Microsoft is Presently Being Audited By the IRS

Microsoft is Presently Being Audited By the IRS

The IRS is suing a number of former and current executives of Microsoft in a bid to force them to testify in an investigation into the company’s corporate tax practices.

According to The Seattle Times, at issue is whether the company is following corporate tax law in its practices of transferring the rights to its software to various subsidiaries in countries and territories of the U.S. with low taxes. This practice is commonly used by multinational corporations with valuable intellectual properties, and reportedly had “billions of dollars of impact” on Microsoft’s taxable income between 2004 and 2006, according to the lawsuit being brought by the IRS.

How it works

Companies that have subsidiaries in countries around the world are supposed to operate as though those subsidiaries were an “arm’s length” away for tax purposes. This means negotiating and dealing fairly with each other instead of setting prices that are favorable to the company come tax time. Frequently, this is not what happen.

Picture a large, multinational company with Subsidiary A in a country or locale with low taxes but a small market for its intellectual goods. Subsidiary B is in a country with higher taxes but a much larger market. Subsidiary B makes $1 billion in profits, but to reduce the overall tax burden, the company shifts the rights to the intellectual goods to Subsidiary A and sets the “price” for Subsidiary B to sell those goods at $1 billion. The result is that Subsidiary B makes no profits on paper, meaning that it has to pay virtually nothing in corporate tax. Subsidiary A has $1 billion in profits and pays the lower taxes on those profits that are mandated by its location.

The Internal Revenue Service appears to believe that this is what is happening in the case of Microsoft, and is attempting to get to the bottom of the issue.

According to GeekWire, the IRS issued a summons to longtime CEO Steve Ballmer at his home in Seattle demanding that he testify on Dec. 8, but he failed to appear. Microsoft had already told the IRS by this point that it was declining to make Ballmer and other former executives available because of a disagreement with the IRS over interview procedures. The IRS is also seeking to interview former chief Jim Allchin, former executive Bill Veghte, former Office division leader Jeff Raikes, former research and strategy chief Craig Mundie, former VP of Microsoft’s Worldwide Partner Group Jon Roskill and former marketing chief Mich Matthews, among others.