Microsoft Operations Puerto Rico (MOPR) copies Microsoft computer software onto CDs and ships the CDs throughout North and South America, where MOPR sells the product.
In 2011, Microsoft claimed that 47% of its sales revenue from the western hemisphere comes from its operation in Puerto Rico. That was about 25% of its $69 billion in worldwide sales.
Legally, MOPR is a separate company from Microsoft. It is owned by MACS Holdings in Bermuda. MACS, in turn, is owned by Round Island One of Ireland. Microsoft owns Round Island One.
The multiple corporate layers of ownership are complex but the reason for the structure is simple: to avoid taxes.
Most of the value of the CDs comes from the software developed by the parent company in the States. Only a very minimal amount of the value comes from copying the software on the CDs in Puerto Rico.
But Microsoft has avoided Federal taxation of 47% of the value by leasing patents on the software to MOPR — its ‘controlled foreign corporation’ (‘CFC’) subsidiary in a U.S. territory of a subsidiary in a foreign country of another foreign subsidiary. The patents can cover the software and the Microsoft name.
MOPR paid Microsoft $1.9 billion for the rights to use this this ‘intellectual property’ in 2011. Microsoft paid MOPR approximately $6.3 billion for sales.
MOPR’s earnings after expenses were $4.015 billion that year, about 10% less than it made in each of the previous two years.
It paid a total of $41.4 million in taxes in 2011. This went to Puerto Rico’s territorial government. It was an effective tax rate of 1.02%.
The structure saved Microsoft about $1.5 billion in Federal taxes that year. The Federal corporate tax rate is 35%.
This Federal income tax is not due on earnings from a foreign subsidiary — including in the U.S. territory of Puerto Rico — until a parent company in the States takes legal ownership of the profits. Tremendously profitable and cash-rich, parent company Microsoft does not take possession of 89% of profits from its foreign subsidiaries.
All of this came out in a case study of U.S. company tax avoidance by the U.S. Senate Permanent Subcommittee on Investigations.
At a hearing reviewing Microsoft figures for the years 2009-11, it was reported that Microsoft employed more than 90,000 people, 54,000 in the U.S. Its 47% of sales in the Americas, however, were supposedly produced by the employees of MOPR — who totaled only 177 in 2011, about the same number as in the previous two years.
These workers were paid an average salary of $44,000 in 2011 — and each was credited with being responsible for about $22.5 million in earnings for the company.
The company had operations similar to that of MOPR in Ireland and Singapore.
It had two subsidiaries in each of the two countries. One subsidiary in Ireland had 390 employees and earned $11 million per worker. It’s effective tax rate was 7.2%. The other subsidiary had 650 employees and earned $3.3 million per worker. Its effective tax rate was 7.3%.
In Singapore, only one of the subsidiaries had employees. It had 687 workers and earned $862,000 per employee. Its effective tax rate was 10.6%. The company that had no employees was credited with earning $1.8 billion and paid an effective tax rate of .3%.
The MOPR operation is a pretty good deal, to say the least, for Microsoft — even in comparison to its operations in Singapore and Ireland. The company’s only defense for it is that it is legal, not that it makes sense for the United States.
The Puerto Rico CFC tax dodge is used by a few dozen companies. Together, they pay the territorial government — which operates at a deficit by borrowing through bonds — only a little more each year than Microsoft saved in any of the three years through MOPR from 2009-11.
Microsoft’s Puerto Rico scheme was put into place in 2005, the last year it could claims credits against Federal taxes under Section 936 of the U.S. Internal Revenue Code. Under a 1993 amendment, Sec. 936 provided credits for 40% of the income attributed to the territory. Before that the tax credits were equal to the income.
But 936 was abused by companies and ended by a 1996 law, although some users at the time were allowed to continue claiming the credit through 2005.
936 was enacted in 1976 to encourage companies to make job-creating investments in underdeveloped Puerto Rico. They did. But too many of the companies avoided much more in Federal taxes than they paid in wages or otherwise contributed to Puerto Rico’s economy, as was found in audits, such as a study by the U.S. Government Accountability Office.
The companies avoided the taxes — abused 936 — in the same way that Microsoft has through MOPR: by transferring ‘intangible assets,’ such as patents and trademarks, to their Puerto Rico operations and attributing income to the insular operations.
Another reason for the repeal was that there should not be a greater tax incentive to operate in the territory than in a State, according to Congress’ Joint Committee on Taxation.
The Federal government replaced an earlier tax exemption for income attributed to territories, Section 931 of the Federal tax code, with 936 because companies took unintended advantage of 931.
Within a few years of 936’s enactment, however, the U.S. Treasury acted to prevent corporate abuse under 936 with a regulation. When the regulation failed, Congress enacted a law to prevent abuse.
Because of continuing abuse, President Reagan proposed to replace 936 with a credit for wages paid in Puerto Rico vs. income merely attributed to the territory. He failed but President Clinton got a similar credit created in 1993 along with the reduction in the tax credit for income from 100% to 40%.
When the Congress sunset 936 in 1996, it was with overwhelming bipartisan votes.
Since 2001, some companies and politicians in Puerto Rico have tried to recreate the tax exemption for income attributed to the territory with a series of at least three proposals — with different tax code section numbers but all essentially proposing the same result. Tens of millions of dollars have been spent on lobbying but all of the proposals have been rejected by Federal officials.
Tax exemption for corporate income from Puerto Rico is a high priority for the territory’s “commonwealth status” party. The administration of “commonwealth” party Governor Alejandro Garcia Padilla and some companies have been lobbying for it to be incorporated into a reform of the Federal tax code.
The concept, however, contradicts a goal of Federal tax reform agreed upon by both Republicans and Democrats: Preventing companies from avoiding equal Federal taxation by transferring patents and trademarks developed in the States to low tax jurisdictions outside of the States.
This, the 936 experience, and examples such as Microsoft’s use of MOPR from 2009-11 illustrate why the current tax exemption efforts can also be counted on to fail.