Zuckerberg sends signal: Big tech bracing for tax-shelter reforms

In what figures to be a stunning moment in the usually arcane world of corporate taxes, Facebook CEO Mark Zuckerberg plans to voice support for a landmark overhaul of rules that could limit the ability of tech firms to shift profits overseas. His remarks will be given at a high-profile security conference in Munich on Saturday, and come at a critical juncture for talks over a tax reform proposal backed by the Organization for Economic Cooperation.

"I understand that there's frustration about how tech companies are taxed in Europe. We also want tax reform, and I'm glad the OECD is looking at this," Zuckerberg plans to say, according to an excerpt of his prepared remarks obtained by POLITICO.

Get what matters in tech, in your inbox every morning. Sign up for Source Code.

The statement suggests that Silicon Valley's biggest firms — many of which have come under intense scrutiny in recent years over their deft use of tax loopholes — have accepted they will no longer be able to use profit-shifting strategies to legally enjoy tax rates of less than 20% and, in some cases, less than 10%. Or at least, not as much.

On Thursday, the Paris-based OECD estimated that governments across the globe would rake in a collective $100 billion annually if they agree to a fundamental change in how multinational companies are taxed, abandoning the current method of taxing firms based on the physical address where their profits are claimed. This system has allowed numerous tech firms to book profits through foreign subsidiaries in low-tax jurisdictions, reaping billions in savings and prompting widespread public backlash. Nearly 140 governments recently agreed to negotiate a resolution before the end of the year.

The pressure to reach an agreement is acutely felt by large tech firms such as Facebook, which would have an unprecedented headache on its hands if the individual countries that are drafting distinct tax rules to address profit-shifting were to implement such changes piecemeal. Tax experts say Silicon Valley desperately wants to avoid this alternative, as companies would need to file taxes in potentially dozens of countries. Hence Zuckerberg's expected remarks this weekend.

"We accept that [the reforms] may mean we have to pay more tax and pay it in different places under a new framework," Zuckerberg plans to say, according to POLITICO.

"[Tech] companies have a real reason for having a coherent system that works internationally, even if it means paying some additional tax," said Kimberly Clausing, an economics professor at Reed College in Portland, who studies international tax issues. Large companies in particular, "have benefited from incoherence," Clausing said. "But as there's less tolerance for this, they now have to worry about everyone taxing the same income."

Traditionally, companies pay taxes in the jurisdiction where their profits are derived, typically the same place their customers are. This has been the case for the past century. Tech companies, however, derive their value from more intangible assets, such as intellectual property and patents, which are more easily shifted to subsidiaries overseas. This allows firms to book profits in countries with corporate tax rates far lower than the 21% rate in the U.S., which was slashed from 35% in 2017.

Key to the arrangement is an obscure tax principle known as the "arm's length" transaction, whereby a company based in, say, Silicon Valley, must value the transfer of its intellectual property to a subsidiary in the same way it would if the subsidiary were, in fact, controlled by a separate company, and thus pay royalties on the IP that match its actual worth. Critics say this notion is routinely exploited by companies looking to minimize their tax bills by booking revenue on paper in far-flung jurisdictions, thousands of miles away from where the work that generated the revenue originated.

The situation is actively playing out in a landmark case brought by the IRS against Facebook, which heads to trial next week and could put virtually every one of the company's peers on notice. The case centers on profits booked by Facebook's Irish subsidiary and a Cayman Islands holding company that was set up prior to Facebook going public in 2012, mirroring an approach popular in Silicon Valley. The IRS says Facebook owes back taxes and fees as high as $9 billion; Facebook argues it is, in fact, entitled to a refund.

How much money, if any, that Facebook ultimately owes will be based on whether the court finds that the company appropriately valued intellectual property assigned to the subsidiary in Ireland.

"Facebook illustrates the untenable nature of the arm's length standard," Clausing said. "We have this notion that companies can transact with themselves as if they are transacting with third parties. Obviously, they don't do it that way."

Corporate tax lawyers are keeping a close eye on the outcome of the case, which will likely be unclear by a June deadline for the U.S. and other countries to agree on a proposed framework to rewrite the rules. The OECD's estimates for how much a rewriting of the tax code would affect companies came from researching more than 27,000 companies across more than 200 countries.

While President Trump has often been critical of tech behemoths including Amazon, Apple and Facebook, his administration has made clear that any changes to international tax rules could have an outsized impact on Silicon Valley's most profitable companies, creating political tension and uncertainty.

The digital economy has shown that the current system "doesn't work," Clausing explained. "But it also makes companies nervous because they think it's just targeting U.S. companies. It does raise some really important policy discussions."