This paper performs a forensic analysis of Microsoft Corporation’s transfer pricing cost sharing arrangement based on forensic economic analysis of public and information, including Microsoft’s SEC and foreign country regulatory filings, documents disclosed during a recent federal court trial, materials published by Microsoft, and information from former insiders interviewed for this paper, and other sources. The paper finds that Microsoft appears to have violated U.S. transfer pricing laws in 2009 and later years, in ways that caused its transfer pricing cost sharing arrangement with its Irish, Singaporean and Puerto Rican affiliates under U.S. tax laws to be invalid. However IRS had never detected this and has never to date challenged Microsoft’s non-compliance with the transition rules contained in the 2009 Section 1.482-7(m)(1) regulations or sought to examine Microsoft’s periodic adjustment calculations that it should have maintained since 2009. These tax violations and Microsoft’s invalid cost sharing arrangement mean that Microsoft is subject to a periodic adjustment, if triggered by its U.S. and foreign profit results. This paper shows that such a periodic trigger occurred as early as 2009 and a periodic adjustment (including penalties of 40% and interest since 2009) calculated by this paper estimates that Microsoft could owe the IRS as much as $169 billion. The company's reserves for Uncertain Tax Positions reported in its most recent Form 10-k issued on July 8, 2022 were $15.6 billion – an amount representing only around 9% of this possible financial liability. This periodic adjustment is not limited by any statute of limitations as long as the arrangement continues or the covered intangibles continue to be exploited. The IRS however has historically not enforced the periodic adjustment regulations of Section 1.482-7(i)(6) since they became effective on January 5, 2009. Microsoft’s non-compliance with these regulations and its exposure to this tax risk has never to our knowledge been reflected in its SEC filings.
Curtis, Stephen L. and Reuven S. Avi-Yonah. "Microsoft's Cost-Sharing Arrangement: Frankenstein Strikes Again." Tax Notes Federal 178 (2023): 1443-1500.
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