The Accounting Podcast

I'm Blake Oliver, and this is The Accounting Podcast.

Today, we're looking at the huge tax bill Microsoft is facing after a lengthy IRS audit. In 2012, the IRS launched its largest-ever audit, accusing Microsoft of using offshore tax havens to avoid paying US taxes. The audit focused specifically on Microsoft's use of subsidiaries located in Puerto Rico, where it was able to negotiate favorable tax rates.

After a decade of litigation between Microsoft and the IRS, the agency has now determined that Microsoft owes $28.9 billion in back taxes plus penalties and interest for the years 2004 to 2013. Microsoft says this bill is inflated by at least $10 billion and plans to appeal.

Some background on how Microsoft set up its tax avoidance scheme:

According to ProPublica, in 2005, Microsoft sold some of its most valuable intellectual property, including brands and copyrights, to an approximately 100-person factory it owned in Puerto Rico.

Microsoft had negotiated a deal with Puerto Rico to pay essentially zero percent corporate tax on the island. The company then channeled its global profits through this Puerto Rican subsidiary by having it produce and sell Microsoft software.

The IRS claimed this was illusory, a scheme solely meant to avoid taxes, with the small Puerto Rican operation pretending to generate $30 billion worth of profits by simply burning Microsoft software onto CDs.

The agency also claimed Microsoft had significantly understated its revenue projections during this period by as much as $15 billion annually. Fast Company reports that when the IRS started digging into the scheme, Microsoft lobbied Congress to try to restrict the agency's audit reach. A bipartisan bill did pass, but it didn't end up impacting this particular audit.

In response to the massive proposed tax bill, Microsoft says it followed all applicable IRS rules and plans to appeal the decision within the agency first, a process expected to take years. If the issue still remains unresolved after going through the IRS appeals process, Microsoft says it will take the case to court. The company also believes the final amount owed will be reduced by taxes already paid overseas.

So, this epic audit and legal battle seems far from over.

The final tax bill and broader implications for Microsoft and the IRS remain to be seen. We'll stay on this story. This has been a news update from The Accounting Podcast. I'm Blake Oliver. Thanks for listening.