By Deepa Seetharaman 

Facebook Inc. said it could be on the hook for $3 billion to $5 billion in additional taxes as a result of an Internal Revenue Service investigation into how the social network transferred assets overseas.

The company said in a quarterly filing Thursday that the IRS had issued a "statutory notice of deficiency" a day earlier saying Facebook owes more taxes for 2010. The July 27 notice came the same day that Facebook said second-quarter profit nearly tripled to $2.06 billion.

The notice flows from an investigation that started in 2013 into the company's treatment of assets it transferred to Ireland in 2010.

The IRS earlier this month sued Facebook for documents related to the transfer, saying it suspected that Facebook's accountants had undervalued some of those assets by "billions of dollars." But neither the agency nor Facebook had said before Thursday what the company's potential tax liability could be.

The IRS notice applies only to the 2010 tax year, but if the IRS takes a similar position for other years it is investigating and wins in court, it could result in an additional federal tax liability of between $3 billion and $5 billion, plus any interest or penalties.

Facebook said it disagrees with the IRS's position and plans to file a petition in U.S. Tax Court challenging the notice. If the IRS prevails, it would have a "material adverse impact to Facebook's finances," the company said in the filing. Tax Court cases can take years to conclude and can be appealed into other federal courts.

If Facebook were required to pay an additional $5 billion in taxes, that amount would exceed its entire tax cost for 2014 and 2015 combined.

Other major companies like Microsoft Corp., Amazon.com Inc. and Coca-Cola Co. have tangled with the IRS over the issue of attributing profits to foreign subsidiaries. Last year, Coke received notice of a potential $3.3 billion federal income-tax liability and is challenging that in tax court. Amazon, like Coke, is also challenging the IRS in tax court. Microsoft said in a securities filing Thursday that its audit is continuing and could have a "significant" impact on the company's finances.

U.S. companies pay the country's full 35% tax rate on profits they earn around the world. They get foreign tax credits to prevent double taxation and don't have to pay the residual U.S. tax until they repatriate the money. That gives companies incentives to book profits in low-tax countries and leave the money there.

One common technique is to put intangible property -- such as patents -- in foreign countries such as Ireland, allowing much or all of a company's non-U.S. profits to be booked there instead of in a high-tax foreign country. Those transactions between the parent company and a subsidiary are supposed to be conducted as if between two unrelated parties, and that rule leads to frequent disputes with the IRS over what that right price should be.

In its lawsuit filed earlier this month in U.S. District Court in San Francisco, the IRS said Facebook entered into agreements in September 2010 with Facebook Ireland Holdings Unlimited to transfer the rights to its "online platform" and its "marketing intangibles" outside the U.S. and Canada. It also entered into a cost-sharing agreement with the Irish subsidiary to cover future development.

Facebook then hired the accounting firm Ernst & Young, now known as EY, to assign a value to the transfers. The IRS's initial investigation in 2013 and 2014 signaled that EY's methodology for valuing the assets was "problematic" and it shared that information with Facebook in April 2015, according to court filings.

The IRS said it went to court because Facebook failed to hand over requested documents. In a court filing Monday, the IRS said Facebook failed to respond to a seventh summons from the IRS. Facebook also didn't show up in court on June 29 and didn't provide the information demanded by the IRS.

A Facebook spokeswoman didn't immediately respond for comment. The IRS doesn't comment on individual companies.

--Richard Rubin contributed to this article.

Write to Deepa Seetharaman at Deepa.Seetharaman@wsj.com

 

(END) Dow Jones Newswires

July 29, 2016 02:48 ET (06:48 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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