Microsoft and Its Foreign Cash Holdings

When Microsoft announced that it would be purchasing the Internet communications company
Skype for $8.5 billion less than a decade after its origin, many people in the technology industry
took notice. When the deal was announced as an all-cash deal, shareholders and taxpayers in the
United States also started wondering. Why would Microsoft buy Skype using all cash, and where
does Microsoft have such large cash reserves?
But, let’s backtrack: Skype was founded in 2003 by two Scandinavians—Janus Friis from Denmark
and Niklas Zennström from Sweden. The Skype software was created by Estonians Ahti Heinla,
Priit Kasesalu, and Jaan Tallinn. At this time, Skype is an instant messaging app that can manage
both text messages and video chat services. Users may transmit both text and video messages,
and they can exchange digital documents such as images, text, and video via the Skype software
on a computer or app via various gadgets (e.g., smartphones). Skype also allows video conference
calls.
After the sale, Skype was incorporated as a division of Microsoft. The acquisition was the largest
in Microsoft’s history at that time (2011). Skype had been purchased by eBay in 2005 for $3.1
billion, but eBay took a $1.4 billion accounting charge in 2007 after the acquisition failed to realize
hoped-for synergies. In 2009, eBay sold a 70 percent stake in Skype to a group of investors led by
the U.S. private equity firm Silver Lake Partners. The sale to Silver Lake valued Skype at $2.75
billion. Many observers were surprised that only 18 months later, Microsoft was prepared to pay
$8.5 billion. Microsoft’s stated goal was to integrate Skype’s voice and video communication
offerings into Microsoft’s suite of products in order to bolster sales of those products and make
Microsoft more relevant in the age of digital devices, mobile communication, and cloud
computing.
Perhaps the most eye-opening aspects of the sale of Skype to Microsoft was that the company
used cash held overseas in foreign subsidiaries. These are subsidiaries located in countries with
very low corporate tax rates, such as Ireland, Singapore, and Bermuda. Microsoft stated in its
annual report that it had more than $30 billion in “permanently reinvested earnings” outside the
United States. As an example, in a report to the U.S. Senate, Microsoft Corp explained that it does
85 percent of its R&D in the United States. In fact, 36,000 of Microsoft’s 94,000 employees are in
product R&D. Last year, the company reported income of $23.2 billion but paid only $3.11 billion
in federal tax (13.4 percent). Those $3.11 billion—as much as it sounds—is much lower than the
corporate tax rate of 35 percent (President Donald Trump has proposed to lower this rate to 20
percent).
Now, Microsoft is no exception to holding foreign cash and monetary instruments. It is estimated
that American corporations stash more than $2 trillion in untaxed profits outside the country.
The U.S. election cycle in 2016– 2017 highlighted tax rules that encouraged this behavior.
Interestingly, as divided as the United States is politically, there appears to be growing political
consensus that a change in the tax rules should be made to encourage repatriation of the vast
troves of multinational corporations’ earnings held outside the country. But, companies,
American taxpayers, and investors often have conflicting stakes in the outcome, so it remains to
be seen what economic climate the United States will be in moving forward. What we do know
is that the corporate tax rate in the United States has ranged from a low of 15 percent to a high
of 50 percent in the last half a century (corporate taxes in the U.S. effectively began in 1909), and
that at 35 percent maximum, which it is now, the U.S. has among the highest corporate tax rates
in the world.
What we also know is that the $2 trillion in untaxed profits residing collectively with numerous
U.S. multinationals in various subsidiaries outside the country can be used for spending splurges
like Microsoft buying Skype. In Microsoft’s case, the foreign cash represents the accumulated net
proceeds from foreign sales. Under U.S. law, Microsoft does not pay taxes on those earnings until
they are repatriated to the United States. In theory at least, they can be held indefinitely
overseas. Microsoft also noted that the tax cost of repatriating those earnings to the United
States would be $9.2 billion, representing an effective tax rate of 31 percent. The U.S. corporate
tax rate is actually 35 percent. Microsoft stated that the reduction to 31 percent would come
from foreign tax credits, implying that the taxes the company paid on earnings retained overseas
amounts to just 4 percent, nine times lower than the top U.S. rate. Microsoft stated that by using
foreign cash to acquire Skype, it was being tax efficient.
Microsoft wasn’t the only company involved in the acquisition that reaped tax benefits. Skype
itself was incorporated in Luxembourg, a country with a corporate income tax rate of just 0.4
percent. At the time of the acquisition, the U.S. private equity firm Silver Lake owned 39 percent
of Skype. Two of the three Silver Lake entities that owned shares in Skype were based in the
Caribbean tax haven of George Town, Cayman Islands, suggesting that Silver Lake would not be
paying much in the way of U.S. capital gains tax on the profits made from its investments in Skype.
In addition, 30 percent of Skype was owned by eBay. Despite being an American company, eBay’s
Skype shareholding was held by eBay International AG, which is based in Switzerland, where
corporate tax rates are between 13 and 25 percent.
Despite paying $8.5 billion for Skype, Microsoft’s foreign cash hoard has continued to grow.
Microsoft holds more than $100 billion in cash in foreign subsidiaries, representing more than 90
percent of all of the company’s cash holdings. In its regulatory filings, the company noted that
this cash would be subject to material repatriation tax effects if returned to the United States.