According to a CBC article based on wire reports, Microsoft reportedly has been reassessed by the US Internal Revenue Service for $23B in taxes owing in respect of certain transfer pricing transactions involving “cost sharing agreements’ in 2013 and 2014.
While we are unable to comment on the exact content of these allegations, and we do not advise in respect of US tax in any way, there are certain generic observations that we can make. First of all, this audit started in 2007 and ended this year. That is a long time, and a lot of effort for the IRS; 16 years on the same audit! Our experience with tax agencies is that if they audit, they find something because they do not want to look like they wasted their time. And the longer they take, the bigger the number of the reassessment. It does not look good for them internally to spend a lot of time and not come up with something to show for it.
Moreover, inside of tax authorities there is no accountability for failed assessments. If, just as a thought experiment, let’s say Microsoft appeals this, and Microsoft spends millions of dollars defending itself, and the government spends millions more of taxpayer dollars to prosecute, but this whole thing blows up and eventually they settle for peanuts… nothing with happen. It will take years to dispute this. All of the auditors on the audit will have received their promotions, bonuses etc. and will have moved on, some will be already retired by the time it comes down to an actual resolution. There will be no consequences to any of the audit team. None. So there is no downside to assessing for a big number, and a lot to be gained internally to do so. One should take that into consideration when thinking about the validity of the big headline number.
The second issue from our perspective is that the basis of the assessment are cost-sharing agreements between Microsoft subsidiaries in different countries. Cost sharing agreements are a common way of dealing with the fact that although research and development of new technologies and products can take place in one country, the benefits of those efforts are realized throughout the organization. As a result, if subsidiaries in different countries all benefit, then they should contribute to the costs as well. These payments are done to equalize the cost burden, and are likely prepared by professional outside advisors based on actual costs and calculated benefits. These arrangements are not done in a haphazard manner, and are likely to be defensible. They may even have been calculated to leave some money on the table, so do not be surprised if Microsoft comes back and claims a tax refund for billions. I do not expect that a company like Microsoft would be lazy, stupid or excessively aggressive in just two years out of 16. So unless there was a significant mistake made or change in facts that was not addressed in a timely manner, the idea that there would be a big issue with this type of agreement in just two years out of 16 does not make a lot of sense. These agreements are likely ongoing and deal with multiple overlapping projects over extended periods. If there was a problem with the agreements, issues would expend over a longer period of time. So again, maybe this headline number is perhaps not going to be as big of an issue as one might think.