Facebook’s CSA in the Metaverse and How Facebook Substantially Reduced its Platform Contribution Payment

On January 13, 2025 the United States Tax Court decided Facebook, Inc. v. Commissioner, 164 T.C. No. 9 (2025). The opinion of the Tax Court addressed the validity of the 2009 temporary cost sharing regulations. The significance of this case is that the Tax Court validated the Internal Revenue Service’s (“IRS’s”) method of valuing asset transfers between Facebook, Inc., (A U.S. parent corporation) and its foreign subsidiary. Although the Tax Court endorsed the IRS method of valuing the asset transfers between Facebook, Inc. and its foreign subsidiary, the Tax Court ruled in favor of Facebook overall. This article discusses why the Tax Court ruled in favor of Facebook overall in its litigation with the IRS.

Background

On September 15, 2010, Facebook, Inc. and two related licensing subsidiaries (Facebook-U.S.), entered into a cost sharing agreement (“CSA”) with its wholly-owned Irish subsidiary, Facebook Ireland Holdings Limited (Facebook-Ireland”). The CASA involved the international expansion of the Facebook platform in moving from a web-only social media platform onto a smartphone application. This project included the build-out of an international headquarters facility in Dublin, Ireland. The so-called “double Irish sandwich” structure was used in order to materially reduce Facebook’s worldwide effective income tax rate. The double Irish sandwich was a corporate tax avoidance structure used by multinational corporations such as Facebook to shift profits from higher-tax countries to a tax haven, effectively achieving a near-zero tax rate on non-U.S. income. This structure is now defunct.

The Facebook- U.S. CSA was governed by Temp Reg. Section 1.482-7T which was enacted in 2009 and finalized by the IRS. The IRS audited the Facebook CSA and ultimately issued Facebook a Notice of Deficiency for the 2010 tax year. In the Notice of Deficiency, the IRS alleged that Facebook U.S. underpriced the required buy-in payment from its Irish subsidiary for territorial exclusivity for exploiting its core technology by $13.6 billion. The Notice of Deficiency issued to Facebook-U.S. proposed an additional income tax of $1.3 billion plus penalties and interest which were estimated to be in excess of $9 billion.

Cost Sharing Arrangements

The Facebook litigation involved a dispute regarding a CSA. In order to understand the dispute, it is important to understand the rules governing CSAs. In the context of cross-border transactions, the operating units of a multinational corporation usually engage in a variety of intercompany transactions. For example, a U.S. manufacturer may market its products outside the U.S. through a foreign marketing subsidiary. The same U.S. parent corporation may also provide managerial, technical, and administrative services for its subsidiaries. A “transfer price” must be computed for these controlled transactions in order to satisfy various financial reporting, tax, and other regulatory requirements. Section 482 of the Internal Revenue Code adopts an arm’s-length standard for evaluating the appropriateness of a transfer price. Under this standard, a taxpayer should realize the same amount of income from a controlled transaction as an uncontrolled party would have realized from a similar transaction under similar circumstances. See Treas. Reg. Section 1.482-1(b)(1). To arrive at an arm’s length result, the multinational corporation must select and apply the method that provides the most reliable estimate of an arm’s length price. See Treas. Reg. Section 1.482-1(c)(1).

The Section 482 regulations contain an important exception to the general rule that an arm’s length royalty or other consideration must be paid by a related enterprise when intangibles are transferred to it by an enterprise controlled by the same interests. Intangibles may be shared between two or more related enterprises under an arrangement that provides for the sharing of the costs and risks of developing intangible property in return for an interest in the intangible property that may be produced. Under a qualifying sharing arrangement, the related person receiving an interest in intangible property is not required to pay an arm’s length royalty for its use; it need only bear or pay an appropriate share of the cost of the research and development concerned.

At the time Facebook-U.S. entered into its CSA, the 2009 cost sharing arrangements were in effect. The 2009 cost sharing regulations defined a cost sharing arrangement as an arrangement for sharing of costs of development of one or more intangibles in proportion to the participants’ shares of reasonably anticipated benefits from their exploitation of interests in any intangibles that are developed. See Treas. Reg. Section 1.482-7(a)(1). If a “qualified cost sharing arrangement” exists, no Section 482 allocation of arm’s length royalties or equivalent payments can be made by the IRS. The IRS can only adjust the cost sharing payments to make each controlled participant’s share of the relevant intangible development costs equal to its share of reasonably anticipated benefits from use of the intangibles developed. See Treas. Reg. Section 1.482-7(a)(2).

To be treated as a qualified cost sharing arrangement and thus insulated from risk of royalty allocation, the arrangement must:

1. Include two or more participants;
2. Provide a method to calculate each controlled participant’s share of intangible development costs, based on factors that can reasonably be expected to reflect the participant’s share of anticipated benefits;
3. Provide for adjustment to the controlled participant’s shares of intangible development costs to account for changes in economic conditions, the business operations and practices of the participants and the ongoing development of intangibles under the arrangement; and
4. Be recorded in a document that is contemporaneous with the formation (and any revision) of the cost sharing arrangement that includes:

i) A list of the arrangement’s participants, and any other member of the controlled group that will benefit from the use of the intangibles developed under the cost sharing arrangement;

ii) A description of the scope of the research and development to be undertaken, including the intangible or class of intangibles intended to be developed;

iii) A description of each participant’s interest in any covered intangible;

iv) the duration of the arrangement; and

v) The conditions under which the arrangement may be modified or terminated and the consequences of such modification.

Requirement (2) is intended to ensure that cost sharing arrangements will not be disregarded by the IRS as long as the factors on which an estimate of anticipated benefits was based were reasonable, even if the estimate proves to be inaccurate.

Covered Intangibles and Participants

The intangibles developed under a cost sharing arrangement are referred to as “covered intangibles.” A covered intangible is defined broadly as “any intangible property that is developed as a result of the research and development undertaken under the cost sharing arrangement (intangible development area).” See Reg. Section 1.482-7(b)(4)(iv). The term “intangible” is defined broadly for purposes of Section 482 to include patents, knowhow, copyrights, trademarks, and franchises.”

Unrelated persons – “uncontrolled participants”- may participate in a qualified cost sharing arrangement. Commonly controlled taxpayers-”controlled participants”- may be participants if they satisfy certain conditions. See Treas. Reg. Section 1.482-7(c)(1). To qualify as a controlled participant, a controlled person must reasonably anticipate that it will derive benefits from the use of the covered intangible. See Treas. Reg. Section 1.482-7(c)(1)(i). This requirement can be satisfied if the controlled participant uses the intangible property or otherwise transfers the intangible to others as long as the benefits can be measured.

Development Costs and Reasonably Anticipated Benefits

Treasury Regulation Section 1.482-7(d)(1) defines intangible development costs of a controlled participant as all of its costs related to the intangible development area, including operating expenses other than depreciation and amortization expenses, plus an arm’s length charge for tangible property made available to the CSA. Costs include cost sharing payments the participant makes to the other participants less such payments it receives from other participants. The IRS may adjust the pool of costs shared to properly reflect costs that reflect the intangible development area.

Reasonably anticipated benefits (“RAB”) are defined as additional income generated or costs saved by the use of covered intangibles. The pool of anticipated benefits may also be adjusted by the IRS to properly reflect benefits that relate to the intangible development area. Cost allocations that may be made by the IRS to make a controlled participant’s share of costs equal to its share of RAB are governed by Treasury Regulation Section 1.482-7(f). Anticipated benefits of uncontrolled participants will be excluded from anticipated benefits in calculating the benefits shares of controlled participants. A share of RAB will be determined using the most reliable estimate of benefits. The reliable measure of RAB depends principally on two factors: the reliability of the basis for measuring benefits used and the reliability of the projections used. An allocation of costs or income may be made by the IRS if the company did not use the most reliable estimate of benefits, which depends on the facts and circumstances of each case.

Multinational Corporations and Cost-Sharing Arrangements

For multinational corporations that have already made a substantial R&D investment, the use of a CSA agreement involving the participation of foreign controlled affiliates in low or non-tax jurisdictions have become a very attractive tax planning opportunity. Undoubtedly, there is a fair amount of effort involved in properly threading the transfer pricing needles in meeting the Section 482 requirements, foreign tax law, and applicable tax treaty provisions. The obvious goal for the U.S. parent is to achieve a lower effective rate of worldwide taxation.

Defining a Platform Contribution for Cost-Sharing Arrangements

A platform contribution (“PCT”) is a transaction that occurs within the context of an intercompany CSA, in which a participant transfers a pre-existing resource, capability, or right that is reasonably anticipated to contribute to the development of new intangibles under the CSA. The purpose of a PCT is to compensate the participant providing the pre-existing asset (the “platform”) for the value that asset will bring to the shared development activity. Payments for a PCT are known as “buy-in” payments. Special buy-in and buy-out rules are provided in Treasury Regulation Section 1.482-7(g). If, after any cost allocations made by the IRS to make each participant’s share of costs equal its share of RAB authorized by Treasury Regulation Section 1.482-7(a)(2), the economic substance of the arrangement is inconsistent with the terms of the arrangement over a period of years, the IRS may impute an agreement consistent with the participant’s actual course of conduct. In that case, one or more of the participants that bore a disproportionately greater share of costs would be deemed to own a greater interest in covered intangibles than provided under the arrangement and must receive buy-in payments from the other participants. Treas. Reg. Section 1.482-7(g)(5).

Under the treasury regulations, a “platform” is broadly defined as any resources, capability, or right (such as existing intellectual property, patents, or technical expertise) that is a participant developed or acquired externally to the cost sharing arrangement’s main development activity. See Treas. Reg. Section 1.482-7. Payments for PCTs must be at “arm’s length,” meaning they should reflect what unrelated parties would pay in a comparable transaction, to ensure proper allocation of income and expenses among the controlled entities for tax purposes.

Facebook’s Cost Sharing Agreement

Facebook established its international headquarters in Ireland in order to reflect its parent-subsidiary structure. On September 15, 2010, Facebook-U.S. entered into a CSA with its Irish subsidiary, Facebook Ireland Holding Unlimited (“FIH”) and Facebook Ireland Limited (“FIL”) collectively, (“Facebook Ireland”). Facebook-U.S. and Facebook Ireland agreed to develop future versions of the hardware and software systems underlying Facebook’s Online Platform (“FOP Technology). The CSA’s definition of coast shared intangibles explicitly user community rights and marketing intangibles, which were separately licensed under a User Base Transfer and Marketing Intangibles licensing Agreement (“UBMI License”). Facebook U.S. and Facebook Ireland divided all interest in cost sharing intangibles into two nonoverlapping territories and assigned the perpetual and exclusive right to exploit the cost shared intangibles accordingly.  Facebook U.S.’s territory consisted of the United States and Canada, and Facebook Ireland’s territory consisted of the rest of the world (“ROW”) excluding those two countries. Gross profits of the CSA participants were used to measure the RAB shares to share the intangible development costs (“IDCs”). For this purpose, the gross profits in the current fiscal year plus projected gross profits for the following two fiscal years were considered by Facebook in determining the R&B shares for the CSA participants.

In connection with the CSA, Facebook U.S. and Facebook Ireland concurrently entered into two additional agreements pursuant to which, Facebook U.S. conveyed certain resources, capabilities or rights to Facebook Ireland; the Online Platform Intangible Property Buy-In License Agreement (FOP Technology License) and UBMI License. In addition, the parties executed ancillary agreements, including a “Data Hosting Services Agreement” (“DHSA”), in which Facebook Ireland agreed to reimburse Facebook US for data hosting services at cost-plus-10%. In 2010, Facebook Ireland paid Facebook-U.S. royalties of approximately $100 million, 60% of which was for Facebook’s FOP, 38% for community rights, and $2 million for marketing intangibles. Of the $100, Facebook Ireland paid $5 million cash and issued a $95 million intercompany note. Facebook calculated the net present value (“NPV”) of PCT as 6.3 billion. The IRS contended that the NPV of the PCT payment was $19.945 billion.

In other words, the CSA Facebook-U.S. entered into with Facebook Ireland permitted Facebook-U.S. to reduce U.S. taxes by shifting the ownership of valuable intangibles, like platform technology, outside the U.S. The CSA permitted Facebook Ireland to have the right to use these intangibles for international markets, while Facebook-U.S. only kept the rights for the U.S. and Canadian markets. This planning also enabled Facebook-U.S. to shift a significant portion of its profits to low tax countries.

Tax Court Holding

The Court held that the 2009 cost shareholding regulations (including the specified income method for valuing a PCT) are not valid, and that using the income method to determine the PCT payment value produced an arm’s-length result if the correct inputs are used. The Tax Court noted that there are six methods to evaluate an arm’s-length amount for buy-in payments with respect to a PCT. With respect to IDC payments, the regulations prescribe the RAB share method whereby controlled participants share IDCs in proportion to their respective RAB share in the agreement. The Tax Court stated the four components of the contributions made by the participants to a CSA: 1) platform contributions (previously developed, developed or acquired externally to the IDC agreement); 2) operating contributions (which are charged to the participant benefitting under the exclusive territorial arrangement; 3) cost contributions; and 4) operating cost contributions. Cost contributions are the IDCs borne by the controlled participant less all such CST payments received from other controlled participants. Operating cost contributions are anticipated to be incurred to exploit the cost-shared intangibles but are incurred after the CSA has commenced.

The 2009 regulations described three methods for judging the acceptability of a transfer price for intangible property, along with a fourth category called “unspecific method.” They include the following three methods: income method, cost-sharing alternative, and residual profits split method.

The first enumerated method is characterized as the “income method.” The “income method” is generally used in the context of valuing highly valuable and unique intangible property for transfer pricing purposes. This method is generally used where one CSA participant makes nonroutine platform contributions. The income method requires a controlled participant that does not make a nonroutine platform contribution to another CSA participant for: 1) financial benefits that the PCT payee’s nonroutine PCT is projected to generate in the PCT payor’s territorial zone; less 2) a market rate of return for the functions and risks the PCT payor commits to from an economic standpoint under the CSA (operating cost contributions) and further commits to pay for its costs contributions. See Treas. Regs. Sections 1.482-4(f)(6); 1.482-7(i)(6).

The second method of characterization is the “cost-sharing alternative method.” This method is best used when the PCT payor performs the same functions and incurs the same risks under the CSA except for its RAB share of the IDC.

The third method is the “residual split method.” Under this method the operating profit and loss is determined from the most narrowly identified business activity of the controlled participant which includes the controlled transaction. Such profit or loss is then divided between the controlled parties based upon “the relative value of each controlled taxpayer’s contributions” to the success of the activity. The value of each party’s contributions is to be based upon “the functions performed, risks assumed, and resources employed ***.” Treas. Reg. Section 1.482-6(b). The residual profit split calls for the application of a two-step process. First, the operating income is allocated to each party by reference to the market rate of return for its routine contributions to the activity. Treas. Reg. Section 1.482-6(c)(3)(i)(A). Routine contributions are those made by uncontrolled parties involved in similar business activities for which market returns can be identified. They include contributions of tangible property, services and intangibles which similarly situated uncontrolled parties generally own. The market rate of return is determined by reference to uncontrolled parties engaged in similar activities.

The fourth is the “unspecified method,” described in Treasury Regulation Section 1.482-3(e)(1). The method is to be applied in accordance with Treasury Regulation Section 1.482-1 and should take into account the general principle that all of the “realistic alternatives” should be considered.

The IRS argued before the Tax Court that the “income method” was the “best method” for determining the CSA outcomes in this case. The Tax Court agreed. The IRS made a number of financial projections of future ROW cash flows and applied a discount rate to estimate the present value of Facebook’s global operations as of the transaction date. Through these claims, the IRS alleged that Facebook-U.S. underpriced the required buy-in payment from Facebook Ireland for territorial exclusivity for exploiting its core technology by $13.6 billion. The Tax Court held that the income method was the best method for determining the CSA outcomes in this case. However, the Tax Court held that Facebook-U.S. had only underpriced the PCT by only $1.5 billion and not by $13.6 billion as alleged by the IRS. In reaching its decision, the Tax Court determined that the IRS had significantly overvalued the PCT amount from the reported NPV amount. The Tax Court adjusted the forecasted cash flows used by the IRS to exclude 1) projected “Other Revenue” that the Tax Court found to be aspirational or “future unknown revenue source” and 2) adjustments for the cost of future acquisitions. The Tax Court also increased the discount rate applied to forecasted cash flows to better reflect Facebook Ireland’s market-correlated risks of participating in the CSA.

The Tax Court’s opinion is significant in that the court rejected the IRS’s application of the “income method” in regards to interpreting a CSA. The IRS is now on notice that courts will closely scrutinize projected cash flows and discount rates in transfer pricing cases involving CSAs. Given the amounts at issue in this case, the Facebook decision is unlikely to be the last we will be hearing about CSA audits and tax litigation. Multinational corporations should expect CSA agreements in general to be closely scrutinized by the IRS.

Conclusion

The Facebook case is unlikely to be the last case involving transfer pricing and CSAs. As a matter of fact, in January 2025, the IRS announced through its Internal Revenue Manual (“IRM”) that it would engage in periodic adjustment audits of CSAs. Consequently, multinational corporations should carefully consider the robustness of their projections and valuation assumptions when considering the transfer of intangible assets or the valuation of PCT payments related to CSAs. In addition, multinational corporations that have entered or are considering entering into a CSA should carefully consider financial projection and valuation assumptions upon which the applicable CSA is valued.

Anthony Diosdi is an international tax attorney at Diosdi & Liu, LLP. Anthony, based in San Francisco, California, maintains a national and international tax practice, focusing on most areas of federal income tax, state income tax, and federal gift and estate tax law. Anthony is the author of a number of published articles addressing cross-border taxation. Anthony also frequently provides continuing educational programs regarding various international tax topics.

Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.