by Julie Martin
Facebook has filed a petition in US Tax Court, contesting IRS adjustments that increased the social media giant’s royalty income on account of an allegedly undervalued transfer of intangibles to a related Irish company.
Facebook is also contesting IRS adjustments associated with its cost sharing agreement with the Irish company, as well as other items relating to its 2010 tax year.
In its petition, filed October 11, Facebook states that the IRS determined a deficiency of 1.7 million for 2015 and also increased the amount of the net operating loss carryover deduction used by the company by about 90.3 million that year.
The primary dispute concerns the valuation of September 15, 2010, grants by Facebook to Facebook Ireland Holdings Unlimited (Facebook Ireland) of rights to exploit Facebook’s intangible property in Facebook Ireland’s territory, which is everywhere outside North America.
The rights were transferred through separate agreements covering Facebook’s user base, online platform, and marketing intangibles. In exchange for the transfer of rights, Facebook Ireland agreed to pay arm’s length annual contingent amounts to Facebook under the agreements.
According to the IRS, while Facebook valued the 2010 transfers of intangible property at $6.7 billion, the actual value of the transfers was $13.8 billion. As a result, in its audit of Facebook’s 2010 tax year, the IRS increased Facebook’s gross royalties from the Irish company by about $85 million.
Facebook maintains in its petition that the IRS did not explain how it arrived at its conclusion that the intangibles transfers were undervalued or how it calculated the royalties. The IRS’s assessment is a naked assessment, Facebook argues, and is thus arbitrary, capricious, or unreasonable.
In a US Department of Justice lawsuit filed in Federal court last July seeking to enforce six summons issued to Facebook relating to the 2010 transactions, IRS agent Nina Wu Stone explained that IRS was concerned about Facebook’s valuation method because the user base, online platform, and marketing intangibles were separately valued using different methodologies, each on a stand-alone basis. At that time the IRS said that valuation of the intangibles on a stand alone basis was “problematic.”
“Several [Facebook] employees indicated that the user base, online platform and marketing intangibles were interdependent and it would be difficult to isolate one from the other,” she said.
Cost sharing agreement
Facebook is also contesting an adjustment of about $5.4 million related a cost sharing agreement whereby Facebook and Facebook Ireland agreed to share future costs to jointly develop the Facebook online platform.
Facebook argues that the IRS erred in adjusting Facebook’s reasonably anticipated benefits (RAB) share and incorrectly allocated intangible development costs under the cost sharing agreement.
IRS has not revealed the methodology used to compute Facebook’s RAB share, Facebook said, thus, this was a naked assessment that increased Facebook’s taxable income in an arbitrary, capricious, or unreasonable manner.
In its petition, Facebook also contested the IRS’s decision to reduce its domestic production activity deduction of about $6 million to zero in 2015, as well as the IRS’s decision to lower Facebook’s credit for research activities by about $7 million that year.
Facebook is being represented by Baker & McKenzie LLP.
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