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Facebook Launches High-Risk Tech Defense in IRS Tax Dispute

Feb. 19, 2020, 12:02 AM

The IRS accused Facebook of downplaying its financial success last decade, while the company defended the importance of its Irish subsidiary during the opening of a closely watched Tax Court trial.

Facebook Inc. is challenging a tax bill for 2010 on the value of intangible assets, such as trademarks and copyrights, that it transferred to an Irish subsidiary. The IRS claims that Facebook undercharged its Irish subsidiary for the use of those assets, which the agency alleges are worth billions more than the company claimed they were.

The case focuses on facts and circumstances from a decade ago, and hinges on the question of whether the U.S. operations or the Irish operations bore the risks and made the contributions that led to Facebook’s ultimate success. The tax bill in dispute is only in the millions, but Facebook could be on the hook for as much as $9 billion plus interest and any penalties if the IRS wins because the agency plans to apply its position to subsequent tax years.

Facebook “was a high-risk technology” and relied on related parties outside of North America, including its Irish subsidiary, to help the company grow its mobile technology and develop international marketing and advertising strategies, Scott H. Frewing, a partner at Baker & McKenzie LLP representing Facebook, said during opening argument at the trial in San Francisco.

Frewing said that in 2010, Facebook identified mobile advertising as a challenge because the company was transitioning from a social network viewed mostly on computers to one accessed on cell phones.

Justin L. Campolieta, special trial attorney at the IRS Office of Chief Counsel, argued that Facebook tried to downplay its success by placing projected opportunities and risks onto its Irish subsidiary.

“‘It was the best of times and the worst of times.’ In 2010, for Facebook, it was the worst of times for transfer pricing,” Campolieta said.

Campolieta said to expect Facebook’s witnesses to highlight slow growth in a limited number of countries, including Japan, while neglecting to mention countries like Indonesia and the Philippines where the company grew quickly.

Transfer pricing—the means by which multinational groups value the transfer of assets between entities—underlies most, if not all, disputes involving multinational companies and potential shifting of income. Guidelines for transfer pricing require related parties within a multinational group to transact at arm’s length, or as if they were unrelated. Transfer pricing also takes into account the risks the parties assume.

The trial is expected to last three to four weeks and will feature testimony from former and current Facebook employees, including former chief technology officer Mike Schroepfer and vice president of product design Julie Zhuo—the company’s first intern—who both testified Tuesday. Facebook does not plan to call Mark Zuckerberg, its CEO and chairman, or Chief Operating Officer Sheryl Sandberg.

The case is Facebook, Inc. v. Commissioner, T.C., No. 021959-16, trial started 2/18/20.

To contact the reporters on this story: Sony Kassam in Washington at skassam1@bloombergtax.com; Yuri Nagano at ynagano@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; David Jolly at djolly@bloombergtax.com