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Insight: Microsoft use of low-tax havens drives down tax bill

Jul 27, 2011, 2:14 p.m.

A TWIN SHIFT

Concern about the use of tax-reducing measures now used by many major U.S. corporations has been a big issue for President Obama and the Democrats as they race to hammer out a deal with Republicans by August 2 that would allow the United States to avert imminent default on its debt.

Some Congressional leaders are calling for a "repatriation holiday" that would allow corporations to bring back money held offshore at a lower rate of 5.25 percent, similar to a one-off deal in 2005 through which corporations brought back $312 billion.

Nearly $1.2 trillion of accumulated U.S. corporate profits, are now held in overseas subsidiaries.

The U.S. government taxes U.S. businesses on income earned worldwide but allows them to defer taxes on the money until brought back to the U.S., so corporations like to keep the money abroad, particularly as they increase investment overseas. Critics argue the U.S. system also encourages businesses to move jobs overseas at a time of high unemployment -- now at a 9.2 percent rate -- in the U.S.

Obama and the Treasury Department oppose a "repatriation holiday" while Microsoft, along with other multinationals, including Apple, Cisco Systems and Pfizer Inc , backs the repatriation idea, through Win America, a Washington, D.C., lobbying group.

Most industrialized nations tax businesses only on income earned within their borders. U.S. corporations argue the U.S. worldwide system is anti-competitive and forces money overseas.

But critics such as Richard Murphy of Tax Research LLP, an anti-poverty and tax research firm based in Britain, argue the U.S. system allows companies to park profits in places where the tax obligation largely disappears. He called Microsoft "a giant tax-planning exercise."

LOWER RATES ABROAD

Microsoft said its lower taxes in the recent quarter were "primarily due to a higher mix of 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, which are subject to lower income tax rates."

The details of precisely how it does this have not been disclosed.

U.S. companies do not have to break out earnings in foreign subsidiaries, making it hard to determine from financial filings how much tax they are saving through each jurisdiction. "We're in the land of guesswork here," said Professor James Hines Jr., a tax scholar at the University of Michigan.

What is clear is Microsoft's increasingly sophisticated use of the havens. Foreign earnings taxed at lower rates reduced Microsoft's U.S. rate by 16.3 percentage points to 18.7 percent, for the just-ended year. That compares with a lowering by just 4.6 percentage points to 30.4 percent in 2006, according to SEC. filings.

Ireland taxes corporate profits at 12.5 percent. Singapore taxes them at anywhere from 0 percent to 17 percent. Puerto Rico, a U.S. territory but a foreign country in the eyes of the IRS, offers U.S. multinationals an unusual credit for taxes paid there as well as tax credits for production.

Microsoft operates a 123,000 square-foot factory in Puerto Rico that makes up to 80 million disks a year for sale in the Americas, according to its Spanish-language website -- its only company-owned plant in the world.

A Microsoft spokeswoman declined to answer questions on how it records revenue and earnings in certain jurisdictions, adding, "Microsoft complies with the tax laws of every jurisdiction in which we do business."

Legislation introduced this month by Senator Carl Levin, a Michigan Democrat, would require large U.S. corporations to report results country-by-country.

The Securities and Exchange Commission earlier this year asked the company to do the same, citing what it called the "disproportionate relationships among domestic and foreign revenues, pre-tax income and tax rates."

Microsoft told the SEC it would supply additional information in future filings. The company says it will provide the requested information in its 2011 annual 10K financial report due to be filed on Thursday.

By finding ways to minimize its taxes, Microsoft can argue that it is only behaving in the interests of its shareholders.

Shifting income to low-tax jurisdictions "is not illegal," said Robert Willens, a tax and accounting expert in New York. "It behooves companies to do this."

(Additional reporting by Dena Aubin, David Cay Johnston, Scott Malone and Bill Rigby, editing by Martin Howell)

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