Microsoft NZ and IRD at odds over transfer pricing

Microsoft NZ generated revenue of $184.1 million in the 12 months ended June 30.

Microsoft New Zealand and the Inland Revenue Department are officially at odds after a lengthy audit of the software giant's local books.

IRD has been auditing Microsoft's transfer pricing since at least January last year, initially covering the June 2013 to June 2015 financial years. The tax department later extended that through June 2017.

Microsoft first acknowledged the audit in its 2016 annual report. In the 2018 annual report, the directors again noted that they and their legal advisers believed the company had adequately assessed and provided for its tax through the period, while acknowledging the final outcome wasn't certain.

The latest accounts say the matter is now in a formal tax dispute resolution process. The IRD's website says the process starts with a notice of proposed adjustment and response, followed by a conference, after which the respective parties put forward their positions. An IRD unit staffed by independent experts then reviews the matter, and if either party is still unhappy it can be taken to either the Tax Review Authority or the High Court.

"No further information relating to the dispute has been disclosed on the basis that it is considered legally sensitive and may be detrimental to the company to do so," the annual report said.

Microsoft NZ's tax expenses through the 2013 to 2017 periods totalled $25.6 million. Over the same period, it generated $80.6 million in pre-tax profit, a margin of about 16.7 percent to its revenue of $483.6 million. Its effective tax rate through the period was 31.8 percent - that's higher than the base 28 percent corporate tax rate because of non-deductible items such as share-based payments.

Microsoft changed the way it recognised revenue during the period. From February 2018, the local unit's accounts were extended to include the distribution of computer software and hardware, having previously covered marketing. The change effectively means local product sales are being captured. A popular way for multinational firms to minimise their around tax bill is to book sales in a low-tax jurisdiction.

Still, the latest change didn't affect Microsoft's New Zealand income tax expense, which fell to $5.1 million from $6.6 million a year earlier due to another legislative change that resulted in a tax deduction in future periods for share-based staff payments. That's also lowered its effective tax rate to 23.9 percent in the latest year.

The cashlow statement showed an increase in income tax paid to $8 million from $6.7 million. The changes to Microsoft's revenue recognition also seem to route GST through the local unit, with GST payments of $8.1 million in the year ended June 30, compared to just $13,441 a year earlier.

Parliament this year passed legislation aimed at reducing multinational transfer pricing tax strategies. Papers accompanying the bill showed IRD was auditing 16 firms involving an annual $100 million of disputed tax.

Including five months of the new revenue recognition, Microsoft NZ generated revenue of $184.1 million in the 12 months ended June 30 compared to $115.2 million a year earlier. The new accounting method also introduced $69.6 million of sales and distribution expenses. Net profit increased to $16.2 million from $14 million a year earlier.