Facebook Files Pretrial Memo in Tax Court Transfer Pricing Dispute

FACEBOOK, INC. & SUBSIDIARIES,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

Judge Cary D. Pugh

Special Trial Calendar: San Francisco, CA
Date: February 10, 2020

PETITIONER'S PRE-TRIAL MEMORANDUM

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TABLE OF CONTENTS

PRELIMINARY STATEMENT

AMOUNTS IN DISPUTE

STATEMENT OF ISSUES

SUMMARY OF FACTS

BRIEF SYNOPSIS OF LEGAL AUTHORITIES

ESTIMATED TIME FOR TRIAL

WITNESSES

MOTIONS AND EVIDENTIARY ISSUES

STIPULATIONS OF FACTS

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PRELIMINARY STATEMENT

In 2010, Facebook's mission was “to give people the power to share and make the world more open and connected.” But in 2010, Facebook had only connected a modest part of the world, had not made significant inroads into international advertising markets, and did not have technology to show ads to users on mobile devices, at a time when the world, particularly outside North America, was moving to mobile devices. As a result, in 2010, Facebook Inc. (“Facebook US”) had to choose (i) how it went to market outside North America, and (ii) how to fund its future development of mobile and other high-risk, advanced technology. For sales outside North America, Facebook US could have its foreign affiliates build a sales force, or it could pay the general market rate of 30% of revenue to third-party resellers of digital ads. For international markets, Facebook US chose to have Facebook Ireland¹ and its other foreign affiliates, as well as third parties, sell Facebook ads. To develop technology, Facebook US could go-it-alone, or it could share risk by entering into cost sharing arrangement as contemplated by Congress and the Treasury Regulations. Facebook US chose to enter into cost sharing, paying royalties that were consistent with or exceeded the requirements of Section 482. As a result, from 2010 through 2016, Facebook Ireland paid Facebook US more than $4.1 billion in cost sharing payments and $10 billion in royalties. In exchange, it received the rights to use and develop technology, but it also assumed the risk that its investment would fail or underperform if, for example, Facebook was unable to market ads or develop a mobile platform for its ads.

This case requires the Court to determine the arm's length amounts under Section 482 for three royalties Facebook Ireland paid to Facebook US as part of Facebook's international expansion: (i) a Platform Contribution Transaction (“PCT”) royalty for platform technology existing as of September 2010; (ii) a user royalty for access to a portion of existing Facebook users to which Facebook US had rights as of that same date; and (iii) a royalty for trademark and marketing intangibles. Facebook Ireland paid the three royalties pursuant to two agreements that transferred these distinct intangibles.

Facebook asserts that royalties that Facebook Ireland paid met or exceeded the amount required under Section 482 for at least three reasons. First, Facebook Ireland and Facebook's other foreign affiliates — not Facebook US — led the high-risk, and ultimately successful, international effort to sell Facebook ads. In 2010, the international advertising market was skeptical of social networking ads, and Facebook Ireland faced the choice of building its own sales force outside North America or paying third-party resellers to try to sell Facebook ads. Facebook Ireland did both. In some markets, Facebook Ireland and other Facebook affiliates developed strategies to sell Facebook ads and grew a world-class sales force. In other markets, Facebook Ireland paid third parties to sell Facebook ads. These international sales efforts — not sales made by Facebook US — grew annual revenues in Facebook Ireland's territory from $281 million in the last three months of 2010 to more than $13 billion in 2016. As of September 2010, Facebook US and Facebook Ireland contracted with third parties to sell Facebook ads in markets outside North America, paying the majority of these third-party resellers 30% of revenue, prove that in 2010, the market rate for selling Facebook ads was 30% of revenue. Whether or not Facebook US and Facebook Ireland entered into cost sharing, the only “realistic alternative” to succeed was for Facebook US to pay Facebook Ireland and its other related affiliates, or to pay third parties to resell Facebook ads. Either way, 30% of revenue was not includible in a PCT payment.²

Second, with regard to the user royalty, Facebook Ireland had rights in the Facebook user base outside of North America, and after September 15, 2010, Facebook Ireland continued to grow the user base. As of September 2010, both existing Facebook users and users that had not yet joined Facebook, could choose to join Facebook as well as competing social networks. Unlike copyrighted software, a trademarked brand, or other property, neither Facebook US, nor Facebook Ireland, nor any other entity owned the 392 million users of Facebook outside North America in September 2010. Nonetheless, pursuant to the intercompany agreements and the Facebook terms of service entered into by Facebook users, and because Facebook Ireland funded user growth prior to cost sharing, both Facebook US and Facebook Ireland had rights to portions of the 392 million users that existed in September 2010. The user royalty that Facebook Ireland paid to Facebook US exceeded an arm's length amount because it did not credit Facebook Ireland for its rights in the existing user base outside North America as of September 2010.

While third parties might have paid to access the Facebook US portion of the existing 392 million users outside North America in 2010, third parties would not have paid Facebook US for future, unidentified users that had not yet joined Facebook, and with whom Facebook US did not have any relationship at all. A third party might have paid Facebook US to transfer its portion of the 2010 existing users so that the third party could have the opportunity to retain the users, to show them ads, or to try to have those existing users recruit new users. In contrast, however, Facebook US had no ability to transfer future users that it had not yet identified, and no third party would pay for unidentified Internet users, with whom Facebook did not have a relationship and about whom it did not have any information.

As a result, any 2010 net present valuation must account for the fact that Facebook's 2010 income projections were dependent upon both existing users to which Facebook Ireland had rights, and unidentified future users. With regard to the future users, (i) they did not yet exist (e.g., they included users not yet born); (ii) Facebook US could not, and did not, transfer them to Facebook Ireland in 2010; (iii) they were neither a platform contribution³ nor an intangible under the Section 482 regulations; and (iv) third parties would not pay for access to them.

Third, Facebook Ireland is entitled to profits from the foreign business it built and its interest in cost-shared intangibles, as required by Section 482 and the evidence of actual market transactions. Outside North America, Facebook Ireland and other foreign affiliates — not Facebook US — developed foreign goodwill, foreign going concern value, and an international workforce. Facebook US was not entitled to profits under Section 482 for these assets because Facebook US did not transfer them to Facebook Ireland. Rather, the work of Facebook Ireland and other non-U.S. Facebook affiliates created these assets outside North America. Further, with regard to technology, the parties anticipated that Facebook Ireland would codevelop, and Facebook Ireland has indeed co-developed, future technology. Facebook Ireland's co-development effort led Facebook US and Facebook Ireland to build, among other innovations, new mobile technology platforms that displaced Facebook's 2010 desktop platform.

Facebook Ireland would only have agreed to build a risky business (i.e., a going concern and an international workforce, with attendant goodwill) and to fund risky efforts to develop future technology (e.g., mobile), in return for an opportunity to share in profits (i.e.., to receive an interest in future cash flows, if they occurred) to offset the risk it undertook. Neither Facebook Ireland nor any rational co-venture partner would have agreed to a capped or fixed return.⁴ Section 482, the regulations under Section 482, and the legislative history demonstrate that returns from foreign “residual assets” such as going concern value and goodwill are not compensable to Facebook US and properly belong to Facebook Ireland or other foreign affiliates. Further, Congress intended “cost sharing" to result in profit sharing, too. Respondent's position, to the extent that it takes profits from Facebook Ireland's interest in cost-shared intangibles and the business it builds, conflicts with Congressional intent and Treasury Regulations, and exceeds Respondent's authority under Section 482. Those authorities permit Facebook Ireland to earn future profits from building a business outside North America and co-developing new technology. To the extent that Respondent argues that the Treasury Regulations mandate that the foreign cost sharing participant (Facebook Ireland) cannot keep its profits, or to the extent the regulations as interpreted and applied by Respondent deny Facebook Ireland its appropriate profits, the regulations are invalid, and Respondent's determination is arbitrary, capricious, and unreasonable.

In summary, Facebook Ireland paid royalties that met or exceeded what was required by Section 482 because (i) Facebook US did not conduct the risky and ultimately successful sales efforts outside North America; (ii) Facebook US could not, and did not, transfer unidentified future users who were not intangibles or platform contributions under Section 482 or the regulations, and for which third parties would not have paid; and (iii) under Section 482, Facebook Ireland was entitled to share in future profits from its future business operations and the cost-shared technology, given the risks it assumed and contributions it made.

AMOUNTS IN DISPUTE

Respondent's Notice of Deficiency asserts that Facebook is liable for additional 2010 income taxes of $1,733,335. In making this determination, Respondent increased Facebook's gross royalty income for 2010 by $84,915,248. Respondent predicated his adjustment upon a draft economist report that determined a total 2010 net present value (“NPV”) of intangibles transferred of $13.9 billion. Respondent did not allocate his adjustment among the three royalties paid by Facebook Ireland.

On December 20, 2019, Respondent moved to amend his Answer. In his First Amended Answer, Respondent asserts that Facebook is liable for additional 2010 income taxes of $2,380,252. Respondent determined this revised tax amount based on an increase in Facebook's gross royalty income for 2010 of $115,209,042. Respondent determined the gross royalty amount using the upper end of a NPV range, equal to $21.15 billion, although Respondent also asserts that his median NPV of $20.1 billion would be arm's length. Respondent has not allocated his revised adjustment among the three royalties.

Under the law, separate values for the three royalties must be determined.⁵ Facebook asserts that the NPV for the PCT royalty was in a range of $1.76 billion to $2.5 billion if determined consistent with the definitions of intangible property under Section 482, and in a manner that properly permits Facebook Ireland to share in future profits. In the alternative, even if Treas. Reg. § 1.482-7T is valid and mandates that the present value of all future technology profits return to Facebook US, and such a mandate is followed (which Facebook asserts is contrary to Section 482), the royalties paid by Facebook Ireland met or exceeded arm's-length amounts because the NPV of the PCT royalty was $3,259 billion. Separately, the NPV of the royalty for the existing users in 2010 was a range of $718 million to $1.2 billion. Finally, the arm's-length trademark royalty was 1%. The NPV amount for user royalties is less than the amount actually paid by Facebook Ireland.⁶

STATEMENT OF ISSUES

Determining the arm's length amount for each of the three royalties will require addressing the issues that divide Facebook and Respondent. Although both parties agree that calculating the royalties requires determining 2010 NPV amounts, Facebook and Respondent disagree upon multiple inputs to that calculation.

A. Aggregate or Separate Valuation

A threshold issue the Court must determine is whether the NPV of the three royalties should be determined separately or in the aggregate. The regulations state that a transaction must be evaluated “as actually structured by the taxpayer unless its structure lacks economic substance.” Treas. Reg. § 1.482-1(f)(2)(ii)(A). Although Treas. Reg. §§ 1.482-1(f)(1) and 1.482-7T(g)(2)(iv) permit aggregate valuation if it is the “most reliable” approach, in this case the law and third-party comparables demonstrate that a separate valuation is the most reliable. Moreover, even if an aggregate valuation is permissible in some form, it must only value the items transferred. When an aggregate valuation is predicated upon enterprise-level financial projections, the aggregate valuation can improperly capture value from non-transferred items (e.g., future users, goodwill, or going concern value).

Here, market transactions, including Facebook's own transactions with third-party developers, demonstrate that developers of technology (in this case, Facebook US) receive 70% of revenue, and parties that make users available to technology developers (i.e., Facebook Ireland) receive 30% of revenue.⁷ These market transactions identify a separate technology income stream, consistent with the different nature of the intangibles (e.g., copyrighted software versus terms of service with individual users).

In addition, the law defines intangibles and platform contributions such that specific items must be identified and excluded from an aggregate valuation. For example, any aggregate valuation must account for and exclude goodwill and going concern value (i.e., the residual value of the business after a taxpayer identified and valued all the pre-existing tangible and intangible assets).⁸ These items cannot be platform contributions because they cannot be anticipated to contribute to developing cost-shared intangibles as listed in Treas. Reg. § 1.482-4(b)(1). A separate valuation avoids this issue by not capturing the goodwill and going concern value in the separate items. Similarly, an aggregate valuation must exclude items not transferred such as the value attributable to the portion of the 2010 existing users to which Facebook Ireland had rights of its own.

In contrast, Respondent's unadjusted aggregate valuation values too much and is not reliable. Without explanation, Respondent's new valuation approach makes no adjustments for the following: the portion of the existing users to which Facebook Ireland had rights;⁹ for the unidentified future users that Facebook US could not, and did not, transfer to Facebook Ireland; for foreign going concern value or foreign goodwill; for non-platform contributions; or for other items that Facebook US did not transfer. For example, the future users were not transferred, were not platform contributions,¹⁰ and were not intangibles under Section 482, Treas. Reg. § 1.482-4(b), or any other authority. Similarly, foreign going concern value and foreign goodwill were not transferred, were not platform contributions, and were not compensable pursuant to Sections 367, 482, or 936. Any aggregate valuation necessarily requires carving out value for these items. In other words, an aggregate valuation necessarily requires disaggregation to identify cash flows attributable to non-platform contribution items, such as the existing users to which Facebook Ireland had rights, future users (including users that have not yet joined today), foreign goodwill, foreign going concern value, the international work force, and other items. Respondent has not made such adjustments, and thus his aggregate valuation approach is not reliable.¹¹

B. PCT Royalty

With respect to the PCT royalty, three issues are responsible for substantially all of the difference between Facebook's valuation and Respondent's valuation. The three issues each relate to the characterization of Facebook Ireland's business in 2010:¹² (i) the arm's length amount for the “realistic alternative” which must address the significant contributions made by Facebook Ireland and other affiliates (i.e., not by Facebook US), including for leading and bearing the risk of sales in its territory; (ii) the projections to be used for the NPV calculations; and (iii) the overall riskiness of Facebook Ireland's business, in light of the uncertain state of social networking ads and mobile technology, including how that risk should be reflected in a discount rate.

1. The Arm's Length Realistic Alternative

The first key disputed PCT royalty issue the Court must address is the appropriate compensation for the anticipated contributions of Facebook Ireland and other Facebook affiliates, including for the “realistic alternative” for selling Facebook ads outside North America. Third-party transactions answer this question.

The regulations provide that the compensation of a “PCT Payor” (i.e., Facebook Ireland) may be determined using a comparable uncontrolled transaction (a “CUT”). The evidence will demonstrate that in 2010, third-party sellers of Facebook ads earned 30% of revenue for performing similar functions to the international sales team. As a result, Facebook US was not entitled to that 30% of revenue as part of a PCT payment.

2. Projections for Facebook Ireland's Business

The second key disputed PCT issue the Court must resolve relates to the financial projections for Facebook Ireland's territory. In 2010, for independent business purposes, Facebook developed a long-range financial plan, referred to as the “2010 LRP.” Both Facebook and Respondent rely upon the 2010 LRP, but they differ in their treatment of several issues. Most prominently, Facebook and Respondent differ in their treatment of aspirational revenue that Facebook included in a 2010 LRP scenario for products that Facebook had not yet identified or invented, and for which Facebook had not considered a cost structure. Respondent asserts that such “other” revenue should be included in income projections without any projected costs — the first cost-free revenue in business history. In contrast, Facebook asserts such “other” revenue should either be excluded from the income projections, or burdened with costs consistent with Facebook's advertising business.

3. The Risks Facing Facebook Ireland

The third key disputed PCT issue is the risk Facebook Ireland's business faced in 2010. As of September 2010, Facebook's international sales force, its value proposition, and its digital advertising products were unproven. Facebook Ireland and the other foreign affiliates had yet to develop a capable sales force, and advertisers in Facebook Ireland's territory generally did not understand how Facebook could create value for them. Further, as of September 2010, Facebook had focused its technology on its desktop website, and yet mobile technology had the potential to radically change the way Internet users accessed websites, and how digital advertising would be delivered. As of 2010, Facebook did not have an answer to this existential threat to its advertising business. In addition, Facebook's investment and development in artificial intelligence and machine learning was very limited as of September 2010, and Facebook faced many execution challenges in developing and implementing artificial intelligence technology in its social products.

These risks inform several aspects of this case, including the discount rate the Court should apply to the projections for Facebook Ireland's territory. The reports from Drs. Timothy Luehrman, Timothy Reichert, and Sanjay Unni that Facebook has lodged with the Court provide discount analyses consistent with the risks faced by Facebook Ireland. The discount rates adopted in these reports range from 16.28% to 17.28%.

In contrast, the report Respondent has lodged from Dr. Newlon applies a median discount rate of 14.4% to the international cash flows based on a very different characterization of Facebook Ireland's business. Dr. Newlon concludes that “Facebook had a successful business model that dominated most markets,” that the cost of capital for Facebook's business in North America and outside North America should be close, and that Facebook Ireland had little capital at risk.¹³ Respondent's position ignores the facts.

4. Profits: Foreign Goodwill, Going Concern, International Work Force, and Cost-Shared Intangibles

Depending upon the valuation approach applied, the Court may need to address two additional issues implicated by Respondent's arbitrary and capricious aggregate PCT valuation. First, the Court will need to determine how to exclude foreign going concern value, the value of the international work force, and foreign goodwill from the NPV of the PCT. Treasury explicitly defined foreign goodwill and going concern value as the residual value of the business after a taxpayer identified and valued all the pre-existing tangible and intangible assets.¹⁴ Such a residual value cannot be a platform contribution because it cannot be anticipated to contribute to developing cost-shared intangibles as listed in Treas. Reg. § 1.482-4(b)(1). With regard to the international work force, Facebook Ireland and Facebook's other affiliates developed that work force, not Facebook US. If the Court adopts a separate valuation methodology however, (i.e., one generally consistent with Facebook's approach), separate identification and valuation of foreign goodwill, going concern value, and the international work force are largely unnecessary because the value of these “residual assets” are generally excluded from the separate values determined for specific intangibles.

Second, the Court will need to address the future profits that Facebook Ireland was, and is entitled to receive from its participation in a cost sharing arrangement. Congress intended for cost sharing participants to allocate costs based on profits and then share profits proportionately. See Conference Report to Accompany H.R. 3838, Tax Reform Act of 1986, H.R. Report No. 99-841, at II-638 (“In order for cost sharing arrangements to produce results consistent with changes made by the Act to royalty arrangements, it is envisioned that the allocation of R&D cost-sharing arrangements generally should be proportionate to profit as determined before deduction for research and development”).

In this case, Facebook Ireland built a business and co-developed new mobile technology, among other key technologies. Respondent's proposed adjustment denies Facebook Ireland a sufficient share of future profits from its operations and from future technologies, in violation of Section 482 and Congressional intent. To the extent that Treas. Reg. § 1.482-7T mandates that Facebook Ireland cannot retain future profits from Facebook Ireland's business operations and from the cost-shared intangibles, the regulation is invalid under Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), Kisor v. Wilkie, 139 S. Ct. 2400 (2019), the Administrative Procedure Act, and other applicable laws.

C. User Royalty

With regard to users the Court must resolve two additional issues:¹⁵ (i) whether Facebook Ireland would pay for the opportunity and obligation to recruit future Facebook users (including those that had not yet been born) that Facebook US could not, and did not, transfer; and (ii) the value of the existing 2010 users to which Facebook Ireland already had rights, as a result of investments Facebook Ireland made in user growth prior to cost sharing, and as established in the intercompany agreements.

First, with regard to excluding the value of future users, Facebook asserts that an arm's length price can be determined for the 392 million users that existed as of September 15, 2010, thus avoiding a wrongful inclusion of the value of future users. Facebook has lodged the report of Dr. Susan Athey in which she quantifies the impact of the transferred users on the growth of the user base outside North America, and upon the monetization of Facebook users, after September 2010. Dr. Athey's analysis appropriately accounts for the growth of future users from the transferred users, and it provides a basis for determining a value of the 392 million users without the value of future users that Facebook US could not, and did not, transfer. Facebook has also lodged the expert report of Dr. Luehrman in which Dr. Luehrman relies upon Dr. Athey's analysis to perform a discounted cash flow analysis to value the 392 million users.

In contrast to the analyses of Drs. Athey and Luehrman, Respondent makes no effort to account for the fact that Facebook US did not transfer future users. The law does not permit Respondent to expand his aggregate valuation to charge Facebook Ireland for the opportunity to recruit future users in its territory. An unidentified future Facebook user (i.e., a user with which Facebook US did not have any relationship in 2010) was neither transferred, nor was an “intangible” as defined in Section 482 or Treas. Reg. § 1.482-4(b).

Second, the Court must resolve how to credit Facebook Ireland for having funded user growth costs incurred in its territory from January 19, 2009 (i.e., 19 months prior to cost sharing), consistent with the intercompany agreements that memorialized Facebook Ireland's rights to those users. In particular, if an aggregate valuation method is applied, the Court must apportion profits among the investments made in users by both Facebook US and Facebook Ireland, both before and after cost sharing. As mentioned previously in footnote 9, Facebook has submitted an alternative aggregate valuation in the report of Dr. Reichert. Dr. Reichert's aggregate residual profit methodology gives both Facebook US and Facebook Ireland credit for their prior and future investments. In contrast to Dr. Reichert's report, Respondent's witness, Dr. Newlon explicitly concludes that he will not credit Facebook Ireland for its pre-cost-sharing funding of user growth.

D. Trademark Royalty

Facebook asserts that a separate trademark royalty of 1% is arm's length based on comparable transactions, and the fact that Facebook Ireland was responsible for marketing expenses in its territory. Respondent continues to refuse to state a position regarding an allocation to the trademark royalty, other than that Respondent asserts an aggregate valuation approach.

SUMMARY OF FACTS

Petitioner, Facebook, Inc. & Subsidiaries (“Facebook”) is the parent company of Facebook Ireland, an Irish corporation that operates as the international headquarters for Facebook. Beginning in January 2009, through its wholly owned subsidiary (a foreign corporation that became a disregarded entity for U.S. tax purposes), Facebook Ireland began hiring employees, funding user growth, paying certain marketing expenses, and developing its operations. These operations grew to include international sales, providing user and customer operations, providing technical operations, and developing technology. Facebook Ireland grew from its first employee in January 2009, to 230 employees by the end of 2010, to 840 employees by the end of 2016, and to 1,716 employees by the end of 2018.

A. Facebook's Ad and Credits Businesses in 2010

As of September 15, 2010, Facebook earned two types of revenue: (1) advertising revenue from selling ads on Facebook's websites accessed by desktop computers; and (2) revenue from Facebook Credits, a payment method used by third-party developers of applications to sell virtual goods to Facebook users using the developers' applications on Facebook's websites accessed by desktop computers. In 2010, Facebook earned 94.6% of its revenue from ads and 5.4% of its revenue from Credits.

In 2010, a Facebook ad allowed a business or brand to promote its product or service on Facebook. However, as of 2010, Facebook's ad formats were limited and Facebook's ad targeting offerings were rudimentary. Importantly, at the time of the transfer, Facebook did not offer mobile advertising because it had not yet developed separate technology capable of displaying ads on mobile devices. Facebook faced substantial uncertainty in how it would monetize advertising on mobile devices. Advertisers were skeptical about how their ad dollars translated to sales on a social media platform as opposed to a more conventional e-commerce platform (such as Google or Yahoo!).

Facebook began developing Facebook Credits in May 2009 as a means to facilitate millions of people buying virtual goods with micro-payments online. Facebook envisioned building Facebook Credits into a large business that one day might be as large as its advertising business. Credits allowed Facebook users to use a single payment method across all third-party apps available via Facebook. Using essentially the same price structure that Apple used for apps in its Apple App Store, and Google used for apps in its Google Play store, Facebook charged the third-party app developers 30% of Facebook Credit redemptions, and the third-party app developers retained 70% of the Facebook Credit redemptions.

B. Facebook Ireland's Operations in 2010

1. Prior to Cost Sharing, Facebook Ireland Developed Its Territory

Effective January 19, 2009, Facebook Ireland entered into an Intangible Property License Agreement (the “2009 License Agreement”) and an expense reimbursement agreement with Facebook US for the territory outside North America (Facebook Ireland's “Territory”) giving Facebook Ireland the right to develop users, advertisers, and developers in its Territory, and the obligation to pay costs related to that effort. Facebook Ireland paid costs incurred from January 19, 2009, to develop users, advertisers, and developers in its Territory. During the period from January 19, 2009 to September 14, 2010, Facebook Ireland spent more than $35 million on its market development efforts, successfully growing the user base by nearly 300%, from 101 million users to over 392 million users. Although Facebook Ireland bore the costs of this effort, Facebook US billed and collected the advertising revenue through September 14, 2010.

Consistent with Facebook Ireland developing its Territory, and in compliance with local laws such as the European Privacy Directives that governed privacy for users that were in the European Union, Facebook users outside North America entered into terms of service with Facebook Ireland. As of August 2010, Facebook's terms of service read:

If you are a resident of or have your principle [sic] place of business in the US or Canada, this Statement is an agreement between you and Facebook, Inc. Otherwise this Statement is an agreement between you and Facebook Ireland Limited. References to “us,” “we,” and “our” mean either Facebook, Inc. or Facebook Ireland Limited, as appropriate.

See Ex. 1084-J at ¶ 18 (emphasis added). As a result, Facebook users that joined Facebook as of August 2010 had a contractual relationship with Facebook Ireland, not Facebook US.

Facebook needed to continuously maintain a healthy, growing, and engaged ecosystem of international users to sell advertisements and collect Facebook Credits revenue in Facebook Ireland's Territory. Sustaining, let alone growing, the user base demanded constant effort of Facebook growth personnel in various markets, because the general state of users is toward losing engagement, known as “churning,” absent new features, new tools, and new ways of engaging with users. To drive positive user base growth outside of North America, dedicated Facebook growth personnel in various markets, funded by Facebook Ireland, developed and implemented country-specific growth plans, identified targeted product improvements for local markets, invested in contact importer development, and drove localized marketing campaigns to increase international user engagement and adoption.

2. User Operations as of 2010

Before September 15, 2010, Facebook Ireland began to build a user operations team to “build and protect the world's trust and engagement in Facebook.” By the end of 2010, Facebook Ireland's user operations team had grown to approximately 65 people supporting 16 languages, and Facebook Ireland anticipated that the team would grow to support over 30 languages, with team members from more than 30 countries. It was insufficient for team members to speak local languages. Rather, they had to understand Facebook's global policies in the context of the cultural and legal nuances in each country, as well as in the context of the content that they were moderating. Typically, Facebook Ireland hired team members with historical ties to the specific market (e.g. having grown up there), and who were problem solvers, good with data, and passionate about Facebook products and user support.

The core functions of the user operations team included interfacing between users and the rest of the company and keeping the Facebook site safe, simple, and easy to use. In 2010, the team addressed verification and access issues, user authenticity, site integrity, user appeals, privacy, and intellectual property. The team enforced Facebook's policies, both reactively, as calls, emails, or other queries came in, and proactively, by working with engineers to build systems that helped flag violations. As of 2010, the Facebook Ireland user operation team responded to issues that other Internet companies had not previously faced, such as cyberbullying, abusive or inappropriate content, and child exploitation. Facebook Ireland's challenges in this regard grew substantially over time, including addressing election fraud and other cutting-edge user growth and retention issues.

C. The 2010 Technology Transactions

1. Facebook Ireland Entered Into Cost Sharing on Sept. 15, 2010

On September 15, 2010, Facebook Ireland began billing and collecting advertising revenue in its Territory. In connection with becoming responsible for ad sales outside North America, Facebook Ireland began cost sharing with Facebook US pursuant to an “Agreement to Share Costs and Risks of Online Platform Intangible Property Development (the “Cost Sharing Agreement” or “CSA”).

2. The PCT License

Also effective September 15, 2010, Facebook US and Facebook Ireland entered into the “Online Platform Intangible Property Buy-In License Agreement (the “PCT License”). Pursuant to the PCT License, Facebook US licensed to Facebook Ireland the software and hardware systems that allowed: (i) Facebook users to share information and build communities: (ii) Facebook Ireland to sell ads to advertisers for display to users using desktop computers; (iii) third-party developers to develop applications for Facebook users; and (iv) third-party developers to sell virtual goods to Facebook users.

3. 2010 Desktop Technology

When Facebook Ireland entered into the cost sharing arrangement, Facebook operated a desktop technology platform. The Company's engineering workforce, ad revenues, and innovation up until September 2010 focused on developing technologies that furthered the ability to sell ads and further the user experience through desktop access to the Facebook website. In 2010, Facebook did not have the technology to show ads to users on mobile devices. Through the joint development in the cost sharing arrangement, Facebook Ireland and Facebook US altered the trajectory of the Company.

Simply put, Facebook Ireland and Facebook US jointly developed the Company's mobile platform and the associated infrastructure necessary to operate as a “mobile first” company, which required constant innovation and development to stay ahead of changes in technology. This effort was not without risk. In 2010, Facebook had settled on a HTML5-based mobile strategy that was designed to avoid writing separate code for different mobile operating systems. That strategy proved to be a significant failure, and Facebook's leadership later recognized it as the “biggest mistake” in the Company's young history. Facebook personnel and others will testify at trial regarding the state of Facebook's technology in September 2010 and the transformational development efforts undertaken after this time with respect to mobile technology. Specifically, Facebook scrapped the HTML5 strategy and developed new mobile applications from the ground up. Facebook released these new applications in 2012, almost two years into cost sharing. As a result of these new, fully cost-shared, new native applications, Facebook saw mobile ad revenue grow from 11% of total ad revenue in 2012 to 83% of total ad revenue by 2016.

4. Realistic Alternative Evidence: Third-Party Ad Sales

As of September 15, 2010, Facebook US and Facebook Ireland contracted with third parties to sell Facebook ads in markets outside North America. In return for selling ads, Facebook US and Facebook Ireland paid these third-party resellers 30% of revenue. This is not surprising. In 2010, 30% of revenue was a standard industry price for reselling digital ads. The third-party resellers:

Like Facebook Ireland, the third-party resellers were at risk for the success or failure of their business in their markets.

D. Facebook US Transferred a Portion of the 2010 User Base

Separately, pursuant to a User Base Transfer and Marketing Intangibles License Agreement (the “User Base and Marketing License”) Facebook US transferred to Facebook Ireland the existing rights Facebook US had to a portion of the 392 million Facebook users outside North America as of September 15, 2010. The User Base and Marketing License explicitly superseded the prior Intangible Property License Agreement entered into between Facebook US and Facebook Ireland and stated that Facebook Ireland retained all the rights that Facebook Ireland had previously “created or developed with respect to the user, advertiser, and developer communities located in Facebook Ireland's Territory and the good will Facebook Ireland developed.”¹⁶ In other words, effective September 15, 2010, Facebook US and Facebook Ireland acknowledged that Facebook Ireland controlled rights in users that existed prior to September 15, 2010, and it was only incremental additional rights in existing users that Facebook US transferred to Facebook US.

E. Facebook's Financial Projections

In 2010, Facebook's Finance team developed a three-year, long-range financial plan, the 2010 LRP. The 2010 LRP included three-year financial projections for 2011 through 2013. In August 2010, Facebook's Chief Financial Officer (“CFO”), David Ebersman, presented the 2010 LRP to Facebook's Board of Directors.

The final 2010 LRP included multiple profit and loss scenarios, including a scenario that reflected Facebook's projections for its existing business lines — advertising and Facebook Credits — and it also included a “plug” of additional, unidentified “other revenue.” Facebook's CFO included this “other revenue” in the 2010 LRP to inspire and challenge Facebook's employees. Facebook and its CFO had no idea what future product or innovation would produce this “other revenue.” Because the “other revenue” was aspirational, and there was no existing business that would produce the “other revenue,” Facebook's CFO did not include in the 2010 LRP any cost structure for the “other revenue,”¹⁷ although Facebook and its CFO did not actually anticipate that whatever innovation Facebook might develop would include cost-free revenue.

Facebook and Ernst & Young used the three-year 2010 LRP to develop extended projections for 2014 through 2020. To be as accurate as possible, Facebook and Ernst & Young extended the projections using separate profit and loss (“P&L”) projections for ads and Credits. To extend the 2010 LRP projections for ads, Facebook and Ernst & Young used projected internet user growth rates on a country-by-country basis, extended Facebook's contemporaneous company user growth rates in each country from the 2010 LRP, and applied the average revenue per user (“ARPU”) projections. For Credits, Facebook and Ernst & Young had limited country-by-country data, so they extended the 2010 LRP using assumptions regarding addressable markets, market share, growth rates, and other assumptions. Facebook and Ernst & Young also attributed costs to the “other revenue” P&L using the same cost structure that Facebook had determined and projected for its advertising business.

BRIEF SYNOPSIS OF LEGAL AUTHORITIES

I. Facebook Ireland Paid Arm's Length Royalties

As stated above, this case involves three different royalties: (i) a PCT royalty for technology in connection with a cost sharing arrangement under Treas. Reg. § 1.482-7T (2009); (ii) a royalty for transferred Facebook users under Treas. Reg. § 1.482-4; and (iii) a trademark and marketing intangible royalty under Treas. Reg. § 1.482-4.

A. The PCT Royalty

On December 31, 2008, the U.S. Treasury issued Temporary and Proposed Regulations under Section 482 for cost sharing arrangements. The Temporary Regulations were effective on January 5, 2009, and the relevant Temporary Regulation governing PCTs is Treas. Reg. § 1.482-7T (the “2009 Temporary Regulation”).

The 2009 Temporary Regulation provides that a “platform contribution” is “any resource, capability, or right that a controlled participant has developed, maintained, or acquired externally to the intangible development activity that is reasonably anticipated to contribute to developing cost shared intangibles.” Treas. Reg. § 1.482-7T(c)(l). The 2009 Temporary Regulation further defines “reasonably anticipated cost shared intangibles” as “any intangible within the meaning of Treas. Reg. § 1.482-4(b), that at the applicable point in time, the controlled participants intend to develop under the CSA.” Treas. Reg. § 1.482-7T(d)(ii).

1. Intangibles Subject to a PCT

The 2009 Temporary Regulation states, therefore, that a platform contribution is a “resource, capability, or right” that is reasonably anticipated to contribute to developing an intangible listed in Treas. Reg. § 1.482-4(b). That regulation subsection states:

For purposes of section 482, an intangible is an asset that comprises any of the following items and has substantial value independent of the services of any individual —

(1) Patents, inventions, formulae, processes, designs, patterns, or know-how;

(2) Copyrights and literary, musical, or artistic compositions;

(3) Trademarks, tradenames, or brand names;

(4) Franchises, licenses, or contracts;

(5) Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and

(6) Other similar items. For purposes of section 482, an items is considered similar to those listed in paragraph (b)(1) through (5) of this section if it derives its value not from its physical attributes but from its intellectual content or other intangible properties.

This definition in Treas. Reg. § 1.482-4(b) generally conforms to Section 482, which in 2010, defined intangible property as “intangible property (within the meaning of Section 936(h)(3)(B)).”¹⁸ Section 936(h)(3)(B) in turn included substantially the same list of intangibles as in Treas. Reg. § 1.482-4(b).¹⁹

In 2010, Section 936(h)(3)(B) excluded from its definition of intangible property any asset not having “substantial value independent of the services of any individual,” and Section 936 did not include goodwill, going concern value, or workforce in place, in the list of intangibles.²⁰ Not surprisingly, Treas. Reg. § 1.482-4(b) similarly did not include goodwill, going concern value, or workforce in its list of intangibles.

As a result, in 2010, foreign goodwill and going concern value (“FGGCV”) were not platform contributions. With regard to FGGCV, it was not a platform contribution because it was not reasonably anticipated to “contribute to developing cost shared intangibles.” The section 367 regulations explicitly defined FGGCV as the residual value of the business after a taxpayer identified and valued all the preexisting tangible and intangible assets.²¹ Such a residual value cannot reasonably be anticipated to contribute to developing future intangibles such as copyrighted software, under a cost sharing arrangement.

Congress intended, and Treasury, and Respondent have long acknowledged, that as of 2010, FGGCV was separate and distinct from so-called platform intangibles. Congress intended that gain or income would not be recognized on an outbound transfer of FGGCV used in an active trade or business.²² Further, the regulations under section 367(d) explicitly prescribed non-recognition treatment for a section 351 controlled transfer of FGGCV,²³ demonstrating that FGGCV was not a compensable pre-existing intangible or platform contribution. FGGCV was not a platform contribution and thus not compensable in 2010. Respondent's all-in, aggregate income methodology wrongly captures income attributable to FGGCV.

2. CUTs and the Realistic Alternative

The income method generally evaluates the amount charged for a PCT by reference to a participant's “best realistic alternative.”²⁴ The 2009 Temporary Regulation states that, in general, the best realistic alternative of a PCT Payor (in this case, Facebook Ireland) is to license intangibles from an uncontrolled licensor.²⁵ The licensing alternative shifts the risk of the cost of developing the PCT technology from the PCT Payor (Facebook Ireland) to the licensor²⁶ The 2009 Temporary Regulation further states that all other contractual provisions and risks should be consistent with the actual CSA²⁷

As a result, pursuant to the 2009 Temporary Regulation, the best realistic alternative for Facebook Ireland was to perform all the functions it was anticipated to perform as of September 2010, and bear all the risks it was anticipated to bear, except for the risk of making cost sharing payments to develop technology. Because one of the primary functions Facebook Ireland anticipated performing was to sell Facebook ads outside North America, the realistic alternative requires pricing this function, as well as Facebook Ireland's other anticipated functions and risks.

Facebook relies on its agreements with third-party ad resellers to establish a floor for the arm's length price for Facebook Ireland's realistic alternative. The 2009 Temporary Regulation allows use of the CUT method to evaluate Facebook Ireland's licensing alternative.²⁸ In addition, this Court has overwhelmingly favored the use of market transactions. VERITAS Software Corp. & Subs. v. Commissioner, 133 T.C. 297, 331 and 335 (2009) (comparability standards satisfied where CUTs were “sufficiently comparable to the controlled transaction”); Compaq Computer Corp. v. Commissioner, T.C. Memo. 1999-220 (CUTs were “sufficiently similar to provide a reliable measure of an arm's-length result”); Sundstrand Corp. v. Commissioner, 96 T.C. 226, 383 (1991) (same).

Here, the agreements with the third-party resellers establish that in 2010 the price for selling Facebook ads, the function that Facebook Ireland and the other Facebook foreign affiliates performed outside North America (and that Facebook US did not perform), was typically 30% of revenue. The functions of the third-party resellers were substantially the same as the sales functions performed by the international sales team. The comparability factors in the regulations demonstrate the third-party resellers were the most reliable measure of an arm's-length result for the sales functions performed outside North America. See Treas. Reg. § 1.4821 (d)(3)(i) (providing comparability factors). As a result, the “realistic alternative” requires acknowledging that an unrelated licensor would need to pay 30% to Facebook Ireland or some other party for the sales of ads.

B. User Royalty

On September 15, 2010, Facebook US transferred to Facebook Ireland a “user base,” consisting of the “contracts and other relationships with persons comprising the various user communities developed and maintained by the Parties, information about such users, and networks developed by users on the various Facebook sites.” As noted above, pursuant to the 2009 License Agreement and expense reimbursement agreement, Facebook Ireland had been investing in the growth of that user base since January 2009.

The transfer of the contracts and relationships of the portion of the 2010 existing users to which Facebook US had rights was a transfer pursuant to Treas. Reg. § 1.482-4(b)(1). Specifically, the user base consisted of relationships with individuals that had agreed to Facebook's terms of service. The transferred relationships included the terms of service agreement that each user entered into with Facebook.

Facebook US did not, and could not, transfer to Facebook Ireland the future, unidentified users with whom Facebook US did not have any relationship. Facebook US did not have any “contracts” or relationships with such future users, and thus could not transfer them. Indeed, as of August 2010, Facebook users outside North America entered into terms of service agreements with Facebook Ireland, not Facebook US.

At best, Facebook Ireland obtained an opportunity to recruit unidentified future users outside North America. This Court has consistently prohibited Respondent from expanding the definition of intangibles under section 482 to include a business opportunity. See Hospital Corp. of America v. Commissioner, 81 T.C. 520 (1983) (denying Respondent's attempt to argue that the sharing of business opportunities among members of a controlled group qualifies as “intangible property” subject to payment by the other controlled members). The opportunity to recruit Internet users simply does not qualify as an intangible asset, and in any event, Facebook Ireland, like any independent third-party entity already had the right and opportunity to recruit future users. Id. See also Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525 (1989), aff'd, 933 F.2d 1084 (2d Cir. 1991); Eli Lilly & Co. v. Commissioner, 84 T.C. 996 (1985), aff'd in part, rev'd in part, and remanded, 856 F.2d 855 (7th Cir. 1988).²⁹

C. Facebook Ireland's PCT, User, and Trademark Royalties Were Based Upon Reliable Projections

The 2009 Temporary Regulation fully anticipates that a PCT will be based upon a taxpayer's reasonable projections, including “a projection of sales, IDCs, costs of developing operating contributions, routine operating expenses, and costs of sales.” Treas. Reg. § 1.482-7T(g)(2)(vi). The 2009 Temporary Regulation states that projections should be evaluated based upon “the completeness and accuracy of the underlying data, the reliability of the assumptions, and the sensitivity of the results to possible deficiencies in the data and assumptions.” Id.

Here, Facebook developed the 2010 LRP for independent business purposes, and Facebook and Ernst & Young extended the financial projections for 2014 to 2020, based on how Facebook anticipated revenue and costs to grow for three different revenue segments: Ads, Facebook Credits, and “other revenue.” The 2009 Temporary Regulation states that such an individual segment approach can be more reliable.

II. Respondent's Determination Is Arbitrary, Capricious, and Unreasonable

Respondent's determination is arbitrary, capricious, and unreasonable. Respondent has abandoned his original determination in the Notice of Deficiency, has failed to take into account how the PCT, user base, and trademark transactions were structured, has mispriced the realistic alternative for Facebook Ireland, and has denied Facebook Ireland sufficient profits from its future business operations, from FGGCV, and from cost-shared intangibles.

First, Respondent has abandoned his original position in the Notice of Deficiency. In the Notice of Deficiency, Respondent proposed a $13.9 billion NPV valuation based on what Respondent characterized as a CUT method, but was really a market capitalization approach because it was based on the purported value of Facebook stock. Now, Respondent asserts a $21 billion NPV valuation based on an income method. This change in position is sufficient to find his actions arbitrary. See Compaq Computer Corp. v. Commissioner, T.C. Memo. 1999-220, slip op. at 28 (“In most instances where respondent abandons his notice position at trial, courts conclude that allocation in the notice under section 482 are arbitrary and capricious.”); see also Nat'l Semiconductor Corp. v. Commissioner, T.C. Memo. 1994-195.

Second, Respondent failed to take into account the actual transactions. Federal case law has long held that a proposed adjustment under section 482 is per se arbitrary, capricious or unreasonable, if the adjustment fails to take into account the manner in which the transactions “actually were structured” by the parties. See Eli Lilly & Co. v. Commissioner, 84 T.C. 996, 1131 (1985), aff'd in part, rev'd in part, and rein'd, 856 F.2d 855 (7th Cir. 1988); see also Bausch & Lomb, Inc., v. Commissioner, 92 T.C. 525 (1989), aff'd, 933 F.2d 1084 (2d Cir. 1991); Sundstrand Corp. v. Commissioner, 96 T.C. 226 (1991). Here, Respondent ignores the separate transfers of technology, users, and trademark. Critically, Respondent fails to take into account the fact that Facebook Ireland began developing users in its Territory in January 2009, that Facebook US did not, and could not transfer unidentified future users, and that Facebook Ireland developed users after September 15, 2010.

Third, Respondent misprices the realistic alternative under Treas. Reg. 1.482-7T(g)(4)(i)(A). Respondent's expert, Dr. T. Scott Newlon, characterizes Facebook Ireland as a service provider and then fails to properly price the service that Facebook Ireland was anticipated to provide, and indeed did provide. Specifically, Dr. Newlon ignores market transactions in which Facebook US and Facebook Ireland paid third parties 30% of revenue to sell ads outside North America.

Fourth, Respondent fails to adjust his valuation for unidentified future users. As described above, Respondent may not expand intangibles under section 482 to include such a business opportunity. See Hospital Corporation of America, 81 T.C. 520 (1983). Further, Facebook users were not a platform contribution under Treas. Reg. § 1.482-7T.³⁰

Fifth, Respondent values too much, denying Facebook Ireland a sufficient share of future profits from its development of a going concern, its growth of an international workforce, the attendant goodwill, and the future cost-shared technology. In doing so, Respondent fails to compensate Facebook Ireland for the significant risks it took given the financial challenges confronting Facebook's business, particularly with respect to mobile technology and the challenges of selling Facebook ads outside North America. Facebook Ireland's growth of its business and its investment in cost-shared technology will be almost wholly responsible for those profits. Respondent's methodology makes no effort to account for these contributions to future profits. Respondent's position improperly seeks to impose a backward-looking “ex post” analysis, instead of evaluating ex ante arm's length expectations. It reflects a survivor bias, wrongly penalizing Facebook, and ignoring the risks shown by many failed social networking and digital advertising businesses.

To the extent Respondent asserts that his adjustment is predicated upon Treas. Reg. § 1.482-7T mandating that the present value of the PCT Payment equal the present value of all future cash flows, after subtracting cash flows attributable to a mispriced controlled participant's “best realistic alternative,”³¹ Facebook asserts that Respondent's position contradicts Section 482, the regulations, and other authorities. Further, Respondent's position would call into question the validity of Treas. Reg. 1.482-7T under Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), Kisor v. Wilkie, 139 S. Ct. 2400 (2019), the Administrative Procedure Act, or any other applicable law.

ESTIMATED TIME FOR TRIAL

Facebook believes that its case in chief will take approximately three to four weeks, depending upon the length of Respondent's cross-examination.

WITNESSES

Facebook will call some or all of the following witnesses:

1. Richard Allan, formerly Vice President, Policy Solutions, Facebook, will testify regarding Facebook Ireland's role as a data controller and the role of Facebook Ireland's policy operations.

2. Susan Athey, Professor of Economics of Technology, Stanford Graduate School of Business, will testify as an economic expert as set forth in Professor Athey's reports lodged with the Court.

3. Lars Backstrom, Vice President of Engineering, Facebook, will testify regarding Facebook's development of artificial intelligence and machine learning.

4. Andrew Bosworth, Vice President of Augmented Reality and Virtual Reality, Facebook, will testify regarding Facebook's development of technology.

5. Pedro Canahuati, Vice President of Engineering, Facebook, will testify regarding Facebook's development of technology.

6. Joaquin Candela, Director of Artificial Intelligence Engineering, Facebook, Facebook's development of artificial intelligence technology.

7. Blake Chandlee, formerly Vice President of Sales, Facebook, will testify regarding building a sales force and sales of Facebook ads outside North America, as well as Facebook's relationships with third-party ad resellers outside North America.

8. Emily Chen, Manager of Gaming, Reseller, and Agency, Facebook, will testify regarding sales of Facebook ads in Singapore and Malaysia.

9. Siobhan Comer, Learning Partner, Europe, Middle East and Africa, Facebook, will testify regarding sales of Facebook ads outside North America, including educating and managing advertisers.

10. Mark Cowan, formerly Agency Development Lead, APAC, Facebook, will testify regarding sales of Facebook ads outside North America and Facebook's relationships with third-party resellers.

11. Julie de Bailliencourt, Senior Manager Market Operations, Facebook will testify regarding Facebook Ireland's user operations function, and keeping the Facebook site safe, simple, and easy to use.

12. Steve DeLucia, Director of Data Science at Facebook will testify regarding Facebook user data.

13. Susan Duong, Client Partner, Facebook, will testify regarding sales of Facebook ads in Australia.

14. David Ebersman, formerly Chief Financial Officer, Facebook, will testify regarding Facebook's financial projections.

15. Stefan Edl, Industry Manager, Facebook, will testify regarding sales of Facebook ads in Germany.

16. Tony Evans, Director Client Measurement for Europe, Middle East and Africa, Facebook, will testify regarding agency trading and the pricing of Facebook ads outside North America.

17. David Fetterman, formerly an Engineering Manager, Facebook, will testify regarding Facebook's development of technology.

18. David Fischer, Chief Revenue Officer, Facebook, will testify regarding Facebook's sales organization.

19. Vanessa Fitzgerald, Regional Director, Facebook, will testify regarding Facebook Ireland's sales organization, including efforts to develop and grow the market for Facebook ads outside North America.

20. Naomi Gleit, Vice President of Social Good, Facebook, will testify about user growth outside North America.

21. Stephen Haines, Global Agency, Facebook, will testify about sales of Facebook ads in Europe.

22. John Hegeman, Vice President, News Feed, will testify about Facebook's ad technology.

23. Steve Hatch, Vice President of Northern Europe, Facebook, will testify regarding efforts to cultivate relationships with third-party advertising agencies in Europe in connection with efforts to build a market for Facebook ads.

24. Adrian Hewlett, founder of the Habari Group, will testify regarding the Habari Group's role as a reseller of Facebook ads in Africa.

25. Martin Ingemansson, Regional Director — Nordics, Facebook, will testify regarding the efforts to develop Facebook's market for digital advertising in the Nordics.

26. Wing Ho Iu, Agency/Reseller Partner, Facebook, will testify regarding sales of Facebook ads in Hong Kong.

27. Erik Johnson, Vice President, Global Client Measurement, Facebook, will testify regarding Facebook sales functions in Asia and sales of Facebook ads in Asia.

28. Chinmay Karande, Engineering Director, will testify regarding Facebook's ad technology.

29. Michael Kearns, Professor and National Center Chair, Department of Computer and Information Science, University of Pennsylvania, will testify as an expert in computer science as set forth in Professor Kearns' report lodged with the Court.

30. Rick Kelley, Vice President, Global Gaming, Facebook, will testify regarding the sale of Facebook ads outside North America, including the establishment of a sales team in Ireland.

31. Taro Kodama, formerly, Manager of Business Development, Facebook, will testify regarding the Facebook's efforts to develop and grow the user base and market in Japan.

32. Francine Lafontaine, Senior Associate Dean and William Davidson Professor of Business Economics and Public Policy, Michigan Ross School of Business, will testify as an economic expert as set forth in Professor Lafontaine's report lodged with the Court.

33. Anja Lambrecht, Professor of Marketing, London Business School, will testify as an expert in digital marketing as set forth in Professor Lambrecht's report lodged with the Court.

34. Dyne Lee, International Product Growth Manager, Facebook, will testify regarding efforts to develop and grow the Facebook international user base, particularly in Korea.

35. Jayne Leung, Vice President, Head of Greater China, Facebook, will testify regarding international efforts to develop and grow the market for Facebook digital advertising revenue. Ms. Leung will also testify regarding Facebook's third party reseller functions and pricing.

36. Susan Li, Vice President, Finance, Facebook, will testify regarding the development of Facebook's 2010 LRP.

37. Deborah Liu, Vice President, Marketplace, Facebook, will testify regarding Facebook's relationships with third party developers, including the 70%/30% split that governed the pricing for technology and users. Ms. Liu will also testify regarding the Facebook's transition to mobile.

38. Colm Long, formerly Director of Online Sales Operations, Facebook, will testify regarding Facebook Ireland's growth and development of the international market, in particular Facebook Ireland's sales, ad operations, user operations, and marketing communications teams and functions.

39. Timothy Luehrman will testify as an expert in valuation as set forth in Dr. Luehrman's expert report lodged with the Court.

40. Alan MacCormack, MBA Class of 1949 Adjunct Professor of Business Administration, Harvard Business School, will testify as an expert in computer science as set forth in Professor MacCormack's report lodged with the Court.

41. Paul McDonald, Director, Engineering, Facebook, will testify regarding the state of Facebook's technology in September, 2010 and the transformational development efforts undertaken after September, 2010.

42. Nicola Mendelsohn, Vice President, EMEA, Facebook, will testify regarding Facebook's international efforts to cultivate relationships with third party advertising agencies in connection with international effort to build a market for Facebook's digital advertising products.

43. David Mortenson, Director, Engineering, Facebook, will testify regarding the transformational technology development related to the Company's mobile first strategy.

44. Hiroyuki Oguro, Product Marketing Manager, Asia Pacific, Facebook, will testify regarding the market for Facebook ads in Japan.

45. Javier Olivan, Vice President, Central Products, Facebook, will testify regarding the Company's efforts to develop and grow the international user base.

46. Eric Olson, Principal, Ernst & Young, will testify regarding extension of Facebook's 2010 LRP projections.

47. Cory Ondrejka, formerly Director, Software Engineering, Facebook, will testify regarding the Company's technology development that led to the transformation into a mobile first company.

48. Jay Parikh, Vice President Engineering, Facebook, will testify regarding the state of Facebook's technology in September, 2010 and the transformational development efforts undertaken after September, 2010.

49. David Parkes, George F. Colony Professor of Computer Science, Harvard University, will testify as a computer science expert as set forth in Professor Parkes' report lodged with the Court.

50. Julie Pellet, Product Marketing Lead — Southern Europe, Facebook, will testify regarding international efforts to develop and grow the market for Facebook ads in France.

51. Gail Power, formerly Director Global Shared Services, Facebook, will testify regarding Facebook Ireland's international efforts to develop and grow the market for Facebook digital advertising revenue.

52. Ted Price, Vice President, Tax, Facebook, will testify regarding the extension of the 2010 LRP into the projections that were utilized to value the rights transferred in September, 2010.

53. Ciaran Quilty, Vice President, EMEA SMB, Facebook, will testify regarding international efforts to develop and grow the market for Facebook digital advertising revenue outside North America, including ads review and user operations.

54. Timothy Reichert, Economic Partners, will testify as an economic expert as set forth in Dr. Reichert's reports lodged with the Court.

55. Daniel Rose, formerly Vice President, Partnerships, will testify regarding the Company's relationships with third party developers and the establishment of the 70%/30% split that governed pricing for technology and users, as well as Facebook's reseller relationship with Microsoft.

56. Mike Schroepfer, Chief Technology Officer, Facebook, will testify regarding the state of Facebook's technology in September 2010 and the transformational development efforts undertaken after September 2010.

57. Beltran Seoane, Agency Director, Facebook, will testify regarding international efforts to cultivate relationships with third-party advertising agencies in connection with the international effort to build a market for Facebook ads in Spain.

58. Scott Steinberg, Chief Executive, TechSavvy Global and FutureProof Strategies, will testify as an expert in digital distribution as set forth in Mr. Steinberg's report lodged with the Court.

59. Yean Har Tan, Agency Partner, GCR Gaming, Facebook, will testify regarding sales of Facebook ads in Singapore and Korea.

60. Sanjay Unni, Berkeley Research Group, will testify as an expert in economics as set forth in Dr. Unni's report lodged with the Court.

61. Robert Wentland, Ankura, will testify regarding will testify as an accounting expert as set forth in Mr. Wentland's report lodged with the Court.

62. Hao Zhang, Machine Learning Engineer, Facebook, will testify regarding the development of machine learning technology.

63. Julie Zhuo, Vice President, Product Design, will testify regarding the Facebook's product development that led to the transformation into a mobile first company.

Facebook reserves the right to identify additional fact and expert rebuttal witnesses.

MOTIONS AND EVIDENTIARY ISSUES

Currently, Facebook anticipates the following motions and evidentiary issues:

1. On January 10, 2020, Facebook responded to Respondent's Motion to Amend Answer. If Respondent is permitted to amend his Answer, Facebook will move to shift the burden of proof to Respondent.

2. Facebook anticipates filing one or more motions in limine to strike certain expert reports lodged by Respondent that improperly opine on law or otherwise fail to provide an opinion that helps the Court understand the evidence or determine at issue. For example, Respondent has lodged the expert reports of James Malackowski and Emer Hunt, each of which opine improperly on law and thus do not assist the Court in understanding the evidence or determine a fact at issue. See Laureys v. Commissioner, 92 T.C. 101, 126-29 (1989) (noting the particular impropriety of experts seeking to opine on the “legitimacy” of the transactions at issue).

3. Facebook is currently considering filing one or more motions to challenge Respondent's experts under Daubert v. Merrell Dow Pharmaceuticals, 509 U.S. 579 (1993), or challenging the admissibility under Daubert of one or more expert reports upon voir dire of the expert.

4. Facebook may file one or more procedural motions regarding Respondent's effort to introduce hearsay in the record.

5. As Facebook has previously advised the Court, Facebook will address at trial and in post-trial briefs any arguments it might have raised in pretrial dispositive motions, including challenges to the validity, interpretation, or application of the Treasury regulations. For example, Facebook may assert that Respondent's interpretation or application of the regulations exceeds the scope of statutory authorization under Section 482 or other provisions, or contravenes the regulations themselves, by denying Facebook Ireland profits from cost-shared intangibles, denying Facebook Ireland arm's-length compensation for its operating contributions, failing to reflect the underlying economic activity, or for other reasons. See, e.g. Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984); Kisor v. Wilkie, 139 S. Ct. 2400 (2019); FCC v. Fox Television Stations, Inc., 556 U.S. 502 (2009); Motor Vehicle Manufacturers Ass'n v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29 (1983); and the Administrative Procedure Act. Respondent's position and interpretation of the regulations may run afoul of other statutory and regulatory mandates and precedent as well. In addition, Respondent's departure from the position it took in the statutory notice of deficiency may violate the Administrative Procedure Act or other principles. See, e.g. SEC v. Chenery Corp., 318 U.S. 80 (1943). Facebook reserves the right to raise these and other arguments depending on the position taken by Respondent at trial and in posttrial briefing, and the evidence adduced at trial.

STIPULATIONS OF FACTS

The parties have lodged a First Stipulation of Fact addressing several topics and attaching many exhibits. Facebook anticipates the parties will lodge additional stipulations of facts for the following topics:

Stipulation Number	Topic	Description
First Stipulation of Facts	General Company Information	General Company Information and Board of Directors Presentations
TBD	International Newsletters	Internal correspondence summarizing international growth efforts
TBD	Platform and Developers	Information on Facebook's platform for third party developers
TBD	Pre-CSA Expenses	Expenses borne by Facebook Ireland prior to entering into the cost sharing arrangement on September 15, 2010
TBD	International Sales Expansion	Information regarding Facebook's sales expansion efforts outside North America, including Facebook's use of third-party resellers
TBD	Technology	Information on Facebook's efforts to develop and deploy innovative products
TBD	User Data	Facebook user growth and retention data
TBD	User Operations	Information on Facebook user operations personnel and functions
TBD	Facebook Work Force	Overview of Facebook personnel and head count
TBD	European Editions	Summaries of achievements by European Facebook personnel and associated efforts, including product launches and speaking engagements
TBD	FB Goals and Plans	Internal documents highlighting certain company efforts and targets
TBD	Financing Rounds and Capitalization Tables	Information on Facebook's private equity fundraising rounds and company capitalization
TBD	Growth and Internationalization	Documents reflecting Facebook's efforts to grow users worldwide and tailor its products to international markets
TBD	Intercompany Draft Documents and Correspondence	Documents related to establishing the intercompany arrangements between Facebook Ireland, Facebook US, and other Facebook affiliates
TBD	Secondary Market Transactions	Documents related to secondary market sales of private Facebook shares
TBD	Facebook Advertising	Documents related to sales of Facebook ads
TBD	Business Overview	Documents addressing high-level company strategy

Respectfully submitted,

Scott H. Frewing
Tax Court Bar No. FS0327
BAKER & McKENZIE LLP
600 Hansen Way
Palo Alto, CA 94304
Tel: (650) 251-5917
Scott.Frewing@bakermckenzie.com

Attorney for Petitioner,
Facebook, Inc., and Subsidiaries

Date: January 15, 2020

Andrew P. Crousore
Tax Court Bar No. CA0420
BAKER & McKENZIE LLP
600 Hansen Way
Palo Alto, CA 94304
Tel: (650) 856-5508
Andrew.Crousore@bakermckenzie.com

Attorney for Petitioner,
Facebook, Inc., and Subsidiaries

Date: January 15, 2020