Facebook and its Transfer Pricing Issues

In addition to Google having European leaders questioning the validity of its transfer pricing models and shifting profits from France, Facebook is also having IRS inquiries about its transfer pricing practices.

As noted in this Reuters' article, the IRS is looking at whether Facebook transferred its intangibles to its Irish subsidiary at too low of a price.  As stated in the Reuter's article, by raising the transfer price of the intangible to the Irish subsidiary, Facebook could have increased taxable profits in the US. The article quotes the complaint which alleges that Facebook may have understated the intangible by billions of dollars.  Facebook was advised in the transaction by Ernst & Young.

Recent news also indicated that Facebook has hired Baker & McKenzie to fight the IRS in this transfer pricing dispute.  As you will recall, Baker & McKenzie just won a major victory against the IRS in the Medtronic case.

In Medtronic, IRS challenged the profit split calculation paid to Medtronic's Puerto Rican subsidiary, by stating that the Puerto Rican subsidiary was nothing more than a contract manufacturer for Medtronic.  Medtronic claimed that its Puerto Rican subsidiary was instrumental in its efforts because it oversaw the quality of Medtronic's products.  The Court determined that IRS's method (valuing the Puerto Rican subsidiary as solely a contract manufacturer) was arbitrary and capricious and therefore IRS abused its discretion. However, the Court didn't stop there, it also stated that Medtronic's proposed model was a better approach (Medtronic chose a comparable transaction involving a competitor and argued that it was actually due a refund), but adjusted the model to better match Medtronic's business.  The Court ended up with the rate the parties had previously agreed to in prior settlements of their transfer pricing dispute.  See these articles: Wall Street Journal and BNA.

While it is refreshing to see that the IRS is challenging US Multinational Corporations at their use of transfer pricing, the question remains whether these challenges will be upheld.  See prior blogs regarding transfer pricing, inversions and earnings stripping.

If you know of a corporation undervaluing assets in its transfer pricing models, contact our firm to discuss filing a tax whistleblower claim.  IRS will pay an award between 15-30% of collected proceeds (tax, penalties, and interest) to whistleblowers who provide substantial and credible information used by the IRS in prosecuting the alleged tax violators.

Inversions, Earnings Stripping and Transfer Pricing, the triumvirate of U.S. companies avoiding U.S. taxation.

As previously noted on this blog, the American public is now aware of U.S. companies inverting to a foreign jurisdiction to reduce or eliminate its U.S. income tax liabilities.  The publicity (see here for outrage over Pfizer’s inversion attempt in 2014 and response by the President and the Treasury’s new Regulations attempting to curtail inversions here) that inversions have received fail to paint a complete picture of the ability of U.S. corporations and former U.S. corporation from avoiding U.S. taxation.

As found here, Professor Steven Davidoff Solomon, outlines in his N.Y. Times article the next step to maximize the inversion by the former U.S. corporation is to strip the earnings from its now U.S. subsidiary.  As noted by Professor Solomon, the process starts by having the inverted offshore parent company make loans to its now U.S. subsidiary to pay for its operations in the U.S.  The loans would generate interest payments to the offshore parent company, which can be deducted by the U.S. subsidiary to offset the earnings (otherwise taxable) in the U.S. 

Professor Solomon also references the studies of inverted companies and their earnings stripping efforts in 2004 (See National Tax Journal 2004 Article, “Effective Tax Rate Changes and Earnings Stripping Following Corporate Inversion”) and the Treasury’s 2007 article regarding the same.  Professor Solomon also notes that while Treasury has attempted to minimize the inversions, there is little being done to stop earnings stripping.  Finally Professor Solomon suggests that the Treasury and Congress adopt a radical approach to prevent earnings stripping, namely Professor Stephen Shay’s article, which would convert the interest payments to the foreign parent to taxable dividends instead of interest income.

While these articles address the effect of inversions and continued expansion of the Tax Gap (See IRS’s website describing the Tax Gap at $2 trillion annually) the current focus on inversions and earnings stripping fail to address how U.S. companies are currently reducing their tax liabilities through transfer pricing.  For a brief description of transfer pricing, see Bloomberg articles here and here.

As documented by the Senate Permanent Subcommittee on Investigations (“PSI”) (See Part 1 (Microsoft and HP) of the PSI hearing on Offshore Profit Shifting and U.S. Code; or Part 2 (Apple), U.S. Multi-National Corporations (“MNC”) have aggressively taken advantage of Transfer Pricing (Section 482) and Subpart F to shift profits to its low tax offshore subsidiaries.  PSI recommends the following changes to address Transfer Pricing abuses including the following: 1. Revise Sections 482 and 956; 2. Revise APB 23 to minimize MNC’s ability to manipulate the earnings reports to enable transfer pricing; and 3. Have IRS utilize its anti-abuse powers to stop transfer pricing.  See PSI’s recommendations.

Despite these recommendations, Congress and the IRS have yet to successfully limit or prohibit U.S. MNC from stripping the earnings from U.S. companies by shifting the profits offshore through transfer pricing.  However, IRS has aggressively pursued MNC on transfer pricing issues regarding cost sharing arrangements between the parent and subsidiary corporations of the MNCs.  See International Tax Review’s summaries of IRS transfer pricing cases.  For example, see the following active IRS cases on transfer pricing issues:

1. Microsoft: IRS is challenging Microsoft’s cost sharing buy-in payment arrangement between Microsoft and its Bermudian Affiliate and its Puerto Rican Affiliate (see Microsoft Corporation vs. Internal Revenue Service, 15-cv-00850, U.S. District Court, Western District of Washington);
2. Amazon: IRS is challenging Amazon’s cost sharing agreement between Amazon and its Luxembourg subsidiary (see Amazon.com, Inc. v. Comm’r, T.C. Docket 31197-12);
3. Zimmer: IRS is making 482 adjustments between Zimmer and its Dutch subsidiary (see Zimmer Holdings, Inc. v. Comm’r, T.C. Docket 19073-14); and
4. Medtronic: IRS is challenging Medtronic’s value of intangibles transferred between Medtronic and its Puerto Rican subsidiary (See Medtronic v. Comm’r, T.C. Docket 6944-11)

If you feel strongly about the injustice of transfer pricing and have specific/credible information about corporations avoiding the payment of tax through transfer pricing, you can get involved in preventing/limiting the tax avoidance by filing an IRS tax whistleblower claim.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower with specific and credible information about a corporate taxpayer’s avoidance of tax (through transfer pricing, or other methods).   Contact us if you want to file a tax whistleblower claim.

Transfer Pricing

As discussed in my prior blog, Inversions are one method that corporations (formerly located in the United States) can shift their income offshore and not be taxed in the United States.  While this is one method to increase profits and earnings outside the United States and away from taxation, another method would be to utilize transfer pricing.  See Bloomberg articles (http://www.bloomberg.com/news/articles/2010-05-13/american-companies-dodge-60-billion-in-taxes-even-tea-party-would-condemn or http://www.bloomberg.com/news/articles/2010-05-13/exporting-profits-imports-u-s-tax-reductions-for-pfizer-lilly-oracle) for a brief background about transfer pricing.

As everyone is aware, Tim Cook, Apple’s CEO was recently featured on 60 Minutes defending Apple’s Transfer Pricing operations.  In the interview, Tim Cook claims that he is not bringing back the money to the United States because 40% would be stripped away for taxes.  Mr. Cook’s comments are interesting because by characterizing taxes paid to the US as striping away value implies that the profits were not subject to tax in the first place.  Mr. Cook’s comments ignore the fact that in the United States, corporations are taxed on worldwide income and that the tax on the profits that Mr. Cook alleges are being stripped of their value by 40% were to have been paid to the U.S. government prior to shifting the profits offshore through transfer pricing.  

For a re-cap of Apple’s Transfer Pricing efforts, see Exhibit 1 of the Congressional Permanent Subcommittee on Investigation’s (“PSI”) report on Apple’s Transfer Pricing efforts.

But Apple is not the only company taking advantage of transfer pricing to shift its profits offshore and to avoid taxation in the United States.  See Reuter’s article re-capping the Citizens for Tax Justice’s and the U.S. Public Interest Research Group Education Fund’s report on the top US companies holding over 2.1 trillion dollars offshore or Rolling Stones article about companies avoiding U.S. taxes.

For more information on the other companies taking advantage of transfer pricing see the Congressional PSI hearings on Microsoft and Hewlett Packard. Also see Bloomberg’s article on Google’s use of transfer pricing to lower its tax rate to 2.4% or Bloomberg’s article about pharmaceutical companies using transfer pricing.

The problem people have with the large multi-nationals isn’t that they are using transfer pricing, but that they are using transfer pricing to avoid paying tax on profits, and then flaunting the use of the untaxed funds.  See Apple’s use of debt instruments to utilize its offshore cash horde to avoid paying taxes.  See also Congressional PSI’s report on the use of the alleged undistributed accumulated foreign earnings utilized in US assets (in US bank accounts or in US treasuries or US corporations.

If you feel strongly about the injustice of transfer pricing and have specific/credible information about corporations avoiding the payment of tax through transfer pricing, you can get involved in preventing/limiting the tax avoidance by filing an IRS tax whistleblower claim.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower with specific and credible information about a corporate taxpayer’s avoidance of tax (through transfer pricing, or other methods).   Contact our firm if you want to file a tax whistleblower claim.