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was filed. It was the common parent of an affiliated group of
corporations, which filed consolidated Forms 1120, U.S. Corporation
Income Tax Return, for 1987, 1988, 1989, 1990, and 1991.
During the years in issue, petitioner conducted its business
through several operating groups: Systems software, applications
software, systems peripherals and accessories group, OEM sales,
U.S. sales and marketing, international operations, and press.
Approximately three-quarters of petitioner’s worldwide
employees were based in Redmond, where petitioner developed its
products.
B. MS-FSC
MS-FSC was organized as a Virgin Islands corporation on
December 24, 1984. On January 1, 1985, petitioner and MS-FSC
entered into a Commission and Expense Agreement, which remained in
effect during the years in issue. At all relevant times, MS-FSC
elected to be taxed as a foreign sales corporation and was so
qualified. MS-FSC determined its commission income using section
925(a) administrative pricing rules.
C. Petitioner’s Products
Petitioner’s first products were programming languages and
tools that permitted software developers to create computer
software. Thereafter, petitioner’s product line was expanded to
include operating systems. In 1981, petitioner released its first
operating system, “Microsoft Disk Operating System” or “MS-DOS”,
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