Microsoft Tax Dodge

Dear Brad Smith, Did Microsoft Pay Royalty Taxes in Washington 1998 - 2010?

Following up on our post asking Microsoft to disclose its Washington State royalty tax payments from 1998 - 2010 to back up its claims of innocence, I've written an open letter to Senior Vice President and General Counsel Brad Smith. If Microsoft thinks this blog is spreading misinformation about its Nevada tax dodging, it just needs to disclose the amount of royalty tax it paid in the years 1998 - 2010. 

Last month, Smith wrote a column in The Seattle Times in which he expressed concern that falling tax revenues are hurting education: "Like many states, Washington continues to battle significant budget challenges. Unlike many states, however, our constitution declares that it's the state's paramount duty to provide for the public education of all children. Unfortunately, steady declines in public resources now threaten our ability to live up to that commitment."

To Refute Claims, Microsoft Should Disclose Its Royalty Tax Payments

Update: Microsoft refuses to release the amounts of its royalty tax payments to Washington State.

Beginning with the publication of Citizen Microsoft in Seattle Weekly in 2004, I've reported that Microsoft used its Nevada office to avoid payment of the state's Royalty Tax from 1998 - 2010. I've blogged that the amount of the tax dodge has likely exceeded $1.07 billion (not including penalties). 

Last week, after John Burbank, Executive Director of the Economic Opportunity Institute, wrote an editorial condemning the company's hypocritical record of tax dodging while advocating for more education funding, Jeffrey Reading, Microsoft's Senior PR Manager wrote The Herald to refute the claims Burbank made (Burbank based his article on my reporting):

"Mr. Burbank does not include sourcing to support his claims regarding Microsoft’s Nevada licensing, which is part of a very complicated piece of state tax law. Much of the information regarding this issue is misinformation primarily spread by a blogger, and no state official has ever provided any factual data supporting his claims."

I stand behind my research and all of my claims. If Microsoft wishes to prove that it paid Washington State Royalty Taxes during the years 1998 - 2010, it should disclose its worldwide licensing revenue and its Royalty Tax payments for this time period. It would be quite simple for the company to provide these two sets of numbers and would put the issue to rest once and for all (as I have done here). 

If it is not willing to provide this data, it should frankly stop sending knowingly false letters to journalists accusing this blogger of spreading "misinformation".

I know that Microsoft's accusations about my reporting are false for two reasons:

1) Using the same analysis we reported in Citizen Microsoft in 2004, we know that the state's Royalty Tax collections are much smaller than they should be given Microsoft's reported licensing revenue. 

Since 1997, Microsoft’s reported $480 billion in revenue, approximately $149 billion from licensing. Under the state’s Royalty Tax from 1998 - 2010, more than $757 million dollars should have been paid in tax. However, since 1999, the Department of Revenue (DoR) reports that all taxpayers combined have only paid $72.9 million in royalty taxes.

For example, in 2009, Microsoft earned approximately $18.7 billion in licensing revenue. Washington State should have recorded more than $87.6 million in tax receipts, but the DoR reported only $6.3 million in royalty taxes paid that year. 

2) When I interviewed Microsoft's General Council and Vice President Brad Smith in 2004 for Citizen Microsoft, he admitted the tax avoidance effort, while attempting to make light of its scope:

"Well, the principle focus of discussion inside the company and with people in state government here at times has been both the focus on revenue generation for the State of Washington and job creation in the State of Washington. And, obviously the company did make a decision, I'm not remembering exactly how many years ago to put Microsoft Licensing Incorporated in Nevada, in part to recognize the lower tax rate[sic - Nv. tax rate is zero] that was in place there. And, there have have been times when people in state government have mentioned to us the issue of whether we might move that back to the state of Washington. The reality is that in the scheme of things the impact is not very significant either for the company or for the state either the state government or the state economy."

Just prior to publication of Citizen Microsoft, Seattle Weekly handed over our facts and figures to Microsoft and asked them to correct our reporting. They did not refute the facts at that time. So, it seems odd that they are now refuting these facts to The Herald.

Microsoft has never outrightly denied not paying the Royalty Tax for its licensing revenue during the years of 1998-2010. It's time for them to set the record straight and release the data. In my interview, Mr. Smith said that at the time that the company would consider releasing such data. It never has.

In closing, I'd like to make three important final points:

1) A Microsoft employee reported to me that the company used to send invoices for Microsoft Nevada from its Washington State office with envelopes printed with Reno, Nevada return addresses. Perhaps the company would also like to explain at this time how this practice might affect the legal independence of its Washington and Nevada based corporations that it claims in its tax records. If evidence of fraud is found in Microsoft's tax reports, this could potentially expose the company to severe financial penalties. 

2) The Royalty Tax rate actually was 1.5 percent (more than three times higher) prior to 1998, but was cut in response to software industry lobbying. Scenario B in the Financial History shows that if not for its lobbying to cut the Royalty Tax from 1.5 to .484 percent, Microsoft would owe $4.37 billion in taxes, interest and penalties.

3) A 2010 job listing at Microsoft's Nevada website (see background) claimed the sub-corporation records more than $30 billion in revenues annually. If accurate, this figure is about half the company's revenue and 40 percent greater than our earlier estimates. After re-calculating Microsoft's tax avoidance based on this figure (it stopped publicly reporting licensing revenues in 2004), we estimate Microsoft would owe $6.1 billion in taxes, interest and penalties - enough to fund all of the Legislature's 2010 cuts and the current shortfall.

Related Links:

• Overview of Microsoft's Nevada Tax Dodge including video by Amanda Congdon
• 2010 Fact Sheet
• Historical Financial Analysis of Microsoft's Nevada Tax Dodge (Google Docs Spreadsheet)
• Washington State Doesn't Have a Budget Deficit

John Burbank Tells Legislature to Target Microsoft

In his Everett Herald column today, John Burbank, Executive Director of the Economic Opportunity Institute, zeroes in on Microsoft's tax dodge and its harmful effects on the state's educational system:

Seeds planted by corporate lobbyists in our state's tax code, and fertilized by an obedient Legislature, have grown to the point where waste, fraud and abuse in corporate taxation is crowding out our kids' K-12 education, the paramount duty of the state. ...

Microsoft made over $23 billion in profit on $69.9 billion of revenue in its 2011 fiscal year, a tidy profit rate of 33 percent. But apparently the company still needs to skimp on taxes. By running its licensing sales through a shop in Reno, Nev., it avoids royalty taxes that could be funding high-quality schools for Washington's children.

The Legislature has enabled Microsoft to continue this ruse. Last year the state budget included a provision to ensure that only Microsoft's licensing revenue from Washington state customers is taxable. For good measure, the Legislature agreed to an amnesty clause that legally prohibits the state from trying to collect back taxes owed by Microsoft before the narrower definition of taxable licenses was passed.

So how much did public school students and their teachers and professors lose from this ruse? Somewhere between $100 million and $400 million a year for the past 15 years. (We can't get much more accurate because we can't see Microsoft's internal corporate accounting.)

Read the full article: State Must Stop Coddling Corporations 

Washington State Doesn't Have a Budget Deficit

Washington State doesn't have a deficit, it just has a destructive array of tax breaks for wealthy corporations such as those highlighted by the Economic Opportunity Institute and Seattle Weekly's ongoing Candyland of Tax Breaks series. Amazingly though, the impact from Microsoft's lobbying and dodging of the state's Royalty Tax is enough on its own to make up the entirety of last year's draconian cuts and the current budget shortfall.

Until 2010, Washington State's Royalty Tax required Microsoft to pay about half a percent (.484) of its worldwide licensing revenue in taxes (cumulatively, about $180 billion since 1998). By recording its revenue through a small Reno, Nevada accounting office, the company claimed the revenue was not taxable (for deeper background, read our Overview and 2010 Fact Sheet). The company has never denied this activity and in fact has confirmed its Nevada tax practices in public statements.

Here's three ways to look at Microsoft's impact on the state's budget deficit:

1) $1.51 Billion in Tax Savings: Based on Microsoft's own reporting, I estimate the company has saved $1.51 billion in taxes, interest and penalties since 1998. For the first time, we've published our entire analysis in a Google Docs spreadsheet: Financial History of Microsoft's Nevada Tax Dodge.

This estimate includes the $104 million that Microsoft saved last year after Chair of the Finance Committee Ross Hunter, a former Microsoft Executive, led the Democratically controlled Legislature to drastically shrink the Royalty Tax from a tax on worldwide revenue to one based just on sales to Washington State customers. Hunter's action will continue to cost the state more than $100 million annually going forward. Hunter even slipped in a section to grant Microsoft amnesty from its past abuses.

2) $4.37 Billion in Tax Savings: The Royalty Tax rate actually was 1.5 percent (more than three times higher) prior to 1998, but was cut in response to software industry lobbying. Scenario B in the Financial History shows that if not for its lobbying to cut the Royalty Tax from 1.5 to .484 percent, Microsoft would owe $4.37 billion in taxes, interest and penalties.

3) $6.1 Billion in Tax Savings: A 2010 job listing at Microsoft's Nevada website (see background) claimed the sub-corporation records more than $30 billion in revenues annually. If accurate, this figure is about half the company's revenue and 40 percent greater than our earlier estimates. After re-calculating Microsoft's tax avoidance based on this figure (it stopped publicly reporting licensing revenues in 2004), we estimate Microsoft would owe $6.1 billion in taxes, interest and penalties - enough to fund all of the Legislature's 2010 cuts and the current shortfall.

In general, Microsoft's geographic accounting practices are so deceptive that the Institute of Tax and Economic Policies had to exclude the company from its recent Corporate Taxpayers and Tax Dodgers report:

"We [had] to leave out from the study companies whose geographic allocations were obviously ridiculous (e.g., almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States). Google and Microsoft are two examples of such apparently “liar companies” that we left out of the study. For such companies, it may be that they reported in their annual reports how they misallocated their profits on their tax returns, rather than where their profits were really earned."

It's time to question the frame that Governor Gregoire and the Legislature talk about the budget and education cuts. There is no budget deficit; we've just made a choice to give the region's most profitable company a huge pass on our Royalty Tax law. There is no budget deficit - only the money we've let Microsoft keep for itself through harmful insider lobbying and Nevada tax practices.

So in response to Governor Gregoire's and Microsoft's General Counsel Brad Smith's call for an increase in the already regressive sales tax to stabilize education funding, tell them where they can find the money: One Microsoft Way. 

 

Ballard's Anti-Microsoft Banner Wrong on the Facts

Love to see this agitprop trying to raise awareness about Microsoft's Nevada tax dodge. It's just wrong on the latest facts (photo courtesy of Geekwire):

In 2010, the Legislature changed the state's Royalty Tax in Microsoft's favor. The change was led by (wait for it) former Microsoft executive Ross Hunter, Democratic Chair of the Finance committee. The Royalty Tax used to be a .484%* tax on worldwide revenue from software licensing. Microsoft claimed its licensing revenue from its Alter Ego corporate sub-identity in Nevada to avoid the tax. It saved between $1.51 billion and $6.1 billion depending on how you calculate it. However, Hunter changed the tax so the Royalty Tax is now apportioned. The tax now only applies to sales to Washington State customers (not worldwide revenues).

It was a huge gift (tax cut) for Microsoft. And, of course, Governor Gregoire appointed another Microsoft executive to run the Department of Revenue last year ... so it's unlikely the department will crack down on Microsoft's Nevada activities.

So a more accurate banner would have to read, "Microsoft's dodged $6.1 billion in Washington State taxes before it lobbied the legislature to rewrite the law to eliminate the tax."

* Prior to 1998, the Royalty Tax was actually 3x higher (1.5 percent) but was reduced to .484 percent after (wait for it) lobbying from the software industry (aka Microsoft)

 

Hypocritical, Tax-dodging Microsoft Supports Increased Sales Tax to Fund Higher Education

TechFlash reports that Microsoft's General Counsel Brad Smith has called for the Governor to end cuts to higher education and is supportive of an increase to our state's sales tax. Microsoft loves the sales tax because it's a regressive tax - meaning that the poor pay a higher percent of their income in taxes than the rich:

"People earning less than $20,000 annually pay 17.3 percent of family income toward sales and excise taxes and property taxes, the report said. People making between $99,000 and $198,000 each year pay 7.6 percent toward their tax bill. Meanwhill, people in the top 1 percent of earners – those making more than $537,000 a year – pay just 2.9 percent, the report said."

The Institute for Taxation and Economic Policy (ITEP) reports that Washington State already has the most regressive tax structure in the country.

If it weren't for Microsoft's Nevada Tax Dodge and its lobbying effort, Washington State wouldn't have a budget deficit right now. We'll be updating our reporting on this soon (our earlier summary is here).

In general, Microsoft's geographic accounting practices are so deceptive that the ITEP had to exclude the company from its most recent Corporate Taxpayers and Tax Dodgers report:

"We [had] to leave out from the study companies whose geographic allocations were obviously ridiculous (e.g., almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States). Google and Microsoft are two examples of such apparently “liar companies” that we left out of the study. For such companies, it may be that they reported in their annual reports how they misallocated their profits on their tax returns, rather than where their profits were really earned."

 

An Update on Microsoft's Nevada Tax Operations and Washington State's Budget Deficit

As the year draws to a close, I wanted to provide an update for everyone who's followed the story of Microsoft's Nevada tax dodge this year:

• In October, Microsoft announced record profit of $16.2 billion. The company now has approximately $44 billion in cash and short term holdings on hand.

• We learned that the company records about half of its revenue at its Nevada licensing subsidiary - outside the reach of Washington's department of revenue.

• The Washington State Legislature, led by Democrat Representative Ross Hunter, essentially legalized Microsoft's Nevada tax dodge by redefining the state's royalty tax so that the majority of the company's worldwide sales were no longer taxable.

• Partly as a result of this, Washington State is now facing a $5.7 billion deficit, up from the earlier estimate of $3.3 billion. The governor is now threatening a cuts-only budget.

• Most people in Seattle (and Washington State), know nothing at all about Microsoft's Nevada tax practice in part due to the fact that The Seattle Times has never reported the story.
  
  
• Local coverage of this issue does not appear to be improving. e.g. The Gates Foundation gave $400,000 to local news blog Crosscut.com, which later was caught removing anti-Microsoft sentiment from a published editorial by the University of Washington's Bill and Melinda Gates Chair of the Computer Science and Engineering Department.

• Perhaps due to the lack of awareness of his actions, King County voters re-elected Rep. Ross Hunter. Diane Tebelius, Hunter's Republican opponent never mentioned the Microsoft tax dodge, though she was briefed on it (by me), presumably because she did not want to alienate Microsoft employees in her district.

• Statewide voters rejected an income tax on people earning more than $200,000 annually, an initiative laudably supported by the father of Microsoft Chairman Bill Gates, William Gates Sr.

• Shortly after the election (and the failure of the high earners initiative), Microsoft CEO Steve Ballmer announced planned sales of $1.3 billion in Microsoft stock. Ballmer gave $425,000 to help defeat the initiative.

• Statewide voters also chose to repeal the retail candy, soda and bottled water tax which Hunter helped pass ... in part to make up for the shortfall complicated by the royalty tax cut for Microsoft.
  
  
• The City of Seattle is one place where these tax cuts are going to have to be made up in other areas through cutbacks in services and increases in fees. e.g. $4/hr parking.

• And, state voters passed a controversial initiative to require a 2/3 supermajority to raise future taxes further complicating the task of an already conflicted legislature which has never had much skill balancing the burden of taxation between citizens and the state's wealthiest corporations.

• Last but not least, the Department of Revenue finally explained why they haven't challenged Microsoft's Nevada tax practice using appeals court precedents from Louisiana which set clear guidelines for state taxation on sales of intangible goods like software licenses. Most interestingly, the department concludes its explanation saying that after it asked the Legislature for stronger legislation to close these kinds of tax loopholes, the Legislature instead chose to essentially legalize Microsoft's royalty tax dodge by redefining the definition of the tax.

So, where does this leave us? Basically, in a lot of debt with a Legislature which thinks it's been directed by the voters not to raise taxes for anyone (it's possible they were just sending a message that they'd prefer the legislature make these decisions on its own).

Things are going to get harder for Washington State's most vulnerable citizens and costlier for nearly all its residents. Meanwhile, the global shareholders of wealthy companies like Microsoft will continue to get a subsidized ride on our state's declining infrastructure.

One idea to help balance the budget going forward would be for the Legislature to restore the Royalty Tax to its 1997 rate and strengthen the enforcement language, this would raise nearly $300 million annually just from Microsoft and likely another few hundred million from the state's other software makers.

Based on what I've seen and learned this year, it's clear that the issue of Microsoft's Nevada tax dodging is just one tiny part of a much bigger problem - that of corporations funding and influencing the state legislature to pursue policies that favor their shareholders, while leaving residents on the hook to pay higher and higher taxes. Over the next year, you'll probably see me focus more on this issue and less on Microsoft.

 

 

 

 

Microsoft's Nevada Employees Probably Shouldn't Joke About Criminal Activity

If you want to know what the Kool-Aid tastes like at Microsoft, check out this clip of its Nevada Licensing employees offering up their own "I'm a PC" anecdotes. It's not quite as cringeworthy as the Windows 7 Launch Party and not as bizarre as the IE8 vomit girl ad, but it's definitely painful to watch.

I was most intrigued by this brief segment in which an apparent Reno-based Microsoft Licensing employee jokes, "I'm a P.C. and I'm a criminal." On the wall in the background, there appear to be pictures of two to three other mugshot photos - perhaps also Reno employees? Exactly what is she referring to?

Given that we believe that these employees are the folks that have helped Microsoft avoid nearly $1.25 billion in taxes, interest and penalties since 1998 under questionable legal status, you would think they might be more careful about joking about illegal activity.

From our discussions with Washington State's Department of Revenue, Microsoft Licensing's corporate activities are supposed to be clearly separate from Microsoft's Washington-based corporate activities. However, we've heard one anecdotal report of the company mailing its customers from Redmond with envelopes printed with return addresses from Nevada. We've also heard that the company was continuing to move employees from Redmond to Reno to comply with state law - twelve years into its tax avoidance activities.

If you would like to report irregular activities related to tax reporting in Washington State, contact the Department of Revenue or the State Auditor. 

This whole "I'm a PC and I'm a criminal" thing may be funny to Reno-based employees but in Washington State, we're facing a $3 billion deficit due at least in part to Microsoft's tax avoidance activities. We don't think this topic is very funny.

Note: We're hoping Thursday's election counts (4:30 pm expected release) will help determine whether former Microsoft executive Rep. Ross Hunter will be defeated by his opponent Diane Tebelius. Right now, he is only 911 votes ahead with about 32% more of the vote to count. Hunter led the $100 million tax cut and tax amnesty for Microsoft in this year's legislative session.

Thank Ross Hunter for Making Microsoft's Record Profit Untaxable

Today, Microsoft announced record quarterly profit of $16.2 billion. The company now holds $44 billion in cash and short term assets.

Under Democratic Rep. Ross Hunter's leadership in the Washington State Legislature, Microsoft's licensing revenue is no longer taxable in Washington. Hunter led the change to Washington's royalty tax so that only licensing revenue sold to Washington State customers is taxable. Prior to 2010, worldwide royalty revenue was taxable.

Hunter is a former 17 year veteran of Microsoft, now head of the powerful finance committee. Rather than apportion the royalty tax (which resulted in only a tiny gain in state revenues), Hunter could have adopted stricter enforcement language around out of state tax transactions such as was proposed by the state's Department of Revenue. Since 1998, Microsoft has used a small office in Reno, Nevada to record its worldwide royalty profits - avoiding nearly $1.25 billion in tax liabilities.

None of this would be a big deal if Washington State wasn't facing a $3 billion deficit.

Microsoft Tax Dodge founder Jeff Reifman recently endorsed Hunter's Republican opponent, Diane Tebelius, in Tuesday's upcoming election.

We'll have a lot more to talk about in coming weeks. Stay tuned.

Crosscut Strips Anti-Microsoft Paragraph from Published Editorial on Tax Policy

Last week, a colleague excitedly emailed me about an opinion piece on Crosscut about Initiative 1098 (the progressive income tax initiative) which hammered Microsoft for its Nevada tax dodge on many of the points previously mentioned on this blog: 

"Microsoft's behavior regarding B&O taxes — dodging them for years by doing their licensing from Nevada — has been shameful. The state's failure to call them on it has been shameful. Last session's legislation legitimizing this was shameful."

However, by the time I read the editorial, the quote was gone. This concerned me as I've had trouble getting Seattle's journalism community to cover Microsoft's thirteen year billion dollar Nevada tax dodge. It may concern you too because Crosscut has relied heavily on $500,000 in grants from the Gates Foundation over the past year. Is there a conflict of interest at play? Additionally, the author of the editorial, Ed Lazowska, holds the Bill and Melinda Gates Chair in Computer Science & Engineering at the University of Washington.

I contacted Crosscut's publisher David Brewster via email to ask him about the post-publication edit as well as Director Lazowska. I asked each for an on the record response that I could publish.

Disclaimers: I invested $5,000 in Crosscut when it first started as a for profit. It later converted to a nonprofit entity (the investment was converted to a donation). I have written on Microsoft's tax dodge previously for Crosscut (here & here). I'm also a former Microsoft Group Program Manager. I consider myself a friend and colleague to Brewster et al. in the Crosscut community.

Q: Can you explain why the quote was removed?

Brewster: I thought it was too extraneous, and needs much more reporting and context, so took it out on further reflection, and with Ed's concurrence.

Q: Can you explain the post publication corrections policy at Crosscut or why this edit was made post publication? 

Brewster: No real policy. We often change stories after they are first put up, or as second thoughts become first thoughts.

Q: Could you tell me if this is a statement that you wrote and whether it's something you still stand behind?

Lazowska: The statement doesn't have anything to do with 1098.  I also don't feel that it's a defensible statement.

I'm not an expert in journalistic practice but none of these responses erased my doubts. Post-publication edits in a major online news site should be done with great care and transparency. Given that this was an opinion piece, the relevance of contextual reporting and defensibility seems less important. I don't understand why Lazowska would allow something to be published that he didn't think was defensible in the first place. If you read this blog, you know those comments are defensible. 

As investigative and online community journalism is increasingly funded by private foundation funds, it's important that the same ethical guidelines separating funders from coverage apply. While the Gates Foundation is not likely involved in editorial decisions at Crosscut, their support seems to be having an impact on what gets written on the site.

When I wrote an April Fools Piece on Microsoft's Tax Dodge for Crosscut earlier this year, Brewster removed a paragraph about the Gates Foundation: "The Experience Music Project will be razed to provide additional parking for the Gates Foundation, which will move its executive offices to the top of the Space Needle. A zip line will be installed from there to the foundation entrance." (The Foundation is building a new office on formerly public land at Seattle Center). I don't feel it's fair to quote Brewster's email to me from that time in this piece. However, he expressed that the Gates Foundation might have been unfairly dragged into the story. I felt uncomfortable about the change then - but felt it was more important that the piece get out there. 

The edited paragraph (without the Gates Foundation mention) was changed to: "Seattle Center will be transformed. The Experience Music Project will be razed to make room for a new retail store, the Experience Microsoft Project, designed jointly by local glass artist Dale Chihuly and architect of the popular Seattle Public Library, Rem Koolhaas. Koolhaas’ design also calls for a glass helipad atop the Needle and a zip line down to a new private airstrip, for which a portion of Memorial Stadium and McCaw Hall will be relocated."

In retrospect, Crosscut would have been in the final stages of receiving approval for the $400,000 July 2010 grant when my April 1st piece was published.

I have incredible respect for Brewster and the Crosscut team ... but I do not think that this reflects well on the organization or its capacity to effectively perform investigative work in our community. I hope that some thought is given to making the editorial process more transparent.

I also think this raises solid issues for discussion about funding of nonprofit community news sites by foundations who often have a vested interest in coverage.