Facebook appears to have a major tax headache on its hands after the Internal Revenue Service sued the social network on Wednesday to force it to comply with summonses related to a 2010 asset transfer.
According to documents the IRS filed in San Francisco federal court, the agency suspects Facebook and its accounting firm, Ernst & Young, understated the value of intangible assets transferred to Ireland by billions of dollars.
The IRS says it is seeking an order to enforce six summonses that asked Facebook to appear at the agency’s offices in San Jose, Calif., and to produce papers and others records. According to IRS agent Nina Stone, Facebook failed to show up at the appointed date of June 17, and nor did it provide the documents.
“Facebook (FB) complies with all applicable rules and regulations in the countries where we operate,” a spokesperson for the company told Fortune by email.
The dispute arose as a result of an ongoing audit of Facebook by IRS that stretches back to 2010. In that year, the company chose to designate Facebook Ireland as the rights-holder for its worldwide business outside of the U.S. and Canada, and also to transfer intellectual property assets such as its platform and “marketing intangibles.”
The crux of the disagreement between Facebook and the IRS turns on the arcane question of whether the assets in question could be transferred in their entirety or if, as the agency argues, they are “interdependent.” It is summed up in key paragraphs of the agent’s declaration:
Several [Facebook] employees indicated that the user base, online platform, and marketing intangibles were interdependent and would it would be difficult to isolate one from the other. The information gathered suggested to the IRS investigative team that the E&Y approach to valuing Facebook’s transferred intangibles on a stand-alone basis was problematic. […]
The IRS examination team’s preliminary positions suggested that the E&Y valuations of the transferred intangibles were understated by billions of dollars.
Such arrangements are common among U.S. tech companies, and seek to reduce tax payments by scoring revenue in low tax jurisdictions like Ireland, while having higher tax countries (especially the U.S.) reduce profits by paying to license intellectual property from overseas subsidiaries.
As Fortune reported last year, the car service Uber undertook an elaborate rearrangement of its corporate structure that involved the creations of subsidiaries in multiple companies, all in the apparent aim of reducing future tax payments.
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These sorts of arrangements have provoked ire in Washington, especially among Democrats, who claim tech companies are shirking their fair share of tax payments. Others counter that the problem is that U.S. corporate tax rates are too high, and reforming the tax code would incentivize companies like Apple (AAPL) to repatriate the swelling hordes of cash they now park overseas.
As for Facebook, it appears the conflict with IRS will stretch out for the foreseeable future. In the event the agency concludes the company did undervalue the assets, Facebook could go to court to challenge that finding.
The IRS documents also note the agency’s investigation was delayed in the past because of a lack of funding, and that it filed the summonses when it did to avoid overshooting a statute of limitations.
News of the filings was first reported by Law.com (subscription required).
