Is this actually illegal though? Or is it just clever exploitation of the rules? Tax avoidance is not the same as evasion.
> The IRS argues that Facebook understated the value of the intellectual property it sold to an Irish subsidiary in 2010 while building out global operations, a move common among U.S. multinationals. Ireland has lower corporate tax rates than the United States, so the move reduced the company’s tax bill.
The value of intellectual property is kind of a murky thing, especially before it is fully monetized. So I guess the question comes down to: Did FB executives knowingly undervalue the assets to save money on taxes? Is there a paper trail to that effect?
OTOH, if FB:USA sold the rights to FB:I for $1, knowing it would pay billions to license those rights the next year, I don’t get how that can be a proper valuation, even without a clear price discovery mechanism.
Suppose it costs $50M in salaries to create intellectual property which is then licensed to customers for $500M. Which one is the "market price"? It was sold for both prices, once by the employees to the company and then by the company to the customers. But the difference is a factor of ten.
More than that, the difference can be justified. When the $50M is paid, you don't know whether anybody will buy it. Maybe you'll make a billion dollars, or maybe you'll make nothing and just flushed $50M down the toilet. Or maybe you'll make a profit but the profits are spread over future years whereas the work was paid for immediately, so in an arms length market transaction you would expect the price paid to be discounted for the time value of money.
So they pay $50M for something they go on to sell for $500M. Which one is the market price? Both of them.
This obviously leaves more than enough slack for chicanery.
Suppose some code is written by an independent contractor instead of your employees. The contractor is in San Francisco. The San Francisco office pays the contractor, then does nothing more than immediately sell the rights to the code to the Ireland office for approximately the same amount. You just demonstrated that that was the market price -- the contractor was willing to accept it in an arms length transaction with an independent third party. The Ireland office could have just as well paid the contractor directly. What value is the San Francisco office supposed to be adding that justifies being awarded a significant fraction of the total revenue?
You can only use a sale price to justify a valuation when it's under those circumstances, or a good-faith approximation of such circumstances.
In normal circumstances t would make no sense for FB to take on the risk of hiring a contractor and justify the RoR to shareholders knowing they could only immediately sell for exactly what they paid. That's not how sane businesses operate.
Why not? The San Francisco office doesn't have any monopoly over the contractor. It doesn't have anything the Ireland office wants that nobody else could provide. So what is it doing that justifies it receiving a significant premium?
> You can only use a sale price to justify a valuation when it's under those circumstances, or a good-faith approximation of such circumstances.
How isn't the transaction between employee and employer any different? If there were two otherwise identical jobs doing the same work and one paid more, the employee would choose the higher paying one, so it's not unreasonable in general to assume that what the company paid the employee was the market rate to have that sort of work done.
> In normal circumstances t would make no sense for FB to take on the risk of hiring a contractor and justify the RoR to shareholders knowing they could only immediately sell for exactly what they paid. That's not how sane businesses operate.
But they do know that. The Ireland office is willing to immediately pay them the full amount they're paying the employees, so the US office is taking no risk. No risk, no reward; thin margins are the norm in that sort of transaction.
The law, tax, business, and reality doesn't work that way. They make policy based on a view of the entire forest, not on the gnarls in a single tree branch.
Territory matters when you're talking about taxing value creation. It always has. If you're arguing against that you're literally arguing against thousands of years against human history. The short answer: it's this way because humankind fought a lot of wars to make it this way, and trying to change it could result in more violence.
How isn't the transaction between employee and employer any different? If there were two otherwise identical jobs doing the same work and one paid more, the employee would choose the higher paying one, so it's not unreasonable in general to assume that what the company paid the employee was the market rate to have that sort of work done.
No, it's not reasonable to make that assumption based on the facts. The employee/business relationship is not related to the value of product created by the employee. This is literally not how any business works. If it was, then most tech startup employees would get paid below minimum wage. FAANG programmer salaries would start in the low millions after a year or two on the job. Mid-level attorneys at most law firms would be making a cool million each year. Backoffice employees at any company wouldn't get paid at all, because they don't contribute to the creation of products.
But they do know that. The Ireland office is willing to immediately pay them the full amount they're paying the employees, so the US office is taking no risk. No risk, no reward; thin margins are the norm in that sort of transaction.
Valuation isn't about what the Irish company would do. Valuation is about how much the IP would be worth on the open market, to unrelated third parties who might not have insider knowledge of the actual cost of creating the IP, and thus who base their offer prices on the value of the IP to their own interests.
More importantly, if the Irish office was always going to reimburse the US office for hiring the US contractor to create the IP, that trail of paperwork says the Irish office was the actual creator of the IP, because the US office was just acting as its agent in hiring the contractor. And that's a very different scenario than what you were originally talking about. (And side note: backdating legal documents to suggest this was the contemplated transaction all along is a crime in both the US and Ireland likely to result in prison time if the IP has any significant value.)
Cost of creation is not a valid measure of the value of IP or intangible products generally, though it can provide a lower bound for physical products.
e San Francisco office pays the contractor, then does nothing more than immediately sell the rights to the code to the Ireland office for approximately the same amount.
The market price is what an independent third party would pay for the IP, not what your other office would pay. And what a third party would pay is based on how much they would be able to monetize the IP for in their own uses or the value they would derive from it (for example, like a process-based IP that increases efficiency).
The Ireland office could have just as well paid the contractor directly.
Maybe they could have. If the idea actually would have originated in Ireland, then they should have contracted the programmer directly, and then they would own the IP instead of the US office. But they didn't. It was the US office's idea to engage the contractor, to tell him what to program, and to evaluate the fruits of his labor. You would need to establish that the idea would just as easily have originated in the Irish office, and generally that's a very difficult to prove.
What value is the San Francisco office supposed to be adding that justifies being awarded a significant fraction of the total revenue?
Because territory matters when you're talking about sourcing income for tax purposes, especially where you're dealing with two related but legally distinct entities in different countries. There are literally millions of pages written about this (see "transfer pricing") because it has been the primary means of tax avoidance and tax evasion by multinationals for the past 3 decades. It is the primary focus of the OECD and (pre-trump) of the IRS and the EU.
Note: if both entities were in the same country, these concerns usually go away because related companies usually file consolidated tax returns (i.e., as if they were a single company), so all of this valuation crap would be rendered meaningless for tax and reporting purposes.
FB is right, they were still pretty unproven in 2010. It took nearly 1.5 years after their IPO before they convinced people they could make money.
I agree, it seems like they would be looking for evidence of undervaluing. But like, let's say you are discount potential cash flows. I don't even know if FB was profitable in 2010, what kind of projected cash flows are you going to have?
I just think that if the governments cared about this so much, they would actually fix this. The double irish is going away, but while the US had a chance to fix stuff in 2018, there's still incentive to offshore IP, and in fact, reinforces the advantage of offshoring production.
The reason why the IRS are challenging FB is that Apple's Irish tax arrangements became public and were very embarrassing to the US authorities, which were revealed not to be applying US law.
Now, to the matter of hindsight.
The essential point is that the transactions have to be a sham to work.
There is precisely no point in selling IP from a US subsidiary to one in Ireland at a fair price. That would just trigger an immediate taxable event in the US for no benefit whatsoever.
The transaction is by design intended to sell IP at a large undervalue and the game was to satisfy the US and Irish authorities, both of which were happy to play along.
Apparently there is if you want to book your international operations in Ireland without the IRS dragging you to court saying you lowballed them a decade ago.
Facebook had a funding round in mid 2009, and mid 2010. The 2009 valuation was $9.8B, and $13.8B in 2010. And this case is solely about their ex-US operations, which they're saying basically didn't exist at the time.
I mean it's like if you join a startup, how much are your equity options worth? Does the IRS go back and say your options were worth way more because it turns out you were working at the next Netflix or something?
Other alternatives: If, for example, the IRS has been pressed into the case by public or political pressure they may pursue an unwinnable legal case to win in the court of public opinion or to give other corporations with fewer legal resources than Facebook pause before they engage in similar.
At the risk of sounding reductive, that is exactly why it is in court: to figure out if it was illegal.
IMO illegality has a human and personal component too. I understand your question is about whether what they did was legal or illegal.
But let me give you an example of something that is "clearly wrong" but sometimes legal. Let us assume that you buy something (or are paid cash) and the amount is $100. If you pay $20 tax, then we say you are taxed at 20% and the amount becomes $80. So far so good. Now let's suppose that you claim back that $20 and you put it in your pocket. You still have the $80 (or the item you bought). So you net is at $100 whether in cash fully or $20 cash and something worth $80.
Now, let us suppose that in this scenario the cash was paid to you (I am specialising away from the case where you are buying something). You thus have $100, and effectively there was no tax. Now assume you go back to the tax office and you tell them that you are reclaiming another 20% on top of the 20% you paid and then reclaimed. Now, suddenly you have $120. You got $40 in tax reclaims but only ever paid $20. This is essentially the cum-ex scandal. [1] Once with and once without. The with part is the tax you reclaimed; the without is the tax you reclaimed with no base for it at all. Note that these are not tax credits, it's hard cash!
The cum-ex tactic is not always illegal, and this is why I say that legality is sometimes dubious (but not always). The reason why they could steal 50 BILLION EUROS from the German tax office is exactly because 1) the banks were and are in on it and 2) they lobbied for and blurred the lines of legality.
Apparently the German tax office still thinks, even today, that claiming $40 after only ever paying $20 somehow makes sense.
A stock can only have a single holder of record, and only one dividend payment should ever be made to whoever the holder of the stock was at the time of the payment.
https://www.bloomberg.com/news/articles/2019-09-02/the-germa...
If that article is to be believed, I'd suspect there was a bank who needs some serious auditing; because there is simply no way there should be any ambiguity as to who the stockholder of record is at that time; and the issuance of a multitude of "tax certificates" to multiple individuals implies they fundamentally mishandled that particular taxation event.
Transactions are atomic, and serial in nature as far as finances go. Automated or manual. They must resolve down to chronological order.
This is also part of the reason the Feds hate structuring, and will stamp it out in any form they can get enough information about in order to recognize it. Don't be like these people ever.
There is no moral or fiscal imperative to commit or concoct structures/mechanisms capable of becoming or facilitating tax fraud. Hell, this exact kind of chicanery is why AML/KYC/tax law ends up making normal financial service providing such a slog; because every link in the chain is yet another gear in the machine. If it seems like you're having to go through lot of hoops to do a relatively straightforward transfer of value, odds are, you may be taking part in some form of either structuring or other financial engineering. If you think that's a tenable of affairs, have fun, but when it comes back around, don't be surprised if there isn't much sympathy to be found.
Yes you are right with this. I have suggested a way to handle this to my colleagues informally, but I don't work with the tax offices themselves. What I would do is to have each share at the atomic level as you mention to have a serial number. If you reclaim for 100 shares then you need to supply 100 serial numbers.
With regards to the banks, absolutely, they are the critical step in this kind of fraud.
The serial number solution does have one weak point: You can use "unused" serial numbers for your reclaim or you can use serial numbers from someone who lives in a country that does not participate in the bilateral treaty that allows the reclaim. This latter example is also essentially using "unused" serial numbers. Typically there are many billions of dollars of withholding tax that remains unclaimed for whatever reason, sometimes even just ignorance. But at the very least this allows you to be better off than today. The tax offices, if they are competent, can even try to attach each serial number to a person, but there are privacy laws that can prevent this. Another subtle point is that a dividend payment event is not the same thing as receipt of the dividend in your account. Typically, the receipt of the dividend is the critical point that tax offices want, not proving ownership of the dividend. This is why the banks have so much power here. They essentially prove payment receipt, not dividend ownership. The logic is that you can't have had the payment into your account if you didn't have ownership of the dividend. There are also other examples of fraud such as forging the country of residence of the shareholder.
Oh yes, and then lastly: Apparently around 2009 some countries turned a blind eye to cum-ex because they saw it as a way to "boost the recovering economy" by pushing up bank revenues... ¯\_(ツ)_/¯
And there’s an argument to be made in the other direction too: everyone should be doing everything they legally can, and where it makes financial sense to exert the effort, to avoid paying any more tax than they have to...
because giving money and power to politicians is like giving whisky and car keys to teenage boys.
I hear this a lot and I kind of disagree with the sentiment. I think it's rooted in petty selfishness.
If you have enough money, as these companies surely do, good for you, ok. The attitude that sees any additional proceeds as wasted if they "needlessly" go to governments where it gasp might give other people useful public services ... Seems to have priorities in the wrong place. One must have proper perspective when you see financial success. Petty greed over small percentages of huge incomes is not the way to go. There is value in seeing how lucky you are and being happy with what you have, then subsequently seeing your role in our social system as paying some of that back.
For example, tax free savings accounts are often mentioned as "avoidance" in this context, to suggest that it's somehow nonsense to criminalise avoidance. But saving money is a reasonable thing lots of people might want to do anyway even if there was no tax advantage.
On the other hand, a scheme in which rich people pay somebody else to pointlessly buy and sell cars at a loss makes no sense - except that they then claimed a large tax discount as second hand car dealers...
One of the cleverest parts of the English scheme is that tax advisers, who sell such schemes to the rich for lots of money, are insulated from any penalty for doing so... As long as they tell the tax authorities how their scheme is supposed to work.
Countries would be better off if they simply did not allow IP assets to be transferred to a subsidiary in a different country. The IP stays in the country where it was created, or else sold on the open market.