How Microsoft moves profits offshore to cut its tax bill

[steven36]

Seattle — When someone in Seattle buys a copy of Office at a Microsoft Store, that cash doesn't take the short route to the company's area headquarters.

 

Instead, after accounting for state taxes, the profit goes to a Microsoft sales subsidiary in Nevada.

 

From there, much of that money begins a complicated global trek that ultimately leads across the Atlantic, with two stops on the island tax haven of Bermuda.

 

Microsoft in the past 20 years built that network of subsidiaries in part to minimize the taxes it pays to governments worldwide.

 

The company is hardly alone. Many multinational corporations have set up similar structures, in some cases reducing their tax burden to near zero.

 

But a court fight this year between Microsoft and the Internal Revenue Service brought to light new documents outlining the deals that set up the company's structure. Additional court papers, corporate filings and tax records from four continents offer a rare, detailed look at the business of avoiding taxes.

 

In the case of the Seattle Office purchase, after paying state taxes, the company sends the money to the subsidiary in Reno, Nev. After landing in Nevada, more than half the cash from the sale goes to a Puerto Rican entity.

 

The Puerto Rican company, after paying a 2% local tax and accounting for a share of Microsoft's research costs, passes a portion of the remaining cash to an Irish company.

The final stop is an entity called RI Holdings. Its headquarters is a law firm in Hamilton, Bermuda, a United Kingdom territory that charges no corporate tax.

 

Similar structures cover Microsoft's operations across the globe.

 

From 2001 to 2006, Microsoft completed a series of intracompany deals that, in exchange for upfront payments, shifted the rights to software code and other assets developed largely in the U.S., to subsidiaries in Bermuda, Ireland, Singapore and Puerto Rico.

 

Those deals reduced Microsoft's cumulative tax bill in future years by tens of billions of dollars, according to court documents and an analysis of the company's filings.

 

Microsoft has $108 billion in income held offshore. That's evidence of the company's success avoiding not only the relatively high U.S. tax rate, but income-tax payments in the U.K., Germany and other countries where it sells products.

 

The type of structures Microsoft has created are legal, and company representatives say Microsoft pays the appropriate amount of taxes in the countries in which it operates.

 

"We serve customers in hundreds of countries all over the world and our tax structure reflects that global footprint," the company said in a statement. A spokesman noted the company paid $4.4 billion in taxes in its most recent fiscal year, and said Microsoft's tax rate was in the middle third of companies in the S&P 500.

Middle of the pack

During the past decade, Microsoft's cash tax payments have averaged an effective rate of 21.7%, according to S&P Capital IQ.

 

That measure strips out taxes deferred to future years and some one-time items, and includes taxes paid to both the U.S. and other governments. Microsoft's rate puts the company in the middle of the pack

among U.S. technology firms.

 

The top U.S. federal corporate income tax rate is 35%.

 

Looking only at Microsoft's operations outside the U.S., however, the company's tax rate is as low as 4.5%, according to Microsoft financial disclosures. That rate is lower than the tax rate in any of the countries in which the company does business.

 

Governments worldwide have started to take notice of companies that shift profits for tax reasons. Microsoft's tax arrangements in recent years have drawn scrutiny from regulators in the U.S., the European Union, China and Australia.

 

Microsoft's tax practices are a contradiction for a company that bills itself as a model corporate citizen, some tax experts and business-ethics scholars say.

Charitable efforts

Microsoft gives away software to nonprofits, encourages employees to donate time and money to charitable causes, and sponsors educational programs. Those efforts, along with commitments to a diverse workplace and environmental stewardship, earn the company high marks in rankings that measure corporate citizenship.

 

In Washington state, the company has used its platform to encourage policy-makers to boost funding for education and infrastructure.

 

But when it comes to another inherent component of citizenship — paying the taxes that support those programs — Microsoft behaves as do many of its peers in corporate America: The company has worked to limit what it pays to governments.

 

"One of the things we think of when we hear the word 'citizenship' is meeting certain basic obligations," said Jeffery Smith, who teaches business ethics at Seattle University's Albers School of Business and Economics. "You could make a pretty tight case that if you're going to consider yourself a good citizen, you make sure you contribute your due to the system."

 

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