Transfer pricing is sort of just a pile of black magic. Microsoft's American business is required to charge their European subsidiary some "fair market price" for the Windows intellectual property, but what is a fair price for a license to sell Windows on the European continent? Unlike with fungible goods, there is no established market for this product that the IRS can easily refer to.

In this case Microsoft is saying that some amount of their IP was developed by their overseas subsidiary and thus doesn't need to be included in the transfer pricing calculation, so in their process of making up imaginary amounts of money to charge themselves for their own products they also need to deduct that. If e.g. most of the Windows networking stack was created in Germany they need to figure out what percentage of the value of the overall Windows IP is added by the ability to connect to the internet.

Understandably, it's possible for reasonable observers to disagree on the values chosen here, this is not a case of black and white corporate misconduct (tax issues essentially never are).