Microsoft is suing the Internal Revenue Service in an effort to get details of an agreement between the tax regulator and a law firm examining how Microsoft tallied its sales between subsidiaries.
The underlying tax matter is a big one for Microsoft. At issue is the IRS’s look at “transfer pricing,” or how companies charge for goods and services bought and sold between a company and its international subsidiaries.
Microsoft says the IRS is looking over the company’s income tax returns for its fiscal years 2004 through 2009. The IRS in May entered into a $2.1 million contract with law firm Quinn Emanuel Urquhart & Sullivan to provide services related to the tax audit, Microsoft said in a lawsuit filed in federal court in Washington, D.C. Quinn Emanuel says it specializes in business litigation and arbitration.
In September, Microsoft says it filed a Freedom of Information Act request seeking details of the contract between the IRS and Quinn Emanuel. The IRS twice said it needed an extension of the 20 days required by law to respond to the request, eventually proposing to provide a response by Dec. 9, Microsoft says.
“Government agencies, funded by citizens, have an obligation of transparency under the Freedom of Information Act,” Microsoft said in a statement. “The IRS has failed to meet the deadline to respond to a valid FOIA request, and we’re simply asking a court to ensure that the IRS meets its obligations.”
An IRS spokesman said the agency doesn’t comment on pending litigation.
One of the major principles behind transfer pricing tax law is that companies should charge a reasonably fair market rate for the goods and services they buy and sell between their international arms. In the case of technology firms, the idea is to prevent a company from selling the rights to its valuable patents at a steep discount to a subsidiary located in a country with lower taxes (and thereby reaping the greater profits from further sales originating in the country with a lower tax rate).
Microsoft’s effective tax rate in the year ended in June was 21%, below the statutory 35% U.S. corporate tax rate (which few companies of the international size and scale of Microsoft actually end up paying).
The gap was “primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico,” Microsoft said in its annual report.
Deloitte, the accounting giant that audits Microsoft’s financial statements, provides a handy guide to the effective tax rates across the world. The trio referenced above tax corporate profits at rates of 12.5% (Ireland), 17% (Singapore) and 20% (Puerto Rico — with provisions for increased taxes on profits earned by local branches).
That 21% rate Microsoft paid in its fiscal 2014 was up from 19% paid the prior year. The increase, Microsoft said, was primarily because of a $458 million adjustment on the taxes owed reflecting the company’s transfer pricing in past years.
Transfer pricing is the main unresolved issue between Microsoft and the IRS, which “could have a significant impact on our consolidated financial statements if not resolved favorably,” Microsoft said.