Tax Avoidance: How Microsoft Does It

Yesterday, Microsoft announced it had made net income of $5.87 billion in the latest quarter, but had reduced its tax rate from 25% a year ago to 7%. Annualized, that would be about $4 billion incremental in tax avoidance just over the last year. You’re probably saying to yourself, “Hey, I’d like to reduce my tax rate by 72% from 2010 to 2011, too! What are some tips from Microsoft on how I could do this?”
In the fine print of Microsoft’s July 21, 2011 press release, you can find:

Our effective tax rates for the fourth quarters of fiscal years 2011 and 2010 were approximately 7% and 25%, respectively. Our effective tax rate was lower than the U.S. federal statutory rate primarily due to a higher mix of earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore and Puerto Rico, which are subject to lower income tax rates.

Microsoft’s tax avoidance strategy wasn’t public knowledge until recently. New Is My Business reported on June 7, 2011:

Software giant Microsoft has reportedly been using three jurisdictions where it operates outside the United States – Puerto Rico, Ireland and Singapore – as tax shelters to reduce its federal tax bill, the Financial Times reported.

The strategy is part of Microsoft tax planning methods, details of which the Washington-based company reluctantly disclosed to the Securities and Exchange Commission in its quarterly report filed last month. That was when the company revealed for the first time that most of the $50.2 billion in cash it has amassed is held in so-called “low-tax regional centers.”

If you are wondering why giant American corporations aren’t reinvesting their giant retained earnings in creating American jobs, or at least distributing them to American shareholders as dividends or stock buybacks, well, one reason is because they’ve declared that they just happened to make most of this cash in certain overseas tax havens. Hence, 84% of Microsoft’s $50 billion trove of cash is officially overseas, and can’t be repatriated without paying American taxes on it which means that American shareholders can’t get it and thus can’t pay taxes on their capital gains, either. This kind of tax policy would make sense to Rumplestiltskin, Hetty Green, Silas Marner, and Scrooge McDuck, but it doesn’t seem to make much sense to me.

For purposes of tax avoidance, Puerto Rico is considered, by the U.S. government, to be an untouchable foreign tax haven, because it’s crucial, as Admiral Mahan explained in the 19th Century, for the U.S. Navy to hold Puerto Rico to protect the approaches to the future Panama Canal from the Kaiser’s High Seas Fleet and the new dreadnoughts of the Royal Navy. Or something. The U.S. doesn’t actually have any military bases in P.R. these days, nor does it have the Panama Canal, but it still has lots of tax breaks for Puerto Rico.

Microsoft has had presence in Puerto Rico for more than two decades. The eastern town of Humacao is where it operates its only wholly owned manufacturing facility in the world. Out of that plant come the millions of software and game CDs and DVDs …

Furthermore, the Financial Times also reported that some 62 percent of Microsoft’s international income came from the three aforementioned manufacturing hubs last year, even though the two island nations and Puerto Rico only accounted for 42 percent of the company’s international revenue.

A May 26, 2011 article in Caribbean Businss by Jose Alvarado Vega gave some details on Microsoft’s Puerto Rica operation that helps Microsoft avoid perhaps a billion or two in taxes per year:

Microsoft Humacao plant poised to capture growing software market

Microsoft’s manufacturing plant in Humacao is not only key to the company’s regional and global distribution of disk-based gaming and office-computing software, but also is looking forward to Internet-driven, interactive and unified telecommunications media products. More than 90% of all personal computers used throughout the world are run by Microsoft software. Chances are that such software was made and passed quality-control tests at the 123,000-square-foot plant, a continuation of the company’s 21 years of innovation-driven manufacturing in Puerto Rico.

Julián Herencia, general manager of Microsoft Operations Puerto Rico LLC, which runs the plant, said the facility shows Microsoft’s long-term trust in the local workforce. …

The plant, built in 2006, makes 80 million CD and DVD software units a year, and has 185 full-time permanent employees. …

Herencia didn’t rule out lobbying for moving some research & development, now done entirely at Microsoft’s headquarters in Redmond, Wash., to Puerto Rico.

Now, I get it! You see, Microsoft has over 40,000 employees in the state of Washington in the United States. But they don’t actually physically burn on to disks the software they develop. Instead, Microsoft, has a manufacturing plant in Puerto Rico employing 185 people that gets credited in Microsoft’s books with a lion’s share of Microsoft’s Western hemisphere revenue and profits. It’s making disks that’s the really important thing that Microsoft does.
Despite all you’ve heard about Microsoft being a software company, they are actually a manufacturing company, at least for tax accounting purposes. To the IRS, Microsoft is basically a Puerto Rican, Irish and Singaporean industrial goliath with a money-losing R&D outpost in Redmond, WA.
I’m picking on Microsoft because they are in the news and they are easy to pick on because very few people like Microsoft. But MS barely made the top ten in piling up cash overseas to avoid paying American taxes.

As for Puerto Rico, it’s a really odd story. Imperialism has been in bad odor for most of the last century. There are now a couple of hundred independent countries. But, not Puerto Rico, even though it’s a much more plausible nation-state than many existing counties. It’s an island. They all speak Spanish. Emotionally, Puerto Rico is a nation with its own Olympic team.

But the way it works is that big American corporations and politicians team up to bribe Puerto Ricans via tax breaks for big American interests into staying part of the American empire, all at the expense of average American taxpayers. Any American who would call for kicking Puerto Rico out of America would be branded a racist, so the thought never even crosses anybody’s mind.

It’s another one of these Hi-Lo teamups against the Middle that have been so successful in recent decades.