Hacker News Reader

Comment by cbanek | Hacker News Reader

Well, I guess it depends on the interpretation of the rules. The point of contention seems to be the valuing of assets, which of course FB has incentive to not value highly:

> 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?

View on HN

Part of the problem is, it’s not a legit, best price, arm’s-length, market price. Facebook:Ireland is just a sock puppet for Facebook:USA, and the latter has no intention of selling it to a true outsider.

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.

The real issue is that "market price" legitimately has an amount of slop in it that can eat the company's entire profit.

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.

That is not how IP valuation works. The internal cost is not the measure; the potential or actually sales/licensing value of the IP is the measure.

What measure? It's two different transactions that occur under different terms at different times.

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?

"Sell" is a four-letter word. Was that an actual market transaction where the seller got the highest price they could, and said price was evaluated by the buyer against alternatives? No, of course not. It was a dictated sale, precisely to present a fiction to the tax authorities.

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.

> Was that an actual market transaction where the seller got the highest price they could, and said price was evaluated by the buyer against alternatives? No, of course not.

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.

You keep trying to make logical arguments about a very small portion of the entire transaction without looking how that transaction relates to much larger business concerns.

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.

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.

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.)

You must have the patience of a saint, to untangle and address the parent's arguments.

To be valid for tax and legal purposes, valuations must adhere to generally accepted valuation methodologies. In some cases, like IP, there are enumerated methods of valuation.

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.

IANAL, Retroactively going after the valuation of assets based on success years on is awkward at the least, and dangerous at the worst.

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.

You don't need to be a lawyer to understand what this is all about and it certainly isn't hindsight, as you have suggested.

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.

>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.

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?

Reply on news.ycombinator.com