Microsoft, IRS tax battle isn't over yet

Microsoft took a tax hit due to an IRS audit adjustment last quarter, but its ongoing tax dispute with the IRS looks to wage on, possibly for another year.
Written by Mary Jo Foley, Senior Contributing Editor

Although Microsoft reported it took an income tax charge due to an "IRS audit adjustment" as part of its second quarter fiscal 2015 earnings reported on January 26, the company's tax battle with the IRS is not yet over.

Microsoft reported earnings per share of .71 for its second quarter, which included a two cent negative impact from its Nokia integration expenses, a one cent negative foreign exchange hit, and a four cent income tax charge from an unspecified IRS audit.

Microsoft's effective tax rate for the quarter was 25 percent, which Chief Financial Officer Amy Hood called "higher than expected due to the previously mentioned income tax charge for an IRS audit adjustment." (Microsoft's tax rate last fiscal year was 21 percent, noted the Seattle Times.)

I asked Microsoft officials if the just-reported adjustment had to do with Microsoft's ongoing battle with the IRS over whether Microsoft adhered to tax law in its transfer of software-selling rights to countries and territories with lower tax rates. A spokesperson said the company had no comment beyond what executives said as part of its latest earnings report.

However, there was a bit of additional detail in Microsoft's 10-Q report, published on January 26:

"Tax contingencies and other tax liabilities were $11.3 billion and $10.4 billion as of December 31, 2014 and June 30, 2014, respectively, and are included in other long-term liabilities. This increase relates primarily to current period quarterly growth relating to intercompany transfer pricing adjustments. While we settled a portion of the Internal Revenue Service ("I.R.S.") audit for tax years 2004 to 2006 during the third quarter of fiscal year 2011, we remain under audit for those years. In February 2012, the I.R.S. withdrew its 2011 Revenue Agents Report and reopened the audit phase of the examination. As of December 31, 2014, the primary unresolved issue relates to transfer pricing which could have a significant adverse impact on our consolidated financial statements if it is not resolved favorably. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our income tax contingencies for these issues within the next 12 months. We also continue to be subject to examination by the I.R.S. for tax years 2007 to 2014."

The short of it: As of January 26, Microsoft and the IRS still had not resolved their dispute and Microsoft officials aren't expecting that to happen within the next 12 months. But Microsoft execs also aren't expecting a "significant" impact on its income tax contingencies during that period, according to its filing.

Microsoft's back-and-forth with the IRS accelerated late last year.

In October 2014, the IRS served Microsoft with a summons, seeking more information about the company's transfer-pricing practices in Bermuda and Puerto Rico.

In November 2014, Microsoft sued the IRS, seeking information about the agency's contract with law firm Quinn Emanuel Urquhart & Sullivan LLP, which the IRS hired in May to examine Microsoft's transfer-pricing practices. In late December 2014, the IRS sued former Microsoft CEO Steve Ballmer and a number of other former and current Microsoft officials in an attempt to compel them to testify in the ongoing investigation into the company's tax practices.

Microsoft's contention: the IRS is attempting to continue to extend the statute of limitations in a case that's been underway for nearly eight years. In a December 31 filing, Microsoft sought to consolidate the summons enforcement cases.

Microsoft isn't the only tech company the IRS is battling over taxes; it also has been fighting Amazon over similar pricing issues.

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