Industry Reaches for $100 Million Tax Break

Software companies are pressing their claim for the same tax break that movie and music industries enjoy

Software executives are escalating their multipronged campaign to change a much-hated export tax, which will cost the industry roughly $800 million during the next seven years.

Regulations issued in 1987 by the Internal Revenue Service barred software companies from receiving a tax break created by the 1984 Foreign Sales Corporation tax law. The 1984 law requires companies to pay a 35 percent tax on royalties from the overseas reproduction and sale of their products, but explicitly allowed the movie and music industries to exclude 15 percent of those revenues from taxation.

IRS regulators misunderstood the 1984 law and should have also granted the tax break to the software industry, say software executives.

Without that 15 percent exemption, the nation's software industry pays roughly $100 million extra in annual taxes to the IRS. The industry's 1994 revenues reached $74 billion in 1994, according to an estimate prepared by the industry-sponsored Business Software Alliance.

To win the 15 percent discount, Redmond, Wash.-based Microsoft Corp. has sued the IRS in the federal tax court, while industry lobbyists are promoting a draft tax-reform law sponsored by Sen. Larry Pressler, R-S.D., chairman of the Commerce Committee.

Also, industry officials have persuaded Republican presidential candidate Bob Dole to include the Foreign Sales Corporation reform in his six-year, $551 billion tax-cut proposal. The reform would be worth $600 million to the software industry between 1998 and 2002, according to an Aug. 8 estimate prepared by Congress' Joint Committee on Taxation.

Pressler will introduce his tax-reform bill in September, but it is unlikely to become law this year, said Pressler's spokeswoman, Anne Waltner. In 1997, Pressler will make passage of the law a top priority for the Senate Committee on Finance, on which he serves, she said.

"It will be pretty hard for them to get a tax bill done [this year].... It will be very difficult," said Rachelle Bernstein, a tax specialist with Arthur Andersen LLP, based in Chicago. Bernstein is director of the industry-sponsored FSC Coalition, which is working to reform the tax law.

The fact that there is no comparable bill in the House also makes changes unlikely, said Mark Nebergall, counsel at the Washington-based Software Publishers Association.

However, 52 members of the House of Representatives from California asked President Clinton in May to rewrite the 1987 regulation. They would sponsor a bill reforming the FSC tax, said J.D. Marple, who directs legislative policy issues for the Washington-based Business Software Alliance.

FSC tax reform also could be accomplished by Treasury Department officials, said Marple. "We are continuously trying to convince the Treasury Department that there is no reason they should not make this change on their own [but]... there has been inexplicable resistance," to changes, he said.

In response, Microsoft has turned to the courts, arguing that it should not have paid roughly $19 million in 1990 and 1991 taxes, because the 1987 regulation issued by the IRS wrongly excludes the software industry. "We would argue the current law" allows extension of the break to software companies, said Jack Krumholtz, Microsoft's representative in Washington.

The IRS regulation states the software companies should not receive the tax break because mass-produced, shrink-wrapped software is not intended to be reproduced overseas.

In response, software executives say that much of the shrink-wrapped software sold overseas is first exported on a master disk, before being replicated and sold, much as movie and music companies export master copies of their products for mass-replication overseas.

If Microsoft loses, the IRS will be able to collect $19 million from it, plus additional millions of dollars owed by other software companies that have refused to pay the FSC tax, said Nebergall. But the case will not be decided quickly, he said. "A year is being optimistic.... Things move slowly in court," he said.

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