Washington to Give Microsoft a $100 Million Annual Tax Cut...and Possible Amnesty on Past Tax Evasion

I'd like to encourage any Microsoft employees with knowledge of any manipulation around the company's Nevada tax practices to report what they know to the Department of Revenue. Your efforts could benefit Washington citizens as our state teeters on the edge of bankruptcy.

Update: Rep. Hunter is a former Microsoft general manager. Thanks for linking Digg, Slashdot, Cory @ BoingBoing, Seattle Weekly, Slog @ The Stranger and a big welcome to Publicola! And The Inquirer UK, SeattlePI.

Microsoft's $100 Million Annual Tax Cut

Facing a $2.8 billion deficit and pending insolvency, Washington State's House Bill 3176 proposes changes to the B&O Royalty tax that would give Microsoft an estimated $100 million tax cut annually and possible amnesty for more than a billion dollars in past tax evasion.

Under current law, all of Microsoft's worldwide licensing revenues of approximately $20.7 billion annually are taxable at .484 percent or ~$100.1 million. Under the new law, only the portion of software licenses sold to Washington state customers would be taxable - perhaps resulting in less than a million annually in royalty tax from the company.

The lead sponsor of HB3176 is Democratic Representative Ross Hunter, who represents Medina, home to Bill Gates and a number of current and former Microsoft billionaires and multi-millionaires, and other areas around Microsoft's corporate campus.

It's not like Microsoft has ever paid the royalty tax in full either. Since 1997, Microsoft has evaded an estimated $1.27 billion in royalty taxes, interest and penalties by operating a small office in Reno, Nevada to account for royalty revenue from software licensing.

One need look no further for a description of Microsoft's Nevada tax dodge than the state's own Office of Financial Management assessment of HB3176 (pg. 3):

Royalty income is not apportioned in this state. Rather, royalties are allocated to the domicile of the taxpayer. Businesses that are domiciled outside of Washington, but authorize the use of their intangible property in Washington, do not pay any B&O taxes in Washington on royalties received from the use of their intangible property in this state. This has led some Washington-domiciled taxpayers to transfer their intangible assets to wholly-owned subsidiaries whose sole place of business is outside of Washington. Sometimes these subsidiaries are domiciled in states, such as Nevada, that do not tax income from the use of intangibles.

Slash Microsoft's Tax, then Crack Down on Abuses

Ironically, after gutting the royalty tax and slashing Microsoft's taxable revenue, HB3176 directs the Department of Revenue to crack down on this kind of "abusive tax transaction" going forward using the legal doctrine we've been suggesting to them.

Section 201 of HB3176 (p. 20) instructs the Department of Revenue to "disregard" or enforce against the use of Nevada-like subsidiaries:

The department must disregard, for tax purposes, abusive tax avoidance transactions... (b) Disregard the form of a corporate or other entity, even when legal formalities have been observed, when the form of entity is used as part of an abusive tax avoidance transaction; (c) Treat the tax effects of the transaction, plan, or arrangement according to its underlying substance rather than its form; (d) Treat a series of formally separate steps as a single transaction; and (e) Take any other reasonable steps necessary to deny the tax benefit that would otherwise arise as a result of the abusive tax avoidance transaction.

Section 201 mirrors the legal arguments of substantial nexus, Alter Ego and the Step Doctrine that we've been making to the Department and the Legislature. 

The Department of Revenue's arguments to us explaining their inaction have been vague and weakly argued. Allowing Microsoft to evade the royalty tax to date appears to be an administrative decision.

We're hoping that public records we've been requesting the past few months will shed more detail on this issue. The Attorney General's office is currently reviewing the Department of Revenue's denial of our public records request.

Does HB 3176 Grant Microsoft's Nevada Tax Evasion Amnesty?

Washington's statute of limitations on unpaid tax debts is five years, longer if fraud is involved. Despite HB3176, a court challenge could still force Microsoft to pay its royalty tax bill in amounts from an estimated $370 million to the total amount including extra for interest and up to 35 percent penalties.

However, Sec 1504 of HB3176 raises a huge red flag (p. 88) to us: "Sec. 1504 ... (2) Section 201 of this act does not apply to any tax periods ending before July 1, 2010, that were included in a completed field audit conducted by the department."

In other words, if a field audit was conducted at Microsoft, which the company would know, then its entire billion dollar tax dodge would be shielded from collection under HB3176. In other words, an audit finding based on weaker, older administrative policies at the Department of Revenue could clear Microsoft from wrong doing despite the newer, stronger enforcement edicts in HB3176.

We would encourage Legislators to carefully review Microsoft's influence on HB3176 and its current tax standing with the Department of Revenue before voting on the bill.

Hypocrisy of Microsoft Founders in Spotlight

CEO Ballmer claims the company wants to honor its local communities by providing transparency in its business practices - but so far, he's refused to respond to calls to fully publicize its Nevada tax practices.

Chairman Gates and his Foundation express commitment to the health and welfare of Washington State and Education but this simply doesn't square with Microsoft's Nevada tax dodge and its impact on the state's budget - especially in light of the recent court decision proclaiming the Legislature's failure to Constitutionally fund education.

We assume that if Microsoft employees know of any manipulation related to Microsoft's Nevada tax practices, that Chairman Gates and CEO Ballmer would want them to report this information to the appropriate tax authorities.

HB3176 Isn't All Bad

Honestly, HB3176 may make better, more defensible tax policy going forward. While the royalty tax has always been a small percentage tax, allowable under the commerce clause, it does represent a significant burden on companies like Microsoft who earn revenue from intangible property. Taxing only transactions related to Washington State customers makes more logical sense than a blanket wholesale tax.

HB3176 will also likely collect significant additional tax revenue over time. But it does this by shifting the tax burden from the home team (Microsoft) to businesses around the country that sell products to Washington State consumers. 

We just think the bill could be more clearly labeled. The bill caption "Increasing state revenues to preserve funding for education, public safety, health care, and safety net services for elderly, disabled, and vulnerable people by preventing abusive tax avoidance transactions, narrowing or eliminating certain tax preferences, and providing equitable tax treatment" could more explicitly highlight the $100 million tax cut for Microsoft and the potential amnesty for it's past $1.27 billion in tax evasion.

It may also take several years for HB3176 to pay for itself, given this huge gift to Microsoft at a time when the State is facing dire near term budget challenges.

Yes, HB3176 reduces the incentive for companies to try to evade the royalty tax by setting up "offshore" offices in states of Nevada but it does this by gutting the definition of the royalty tax so companies like Microsoft would have 99% less taxable revenue.

For those wanting a deeper explanation of the changes to the royalty tax, you may want to read the House digest on the bill. Essentially, HB3176 changes the Royalty tax from a domicile tax (which includes worldwide royalty income) to "a gross receipts single-factor apportionment formula for allocating service and royalty income" only for sales to Washington.

In Conclusion

We just want to know why the Department of Revenue hasn't enforced the law as it's written today. We just want Microsoft to pay its due under the existing Royalty tax rather than having their illegal practice blessed with amnesty at a critical juncture for our state's finances.

We also hope that the the local media will ask Representative Hunter about Microsoft's involvement in the authoring of this legislation.