer required. This is the P&L impact and will be seen in 3QFY18 earnings, driving EPS higher by Rs 6.7 (10.4% on FY18E base). Infosys is expected to pay out $233 million due to the differences in payable taxes for the prior period and actual taxes paid. This is the cash flow impact that will play out over the next few quarters (exact period not specified).
Infosys’s overall effective tax rate is expected to decline by 100 bp up till FY21 as a consequence of the agreement. This drives a marginal upgrade of 1.4% to our future earnings estimates. An advance pricing agreement (APA) is an ahead-of-time agreement between a taxpayer and a tax authority on an appropriate transfer pricing methodology (TPM) for a set of transactions at issue over a fixed period of time. It allows the taxpayer and the tax authority to avoid future transfer pricing disputes by entering into a prospective agreement. For most taxpayers, certainty regarding their transfer prices is the single-most important benefit gained through the APA process. Transfer pricing examinations are often time-consuming and expensive.
The APA process generally takes substantially less time to complete than a transfer pricing examination followed by a dispute resolution mechanism, which can easily last three to four years. For Infosys, we expect dollar revenue CAGR of 8% and EPS CAGR of 7.1% over FY17-20E. Lower earnings CAGR is a function of a 90 bp decline in profitability and slight strengthening of the rupee. However, we do not expect Infosys’ performance to lag peers materially, especially after the company having swiftly addressed the heightened issues around governance with the appointment of Nilekani to the Board and Salil Parekh as the CEO. Our price target of R1,200 discounts forward earnings by 16x, implying an upside of 15%. Maintain ‘Buy’.