(Bloomberg) Facebook Inc.’s future cash flows and results could suffer a major blow if it loses a battle over new U.S. tax liabilities related to the transfer of its global operations to Ireland in 2010.
The Internal Revenue Service delivered a notice of deficiency to the social media giant Wednesday for $3 billion to $5 billion, plus interest and penalties, based on the agency’s audit of Facebook’s transfer pricing, the company said in a regulatory filing Thursday. Facebook, which plans to challenge the notice in federal tax court, said its balance sheet could suffer if it’s held liable.
Facebook said in the filing that the liability “could have a material adverse impact” on its finances, results or cash flows. “In addition, the determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment by management, and there are many transactions where the ultimate tax determination is uncertain.”
The IRS on Monday asked a federal magistrate judge in California to force the company to turn over detailed internal corporate records related to the value of the assets moved to Ireland. They included all operations outside the U.S. and Canada.
The IRS claims Facebook’s tax adviser Ernst Young LLP undervalued the company’s property as it was transferred to Facebook Ireland Holdings Ltd. by evaluating pieces of the online platform separately, according to court filings. Facebook employees told the IRS that the property was “interdependent,” and that “it would be difficult to isolate one from the other,” the government said.
“I don’t think Facebook is necessarily hiding anything, but it’s a fight over pricing,” said Stephen Hamilton, a tax lawyer in Philadelphia. “This is what companies do when they transfer their own assets; they try to value them as low as possible and when the issue is litigated, they usually end up somewhere in the middle.”
The IRS began investigating the transaction in 2013 by obtaining documents related to the transfer of licenses and assets that were used to determine the value of the royalty Facebook Ireland paid the primary Menlo Park, California, entity in 2010. Those statements included agreements for the division of users and marketing, the online platform and cost sharing.
During their investigations, IRS officials found that EY’s method for determining the value of those assets individually worked in direct conflict with otherwise intertwined business entities. In April 2015, tax officials issued a preliminary presentation to Facebook, which rejected it about a month later, according to the court filing.
“Facebook complies with all applicable rules and regulations in the countries where we operate,” spokeswoman Bertie Thomson said in an e-mail.
The IRS then set out to find further evidence that EY’s estimates were flawed, but were met with resistance as Facebook first produced “limited” documents in January, then declined to provide further details by April, according to the complaint.
Then in June, officials filed the first of seven requests for records through court summons in hopes of receiving details of the company’s business risks, its decision to make Dublin its international headquarters and its user and advertising growth.
Facebook failed to appear on June 17 at the IRS’s offices in San Jose, California, then again on June 29, according to the complaint. The statute of limitations for the IRS to continue requesting documents was set to lapse on July 31. By serving Facebook with the tax bill, the IRS can continue its court fight, said Hamilton.
The $3.2 billion in overseas revenue reported by Facebook in the quarter ended June 30 accounted for almost exactly half of the company’s total revenue, with the rest coming from the U.S. and Canada.
The case is U.S. v. Facebook Inc., 16-cv-03777, U.S. District Court, Northern District of California (San Francisco).
—With assistance from Sarah Frier