In 2009 Facebook entered a cost-sharing arrangement, under which the US parent company granted its Irish affiliate the right to use its platform, user base, advertising relationships, and other marketing intangibles in all territories outside the US and Canada. Facebook valued those assets at $6.3 billion, arguing that Ireland’s ongoing share of research costs should be calculated from this figure.
The Internal Revenue Service disagreed, asserting that the correct method for valuing the transfer was the ‘income method’. Using its own forecasts, discount rate and licensing benchmark, the IRS concluded that the US assets were actually worth $19.9 billion.
Facebook challenged both the figures and the regulations. The company argued that, since both parties had contributed ‘non-routine’ intangibles, the income method was inappropriate. Even if that method had been applicable, Facebook claimed that the IRS had used inflated revenue projections and an unjustified risk premium in its discount rate, as well as an unrealistically low cost-plus alternative to cost sharing. Facebook also claimed that the 2009 cost-sharing regulations were invalid, and that Ireland’s actual returns already fell within the permissible range, shielding it from further adjustments.
Opinion
The Tax Court ruled in favour of the IRS on the legal basis for adjusting the transaction and on the method chosen for pricing it. However, the amount calculated by the IRS was significantly reduced by the court in favour of Facebook.
While the Tax Court agreed that the income method was the best fit, as only Facebook U.S. had supplied a non-routine platform contribution, it found the IRS’s inputs to be unreliable. After substituting Facebook’s internal ‘Long Range Plan’ forecasts for the ‘Other Revenue’ line, adopting the original 17.7% discount rate used by Ernst & Young, and selecting a 13.9% cost-plus licensing alternative, the court recalculated the present value of the transferred intangibles at approximately $7.8 billion. This was higher than Facebook’s figure of $6.3 billion, but below the IRS’s figure of $19.9 billion.
The Court upheld the 2009 regulations, rejected the idea that cost-sharing payers must achieve a positive net present value and ruled that the IRS’s method of projecting benefits indefinitely to determine Ireland’s annual research cost share was reasonable. However, this method must also be revised using the corrected inputs.