Facebook’s U.S. Tax Woes Could Lead to Global Audits

• Facebook’s SEC filings say it may owe up to $5 billion in additional federal taxes
• Facebook’s tax plans were part of May 31 shareholder meeting, signaling issue affects shareholder risks

Facebook Inc. is likely to be audited by many countries if the social network loses its August 2019 trial in U.S. Tax Court over assets it transferred to Ireland.

An IRS win could lead to a pay-up of more than $5 billion and fuel other tax authorities to audit the Facebook’s intercompany pricing arrangements.

Facebook’s transfer pricing Tax Court case “sets precedent for other tax jurisdictions to come in and make a claim on Facebook as well,” Andrew Silverman, Bloomberg Intelligence tax policy analyst in New York, told Bloomberg Tax.

“I think it’ll be very expensive for Facebook to maintain this, especially if it has to fight the same battle around the world,” Silverman said.

The U.S. Tax Court case, set to begin Aug. 21, 2019, in San Francisco, revolves around the principles of transfer pricing, used when individual units of a larger multi-entity company are treated as being separately run.

August 2019 Trial

Facebook Inc.’s recent procedural loss in the U.S. District Court for the Northern District of California means the social network’s options for avoiding a trial in the U.S. Tax Court are limited. The district court judge said the Internal Revenue Service wasn’t obligated to refer Facebook’s $1.73 million tax bill to the IRS Office of Appeals for an independent review.

Facebook might ultimately owe up to $5 billion in federal taxes, plus interest and any penalties, the company has said in filings with the Securities and Exchange Commission.

The company sought to get its case into the hands of Appeals, which could have circumvented a trial and its associated costs, such as attorney fees and lengthy discovery requests.

“If you’re thinking about cost, what Facebook has done is gone through administrative audit and responded to about 200 requests through the IRS,” Larry Sannicandro, an associate at McCarter & English LLP in Newark, NJ, told Bloomberg Tax.

The Tax Court will have to re-determine Facebook’s tax liability without regard to what happened in the administrative proceeding, Sannicandro said. Facebook would be required to exchange the documents that it provided in audit, which is very expensive.

Irish Subsidiary

Facebook’s tax bill, pending in the U.S. Tax Court, hinges on the value of intangible assets Facebook transferred to its Irish subsidiary in 2010. The IRS argues the value should have been $13.8 billion, not $6.5 billion.

In March, the IRS gave Facebook a second notice for the examination of its 2011-13 tax years and applied its position from the 2010 tax year to each of these years. Facebook’s 2017 tax year remains open to IRS examination.

“If the IRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately $680 million in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted,” Facebook said in its April 26 quarterly report to the SEC.

The ultimate dollar figure could have a material adverse impact on Facebook’s financial position, results, and cash flows, the company said.

Shareholders Care

The Tax Court case was included in the proxy statement for a May 31 annual shareholders meeting with Facebook’s board of directors. Shareholders sought approval for a resolution asking the board to adopt and disclose principles on Facebook’s tax practices—a sign that Facebook’s tax avoidance drama from the European Union to the U.S. is an important issue to shareholders.

“Scandal is not good for the company’s bottom line,” a representative for the AFL-CIO said May 31 during the shareholder meeting in Menlo Park, Calif. “Trying to increase profits through tax avoidance strategies provides an inaccurate picture of the company’s financial performance and health and doesn’t make up for the reputational damage and losses resulting from the scandals.”

The board rejected the proposal, according to preliminary results, the company said, adding that final results will be filed with the SEC within four business days.

“Because we continuously assess our tax policies and practices in light of the changing regulatory landscape and developments in our business, and provide disclosure concerning our tax policies and risks, we believe that this proposal is not necessary and would not be beneficial to our stockholders,” Facebook’s board of directors said in an April 13 proxy statement for the annual meeting.

Facebook announced in December 2017 that it planned to move to a local selling model in countries where it has an office to support sales to local advertisers. Facebook said it aims to achieve this plan by the first half of 2019.

Public Proceedings

Leandra Lederman, tax law professor at the Indiana University Maurer School of Law, told Bloomberg Tax she’s “wondered why Facebook is pushing so hard to have access to appeals, especially in light of the fact that they’re in Tax Court.”

Court proceedings are generally open to the public, she said. So one advantage of appeals is taxpayers can avoid divulging proprietary information. “Once Facebook is in Tax Court, that’s not the case,” Lederman said, “unless it’s sealed. Facebook is drawing even more attention by pushing this procedural issue.”

The company also doesn’t “want to make their own entanglements with the IRS public,” Sannicandro said.

Facebook’s public dealings with the IRS could fuel other jurisdictions to bring forth similar cases, according to Silverman.

“It ties into country-by-country reporting as well,” he said, referring to the Organization for Economic Cooperation and Development’s country-by-country (CbC) reporting under its initiative to combat base erosion and profit shifting. CbC reporting requires certain multinational companies to disclose their financial information on a country-by-country basis. Exchanges between jurisdictions are set to begin in June.

“Before, countries had more of a reason to do a type of settled procedure similar to what IRS does with appeals because it didn’t have information,” Silverman said. But CbC reporting could change that, he said.

Statutory Language

In the district court case, Facebook argued it had a statutory right to IRS Appeals under the Taxpayer Bill of Rights (TBOR) and that March 2016 guidance (Revenue Procedure 2016-22) was flawed.

Under the revenue procedure, the IRS can deny a taxpayer’s access to IRS Appeals in a docketed tax case when division counsel or a higher-level counsel determines that referral isn’t in the interest of sound tax administration. The taxpayer can’t go to Appeals if the issue in the case has been designated for litigation, unless the taxpayer pays the assessment, at which point the case would then go to a district court.

U.S. Magistrate Judge Laurel Beeler said a statutory right to go to Appeals didn’t exist and that Rev. Proc. 2016-22 wasn’t a final agency action. The Tax Court counts as an independent forum as well, Beeler said.

The statute under the TBOR says the IRS commissioner oversees employees and provides training to ensure they’re familiar with the taxpayer rights. Historically, “it was meant to simply organize and summarize rights that already exist,” Lederman said.

The social media company could appeal the district court case if it wanted, Sannicando said, but “that would be difficult for Facebook to do.”

Undo Adverse Rulings

“It’s a pretty powerful thing to go in a negotiation with someone who takes into account risks of litigation and takes into account your actual arguments and gives you an offer to settle,” Kat Saunders Gregor, partner at Ropes & Gray LLP in Boston, told Bloomberg Tax. Transfer pricing issues are “very, very easily negotiated at Appeals,” she said.

The IRS counsel and exam team, however, “are pretty suspicious of the appeals office,” Gregor, co-founder of her firm’s tax controversy group, said. “They really want a high profile big win in a transfer pricing case. They know if it goes to appeals, it’ll get settled for less than they can win it for.”

Sannicandro agreed with Gregor. The IRS might be thinking, “these are pretty good facts we want to take to court to try to undo some of the adverse rulings,” he added.

A spokeswoman for Facebook declined to comment on the Tax Court case.

To contact the reporter on this story: Sony Kassam in Washington at skassam1@bloombergtax.com

To contact the editor responsible for this story: Kevin A. Bell at kbell@bloombergtax.com