A Tale of Two Wins: Tax Court Issues Decision in Facebook Transfer Pricing Case

In Facebook, Inc. & Subsidiaries v. Commissioner, the U.S. Tax Court handed down a split decision with broad implications for companies entering cost sharing arrangements (CSAs). The court upheld the IRS’ use of the income method to value Facebook’s platform contribution transaction (PCT), reinforcing the validity of key transfer pricing regulations. However, it rejected several of the IRS’ valuation assumptions, ultimately reducing the PCT value from $19.9 billion to $7.8 billion.

The case underscores the importance of method selection, robust financial projections and carefully supported assumptions in valuing intangible assets under Section 1.482-7.

Case Background

In accordance with Section 1.482-7(b), a cost sharing arrangement is an arrangement by which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their reasonably anticipated benefit (RAB) shares. A CSA must meet the specific requirements outlined in Section 1.482-7.

In 2010, Facebook-US and Facebook-Ireland entered a CSA. Facebook-US received income from a PCT with Facebook-Ireland related to Facebook’s online platform technology as part of entering the CSA with Facebook-Ireland. Facebook-US and Facebook-Ireland agreed to share in the future development of the online platform technology and share the cost of that development. To enter the CSA, Facebook-Ireland needed to make a PCT payment for the existing online platform technology. Facebook-US and Facebook-Ireland also entered additional agreements alongside the CSA for other intercompany services and the license of user base and marketing intangibles.

Valuation Methods and IRS Challenge

Ernst & Young (EY) assisted in the original Facebook PCT valuation using the residual profit split method (RPSM), claiming nonroutine contributions were contributed to the CSA by both Facebook-US and Facebook-Ireland. Facebook and EY valued the PCT at $6.3 billion, allocating Facebook-Ireland’s RAB share at 44%. However, the IRS selected the income method and ultimately proposed a significant adjustment to the value of the PCT, valuing the PCT at $19.9 billion and adjusting Facebook-Ireland’s RAB share to 53.5%.

Facebook disputed the validity of the IRS’ selection of the income method specified in the Section 1.482-7 cost sharing regulations, the reasonableness of the IRS’ valuation assumptions and the IRS’ RAB share assumptions.

The Court’s Decision and Key Takeaways

The court agreed with the IRS’ selection of the income method concluding that only Facebook-US made a nonroutine platform contribution. The outcome also provides a precedent-setting win for the IRS by validating both the IRS’ method selection and the validity of the Section 1.482-7 cost sharing regulations which will have implications in future transfer pricing cases.

However, the court preferred some of Facebook’s valuation assumptions, ultimately valuing the PCT at $7.8 billion. The outcome provides Facebook with a financial win in comparison to the proposed adjustment of $19.9 billion.

What This Means for Your Business

Companies should carefully consider the robustness of their projections and valuation assumptions when considering the transfer of intangible assets or the valuation of PCT payments related to CSAs. Additionally, companies that have entered or are considering entering a CSA should consider the method selection considerations as well as the financial projection and valuation assumption indications from the Facebook case. All companies considering migration of intangible assets will benefit from the insights into the IRS’ assumptions leading to their initial adjustment and the eventual outcome of the court’s decision.

Weaver Can Help

The Facebook decision demonstrates that while the IRS may prevail on method selection, the assumptions underlying a valuation are just as likely to face scrutiny and revision. This case highlights the importance of selecting an appropriate method and grounding valuation models in well-supported, defensible assumptions.

We’re here to help. Our international tax team can assist your company with issues related to CSAs as well as other transfer pricing matters. Contact us.

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