The Road to a Balanced Budget Leads to Microsoft

Update: The Guardian UK has written an excellent analysis of this post - it's a must read: Is Microsoft a Tax Dodger? Thanks also to Slashdot, TechFlash, PI & macnn!

Microsoft's Cumulative Tax Evasion Now Exceeds Washington State's Biennial Deficit

Last week, the Seattle Times reported that Washington State's tax revenue is expected to decline by $238 million creating a $430 million shortfall in the biennial budget. The deficit is expected to grow further as a result of "rising demand for state services and other factors". Luckily, there is an easy way to shore up our finances - ask Attorney General Rob McKenna to begin enforcing the state's existing tax law on software licensing.

Over the past thirteen years, I estimate that Microsoft has avoided paying more than $707 million in B & O taxes on sales of its corporate software licenses (see Citizen Microsoft and Microsoft's $528 million Washington tax break ). Although the majority of its software development is performed in Washington State, Microsoft records its estimated $18 billion in licensing revenue per year through a corporate office in Reno, Nevada where there is no licensing tax.

Under the state's .484 percent software royalty tax^{(lowered from 1.5 percent in 1998 after industry lobbying)}, I estimate that Microsoft should have paid more than $90 million in 2008 and $87 million in 2009 in state taxes.

Just by enforcing the state's existing tax law from 2008 onwards, we could reduce Washington's revenue shortfall by more than 70 percent. Alternately, we could pursue the entire $707 million from Microsoft's thirteen years of tax dodging and cover most of the expected deficit going forward - perhaps more if damages are awarded through litigation.

Since Microsoft began operations in Reno in 1997, it has enjoyed record-setting revenue of more than $446 billion and profit of more than $124 billion. If it paid its actual tax bill in full today, it would still have more than $24 billion in cash holdings.

Readers love to make excuses for why Microsoft should be exempt from state tax law but all I'm asking for is uniform enforcement of existing state tax law. If we're not going to enforce the tax, why have it?

Given the number of Washington state residents out of work as a result of the recession, I call on  Governor Gregoire and Legislature to enforce existing tax laws before trying to cut benefits to our most vulnerable citizens. How dare they even consider reducing access to health care and unemployment benefits before addressing this long-ignored issue!

Before you comment - please see the "Note to Commenters" below...

Notes

1. If the Washington State Legislature hadn't bowed to industry lobbyists and cut the tax rate by more than 2/3, Microsoft would owe $2.08 billion.

2. I single out Microsoft because it's, by far, one of the biggest offenders, but I would like to see the uniform enforcement of state tax law to all corporations using out of state facilities to minimize tax payments.

Related links

• Microsoft's $528 million Washington tax break (Crosscut)
• Top Reader Excuses for Microsoft's Tax Avoidance (Idealog)
  
• Horrible ten years for Microsoft shareholders (Idealog)
  
• Citizen Microsoft (Seattle Weekly) and Follow up (Idealog) 
• More budget cuts loom for Washington state government (Seattle Times)
• Wash. expected to lose about $238M in tax revenue (Seattle Times)

Note to Commenters

A lot of the arguments made below were already addressed in this piece. Please read it before you comment.

Secondly, please review Washington State's B&O tax before you comment:

RCW 82.04.2907 Tax on royalties from granting intangible rights.

Upon every person engaging within this state in the business of receiving income from royalties or charges in the nature of royalties for the granting of intangible rights, such as copyrights, licenses, patents, or franchise fees, the amount of tax with respect to such business shall be equal to the gross income from royalties or charges in the nature of royalties from the business multiplied by the rate of 0.484 percent.

     "Royalties" means compensation for the use of intangible property, such as copyrights, patents, licenses, franchises, trademarks, trade names, and similar items. It does not include compensation for any natural resource or licensing of canned software to the end user.

[2001 c 320 § 3; 1998 c 331 § 1.]

* Canned software to the end user = retail software sales in boxes with end user licenses, not mass license sales to corporations

* The law does not distinguish between license sales intrastate, interstate or international

* By transferring it's software to Reno for sale from Nevada, Microsoft is accomplishing a "sleight of hand" which probably would not pass muster in Washington State court.

Comments

[George Buford]

Or we could keep the jobs in Washington State and negotiate with Microsoft behind the scenes, rather than force a public confrontation. Besides, if MS goes to Nevada, how can their software possibly get BETTER?

My two cents - tax = no sense,
George Buford

[John Lambert]

I'd be interested in learning more. Which law, precisely, is being violated?

[washinton citizen #3282832]

Of course libs like you don't realize how much the state already receives in indirect tax revenue from simply having Microsoft in the state.

Start raising taxes on corporations and they'll direct new development outside your tax locale. A company like Microsoft does not depend on any Washington resource to do business.

Maybe you should move to California where they have been treating businesses like ATMs.
http://www.economist.com/world/unitedstates/displaystory.cfm?story_id=14327185

[Da_gut]

Its a non issue - there is no tax dodge. The software is NOT licensed in Washington state, so its not subject to the state tax. Its licensed in Nevada, which is the only state that has any claim to tax the licensing.

[Josh]

First, please source your information so it may be verified. Secondly, let's assume you are right and that MS would be forced to pay the back taxes and fix the CURRENT budget issues. How would that fix the underlying problem of the politicians in Olympia spending more money than the state brings in? What will happen when MS decides the best way to continue making the money they are accustomed to making is to move out of Washington State entirely? How will that help the states coufer's?

[Shane]

The problem is that there are several states out there that hunger to attract large companies to them, bringing jobs and all the ancillary economic frosting that goes with them. And the cake doesn't get much bigger than Microsoft.

If Microsoft feels that Washington has become, shall we say, "unfriendly" enough, they could just move their operations somewhere where states are willing to cut a better deal. Sure, WA may get back taxes and penalties (in several years after the court cases are complete), but after that the damage is done.

Fair? Maybe not. But there's no law that says they have to stay, either.

[Floyd Russell]

Perhaps the problem to be tackled is to reduce the state operating expenses. Why is it that during a downturn businesses and individuals have to reduce expenditures but governments are expected to go on business as usual? The goverment doesn't hold an endless pot of money - they are stewards of the tax revenue sent in by the people. A revenue drop means spending should drop.

Consider that the tax in question would only be passed on to the end-user and would certainly not help Microsoft make sales. So, which is better? A Microsoft that grosses $60,420,000,000.00 in FY08 based in Washington or a Microsoft that grosses $60,420,000,000.00 headquartered somewhere else?

I wonder - if we continue to try and chase corporations out of this country what happens if we succeed?

[KT Neko]

Me too (about learning more). What's the justification for them paying WA taxes again? They are a company with offices in many countries and many places -- why Washington taxes specifically for licensing they do out of Nevada? I doubt the law defines 'how much software they develop in Washington', so what's the specific justification for this? Saying "Well they have a big presence here" probably doesn't cut it....

[Guest]

Most large companies do these types of things and with good reason. It is entirely legal. The AG can't do anything because they are not breaking the law. The state has to find another way to tax Microsoft, or god forbid cut back on spending.

Why does everyone applaud competition until it comes to the government. In this case Nevada is competing with Washington over taxes and Nevada is more competitive.

[Robert Kaiser]

You seem pretty misinformed on tax law. I suggest you do some more reading before you start accusing people of not doing their job.
For instance, you can't tax a corporation on revenue they book in another state. Article 4 section 1 of the Constitution has been interpreted to prevent just that.
If your interpretation of the law was allowed, a Toyota dealership opening up in Texas should be taxed by Washington state because the Toyota factory in Washington.
Regardless of your feelings on the matter, that's not how the system works.

[Ben Scherrey]

I am always fascinated by how the destroyers of wealth can always calculate to the penny how much they are "owed" (if only the culprits would quit pursuing their legal options of avoiding our taxes) but are lucky to be within the same order of magnitude on their cost estimates of their favorite new long term "investment" program.

Already Obama is eyeing taxing US-based companies based on their world wide IP income - even of foreign subsidiaries that have no US presence. Now these companies are having to evaluate whether or not being a US company makes sense at all and the answers are not going to be good for the US.

...keep hacking at that goose and enjoy one last meal.

[Ya]

Didn't really think this idea through, did ya? Since laws weren't actually violated (kinda the premise of this fail), all you can do is close loopholes. Do that, and you probably convince Microsoft they should move their headquarters - which would probably cost Washington a lot more in income tax than it gains through sales tax.. But hey, it got your blog some slashdot traffic so it was worth it. :)

[nulled]

This goes BEYOND state tax... MS (as well as just about EVERY majormultibillion dollar Corp) uses a Loop hole in the tax system where they set up HQ in Ireland ... where the corp tax rate is 4% or so...

[Scott]

I wonder if MS will sue this idiot for defamation, while what MS is doing is not against the law, what this idiot is doing (slander) certainly is.

[Jeff@reifman.org]

I've posted more information about Washington States B&O tax and explanation for all of you under "Notes for Commenters" - see above, at the end of the piece.

Please also be sure to read
Top Reader Excuses for Microsoft's Tax Avoidance (Idealog)
http://www.idealog.us/2008/02/top-reader-excu.html

I think it addresses the majority of your other comments.

If I missed something, please re-post a specific question or unaddressed comment! Thanks all!

[Jeff]

You can also reply back to me on Twitter @reifman

[Paul Reinheimer]

You haven't argued that Microsoft's actions are illegal, merely that the practice is reducing the available revenue to a state in need. From that, I'll assume that Microsoft's actions are indeed legal, simply distasteful.

I think arguing for a retroactive change to tax laws is counter-productive. These companies are obeying the law, pulling the rug out from under them by changing the law retroactively creates a very turbulent (and to be honest, scary) business environment. Reserve funds will need to be generated in order to cover possible, retroactive taxes created by the legislature. While, as you've pointed out, Microsoft may currently have a large cash reserve, many other companies are not.

I'll assume you paid your taxes last year, and for the past several. Would you enjoy an environment where the government went back and changed the tax laws for years gone by, leaving you seriously in arrears? I wouldn't, few would. But that's one of the outcomes you're proposing.

If you'd like to argue for changing the laws next year, go for it. But changing the past to better meet your needs today leaves every business in the state in a tenuous position of not knowing what tomorrows laws may bring to yesterday.

[Jeff]

Thanks Paul for posting a thoughtful comment.

You're right that this article is not a legal brief on the merits of the state's case. I agree with you that MSFT's acts are very distasteful and I think short-sighted.

If you go back and read Citizen Microsoft (linked above), MSFT's council Brad Smith called this part of a tax minimization strategy - and said there was more they thought they could do.

However, I disagree with you that this is legal. MSFT is well aware of the law - and if it is enforced, I think the state has every right to push for back taxes and damages.

When the IRS audits a taxpayer, they push for proper payments of all back taxes and sometimes interest and penalties.

[Max Lybbert]

> By transferring it's software to Reno for sale
> from Nevada, Microsoft is accomplishing a "sleight
> of hand" which probably would not pass muster in
> Washington State court.

I would appreciate some citation about why this wouldn't pass muster in Washington State court instead of a simple assertion. Or why this is a "sleight of hand" instead of, say, "patriotically relying on the federalist system" (yes, that statement is deliberately over the top).

> MSFT's council Brad Smith called this part of a
> tax minimization strategy

So? The famous judge Learned Hand once wrote (in a legally binding opinion) "Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes." In fact, judges in Merry Olde England had settled this law there long before taxation without representation.

Taxes are sometimes lowered -- or tax breaks created -- specifically to encourage certain activity (green tax credits, for instance). Is it wrong to take advantage of those lower taxes? Nevada has chosen to keep certain taxes low (no personal income tax, lower-than-average business taxes) and other taxes high (hotel taxes, taxes on gambling winnings) to encourage certain behavior (bring in business) and balance the books (tourism). Is it wrong to take advantage of those lower taxes?

[stalin]

Dear Communist writer,

Thank you for your dedication to the motherland for your inspirational writing. With people like you we should have a glorious victory under our leader obama, to finally eradicate these capitalist pigs.

Sincerely,

Stalin

[Jeff]

You know you're winning the argument when commenters resort to calling you a communist.

[stalin]

Dear Communist editor,

Thank you for your hard work editing out non party capitalist pig comments.

Stalin

[Gazzer]

As opposed to the capitalist banking system that then came crying for tax-payers money when they f***ed themselves up. Rich capitalists sure become communist pretty fast when they need something.

[Jonah]

Amzing perspective. Perhaps you may want to do a cost-benefit analysis for Microsoft. The cost benefit analysis would include the cost of leaving Washington State and the benefit of having administrative offices in a more favorable tax jurisdiction. Then, you may want to do a cost-benefit analysis, for the state of Washington, and what they will do when they loss property tax, sales tax, licensing taxes of the 70,000+ that leave the state as well as the aftermath from other companies because Microsoft has left, in addition to the cost of having to pay for infrastructure entirely (and no Microsoft to pay for half).

Increasing taxes to meet budget shortfalls is one of the most idiotic, short-cited thought processes of the 21st century....see California.

[marty]

You state in a response above to Paul that you disagree that it is legal. Please show your source.

I believe that Microsoft followed the same practice that was used by Visio when we used a similar process to eliminate B&O taxes (I was CFO). In our case we received a private letter ruling from the state declaring that no B&O tax would be imposed.

With a company of Msft's size it is unimaginable that their annual audit by outside auditors (tax experts included), annual audit by state agencies and the due diligence process required during any of their numerous acquisitions which would have required outside legal opinion about unrecorded potential liabilities would have missed this pretty obvious issue without such a ruling.

I also agree that turning a state into an unfriendly business climate by attempting to renege on past rulings is about as short sighted as you can get. Lots of states are offering huge incentives everyday to get businesses to move into state to bring jobs. Remember Russell Investments? Or would you go back and take back those incentives as well?