Microsoft Corporation - Page 6




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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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