Amazon just won in Tax Court against the IRS. If Amazon would have lost, then it would have owed about $1.5 billion in taxes. The Amazon case is similar and could provide insight into one that Facebook is currently contesting with the IRS. In the Facebook case, if the IRS wins, it could collect between $3 to $5 billion in taxes from Facebook.
More importantly, the IRS is contesting a tax strategy common in the tech field. A company such as Amazon establishes a foreign subsidiary somewhere with low tax rates. Amazon then transfers intellectual property (IP) to the foreign subsidiary and in exchange, the foreign subsidiary makes royalty payments to Amazon.
Amazon pays taxes on the royalties received from the foreign subsidiary. The royalty payments in turn depend on the value of the IP transferred. A higher valuation mean higher royalty income for Amazon and more taxes to be paid. This is what the IRS wants, so it valued the IP Amazon transferred at $4 billion or sixteen times larger than Amazon’s estimate.
The Tax Court didn’t agree with the IRS’s valuation and sided with Amazon, and now Facebook faces the same issue. Facebook established its foreign subsidiary in Dublin, Ireland and also transferred IP which Facebook valued at $4 billion. Unfortunately, the IRS valued Facebook’s IP at $14 billion or three times higher than Facebook’s estimate.
With the higher valuation, the IRS is looking for more royalty income and hence more taxes from Facebook; that will only occur if a Tax Court agrees with IRS’s valuation method, something which did not happen in the Amazon case.