Is Exempt OpenAI in a Virtual Merger with Microsoft?

I think the answer to the headline question is . . . “yes” insofar as tax exemption is concerned.  I can’t yet articulate the conclusion as a tax law matter, but that the OpenAI insiders have equity in the for profit investors joint venturing with OpenAI is a fatal flaw to me.  It puts the OpenAI insiders in an intolerable conflict that should doom OpenAI’s tax exempt status.  Anyway, it looks like other countries are concerned with the headline question.   Here is a story from the Wall Street Journal article regarding inquiries in the UK and Germany:

U.K. regulators said they are examining Microsoft’s MSFT 0.02%increase; green up pointing triangle partnership with OpenAI, marking a first push by one of the world’s most influential competition authorities to scrutinize the relationship between the tech giant and the artificial-intelligence company behind ChatGPT.

Britain’s Competition and Markets Authority said Friday that it is seeking feedback on whether the partnership should be considered a de facto merger, in an initial step that could lead to a formal investigation. The move comes after a dramatic turn of events at OpenAI that resulted in the abrupt firing and reinstatement of Chief Executive Sam Altman, along with the formation of a new board. The new three-person board includes Bret Taylor, the former co-chief executive of cloud-software giant Salesforceplans to add more members.

Microsoft, which invested $13 billion for a 49% stake in OpenAI’s for-profit arm, will gain a nonvoting observer position. A Microsoft spokesman later Friday said that the company “does not own any portion of OpenAI and is simply entitled to share of profit distributions.”

The Microsoft investment is part of a complex financial and governance structure in which a nonprofit, governed by the board, controls the for-profit arm and outside investors get stakes in the arm’s profits, according to people familiar with the situation. The CMA said there had been “a number of developments in the governance of OpenAI, some of which involved Microsoft.” As a result, the agency was asking for comments on whether the news “has resulted in a relevant merger situation and, if so, the potential impact on competition.”

If the watchdog determines that the relationship meets its criteria for a merger review, that could prompt a formal investigation into whether it creates competition concerns in the artificial-intelligence market. Such an investigation—if it proceeds—could lead to an order for the two companies to separate or make other structural or behavioral changes. Microsoft said its partnership with OpenAI, which began in 2019, has preserved the independence of both companies and fostered AI innovation and competition.

“The only thing that has changed is that Microsoft will now have a non-voting observer on OpenAI’s Board, which is very different from an acquisition such as Google’s purchase of DeepMind in the U.K.,” Microsoft Vice Chair and President Brad Smith said Friday. Microsoft will work with the CMA to provide it with the information it needs, Smith added.

OpenAI said its partnership with Microsoft empowers it to pursue research and develop safe and beneficial AI tools while remaining independent and competitive. Microsoft’s “non-voting board observer does not provide them with governing authority or control over OpenAI’s operations,” the company said in a statement. OpenAI was founded in 2015 and is governed by a nonprofit organization with a board devoted to making artificial general intelligence safe and available for all humanity. The nonprofit created a for-profit arm in 2019—the arm that then went on to raise billions from investors including Microsoft.

The U.K. authority’s scrutiny comes after an earlier examination of the partnership by Germany’s Federal Cartel Office. The German agency said last month that it didn’t consider the partnership between the two companies to be subject to its merger-control rules but would re-examine the situation if Microsoft increased its influence on OpenAI in the future. The German probe concluded before Altman’s initial firing. The European Union’s antitrust watchdog said Friday that while it hadn’t been formally notified of a transaction between Microsoft and OpenAI, it has been following developments closely. The EU’s merger control rules can be triggered if regulators deem that a transaction has resulted in a lasting change of control.

The European Commission, the EU’s executive arm, “has been following very closely the situation of control over OpenAI already before the recent events involving its management,” including Microsoft’s role, a spokeswoman said. The U.K.’s CMA has emerged as an increasingly important global tech regulator since Britain’s exit from the EU. Earlier this year, it was the only major regulator to formally block Microsoft’s bid to acquire videogame maker Activision Blizzard. It later reversed that decision after the companies submitted a new merger deal.

darryll k. jones