In a recent development, software giant Microsoft reported in its
Form 8-K filing
with the U.S. Securities and Exchange Commission, that the Internal Revenue Service (IRS) is seeking
additional payment of $28.9 billion along with penalties and interest for the tax years spanning 2004 to 2013. Microsoft’s
transfer pricing strategies are under protest by the IRS.
Transfer pricing, though complex, essentially operates when two or more subsidiary companies with a
common parent trade goods and services. The parent company can determine prices,
potentially allowing it to evade income taxes by manipulating prices to shift profits
from high tax jurisdictions to tax havens.
An illustrative example describes an operation where the parent company situated in a 25% income tax jurisdiction
shifts profits to a subsidiary company in a no income tax jurisdiction, thus reducing its effective taxes paid.
Similarly, transfer pricing can come into play involving intellectual property rights, again reducing the
taxes the parent company needs to ultimately pay.
Rules and regulations around transfer pricing are detailed and complex, with provisions to prohibit or
re-characterize such transactions. The purpose is to get all related parties to trade at market rates or
using arm’s length transactions. But, transfer pricing strategies are common in cross-border transactions,
especially when large sums of money are involved.
While it seems viable for profitable corporations, there is a drawback for companies saving on taxes through
transfer pricing – their funds are effectively stuck overseas. Repatriation to the home country could subject the
funds to income tax. However, certain legislative measures occasionally allow for repatriation
with nominal or no taxes. The expectation is that these funds be used for job growth, but several large companies
have faced accusations of using these funds for stock buybacks.
Microsoft, in response to the situation, issued a
statement
explaining its position. The company intends to appeal the proposed assessment, and indicates that resolution may take
several years. Should the issue remain unresolved with IRS appeals, it could potentially end up in the U.S. Tax Court,
the Court of Federal Claims, or a local federal district court.
With billions of dollars and corporate reputations at stake, this case is one of several that highlight the
complex issues revolving around global corporate taxation.