Irish subsidiaries helped Microsoft reduce US tax bill by €1.87bn in 2011

THE CENTRAL role played by Ireland in an “aggressive” global structure created by Microsoft to save itself billions of dollars annually in US taxes is outlined in a memorandum prepared for a Senate committee in Washington.

The Senate Permanent Subcommittee on Investigations used the multinational technology company as a case study on how such companies are using global structures to avoid US taxes.

Using Irish subsidiaries, Microsoft “was able to reduce its 2011 US tax bill by $2.43 billion” (€1.87 billion), according to the memorandum, which formed the basis of a hearing held on Thursday afternoon in Washington.

The $2.43 billion US tax saving was achieved mostly through the avoidance of tax on royalty payments between Microsoft Ireland Operations Ltd (MIOL), and a subsidiary, Microsoft Ireland Research (MIR), which is in turn a subsidiary of a company called Round Island One.

The three companies have their registered addresses at 70 Sir John Rogerson’s Quay, Dublin, the offices of solicitors Matheson Ormsby Prentice. Round Island One is a Bermuda company, despite having its registered office here. It was incorporated in 2001.

MIOL paid a dividend of €4.9 billion in the period after June 2011, according to its most recent set of Irish accounts.

Up to now the financial details of MIR and Round Island One have been obscure, as they are unlimited companies and do not publish their accounts. However Microsoft gave the US Senate committee access to certain information and documents to allow it to produce its memorandum.

(It is now available on the committee's website at hsgac.senate.gov/subcommittees/investigation.)

According to the memo, Microsoft began to create its international network of foreign entities in the 1990s, beginning with Ireland, but also creating centres in Singapore and Puerto Rico.

The Irish centre is responsible for retail sales in Europe, the Middle East and Africa (EMEA). The Singapore centre is responsible for Asia, while Puerto Rico is responsible for sales in north and south America, including the United States.

Last year, Microsoft spent $9.1 billion on research, $7.8 billion of that in the United States. It received $200 million in tax credits from the US government for conducting research in the jurisdiction. However, profit rights to the intellectual property (IP) that resulted from this research, mostly resides in “foreign tax havens”.

In order to transfer the IP abroad, Microsoft and its regional centres have agreements sharing the research costs. MIR paid 30 per cent of Microsoft’s 2011 global research bill and in exchange has the right to sell Microsoft products in EMEA.

Last year MIR, which has 390 employees here, paid its US parent $2.8 billion for its right to sell Microsoft products in EMEA.

It then licensed these rights to MIOL, for $9 billion. MIOL, which has 650 employees here, then manufactured and sold products to 120 distributors in EMEA.

“MIR reported $4.3 billion of profits in 2011, with an effective tax rate of 7.2 per cent. This income equates to about $11 million of profit per employee.”

MIOL reported profits of $2.2 billion, or about $3.3 million per employee, and an effective tax rate of 7.3 per cent. The average pay of the Irish employees is not given in the memo.

Microsoft’s centre in Puerto Rico was established in 2005 using funds from Round Island One, which meant that the Puerto Rico operation belonged to the Irish group, according to the committee.

Microsoft Operations Puerto Rico (MOPR) was “seeded” with $1.6 billion in equity by Round Island One.

MOPR produces software for sale in the Americas and 47 per cent of the profits of the US sales end up in Puerto Rico, where they are taxed at the rate of about 2 per cent. Its customers include the US government. (The US corporation tax rate is 35 per cent.)

“This structure is not designed to satisfy any specific manufacturing or business need: rather it is designed to minimise tax on sales of products sold in the United States,” according to the memo.

The 2011 profits at MOPR translate into about $22.5 million per employee.

“At the same time, MOPR employees made an average salary of $44,000 a year, commensurate with the skills they contributed rather than with the accumulated profits being stockpiled in what served as a low-tax jurisdiction for Microsoft,” according to the memo.

Through the use of a “tiny factory in Puerto Rico”, Microsoft avoided more than $4 million in US taxes per day, the memo said.

Microsoft has shifted almost $21 billion, or half its US retail sales net revenue, from the US to MOPR, which is in turn under the ownership of its Irish operations.

THE TALE OF THE DISAPPEARING TAXES: CORPORATIONS GOING GLOBAL TO STAY PROFITABLE

The United States has a high corporation tax rate (35 per cent) and is unusual in that it taxes the global profits of its multinationals.

Although foreign profits can avoid tax until repatriated, this measure does not apply to passive income, such as royalty payments.

However, changes in US tax regulation in recent years have aided the avoidance of US taxes on passive income earned abroad, according to the memo prepared for the US senate's permanent subcommittee on investigations.

In 1952, corporate tax generated 32.1 per cent of all federal tax in the US. By 2011, that percentage had fallen to 8.9 per cent. The issue has been the subject of ongoing political focus, not least because the US federal debt now surpasses $16 trillion.

Tax code weaknesses in the area of transfer pricing within multinationals is one of the issues identified by the committee.

The committee memo quotes a study by the Office of Tax Analysis in the US Department of Treasury that found that lower effective tax rates had no significant effect on the growth of a company's worldwide pretax profits. "Lower taxes on foreign income do not seem to promote competitiveness," the study found.

Multinationals can also avoid US tax if they permanently reinvest foreign profits abroad.

Over the past decade, the amount of permanently reinvested foreign earnings booked by companies in the SP 500 has grown by more than 400 per cent. However, much of this money, according to the memo, may be lying in bank accounts, and even in bank accounts in the US.

In his evidence to the committee hearing Microsoft's vice president, worldwide tax, William J Sample, said US international tax rules are "outdated and are not competitive with the tax systems of our major trading partners". However committee chairman senator Carl Levin said that while the committee was a fan of Microsoft's creativity and entrepreneurial spirit, it was not a fan of its tax policies. Other multinationals acted in the same way, he said, at a heavy cost to the American public.

In his evidence to the committee, Prof Stephen Shay of the Harvard Law School, said Microsoft's earnings before tax in 2011 were $28 billion, of which more than 55 per cent went through Ireland ($8.9 billion), Singapore and Puerto Rico. He said individuals and small businesses in the US must make up for the taxes not paid by multinationals.