Microsoft says IRS has demanded $28.9bn in back taxes

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Microsoft has received a demand for $28.9bn in back taxes from the US Internal Revenue Service, marking an escalation of one of the biggest-ever corporate tax disputes.

The demand for extra taxes, along with penalties and interest for late payment, is the latest twist in a case that has long stood as the most notable challenge to a common form of international tax planning used by many big US tech companies to greatly lower their tax bills.

The software company said on Wednesday that it had received notices from the IRS seeking to adjust its tax liability for the decade between 2004-13. The agency had been investigating Microsoft’s use of transfer pricing, a practice that critics claim is used by companies to unfairly shift profits to low-tax countries to minimise their liabilities.

Microsoft revealed more than a decade ago that it produced and distributed its software in regional centres in Singapore, Dublin and Puerto Rico, enabling it to route profits in a way that helped to reduce its taxes. 

Many US tech companies have long located their intellectual property overseas, using the arrangement to argue that since part of the costs of creating or maintaining some of their most valuable assets is in a foreign country, part of the profits linked to the technology should also be recognised there.

“Many large multinationals use cost-sharing because it reflects the global nature of their business,” Microsoft said this week.

Microsoft said it disagreed with the IRS’s latest tax demand and would “vigorously contest” the claims “through the IRS’s administrative appeals office”, a process that would take “several years”. If necessary, it added, it would go on to challenge the IRS in court. It also said it would not set aside any extra reserves to cover the tax claim.

Microsoft recently unwound some of the arrangements that had enabled it to report lower taxes for years, in part prompted by changes in US tax law that were designed to encourage tech companies to bring their IP back to US shores. For instance, it has said that in mid-2021 it transferred “certain” IP from Puerto Rico to the US, enabling it to book a $3.3bn tax benefit to reflect the effects of the so-called GILTI tax implemented during the Trump administration. 

In 2019, a US appeals court sided with Amazon in a similar transfer pricing case brought by the IRS. The case turned on whether Amazon had set the value of its IP artificially low when it was transferred to a subsidiary in Luxembourg in 2005. The appeals court ruled that Amazon’s move was justified by the transfer pricing rules in force at the time, though they would have fallen foul of later regulations put in place in 2009.

Along with the investigation of its 2004-13 tax payments, Microsoft is also being audited by the IRS over its tax returns for 2014-17.