Microsoft Corp warned on Thursday that a government review of its U.S. tax obligations in past years could significantly affect its financial statements if not resolved in its favor.

The Internal Revenue Service has looked at Microsoft's use of transfer pricing, among other things, or methods of booking prices and sales between subsidiaries -- often leading to opportunities to report earnings in lower-tax jurisdictions.

Companies routinely and legally book profits overseas to enjoy lower tax rates and avoid stumping up a hefty 35 percent levy on profits in the United States.

But with the United States shouldering a high jobless rate and big budget deficit, there have been increasing calls in Washington for a simplified tax code with a lower corporate tax rate and fewer loopholes. There has also been pressure from major companies on U.S. President Barack Obama's administration to let profits parked offshore be brought home at very low tax rates, to boost investment and jobs.

On Thursday, the world's largest software company said it had accumulated $44.8 billion of non-U.S. earnings -- reinvested abroad -- as of June 2011, translating into deferred taxes of about $14.2 billion.

That marked a sharp jump from the $29.5 billion permanently reinvested overseas as of the end of 2010, meaning $9.2 billion in deferred taxes.

Microsoft did not offer specifics on how it employed cash earned abroad, but reinvestments could encompass anything from buying office equipment to parking it in a bank. While stashing money overseas avoids the repatriation tax, it also means companies have a lot less flexibility in using the money to invest in the United States or other purposes such as dividend payments.

In Thursday's filing, Microsoft said the IRS had issued a Revenue Agent's Report after an examination of the 2004-2006 tax years, but Microsoft was appealing several adjustments cited in the report.

It did not offer details. The company also said it remained subject to IRS examination for the 2007 to 2010 tax years.

We do not agree with the adjustments in the RAR, and we have filed a protest to initiate the administrative appeals process, Microsoft said in an exchange filing. The proposed adjustments are primarily related to transfer pricing and could have a significant impact on our financial statements if not resolved favorably.

However, we believe our existing reserves are adequate.

Part of the IRS issue for the 2004-2006 years was resolved last quarter in Microsoft's favor, with the company recording a $461 million refund.

A DEFT HAND

Experts say Microsoft has proved adept at shrinking its tax bill, and the company itself states that it employs lower-tax foreign jurisdictions.

Microsoft said its lower taxes in the recent quarter were primarily due to a higher mix of earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore and Puerto Rico, which are subject to lower income tax rates.

The details of precisely how it does this have not been disclosed. U.S. companies do not have to break out earnings in foreign subsidiaries, making it hard to determine from financial filings how much tax they are saving through each jurisdiction.

In response to stock regulators' requests, Microsoft also took the extra step of breaking out sales by region and product, providing a more detailed snapshot of its business.

It said 46 percent of its sales came from outside the United States, or about $32 billion, in fiscal 2011, up from 42 percent in 2010.

However, pre-tax profits booked overseas nearly tripled over the past six years, to $19.2 billion in the fiscal year that just ended, from $6.8 billion in the year ended in June 2006, according to company filings.

In contrast, its U.S. earnings have dropped, to $8.9 billion from $11.4 billion in the same period. Foreign earnings now make up 68 percent of overall income.

(Reporting by Edwin Chan and Lynnley Browning; Editing by Richard Chang)

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