The IRS has unleashed an aggressive investigation into Facebook’s tax structure, seeking a court order to force access to their internal records and possibly setting a frightening precedent for anyone or anything with wealth off-shore.
The petition, filed by the Department of Justice, demands access to Facebook’s Protected content documents, when Facebook established a subsidiary in the low-tax jurisdiction of Ireland.
The IRS case claims that Facebook transferred its intellectual property (IP) rights to the Irish subsidiary at a discounted price, thus incurring a tax deficit that ran into the billions.
Of course the IRS squeezing money out of successful American companies is nothing new. But wielding the power of the courts to dismantle financial privacy is a fresh low.
According to Laurence Bambino, co-head of the global tax group, Shearman & Sterling, “It appears to be one of the first instances where they’re seeking to pursue the enforcement remedy.”
It’s a clear message from the IRS: Comply or be punished.
The erosion of financial privacy has been swift and painful. First, they introduced FATCA, which under threat of a 30% withholding tax, all foreign banks have to report foreign deposits to the IRS.
Now the IRS is turning their bullying tactics on Silicon Valley.
If we can’t get the information we want, we’ll force it out of you.
Facebook’s Tax Structure
Facebook uses a method known as “transfer pricing” to structure their tax obligation.
It works like this:
Facebook transfers their IP rights for worldwide business, excluding North America and Canada, to a subsidiary in Ireland, named Facebook Ireland Holdings Ltd. That intellectual property includes all of Facebook’s online revenue streams.
In Facebook’s case – and indeed, most modern tech companies – these intellectual property assets generate most of their profits.
The Irish holding company then licenses Facebook IP to all other countries. This routes all revenue back to the Irish company. Profits are taxed at Ireland’s low corporate tax rate of 12.5%, rather than the USA’s minimum 35%.
It’s a structure used by countless tech companies where intellectual property is the majority revenue source, including Apple and Google.
As a result, Facebook Ireland Holdings accounts for nearly half of Facebook’s total global revenue.
The structure is of course a legal and efficient way to maximize profits.
The American tax authority is simply outfoxed by the simple, legal process of globalization.
US Tax on Worldwide Income
Unfortunately, the IRS is driven by the bizarre, imperial philosophy that it can impose US tax on all foreign earnings.
Individuals are each required to report and pay tax on almost all wealth held overseas. Only America and Eritrea demand such strict tax requirements from their citizens.
It’s no wonder former Facebook founder, Eduardo Saverin, renounced his US citizenship entirely, setting down stakes in Singapore to eliminate his US tax obligation.
Companies, however, get a little more wiggle room. The IRS demands companies pay tax on all international profits but only when they are repatriated to US soil.
Facebook holds most of this cash in Ireland instead, refusing to repatriate and trigger the tax bill. And they’re not the only ones.
At least Protected content the Fortune Protected content “park” their profits in subsidiaries in so-called tax havens.
Apple, for example, has more than $111.3 billion in offshore accounts. In fact, Apple prefers to borrow money in the US rather than repatriate their offshore earnings, because the tax bill would be far larger than any interest on loan repayments.
Of course, the IRS would love to get its hands on this money. And Obama even tried to change the tax code in Protected content allow it to do so.
But since the IRS can’t (yet) get its hands on money while it sits offshore, it has turned to aggressively leveraging the one outlet it can collect: the original transfer of IP assets.
Undervalued IP Assets
The issue at the heart of Facebook’s court summons is the very first transfer of IP assets from Facebook America to Facebook Ireland Holdings. The transfer of course would have triggered a tax bill based on the valuation of assets.
However, the IRS has accused Facebook of deliberately understating the value of those assets by billions.
When Facebook’s own tax advisors, Ernst & Young, calculated the asset valuation, the IRS argues, they valued each individual IP asset individually, rather than considering their value as a combined total.
In other words, the IRS argues Facebook’s whole is greater than the sum of its IP parts and should be valued as such. It should therefore have been subject to a much higher tax bill.
During a Protected content , the IRS used this reasoning to crowbar an additional $3.3 billion out of Coca-Cola.
However, the Facebook court summons is above and beyond the usual audit. Facebook has reportedly “complie[d] with all applicable rules and regulations” and provided their own