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Microsoft’s Super Heroes take on the IRS

sourcefourceMicrosoft launched a federal lawsuit against the US Internal Revenue Service, accusing the agency of not fulfilling its legal obligations under the Freedom of Information Act. Apparently, the IRS has hired an outside firm that specializes in litigation to examine the software giant’s tax returns, and Microsoft had been seeking documentation explaining the terms of its contract with the IRS.

“Government agencies, funded by citizens, have an obligation of transparency under the Freedom of Information Act,” a Microsoft statement explains. “The IRS has failed to meet the deadline to respond to a valid FOIA request, and we’re simply asking a court to ensure that the IRS meets its obligations.”

Here’s what we know so far:

In May, the IRS entered into a contract with law firm Quinn Emanuel Urquhart & Sullivan that is worth $2.1 million. It is examining Microsoft’s tax returns from 2004 through 2009. The firm’s examination of Microsoft is the first publicly disclosed instance of a third-party contractor conducting a tax examination on behalf of the IRS.

The goal may be to discover how Microsoft managed to pay a much lower than usual tax rate, though of course most large companies pay a much lower rate than the statutory corporate tax rate. In its most recent fiscal year, the software giant paid an effective tax rate of 21 percent. But the statutory corporate tax rate was 35 percent, which is among the highest in industrialized countries.

Microsoft explained the gap in its annual report by noting that it was “primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico.”

In other words, Microsoft, like Apple and many other US corporations, is reporting internationally-earned revenues outside of the US to benefit from lower tax rates in other countries. Ireland is a typical example, and one that has fallen under the scrutiny of EU regulators: the effective corporate tax rate in that country was just 12.5 percent.