Microsoft MSFT is facing a demand for $28.9 billion in back taxes from the U.S. Internal Revenue Service (IRS), which marks a significant escalation in one of the largest corporate tax disputes in recent times.
Per a recent 8-K filing by the company, along with back taxes, this demand encompassed penalties and interest for late payment. The core of this dispute centers on Microsoft’s use of transfer pricing, a practice that has been criticized for allowing companies, particularly in the tech sector, to shift profits to low-tax countries, thereby reducing their tax obligations.
Microsoft disclosed over a decade ago that it conducted its software production and distribution through regional centers in countries like Singapore, Dublin and Puerto Rico. By doing so, it was able to manage its profits in a manner that reduced its overall tax burden. This approach of allocating profits to different locations, based on where a portion of the costs and assets are situated, is commonly employed by multinational tech corporations.
Microsoft has expressed its disagreement with IRS’s latest tax demand. It has indicated its intention to contest the claims vigorously through IRS’s administrative appeals office, a process that could span several years. If necessary, MSFT is willing to take the matter to court. Additionally, the company stated that it would not set aside any additional reserves to cover the tax claim.
Microsoft Corporation Price and Consensus
Microsoft Corporation price-consensus-chart | Microsoft Corporation Quote
Microsoft Among Other Tech Giants Facing Tax Disputes
Governments have accused companies such as Apple AAPL, Amazon AMZN and Microsoft of shifting revenues through low or zero-tax jurisdictions in order to escape taxation in their main markets and maximize profits.
This spurred a major international agreement among 140 countries, brokered by Organization for Economic Cooperation and Development (OECD), that is designed to better share and regulate tax revenues of the giants. Recently, OECD published a draft agreement, implementing a major part of that deal with hopes of having it ratified by the end of 2023.
In 2019, a US appeals court sided with AMZN in a similar transfer pricing case brought by IRS. That case revolved around whether Amazon had undervalued its IP when it transferred it to a subsidiary in Luxembourg in 2005. The appeals court determined that Amazon’s actions were consistent with the transfer pricing rules in place at the time. However, it might have been deemed non-compliant with later regulations introduced in 2009.
In the European Union, authorities in 2016 ordered Apple to pay 13 billion euros ($14 billion) in back taxes over similar accounting practices. Yet, Brussels lost an appeal to Apple and is awaiting the outcome of a further appeal.
Apart from the investigation of Microsoft’s tax payments between 2004 and 2013, the company is also undergoing an audit by IRS for its tax returns from 2014 to 2017.
In recent years, Microsoft has taken steps to reconfigure some of its tax arrangements, partly due to changes in US tax laws aimed at encouraging tech companies to bring their intellectual property (IP) back to the United States.
In 2021, Microsoft shifted certain IP from Puerto Rico to the United States, which allowed it to claim a $3.3 billion tax benefit. It reflected the impact of Global Intangible Low-Taxed Income tax implemented during the Trump administration.
The disclosure of IRS notices comes just under two weeks before Microsoft plans to announce its financial results for fiscal 2024’s first quarter.
The Zacks Consensus Estimate for MSFT’s first-quarter fiscal 2024 revenues is pegged at $54.42 billion, indicating year-over-year growth of 8.57%. The consensus mark for earnings is pegged at $2.65 per share, suggesting a year-over-year increase of 12.77%.
Shares of this Zacks Rank #3 (Hold) company have gained 33.2% year to date compared with the Zacks Computer and Technology sector’s return of 33.7%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Microsoft is on the cusp of buying Activision Blizzard ATVI for $68.7 billion, ending its near two-year pursuit of the maker of Call of Duty, World of Warcraft and Candy Crush. The deal is expected to close on Oct 13.
However, despite the merger, popular titles such as Call of Duty: Modern Warfare 3 and Diablo 4 might not be made immediately available on Xbox Game Pass this year. Activision Blizzard plans to start bringing its games to the subscription service from 2024.
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