Facebook Tax Case Could Decide Fate Of Anti-Profit-Shifting Rules

Fb’s tax dispute over the pricing of transactions with an offshore subsidiary marks the primary time an necessary anti-profit-shifting regulatory regime has been challenged in courtroom, and the end result can have main penalties.

Throughout a prolonged Tax Court docket trial, Fb has vigorously contested the IRS’s valuation of mental property and different intangible rights contributed to a cost-sharing association (CSA) with an Irish subsidiary in 2010.

Fb argues that the IRS’s $21.15 billion valuation of the corporate’s contributions to the CSA was practically $15 billion too excessive, and the distinction displays stark disagreements in regards to the variables and assumptions used within the IRS’s valuation technique.

However Fb’s arguments additionally problem the overall validity of the IRS’s valuation technique itself, the revenue technique, which was one of many signature options of a regulatory scheme launched in 2009. The tactic targets circumstances by which a U.S. participant contributes invaluable self-developed intangibles and an offshore “money field” participant merely cuts checks to fund its share of the U.S. participant’s improvement actions.

Plugging Previous Holes

In a CSA, every participant bears the prices of creating intangibles in proportion to the longer term financial advantages it expects to obtain in its territory. This usually begins with an preliminary contribution of intangible property to function the muse for creating future intangibles.

For instance, assume {that a} U.S. mother or father firm with a self-developed software program utility contributes model 1.0 to a CSA with a overseas subsidiary. If gross sales of future variations of the appliance within the U.S. mother or father’s territory are anticipated to account for 40 % of the worldwide whole, the mother or father should bear 40 % of the event prices and the subsidiary should bear the remaining 60 %.

To make the U.S. tax base complete for its lack of anticipated future revenue, the cost-sharing rules require that the mother or father within the instance cost its overseas subsidiary an quantity — known as a “buy-in fee” by earlier variations of the rules — that displays the worth of the preliminary contribution.

The explanation CSAs grew to become the IP offshoring automobile of alternative for a lot of U.S. tech multinationals was that the pre-2009 rules arguably allowed taxpayers to exclude from the buy-in fee the worth of goodwill, going concern worth, and different residual enterprise belongings. The Ninth Circuit endorsed this interpretation in Amazon

AMZN
.com Inc. v. Commissioner, 934 F.3d 976 (ninth Cir. 2019), aff’g 148 T.C. No. 8 (2017), ensuing within the invalidation of the IRS’s valuation technique.

The chance that courts would learn the rules on this means prompted Treasury and the IRS to overtake the cost-sharing rules, which led to the discharge of momentary rules in 2009 and closing rules in 2011. The amended rules mooted the query of what does and what doesn’t represent an intangible by counting on totally totally different terminology. Additionally they acknowledged a set of valuation strategies that incorporate residual enterprise asset worth and established requirements for evaluating strategies’ reliability.

The revenue technique was one among these new valuation strategies, and the rules favor its use when one social gathering makes all of the distinctive contributions and the opposite is a money field.

The Fb Take a look at

In line with the Ninth Circuit panel that determined Amazon, there was “little question” that the IRS’s place would have been appropriate if the 2009 momentary rules had been in pressure. Nonetheless, the amended cost-sharing rules, together with the provisions related to the revenue technique, had not been examined in courtroom — till now.

Considered one of Fb’s main criticisms of the revenue technique is that it deprives the overseas participant of any return for its participation within the CSA, and that this brings the rules into battle with different regulatory provisions and with IRC part 482.

The revenue technique offers a cash-box cost-sharing participant a return on its funding commensurate with the danger of the intangible improvement exercise, which within the Fb case corresponds to a reduction fee of 14 % (because the IRS argues), 19 % (as Fb argues), or someplace in between.

When Fb complains that the revenue technique denies a cost-sharing participant returns on its participation, it’s actually claiming {that a} money field deserves much more than the low cost fee. Nonetheless, it’s unclear why a money field ought to count on to earn greater than a risk-adjusted return on its money funding.

Fb additionally argues that the revenue technique inappropriately allocates returns attributable to the events’ future intangible improvement prices to the preliminary intangible contribution. However a money field contributes solely money, and a risk-adjusted funding appears an applicable reward for its contribution.

The opposite prong of Fb’s assault on the revenue technique makes an attempt to resurrect the semantic defect that led to the IRS’s loss in Amazon by claiming that part 482 contained the identical defect till it was amended in 2017. This argument is odd, contemplating the Amazon opinion’s commentary that the IRS would have gained underneath the 2009 rules and its unique deal with a regulatory definition.

However Fb’s declare that the imprecise wording of part 482 implies that Congress by no means supposed to authorize the revenue technique is outright weird. Below Chevron U.S.A. Inc. v. Pure Sources Protection Council Inc., 467 U.S. 837 (1984), an company’s interpretation of an ambiguous statutory provision should be upheld as permissible except it’s arbitrary, capricious, or manifestly opposite to the statute. Which means that the imprecise wording of part 482 makes it even more durable for Fb to ascertain the impermissibility of the revenue technique rules.

No matter whether or not Fb prevails on different grounds, the Tax Court docket ought to reject these normal assaults on the revenue technique’s validity. By proscribing the offshore participant’s revenue to a return commensurate with the danger related to the related intangible improvement exercise, the revenue technique prevents — or a minimum of limits — multinationals’ capability to shift an outsize share of the returns attributable to U.S.-developed intangibles to lower-tax jurisdictions.

If the Tax Court docket invalidates the strategy, the IRS’s capability to forestall revenue shifting in different cost-sharing circumstances can be considerably weakened.