All Eyes are on the IRS and its Review of Facebook’s IP Valuation Methods

The IRS began an investigation in 2013 examining the valuation methods used in Facebook’s transfer of intellectual property rights to a foreign subsidiary in 2010. In early July, the investigation stepped up a notch when the IRS filed a summons in federal court requesting more information on the transfer. In a common move for large software companies, Facebook transferred a large portion of its intellectual property rights to an offshore subsidiary in order to lighten its tax liabilities. Facebook sold a large chunk of critical intellectual property rights to Facebook Ireland and transferred all of Facebook’s worldwide business (minus the U.S. and Canada) to the same subsidiary. The corporate income tax burden in Ireland is a measly 12.5% compared to 35% in the United States. The IRS is investigating the price and pricing methods used by Facebook and its accounting firm, Ernst & Young (now EY), for the intellectual property rights.

The IRS is trying to determine the real value of the assets Facebook sold to Facebook Ireland. These types of sales are supposed to be done at arm’s length, which is a difficult task to achieve between parent companies and their subsidiaries. The EY approach to valuing Facebook’s assets was done on a stand-alone basis, which was contradicted by several Facebook employees explaining how the rights are interdependent and that it would be difficult to isolate user base, online platform and marketing intangibles from each other, as reported in the IRS’ declaration. Determining the value of patents is a tricky business with many factors to consider: the amount of time remaining for enforcement, how likely the patent is to stand up to invalidity claims, any current licensing agreements, any ongoing litigation, and synergies among patents to name a few important areas. The IRS investigation is focused on how the synergies between the patents transferred was valued; believing EY used a method that did not fully consider how, for example, a patent focused on Facebook’s user base could affect the value of a patent focused on marketing. By examining patents alone or in specific fields at a time and not the whole package, it is possible to find less value in the parts than the whole, just as a car engine is not too useful without a way to start the engine, or a wheel system for the engine to power. The IRS exam team’s preliminary investigation believes the valuations of the transferred intellectual property rights were understated by billions.

In early June the IRS asked Facebook for more documentation on the sale, to which Facebook did not respond, continuing a trend of playing tough with the IRS. Earlier in the investigation Facebook denied the IRS’ request for an extended statute of limitations on for their investigation by only agreeing to the extensions if the IRS gave Facebook a number of guarantees the IRS was unwilling to offer. This prompted the IRS to file their summons in federal court in San Francisco, both to compel Facebook to share the requested documents as well as to preserve the statute of limitations, which would have expired on July 31.

Facebook has remained defiant in the face of the IRS, failing to show up for a seventh summons issued by the IRS.  The results of the IRS investigation are poised to have major impacts on IP portfolio valuation and accounting strategy.


Category: Firm News