| Here’s what’s going on: -Companies that operate internationally make revenue and incur costs in many different countries. -As a result, they owe taxes to many different national authorities. -Each national authority has rules for how costs and revenues are accounted across borders. -These rules are necessarily complex, because it’s often not clear how costs and asset transfers should be accounted from simple first principles. -This is particularly important when accounting costs across countries, because taxable income is often based on your costs. -For example in the US, Federal taxable income equals gross income MINUS the cost of goods sold. -In a multinational, one critical question in figuring out costs is how to value transfer prices of goods, intangibles, and services among enterprises under common ownership. -That is, if the U.S. division of company A and a division of company A in another country exchange assets or services, the question of how they price those goods to one another becomes important for tax reasons. -Typically there’s a lot of accountants with spreadsheets or a software system where all this is calculated, monitored, invoiced, booked, and reconciled. -Accounting and services for this is typically called “transfer pricing.” -To determine how to account for these costs, each national regulator has very specific rules. -The question is whether Microsoft adhered to these rules in how it accounted for costs and revenues between its U.S. and international entities. -These disputes go through a very long back and forth process that often culminates in litigation, which itself can last years, or settlement. -Microsoft says, “Because our subsidiaries shared in the costs of developing certain intellectual property, under those IRS cost-sharing regulations, the subsidiaries were also entitled to the related profits.” -So it looks like the dispute centers around how to account for “the costs of developing intellectual property”, which can be hard if you’re developing software globally. -Finally, there’s one aspect to consider when you see these $XXB figures. At the size of certain very big corporations like Microsoft or Apple, money does not behave like it does for you, or me, or even Sequoia Capital. -Microsoft’s market cap is $2.4T. At that scale, money enters a kind of different state of matter. -Money’s purpose is primarily to coordinate economic activity, especially when you’re talking about non-negligible amounts for multinationals. -So payments among the revenue agencies of various countries and their very large private multinationals are in kind of a closed loop where they mainly have complex macroeconomic effects. -For example, the effect of increasing taxes via heightened transfer pricing scrutiny mostly moves production from one sector to another (e.g. from consumer tech to health and defense.) -The policy and finance folks pulling the levers understand how that works, and often have their own complex set of motives. |