Microsoft’s $528 million Washington tax break

Weekend Essay.

When I heard that Microsoft Chairman Bill Gates had invoked the phrase “creative capitalism” at last month’s World Economic Forum in Davos, Switzerland, it reminded me how Microsoft avoids paying taxes on Washington-made software by selling it through Nevada. Since 1997, I estimate, the company has avoided paying more than $528 million in state taxes while racking up $92 billion in profit and distributing more than $42 billion in dividends to shareholders. Microsoft’s creative capitalism has deprived Washington state a lot of tax revenue it needs to pay for critical infrastructure such as replacing the aging 520 bridge that many of its employees use to get to and from corporate headquarters in Redmond.

In 2004, I wrote about Microsoft’s tax practices in Seattle Weekly. Since then, the process has continued unabated as Microsoft’s revenues have continued to grow.

Here’s how the practice works: Microsoft’s product teams, based mostly in Redmond and Issaquah, build software products such as Windows Vista, Windows Server, SQL Server, and Office. But sales of these products to PC manufacturers and corporate customers are conducted from a License and Operations office in Reno, Nev., where there is no corporate income tax. Microsoft records the revenue for these sales (traditionally about 31 percent of overall revenue) in Nevada and does not pay the Washington business and occupation tax required on software reproduction.

I estimate that for the past 11 years, Microsoft has used this practice to save $48 million annually, cumulatively more than half a billion dollars. If the Washington Legislature had not reduced the software tax rate from 1.5 percent to 0.484 percent in 1998, Microsoft’s tax savings would be more than triple that. As the company’s revenues have grown, so have the savings. Last year, I estimate, it avoided $76.7 million in taxes.

In 2004, Microsoft General Counsel Brad Smith told me, “The reality is that in the scheme of things, the impact is not very significant – either for the company or for the state government or the state economy. … The law is actually structured in such a way so as to permit a company to do precisely what we are doing.”

Maybe, but maybe not. As the lost tax revenue adds up, it’s up to Attorney General Rob McKenna and the Washington Legislature to decide whether Microsoft should be required to pay taxes for selling software from Nevada that was created by 35,510 employees on its 11.2 million square feet of real estate here in metro Puget Sound.

Software license codes are unique in that they can generate hundreds of millions of dollars in revenue by unlocking hundreds of thousands of copies of software for a PC manufacturer like Dell or a large company like General Electric. While shipping a DVD with a replication code might not attract the same kind of scrutiny that trucking timber products or delivering an airplane does, Microsoft accomplishes an astonishing sleight of hand by recording the licensing revenue in Nevada from products made here in Washington.

There will be a lack of equity and fairness as long as state leaders allow Microsoft to operate with a different set of rules than other businesses that pay the taxes on all of their Washington-made products. More importantly, the state will be left without vital revenue from its most successful company. How large does our infrastructure deficit have to become before our elected leaders find the political will to challenge this practice?

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