Facebook Fails to Persuade Tax Court to Invalidate Transfer Pricing Regulations

(Parker Tax Publishing June 2025)

The Tax Court held, in a dispute between Facebook, Inc. and the IRS regarding a cost sharing arrangement between Facebook and its Irish subsidiary, that the income method in Reg. Sec. 1.482-7T(g)(4) could apply to the transaction because only Facebook made a nonroutine platform contribution. However, the court also found that the IRS implemented the income method unreasonably, by selecting the wrong inputs, and therefore abused its discretion under Code Sec. 482 by reallocating income to Facebook to the extent of the wrong inputs. Facebook, Inc. & Subs. v. Comm'r, 164 T.C. No. 9 (2025).

Background

On September 15, 2010, Facebook, Inc. entered into a cost sharing arrangement (CSA) under Reg. Sec. 1.482-7T (the "2009 cost sharing regulations") with Facebook Ireland Holdings Unlimited (FIH), its Irish subsidiary. In the CSA, Facebook and FIH agreed to codevelop future versions of the hardware and software systems underlying Facebook's online platform.

The CSA required Facebook and FIH to engage in a platform contribution transaction (PCT), compensating each other for the value of any "platform contributions" made. Pursuant to the PCT, Facebook and FIH granted each other the right to use any existing online platform technology in their respective territories: the United States and Canada for Facebook and the rest of the world (ROW territory) for FIH. In a separate agreement, Facebook granted FIH all rights relating to Facebook's existing users, advertisers, and third-party application developers in the ROW territory, including their data. Facebook also granted FIH the right to use its marketing intangibles in the ROW territory. FIH made payments to Facebook for 2010 on the basis of Facebook's valuation of these agreements at a September 2010 net present value (NPV) of $6.3 billion.

In addition to a PCT payment to compensate Facebook for its upfront PCT contributions, FIH also was required by the regulations to make (and commit to making annually) cost sharing transaction (CST) payments to compensate Facebook for ongoing intangible development costs (IDCs) in proportion to its share of reasonably anticipated benefits (RAB share) from exploiting cost shared intangibles. FIH made a net CST payment to Facebook of approximately $21 million for 2010.

The IRS determined a deficiency in Facebook's federal income tax for 2010 in a notice of deficiency dated July 26, 2016. This deficiency arose because the IRS reallocated income between Facebook and FIH under Code Sec. 482 in connection with the CSA and related license agreements. The IRS's valuation expert selected the income method as the best method for valuing contributions to the CSA, and opined that the NPV of the assets Facebook contributed to the CSA was $19.945 billion. Because this valuation increased FIH's required PCT payment, the IRS made a PCT allocation for 2010. The IRS also increased FIH's share of reasonably anticipated benefits (RAB share) used to determine FIH's CST payment for 2010.

Facebook took its case to the Tax Court. Facebook contended that the income method could not apply because both Facebook and FIH made "nonroutine platform contributions." Under Reg. Sec. 1.482-7T(g)(4)(i)(D), the income method applies when only one CSA participant makes nonroutine platform contributions, while a different method - the residual profit split method - is preferred if more than one CSA participant makes a nonroutine platform contribution. Facebook contended that, rather than the income method, the unspecified valuation method espoused by its valuation expert should be used to value the participants' contributions to the CSA.

Facebook also argued that the IRS selected the wrong values for three key inputs to the income method: revenue projections for the ROW territory, the appropriate discount rate for those projected revenues, and FIH's best realistic alternative to cost sharing. According to Facebook, once those inputs were corrected the IRS's income method produced a result consistent with Facebook's valuation. Simultaneously, Facebook maintained that the income method could not be the best method because it could not produce an arm's-length result and that the 2009 cost sharing regulations are invalid because they limit the expected return on ongoing intangible development costs (IDCs) to a discount rate reflecting market correlated risks. Facebook also challenged the IRS's adjustments to Facebook's and FIH's RAB shares.

Analysis

The Tax Court held that only one participant in the CSA - Facebook - made a nonroutine platform contribution and therefore, the income method in Reg. Sec. 1.482-7T(g)(4) could apply. In the court's view, Facebook failed to show that FIH made a platform contribution under the CSA. Rather, the court found that FIH's contributions were operating contributions rather than platform contributions because they related to exploiting the cost shared intangibles, not to their further development. The court noted that Facebook's own valuation expert initially selected an aggregate income method, after assuming (as instructed by counsel) that FIH made no platform contributions.

However, the court held that the IRS implemented the income method unreasonably by selecting the wrong inputs, and therefore abused its discretion under Code Sec. 482 by reallocating income to Facebook with respect to the PCT payment to the extent of the wrong inputs. In the court's view, the IRS's valuation expert failed to apply the income method's definition of "cost sharing alternative" under Reg. Sec. 1.482-7T(g)(4) and he did not analyze how his "Cost Sharing Deal" - which did not classify what was contributed to the CSA as platform or operating contributions - reflected the actual CSA. Thus, the court found that the IRS's inputs were unreliable because its expert failed to follow the income method. The court determined that, with reliable inputs, the income method was the best method and produced an arm's length PCT payment.

The court rejected Facebook's challenge to the 2009 cost sharing regulations and held that Reg. Sec. 1.482-7T reasonably implements Code Sec. 482 and is not invalid. While Facebook contended that the regulations impermissibly deviate from the "arm's length standard" required under Code Sec. 482, the court concluded that nothing in the text of Code Sec. 482 bars the IRS from prescribing what arm's length means when no comparable transactions can be identified. The court noted that Code Sec. 482 does not contain the words "arm's length;" rather, its focus is on clear reflection of income and preventing tax evasion in controlled transactions. The court also found that Facebook's interpretation disregarded the function of the inputs into the income method. In particular, the court reasoned that the discount rate is intended to replicate a return to an investor on the funding that it provides, approximating the cost of capital adjusted for systemic risk. In addition, the court held that Reg. Sec. 1.482-7T(i)(6) does not operate as a safe harbor, and therefore did not preclude the IRS from making a PCT allocation under Reg. Sec. 1.482-7T(i)(3).

Further, the court held that the IRS did not abuse its discretion under Code Sec. 482 by adjusting Facebook's and FIH's RAB shares to determine the required CST payment. The court also held that the IRS's method for calculating RAB shares was consistent with Reg. Sec. 1.482-7T and provided the most reliable estimate of reasonably anticipated benefits, using corrected inputs. The court found that the IRS determined the amount of the deficiency attributable to this issue using the forecast its expert developed for computing the PCT payment. The court also noted the interaction between any adjustments to the PCT payment and the CST payment for 2010. Therefore, the court directed the parties to recompute the CST payment using the corrected inputs the court determined with respect to the PCT payment.

For a discussion of IRS allocations of income expenses among relate corporations, see Parker Tax ¶241,597.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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