Microsoft, a stock which we own in our Global Compounders Portfolio, is the subject of this succinct piece on the investigative website PropPublica. The author, Paul Kiel, says “In the largest audit in U.S. history, the IRS rejected Microsoft’s attempts to channel profits to a small factory in Puerto Rico that burned Windows software onto CDs….On Wednesday, Microsoft announced that the agency had notified the company that it owes $28.9 billion in back taxes, plus penalties and interest.” [Note: IRS refers to the US taxman aka the Inland Revenue Service.]

This is the culmination of a decade long investigation by the US authorities: “…the IRS set out to be bolder and more aggressive. It took the unusual step of hiring a corporate law firm to represent the agency, a step that incensed Microsoft. The company, along with others in its industry, responded by rallying allies in Congress to rein in the IRS.”

The root cause of this investigation goes all the way back to 2005: “In 2005, ProPublica wrote, Microsoft “sold its most valuable possession — its intellectual property — to an 85-person factory it owned in a small Puerto Rican city.” Having struck a favorable tax deal with Puerto Rico, Microsoft then channeled its profits to the facility, which burned Windows and Office software onto CDs.

At the time, some Microsoft executives celebrated this “pure tax play,” and they had reason for optimism. Initially, the IRS did not take an aggressive tack. An early audit resulted in a much more modest change in 2011.

But earlier that same year, the IRS had set up a new unit to audit intra-company deals that sent U.S. profits to tax havens — deals that were especially common among tech companies like Google, Facebook and Apple. The leader of the new unit decided that Microsoft’s deal in Puerto Rico was worth a much closer look. The IRS withdrew its initial finding and dug in to build a deep, comprehensive case.”

But as in India, so in America, the wheels of justice grind slowly especially for powerful companies: “The conclusion of the audit sends the fight to a new phase. The IRS has an internal appeals division, and Microsoft said it would pursue its arguments there. It’s a significant development since the IRS had once signaled that it would bar Microsoft’s access to an appeal, a stance that led to blowback in Congress from the company’s allies. IRS appeals officers, who are independent of the auditors, often settle cases for steep discounts out of fear that the agency will lose a court battle. The appeals process is secret.
If Microsoft does not get the result it wants there, it can take its case to the U.S. Tax Court. Each step is likely to take years, meaning the case could easily stretch into the late 2020s.”

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