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"On paper, Microsoft’s facility in Puerto Rico was wildly profitable. With just 177 workers, the plant recorded $4 billion in earnings in 2011, a Senate investigation found.
The gimmick was entirely legal. According to the Senate’s report, the software company’s lawyers were channeling its profits from sales all over the country through the Puerto Rican operation, getting Microsoft out of about $1.5 billion in taxes a year." Ehrenfreund
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How Microsoft avoided billions in taxes, and what the GOP says it will do about it -
Feb10, 2017
On paper, Microsoft’s facility in Puerto Rico was wildly
profitable. With just 177 workers, the plant recorded $4 billion in earnings in
2011, a Senate investigation found.
The gimmick was entirely legal. According to the Senate’s
report, the software company’s lawyers were channeling its profits
from sales all over the country through the Puerto Rican operation,
getting Microsoft out of about $1.5 billion in taxes a year.
It was the kind of scheme that designers
of congressional Republicans’ tax proposal hope to eliminate.
The vast sums Microsoft saved hint at how much money is at stake for
corporations that rely on similar strategies to reduce their taxes, which
are especially common among technology firms and other companies with valuable
brands, patents and copyrights.
Understanding the uncertain and potentially disruptive
consequences of the GOP plan, known as a “border adjustment tax,” has
become an urgent priority for U.S. firms — not just in Silicon Valley, but
throughout the corporate sector, said John Gimigliano, a principal at KPMG
in Washington.
“It is a pretty significant departure from the current
system of taxation,” he said. “It’s almost impossible to talk about anything
else.”
From Redmond to Puerto Rico
The Senate investigation into Microsoft’s taxes in 2012
described this kind of legal strategy in detail. First,
Microsoft had sold a share of its brands and copyrights to its subsidiary
in Puerto Rico. The U.S. territory’s rules for taxes are different from
those that apply to businesses in the 50 states.
The Puerto Rican subsidiary made an impressive profit on
that investment over the years — profits that would otherwise have accrued to
Microsoft’s main office in Redmond, Wash., where they would have
been subject to ordinary federal taxes.
Microsoft’s practices were typical, experts say. Many
multinational firms set up subsidiaries in jurisdictions with minimal
taxes — whether in Europe, Asia or the Caribbean — and then pay those
subsidiaries for goods and services. Those payments come out of the income
taxed in the United States.
In 2011, for example, the Puerto Rican entity paid $1.9
billion to the main U.S. company as an installment on its initial purchase
of the intellectual property. Microsoft then manufactured copies of its
software in Puerto Rico and imported it back onto the mainland for sale.
In 2011, the Puerto Rican subsidiary’s $4 billion in
earnings were taxed at a rate of 1 percent.
“This structure is not designed to satisfy any specific
manufacturing or business need,” the committee's report concluded. “Rather, it
is designed to minimize tax on sales of products sold in the United States.”
Microsoft cooperated with the congressional investigation,
according to the Senate report, which presented no evidence of wrongdoing or
lawbreaking.
“In conducting our business at home and abroad, we abide by
U.S. and foreign tax laws as written,” Microsoft vice president William Sample
told the Senate Permanent Subcommittee on Investigations. “That is not to say
that the rules cannot be improved — to the contrary, we believe they can and
should be.”
A spokesman for Microsoft declined to comment on whether the
company would support the GOP proposal or on whether the company's practices
had changed.
Across oceans
Similar maneuvers are particularly prevalent among
firms with patents, trademarks, copyrights and other valuable intellectual
property. By signing a few contracts, a chief executive can move these
assets across oceans. The profits associated with them go, too.
Firms that avoid taxes this way cost the U.S.
government at least $100 billion a year, by one estimate. Alan
Auerbach, an economist at the University of California at Berkeley predicted
that the situation will worsen as the economy becomes more reliant on hip
brands and lucrative patents.
“Companies with a lot of intellectual property are doing
this,” he said. “It’s one of the main problems of our tax system — especially
going forward.”
Auerbach is one of the most vocal proponents of the border
adjustment tax. Under the proposal, it could be more difficult for these
companies to avoid U.S. taxes this way.
The plan would prevent companies from deducting any payments
to foreign vendors from their income. Consequently, companies would not be able
to reduce the taxes they owe through payments to subsidiaries abroad.
The investigation found that this system allowed
Microsoft to shift 47 percent of its U.S. revenue to Puerto Rico in the
form of payments for imported software.
A Republican bill could treat Puerto Rico similarly to a
foreign jurisdiction for purposes of the tax, in which Microsoft would not be
able to shift any of that revenue by paying its subsidiary to import software.
It is also possible that Puerto Rico would be treated more like a state, in
which case the Puerto Rico subsidiary would presumably have to pay regular
federal taxes.
American brands
Yet while the GOP proposal could force some companies
to pay up, the plan also includes an exemption for exports — so some businesses
could pay less. Microsoft, for example, does extensive business
overseas. As a result, the company could come out ahead.
Whether companies would pay more or less under the plan
would depend on how many customers they have at home and abroad, where their
intellectual property is legally located and to what degree exchange rates
fluctuate once the plan is implemented.
“It really depends on
each company’s individual profile,” said Kathy Michael, a tax partner at
PricewaterhouseCoopers.
Microsoft is holding $109 billion in cash and equivalent
reserves overseas from its sales in foreign countries. Under the current
system, Microsoft would have to pay federal taxes on that money if the firm
returns the cash to the United States. Under the Republican proposal,
Microsoft’s future sales abroad would be free from U.S. taxation — and the
company might even get a break on its existing pile of cash in the bargain.
Several multinational technology companies, including Dell,
Google, Oracle and IBM, are supporting the Republican plan as part of an
industrial coalition called the Alliance for Competitive
Taxation.
The group’s other members include Abbott and Pfizer, which
depend on their patented drugs, and iconic American brands such as Coca-Cola
and Walt Disney.
“They basically think this is good for
them,” said Reuven Avi-Yonah, a legal scholar at the University of
Michigan.
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