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The IRS takes Facebook to court over its Irish tax structure

Facebook has to fight its case in court

The US Tax Court will decide whether Facebook owes more than $9 billion to the Internal Revenue Service (IRS) in a landmark case. This would hit the company’s cash reserves hard.

The IRS is challenging Facebook on its transfer pricing arrangements in Ireland to as far back as 2010. The revenue service have accused the company of “downplaying” the value of its intangible assets in order to pay less tax in the US.

Before going public Facebook valued the assets at $6.5 billion in 2010, however, the IRS claimed the true value was $21 billion. If the IRS wins the court battle, the social media platform will not just face a hefty tax bill but also interest and any penalties tapped on top of the original $9 billion.

The trial is expected to last three to four weeks. The company is standing by the 2010 valuation when “it had not mobile advertising revenue, its international business was nascent and its digital advertising products were unproven”.

The IRS has argued the projections were much “lower” than would have been realistic. The company went through a year of “unbridled growth” in 2010 and made its experimental advertising model a well-established international success, according to the revenue service.

Facebook will argue its valuation was taking into account the risks associated with its international expansion. This was before Facebook became the second-biggest ad seller in the world. Secondly, the company will argue the Irish subsidiary played a key role in this expansion.

“Facebook Ireland and Facebook’s other foreign affiliates – not Facebook US – led the high-risk, and ultimately successful, international effort to sell Facebook ads,” the company said in a pre-trial memorandum.

Witnesses called to testify include chief revenue officer David Fischer and chief technology officer Mike Schroepfer, as well as Naomi Gleit and Javier Olivan, who have overseen the company’s rapid growth in the last 10 years.

The end of double Irish

A lot has changed since 2010. Not only is Facebook a global brand, the company has overhauled its Irish structure and adopted a local seller model in 2017. This model means that Facebook’s ad sales are no longer only routed through Dublin, but are also recorded by the local company in those countries in which it operates.

When the company restructured, Facebook employed more than 2,000 people in Dublin and there was no indication it was about to shift its workforce elsewhere. In fact, Facebook Ireland has expanded and now has more than 5,000 employees in the country.

Facebook’s effective tax rate has risen from 13% at the end of 2018 to 25% in December 2019, according to the company’s 10-K filing for the fourth quarter of 2019. This is after the company’s effective tax rate increased from 18% in 2016 to 23% in 2017.

“Tech companies should serve society. That includes at the corporate level, so we support the OECD’s efforts to create fair global tax rules for the internet,” said Mark Zuckerberg, CEO of Facebook, in a recent FT article.

Under the old structure, Facebook Ireland would pay royalties to the US-based parent company for access to its trademark, users and platform technologies. The Irish subsidiary paid Facebook US more than $14 billion in royalties and cost-sharing payments from 2010 to 2016, according to the court filing.

Yet the company shifted €12.6 billion ($13.6 billion) in European revenue through Ireland in 2016 and paid €29.5 million in tax. This was common practice in the days when the double Irish structure was still in place.

The double-Irish loophole allowed companies to move intangible assets to low-tax jurisdictions such as Ireland and then channel the income through countries like Bermuda, the British Virgin Islands and the Cayman Islands.

“I believe good regulation may hurt Facebook’s business in the near term but it will be better for everyone, including us, over the long term,” said Zuckerberg.

“These are problems that need to be fixed and that affect our industry as a whole. If we don’t create standards that people feel are legitimate, they won’t trust institutions or technology,” he added.

Facebook has more than $55 billion in cash reserves and the hefty tax bill (not taking into account interest and penalties) would cost it almost 20% of those reserves. This is just as the company is undertaking capital-heavy investments in new data centres and undersea cable networks.

However, this is about more than one company’s plans. The IRS case could mean that platforms will face yet further questions about past structures. It could also mean the past stays in the past, if the social media company can defend its record and persuade the US Tax Court to take its side.

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