On Wednesday, Microsoft revealed in a Securities and Exchange Commission filing and blog post that the Internal Revenue Service says the company owes the US Treasury $28.9 billion in back taxes, plus penalties and interest, reports the Associated Press. The claim comes as a result of a lengthy IRS audit that examined how Microsoft distributed its profits across different countries from 2004 to 2013. Microsoft disagrees with the IRS’s claim and intends to appeal the decision.
According to the AP, the ongoing IRS probe began in 2007 and is described as “one of the largest in the Service’s history” in court documents released last year. Recently, Microsoft received notification that the audit phase has concluded, triggering the next steps for settling the dispute. At the core of the IRS investigation is the practice known as “transfer pricing,” which some critics argue allows companies to report lower profits in countries with higher taxes and vice versa, minimizing their overall tax obligations.
Microsoft maintains that it has complied with IRS rules all along and will proceed to appeal the agency’s decision—a process expected to last for years. Here’s how the company described the episode in Section 8.01 of its SEC filing:
On October 11, 2023, Microsoft Corporation announced the receipt of Notices of Proposed Adjustment (“NOPAs”) from the Internal Revenue Service (the “IRS”) for the tax years 2004 to 2013. The NOPAs were received on September 26, 2023. The primary issues in the NOPAs relate to intercompany transfer pricing. In the NOPAs, the IRS is seeking an additional tax payment of $28.9 billion plus penalties and interest. As of September 30, 2023, we believe our allowances for income tax contingencies are adequate. We disagree with the proposed adjustments and will vigorously contest the NOPAs through the IRS’s administrative appeals office and, if necessary, judicial proceedings. We do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.
Per the Associated Press, part of the longstanding IRS inquiry focused on a manufacturing facility that Microsoft established in Puerto Rico in 2005. According to the IRS, Microsoft employed accounting firm KPMG to create a cost-sharing arrangement with its Puerto Rican affiliate, which effectively shifted taxable revenue out of the US. The IRS also examined other Microsoft affiliates, including one connected to retail sales in Asia.
In a Microsoft blog post on Wednesday, Microsoft’s corporate vice president for worldwide tax and customs, Daniel Goff, acknowledged that Microsoft has since changed its corporate structure and practices but defended the use of cost-sharing arrangements. According to Goff, since Microsoft’s subsidiaries shared the costs of developing some intellectual property, they were also entitled to a share of the related profits. Goff added that the sum the IRS is seeking could potentially be reduced by up to $10 billion due to taxes already paid under a 2017 tax law called the Tax Cuts and Jobs Act (TCJA) signed by then-President Trump.
As Microsoft detailed in its SEC filing listed above, the firm says it will “vigorously contest” the Notices of Proposed Adjustment (NOPAs) through administrative appeals and judicial proceedings if necessary. Microsoft doesn’t expect a final decision about its tax dispute to come within the next year, and it also doesn’t foresee the amount it has set aside for possible future tax bills changing significantly during that time.
If forced to pay the nearly $29 billion in back taxes plus penalties, Microsoft would likely be able to come up with the money. As of June 2023, the firm had saved over $111 billion in cash equivalents that it keeps on hand. The corporation reported annual revenue of $211.9 billion in 2023.