Facebook has told a court the reason it valued itself at just $6.5bn back in 2010 is not because it was seeking to avoid paying billions in extra tax, but because people had started using their mobile phones more. At the time, the antisocial goliath was reliant on ads on its desktop site.
The US tax authorities – the IRS – beg to differ, and argue that the social media giant knowingly undervalued itself while selling off its intellectual property to a new company based in low-tax haven Ireland to avoid paying US corporation tax. As such, the officials want Mark Zuckerberg's empire to cough up $9bn in back taxes, plus any court-levied fines and whatnot.
This is far from the first time that Facebook has been accused of avoiding tax. The IRS has already chased it for failing to report $7bn in earnings for the years 2008-2010. This particular lawsuit, again brought by the IRS against Facebook, centers around the Silicon Valley giant's 2010 valuation, and was filed in 2016.
The IRS claims Facebook was really worth at least double its claimed valuation at the time, and told the court that the social network claimed to be having a hard time while at the same time bringing in record revenues. If the IRS succeeds in challenging Facebook’s version of reality, the organization faces a multi-billion-dollar tax bill, possibly with additional penalties tacked on.
During opening arguments in tax court in San Francisco this week, Facebook claimed the IRS’ valuation was based on a "2020 perspective and not a 2010 perspective." Instead, a decade ago, it was far from certain that Facebook was going to make it, its lawyer argued.
It was a tough time, according to this version of events, and while recovering the recession, Facebook discovered it was a “desktop business” while everyone was shifting their daily usage habits to mobile phones. It had to completely rebuild itself to make its platform work on phones, the lawyer explained.
To bring the point home, he explained that Facebook’s biggest competitor at the time was MySpace – and look what happened to MySpace. That could have been Facebook the lawyer argued
Sure there are documents showing Facebook’s projected revenues that completely undermine that story, but that was no more than youthful exuberance, the lawyers said. They were nothing more than "aspirational" goals. "There was less than a 50 per cent chance [the projected revenues] would ever materialize," the lawyer explained.
What about the company’s rocketing revenues? Well, Facebook CTO Mark Shroepfer pointed out while the company may have been making money hand-over-fist, its growth was “messy” and “success was not guaranteed.” Hence the valuation of its assets at $6.5bn – a third of what the IRS says was a real value of $21bn.
At the heart of the matter is a decision by Facebook to follow a number of other monster tech companies and relocate in Ireland in order to benefit from massive tax benefits being offered by the Emerald Isle's government.
Facebook “sold” the rights to its software and trademarks to a subsidiary based in Ireland and every year that company pays Facebook in the US “royalties.” This approach allows Facebook to pay an Irish tax rate of 12.5 per cent rather than what was at the time a 35 per cent corporate tax rate in the United States (since reduced to 21 per cent). The practice even has a name: “transfer pricing.”
Apple has been hit with a multi-billion-dollar tax bill over essentially the same thing but in that case, the argument was that Ireland was unfairly providing big tech companies with a low tax rate. In Facebook’s case the IRS is arguing that it knowingly and massively undervalued itself in order to avoid paying tax.
Other Facebook arguments that raised eyebrows include that it was only really doing well in the United States and the larger world was an unknown entity where Facebook could easily have failed. Plus, it was having to pay 30 per cent to affiliates when it ran ads on its platform in the rest of the world, so that also needed to be taken into account.
The IRS rejected that version of reality, showing a video of Facebook COO Sheryl Sandberg and CEO Mark Zuckerberg at the time in which they talking about the company's enormous success across the world; to the extent that they went out of their way to identify the countries where they weren’t completely dominant: China, Russia, South Korea and Japan.
The affiliate ad argument is also nonsense, the IRS argued, because it only applied in a small number of countries and in most of the world Facebook was taking a full cut of ad revenues.
So, um, MySpace...
Getting back to the argument that MySpace was its main competitor, the IRS has yet to take that one on but it won’t be hard to dispute. In reality, MySpace was already a done force two years earlier, back in 2008, when Facebook overtook it in website rankings.
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The entire MySpace team was overhauled in mid-2009 because it was failing miserably. Top execs were booted and the workforce was cut by a third. Around the same time that Facebook was projecting massive revenue rises and was moving offshore, MySpace gave up being a social media network and struck a deal with Facebook that allowed musicians to connect directly to their Facebook profiles.
The idea was that MySpace would be an entertainment website built around music, TV and celebrities while Facebook was about people connecting to talk to friends about their ordinary dull lives. MySpace was a “complimentary offer” to Facebook, its CEO told the Wall Street Journal in March 2011. It had been put up for sale a month earlier and three months later it was effectively dead.
Not for the first time, Facebook remembers things differently. And it just so happens that in Facebook’s version the company is valued at billions of dollars less than the IRS estimates.
In the meantime, Facebook CEO Zuckerberg said just last week that he expects to have to pay billions of dollars in additional tax in coming years; a similar tactic to his claim earlier this year that Facebook will have to accept new law and restrictions. In each case, however, Facebook always has a Facebook-provided solution to offer in which Facebook gets to decide things and maintain control of the market.
The IRS case is expected to last several weeks. ®