Wednesday, January 28, 2009

Do We Really Import Microsoft Software from Ireland?

John Ensign - Republican Policy Committee Chairman – claims we do:

You know, we have the second highest corporate tax rate in the industrialized world. Microsoft, which is a great American company, has zero exports from the United States. They have a lot of exports from Ireland, because, guess what, Ireland has a 12.5 percent corporate tax rate; we have a 35 percent corporate tax rate.

Microsoft does not manufacture products in Ireland to sell to the U.S. It designs all sorts of software that we can place on our personal computers. While you might argue that Microsoft has to manufacture things like the Xbox – such manufacturing is contracted to third parties. During fiscal year ended December 31, 2008, Microsoft incurred $8.2 billion in R&D expenditures according to its 10-K filing. This R&D is in part performed in Ireland but it also occurs in the U.S., Canada, China, Denmark, India, Israel and the UK.

Microsoft has used the provision of the U.S. transfer pricing regulation under section 1.482 to have whatever is developed by their R&D personal around the world to be jointly owned by the U.S. parent and its Irish subsidiary – even if most of the R&D occurs in the U.S. They do so under a series of contract R&D and Cost Sharing arrangements where the Irish subsidiary had to at one point compensate the U.S. parent for any pre-existing intangible assets. In the usual game, the multinational corporation hires some transfer pricing “expert” to write a “valuation” that supports a really low compensation. The IRS then has the right to challenge this valuation as to whether the compensation is truly arm’s length or fair market value. Often, it is below fair market value which would give the appearance that much of the value is being created by the Irish entity even if much of the value is truly being created within the U.S. To use the actual accounting when intercompany prices are not consistent with arm’s length prices to make the kind of inferences made by John Ensign is really silly.

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