Editor's Note: Adopt Sales Factor Apportionment taxation and this tax litigation becomes irrelevant. Because internal profit shifting becomes irrelevant. Simply tax MNC global profit in proportion to sales occurring in US. Ignore subsidiaries.
Government challenges social-media giant’s transactions with its Irish subsidiary
[Richard Rubin | February 8, 2020 | WSJ]
Facebook Inc. FB 0.03% and the Internal Revenue Service will square off in a U.S. Tax Court case that could cost the social-media giant more than $9 billion and shape the government’s ability to crack down on companies’ efforts to shift profits to low-tax countries.
The trial slated to start in the week ahead caps a nine-year dispute over how Facebook structured its international operations. The IRS argues that more of the company’s profits should have been taxed at higher rates in the U.S., rather than in the company’s Irish subsidiary. Facebook contends that it deserves a refund.
Facebook’s practice of routing overseas profits to low-tax countries is common among U.S. multinationals, which have faced criticism in the U.S. and in Europe for not paying enough in taxes. The case could set the rules of the road for others with similar disputes in the pipeline.
“Both sides have salient arguments, and that makes it an exciting case,” said William Byrnes, a law professor at Texas A&M University, who expects the court to impose additional taxes on Facebook but less than the IRS wants. “What happens with Facebook sets the tone for what happens” to others.
The case stems from internal transactions Facebook conducted in the period before it went public as it was setting up its global operations. The result will likely hinge on the valuation of intellectual property used by Facebook’s overseas subsidiaries, which pay royalties to the parent company.
Facebook had incentives to set a low value for those assets, such as the user base and the company’s technology. By doing so, Facebook could reduce the stream of royalties paid to the U.S. parent that would be taxed at the 35% rate that applied before the 2017 tax law.
Instead, because of a structure involving a Cayman Islands holding company, the profits would face much lower taxes. Facebook did ultimately owe up to 15.5% on those profits because of a one-time tax imposed under the 2017 tax law. It is the gap between that and the 35% rate that is at stake in the case.
“Reducing taxes is a key to preserving profits given Facebook’s trajectory toward significant pretax income in 2010 and beyond,” said a May 2009 presentation to Facebook’s board of directors that is quoted in court records. “Shifting international profits to Ireland—this will be the largest source of long-term tax benefits.”
When it filed its tax returns, Facebook put a $7 billion value on the intangible assets in question. But it has recently argued that its subsequent estimates of that value are even lower, so it is entitled to a refund.
Facebook contends that the value should be low in part because the company’s trajectory was uncertain when the transactions were done in 2010 and because the Irish subsidiary did so much work to expand its non-U.S. business.
“Facebook Ireland and Facebook’s other foreign affiliates—not Facebook U.S.—led the high-risk, and ultimately successful, international effort to sell Facebook ads,” the company wrote in its pretrial memo. “Facebook Ireland is entitled to profits from the foreign business it built.”
Bertie Thomson, a Facebook spokeswoman, said the company looks forward to presenting its case in court.
“This trial is about transactions that took place in 2010, when Facebook had no mobile advertising revenue, its international business was nascent, and its digital advertising products were unproven,” she said in a statement. “Our business has had hits and misses but we stand behind the actions taken over a decade ago during a time of great risk and uncertainty for the company.”
The IRS declined to comment. News Corp, owner of The Wall Street Journal, has a commercial agreement to supply news through Facebook.
The IRS says the components of Facebook’s integrated global business—its user base, technology and marketing assets—shouldn’t be valued separately and instead must be considered as a package with potentially greater value than the sum of its parts.
The government has ridiculed Facebook’s claims that its Irish subsidiary did substantial work to expand the business. In filings, the IRS cites statements from company officials saying Facebook was already on a strong trajectory in 2010 and suggesting that the transactions were largely tax-motivated.
In its pretrial memo, the government quoted Chief Operating Officer Sheryl Sandberg as saying that Facebook had to call Ireland its international headquarters for “tax purposes.”
When it first audited Facebook’s tax returns, the IRS calculated a $14 billion asset value, about double what Facebook determined. But late last year, the IRS said that amount could be as high as $21 billion.
That translates into the $9 billion tax bill, plus interest and penalties, about equal to Facebook’s global tax costs for 2018 and 2019 combined, according to securities filings. That is up from $5 billion before the IRS revised its numbers.
The IRS, depleted after budget cuts, has struggled in similar cases against large companies, losing to Xilinx Inc. and Amazon.com Inc. But last year it defeated Altera Corp., which had become a subsidiary of Intel Corp. The agency now relies on updated regulations that may lack problems judges found in prior versions.
Courts “seem to be very sympathetic to the taxpayer, even where it’s clear that there’s a whole lot of creative stuff going on,” said Daniel Shaviro, a tax law professor at New York University.
The dispute has spawned three separate federal lawsuits, along with a subsequent Tax Court case that could cost Facebook another $680 million plus interest and penalties. Facebook has complained about the IRS’s extensive requests for documents and employee depositions and the recent change in estimates.
The two sides have struggled to agree on basic facts, and the IRS threatened to call Ms. Sandberg and Chief Executive Officer Mark Zuckerberg as witnesses if the company and government can’t come to terms on facts for the record.
The trial before Judge Cary Pugh starts in San Francisco and is scheduled to continue in Washington later this year. The sides listed dozens of potential witnesses. Tax rulings often come months after a trial, and they may not be the end of a case.
“It’s going for sure to the Ninth Circuit” appeals court, Prof. Byrnes said. “It’s too much money.”
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