It’s not surprising anymore to see a U.S. company interested in parking a piece of itself (or all of itself) in Ireland as part of an effort to whittle down its tax liability. Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) has been utilizing the country’s low corporate tax rates for years, and had the U.S. Treasury secretary not thrown a hail-Mary pass in April, Pfizer Inc. (NYSE:PFE) would have slashed its annual tax bill by teaming up with U.K.-based Allergan plc (NYSE:AGN).
A relatively new and surprising name has moved into the Internal Revenue Service’s sights of late, however … Facebook Inc (NASDAQ:FB).
Though the closer regulatory scrutiny of the social networking company’s books hasn’t proven to be a drag on the value of FB stock, Facebook shareholders may want to keep close tabs on the developing situation.
IRS Takes Aim at Facebook
Earlier this week, the IRS petitioned a U.S. district court to allow it to examine some of Facebook’s internal accounting documents relating to a 2010 agreement between the parent company and Facebook Ireland Holdings.
In particular, the IRS is looking to see if assets transferred from the parent to the subsidiary were undervalued by billions of dollars, thus sidestepping a potential tax liability.
It’s not a matter as simple as it may seem it should be on the surface. The Internal Revenue Service is asking questions that are more philosophical in nature, and may ultimately be unanswerable. The court fling explained:
“The IRS issued a number of information document requests (IDRs), reviewed numerous public documents, and conducted interviews of certain Facebook employees. Several of those employees indicated that the user base, online platform, and marketing intangibles were interdependent and it would be difficult to isolate one from the other. The information gathered suggested to the IRS examination team that the E&Y [Ernst & Young] approach to valuing Facebook’s transferred intangibles on a stand-alone basis was problematic.”
And there’s the rub. Facebook as well as the IRS could argue that all aspects of the company — the platform, its members, the name, etc. — could be and should be viewed as one coherent unit that only has value when used together.
For that matter, Facebook as well as the IRS could just as well argue the opposite to be true … that each piece of the company and each stratification of its user base (age, location, etc.) has value in and of itself.
There is no “good” answer, even for an experienced accounting firm like Ernst & Young. There are only assumptions and best justified guesses.
Still, if the value of the assets passed along to the Irish subsidiary was truly understated by billions of dollars, the grey area shouldn’t matter much, if the Internal Revenue Service’s presumptions have any merit.
Bottom Line for FB Stock
While the implications cast Facebook in something of a negative light (though no more than the company’s refusal to comply with prior explicit IRS requests for the information), the calendar may provide an exit path before the matter turns any uglier.
As was noted in the Department of Justice’s petition to the court system this week, the statute of limitations on the matter runs out on July 31 … 23 days from now. By the time the District Court gives the IRS the green light, and then by the time the IRS and Facebook can agree to an audit date, and by the time the Internal Revenue Service can review the information they’ve gathered, the time limit could be expired.
As Villanova law professor J. Richard Harvey Jr. opined:
“Even if the court acts quickly and Facebook produces the information immediately, it is unlikely the IRS will be able to analyze it by July 31. Either Facebook will need to agree to extend the statute of limitations or the IRS will likely propose a very large audit adjustment.”
Somehow an extension allowance from Facebook seems unlikely.
It’s also possible a court could view the statute of limitations as inapplicable — in that Facebook didn’t comply with the original requests — acknowledging the agency’s added point in the petition that a lack of funding is a key part of the reason the IRS waited as long as it did to pursue the matter.
That would be a very lucky break for the agency though.
Either way, if the IRS can’t afford to perform such an audit, it likely can’t afford to argue the matter in a courtroom. See, even if the Internal Revenue Service decides Facebook did indeed undervalue the assets in question, Facebook could contest that decision in a court of law. Facebook is far more willing and able to fight that fight than the IRS likely is.
In other words, the saga isn’t a huge reason for FB shareholders to sweat.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
