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Originally published Sunday, June 2, 2013 at 8:03 PM

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Microsoft could find payoff, take high road by paying up taxes

Wall Street is the last place you’d expect to find someone urging Microsoft to pay more taxes. But that was the heretical idea floated last week by influential analyst Rick Sherlund at Nomura Group.

Seattle Times technology columnist

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Wall Street is the last place you’d expect to find someone urging Microsoft to pay more taxes.

But that was the heretical idea floated last week by Rick Sherlund at Nomura Group, one of the most influential analysts following the company.

Sherlund’s provocative note comes amid growing scrutiny of how U.S. tech giants stash profits overseas to avoid paying taxes in their home country.

It also comes as investors are finally getting interested in Microsoft again — especially those who look beyond the PC vs. iPad squabble and see potential in Microsoft’s broader business.

The stock is waking after a decadelong slumber, and Sherlund believes it could climb 11 percent more over the next year.

To push it along, Sherlund suggested spinning off the Xbox and Bing business. The latter idea is a nonstarter if you’ve seen how deeply Microsoft has woven its search service into upcoming products such as Windows 8.1 and the Xbox One console.

Activist investors wanting to shake things up are making moves on Microsoft, Sherlund said, and will probably try to install sympathetic directors on its board this summer or fall to push for radical changes from the inside.

But to me, Sherlund’s most intriguing suggestion was the simplest. He said Microsoft should bring $66 billion in overseas profits back to the U.S. and pay the taxes that come due. There would still be plenty left over — enough to more than double the company’s dividend.

Earnings reports wouldn’t look as good, but shareholders shouldn’t care because they’d end up with more money in their pockets.

Sherlund figures this could free up $46 billion that shareholders could receive through dividends or stock buybacks. That would be after Microsoft paid perhaps $20 billion in taxes on the foreign income.

“It’s not doing shareholders any good siting offshore doing nothing,” he said by phone Friday afternoon, en route to his Nantucket, Mass., summer place.

This seems to me like a great opportunity for Microsoft to do several positive things at once.

Doubling the dividend would accelerate the stock’s recent momentum. Maybe it would tide over investors until Windows 8.1 is finished and starts winning back customers later this year.

Paying up taxes should earn customer respect and loyalty in the U.S., which remains Microsoft’s largest market. The money would flow through government agencies, which are Microsoft’s largest customers. The people of America would be the ultimate beneficiaries and presumably they’d show some gratitude.

Taking this high road would differentiate Microsoft from competitors that aggressively try to minimize direct financial support of their country, then blame tax codes that were written under the influence of corporate lobbyists.

It’s also another chance for Microsoft to show leadership, as it has on philanthropy and public-policy issues, such as immigration reform. The company’s requests for more H-1B visas and computer-science funding (and a basketball arena for the boss) would be better received if it was paying full freight.

Paying up may also be Microsoft’s best chance to get ahead of the nascent “buy American” movement in tech. Apple and Google are moving to build some gadgets in the U.S., bolstering President Obama’s push to revive American manufacturing.

But it’s hollow flag-waving if they continue stashing profit abroad to shrink their contribution to the public fund.

Schemes that tech companies use to avoid taxes on overseas earnings were highlighted a few weeks ago when Apple Chief Executive Tim Cook appeared before a Senate committee. Cook asked Congress to give poor Apple a break, and lower the taxes it would pay if foreign profits were brought home, or “repatriated.”

Senators fawned over Cook and tax haters nodded in agreement, putting aside their concerns about deficit reduction. Still, it doesn’t look like the Obama administration will think differently about Apple’s tax obligations.

Sherlund isn’t looking for moral and political points. He’s just trying to figure out how Nomura clients can make the most money off the Colossus of Redmond.

He believes Obama won’t offer a “tax holiday” on foreign earnings as Republican presidents have done in the past. Obama has the benefit of hindsight. After previous tax holidays, tech companies pushed even more profits offshore and it’s continuing to hurt the country, Sherlund noted.

If the overseas profit isn’t going anywhere, you could make the case that tech companies are overstating their earnings because they’re not setting aside taxes on those foreign earnings, and the money isn’t available to shareholders, Sherlund said.

“How long are we willing to speculate that some administration some day is going to let us bring it back?” he said.

I asked Microsoft’s new chief financial officer, Amy Hood, if there’s a chance the company would take Sherlund’s suggestion. A spokesman said the company won’t comment.

This tax debate is centered in the other Washington, but perhaps Microsoft will be influenced by what’s happening in its home state. Bridges are falling, roads are failing and the government is on its knees, scrounging for pennies, just to pay for basic education.

There’s no reason to follow Apple this time.

Brier Dudley’s column appears Mondays. Reach him at 206-515-5687 or bdudley@seattletimes.com

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About Brier Dudley

Brier Dudley offers a critical look at technology and business issues affecting the Northwest.
bdudley@seattletimes.com | 206-515-5687

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