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Originally published September 20, 2012 at 9:37 PM | Page modified September 21, 2012 at 6:18 AM

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Hearing: Microsoft (legally) avoided $6.5B in taxes over 3 years

Microsoft became Exhibit A for corporate-tax skirting Thursday during a U.S. Senate hearing on a widening practice that congressional investigators...

Seattle Times staff reporters

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Microsoft became Exhibit A for corporate-tax skirting Thursday during a U.S. Senate hearing on a widening practice that congressional investigators say allows multinational corporations to avoid billions of dollars in U.S. taxes annually by shifting profits offshore.

Microsoft and Hewlett-Packard (HP) were cited as two examples of companies that use aggressive tactics to dodge U.S. taxes by Sen. Carl Levin, D-Mich., chairman of the Senate Permanent Subcommittee on Investigations, which held the hearings in Washington, D.C.

Levin did not accuse the companies of doing anything illegal.

But he opened the five-hour hearing with a 30-minute dissection of the tactics he said Microsoft and HP have used to shield huge portions of their earnings — including profits from making and selling their products in the United States — out of reach of the Treasury Department.

Chiefly, Microsoft sold its intellectual-property rights to subsidiaries in Dublin, Singapore and Puerto Rico. But the revenue those entities booked from selling Microsoft products far exceeded what they paid to acquire the rights — differences that were taxed at lower foreign rates.

For instance, Microsoft's regional operating center in Ireland paid $2.8 billion in 2011 for rights to sell Microsoft products in Europe, the Middle East and Africa. It then licensed those same rights to another Microsoft subsidiary operating in Ireland but headquartered in Bermuda.

Altogether, Microsoft avoided paying at least $6.5 billion in U.S. taxes over three years by using such maneuvers, according to the report.

HP, meanwhile, used billions of dollars of offshore loans to repatriate untaxed foreign profits back into the U.S. to run its U.S. operations, the subcommittee report contended.

"The bottom line of our investigation is that some multinationals use our current tax system to engage in shams and gimmicks to avoid paying the taxes they owe," Levin said. "The resulting loss of revenue is one significant cause of the budget deficit, and adds to the tax burden that ordinary Americans bear."

At a time when huge budget cuts are looming, "these offshore schemes are unacceptable," he said.

Both Microsoft and HP said they comply with tax laws.

"Microsoft has a complex business and we must comply with the complicated tax code of the United States, resulting in an exceedingly complex tax structure," the company said in a statement. "That is why we've advocated for reforms to simplify the U.S. tax code and make it more competitive with the rest of the world."

HP said its finances have been consistently reviewed and approved by its auditor, Ernst & Young, and that "HP has always had an extremely productive and professional relationship with the IRS, who has permanent offices at two of our facilities and has been continually auditing HP since the filing of our 1962 tax return. They have never raised any concerns about these programs."

"Fiscal cliff"

The hearing came as the federal government lurches toward a Jan. 1 "fiscal cliff" triggered by expiring Bush-era tax cuts and more than $100 billion in mandatory spending cuts.

It also came in the midst of political clashes over whether and how to raise revenues to help reduce federal deficits. Many Democrats have complained that the government is missing out on collecting billions of dollars because companies are stashing profits abroad, thus avoiding taxes. Republicans want to cut the corporate tax rate of 35 percent and ease the tax burden on money that U.S. companies make abroad, which they say would encourage them to invest at home.

At the hearing, Levin struggled to keep the complex tax tactics straight. William Sample, Microsoft's vice president of worldwide tax, gave clipped answers that Levin frequently interrupted.

At one point, Levin asked Sample if it was in Microsoft's best interest to have its offshore subsidiaries pay as little taxes as possible by sublicensing as much intellectual property as possible, even though 85 percent of Microsoft's research and development work is conducted in the U.S.

"Senator, again, I would respectfully disagree with that characterization," Sample said.

"It's a question," Levin responded. "You can answer, 'No, it's not in Microsoft's best interest' if you want."

Sen. Tom Coburn, of Oklahoma, the committee's top Republican and the only other member to attend the hearing, said companies were exercising "properly legal tax avoidance."

While tax-law experts seemed to agree that shifting profits offshore to avoid higher U.S. taxes is not unusual for multinational corporations seeking to pay less in taxes, they disagreed on what they thought of Microsoft's and HP's tactics.

"This isn't unusual at all," said Scott Schumacher, director of the graduate program in taxation and associate professor at the University of Washington School of Law.

"The U.S. has one of the highest corporate tax rates in the world," he said. "I would argue the high U.S. tax rate encourages U.S. corporations to take advantage of tax rules that have been around for 50 years."

"Microsoft is right that it really is an issue with the tax system rather than what it is that Microsoft is doing," he said.

Filings with SEC

According to Microsoft's filings with the U.S. Securities and Exchange Commission, the company's effective tax rates for the fiscal years 2012 and 2011 were approximately 24 percent and 18 percent, respectively.

Those rates — especially 24 percent — are "not low by any means, relative to other corporations with really good tax lawyers," Schumacher said.

Eric Talley, a professor at the University of California-Berkeley School of Law, said the U.S. tax code allows for companies to form offshore subsidiaries and shift their profits.

The trick for lawmakers is to figure out what the best public policy is, he said.

While it's right to a certain extent to say that U.S. companies aren't paying their fair share of taxes, Talley said, it's also true that multinational corporations have substantial leeway in where they locate.

"If policymakers decide to close up the loophole, a potential danger is that companies may start to move their physical operations overseas," he said.

David Gamage, an assistant professor at UC Berkeley School of Law, said it's impossible for him to know whether Microsoft or HP have done anything wrong without seeing privileged documents that he doesn't have access to.

"But my guess, based on what's been publicly available, is that Microsoft is, at the very minimum, being extremely aggressive in its interpretation of U.S. tax laws," he said.

Sample, the Microsoft VP, said that while 52 percent of Microsoft's revenue comes from the U.S., its foreign revenue is growing faster than what it earns at home.

Microsoft's tax results, he said in a written statement to the subcommittee, "follow from its business, which is fundamentally a global business that requires us to operate in foreign markets in order to compete and grow."

Kyung Song, reporting from Washington, D.C.: 202-383-6108 or ksong@seattletimes.com. Janet I. Tu: 206-464-2272 or jtu@seattletimes.com. On Twitter @janettu. Information from The Associated Press was used in this report.

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