President Obama's proposal to overhaul U.S. tax policy on international profits, unveiled last week, has raised objections from big companies that would end up paying considerably more in taxes under the plan. One is Microsoft, whose financial statements provide a case study in the benefits and drawbacks of the current system.

Microsoft in its 2008 fiscal year reduced its effective tax rate by 7 percent, or more than $1.6 billion, as a result of foreign earnings taxed at lower rates, according to its latest annual report. That and other factors cut Microsoft's tax bill to $6.1 billion last year, on $23.8 billion in pre-tax income. That's an effective tax rate of less than 26 percent, compared with the U.S. statutory rate of 35 percent.

By comparison, five years earlier, Microsoft trimmed only 1 percent from its tax bill as a result of international earnings. The subsequent increase in tax savings accompanied an overall jump in Microsoft's business overseas. But the company also was among those listed on a recent Government Accountability Office report on large U.S. corporations with subsidiaries in notorious tax havens.

The debate hinges on policies that let companies with international operations avoid higher U.S. tax rates by reinvesting their foreign earnings overseas. The Obama administration last Monday detailed its plan to put a damper on that practice.

"Currently, businesses that invest overseas can take immediate deductions on their U.S. tax returns for expenses supporting their overseas investments but nevertheless 'defer' paying U.S. taxes on the profits they make from those investments," the White House said in a May 4 briefing document. "As a result, U.S. taxpayer dollars are used to provide a significant tax advantage to companies who invest overseas relative to those who invest and create jobs at home."

Obama would change the rules to keep companies from receiving those deductions until they pay U.S. taxes on international profits. Deductions on research and experimentation spending wouldn't be affected, the White House said.

Microsoft isn't alone among tech companies in realizing those kinds of tax advantages, according to an Associated Press report. Others include IBM, Cisco, HP and Google.

Microsoft was among many companies that publicly objected to Obama's plan in a March letter to Congressional leaders (PDF). An excerpt from that letter:

Ninety-five percent of the world’s consumers live outside of the United States. American companies seeking to serve these consumers rely on growth in these markets to restart economic growth and create jobs for Americans. In fact, 22 million Americans work for U.S. multinationals while millions of other Americans are employed by the thousands of small and medium-sized companies that supply and service U.S. multinationals.

American companies require only a level playing field in international tax policy.  Unfortunately, the Administration's proposal to repeal “deferral” would impose a unilateral tax on the foreign earnings of American companies, upsetting the competitive balance between U.S. and foreign companies. This will result in a loss of jobs for Americans and serious negative impacts on the U.S. economy.  

Another issue is the accounting for profits in areas of the world with little or no corporate taxes. Eight of Microsoft's 14 foreign subsidiaries are in tax havens, including five in Ireland, according to a December 2008 GAO report (PDF, 59 pages).

Those are relatively small numbers, compared with the number of subsidiaries operated in tax havens by other companies on the list. In addition, the company maintains operations in countries around the world to support its global sales and product development. But Microsoft's subsidiaries in Ireland, especially, have been under scrutiny since a 2005 Wall Street Journal report (PDF).

Among other things, Obama's plan would crack down on tax havens by requiring "certain foreign subsidiaries to be considered as separate corporations for U.S. tax purposes," the White House said in last week's briefing document.

The actions against tax havens would raise $95.2 billion over the next 10 years, the White House said in the briefing document.

Overall, the White House said the various international tax reforms outlined last week, plus more to be unveiled in Obama's full budget, would raise a total of $210 billion over 10 years.

Contributing: Puget Sound Business Journal reporter Steve Wilhelm.