United States Tax Court

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164 T.C. No. 9

FACEBOOK, INC. & SUBSIDIARIES,

Petitioner

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Filed May 22, 2025.

Docket No. 21959-16. 1

—————

On September 15, 2010, P entered into a cost

sharing arrangement (CSA) under Temp. Treas. Reg.

§ 1.482-7T with S, its Irish subsidiary. The CSA required P

and S to engage in a platform contribution transaction

(PCT), compensating each other for the value of any

“platform contributions” made. See Temp. Treas. Reg.

§ 1.482-7T(a)(2), (b)(1)(ii), (c)(1). Pursuant to the PCT, P

and S granted each other the right to use any existing

online platform technology in their respective territories:

the United States and Canada for P and the rest of the

world (ROW territory) for S. In a separate agreement, P

granted S all rights relating to P’s existing users,

advertisers, and third-party application developers in the

ROW territory, including their data. P also granted S the

right to use its marketing intangibles in the ROW territory.

S made payments to P for 2010 on the basis of P’s valuation

of these agreements at a September 2010 net present value

(NPV) of $6.3 billion.

In addition to a PCT payment to compensate P for

its upfront PCT contributions, S also was required by the

regulations to make (and commit to making annually) cost

1 Petitioner has a related case at Docket No. 12738-18 in which tax years 2011

and 2013 are at issue.

Served 05/22/25

sharing transaction (CST) payments to compensate P for

ongoing intangible development costs (IDCs) in proportion

to its share of reasonably anticipated benefits (RAB share)

from exploiting cost shared intangibles. See id. para.

(b)(1)(i). S made a CST payment for 2010.

R’s valuation expert selected the income method as

the best method for valuing contributions to the CSA, see

id. para. (g)(4), and opined that the NPV of the assets P

contributed to the CSA was $19.945 billion. Because this

valuation increased S’s required PCT payment, R made a

PCT allocation for 2010. R also increased S’s RAB share

used to determine S’s CST payment for 2010.

P contends that the income method cannot apply

because both P and S made “nonroutine platform

contributions.” See id. subdiv. (i)(D). P also argues that R

selected the wrong values for three key inputs to the

income method: revenue projections for the ROW territory,

the appropriate discount rate for those projected revenues,

and S’s best realistic alternative to cost sharing. P argues

that once those inputs are corrected, R’s income method

produces a result consistent with P’s valuation. See Treas.

Reg. § 1.482-1(e). P simultaneously maintains that the

income method cannot be the best method because it

cannot produce an arm’s-length result and that the

regulations are invalid because they limit the expected

return on IDCs to a discount rate reflecting marketcorrelated risks. P also challenges R’s adjustments to P’s

and S’s RAB shares.

1. Held: Only one CSA participant—P—made a

nonroutine platform contribution and therefore the income

method in Temp. Treas. Reg. § 1.482-7T(g)(4) can apply.

2. Held, further, R implemented the income method

unreasonably, by selecting the wrong inputs, and therefore

abused his discretion under I.R.C. § 482 by reallocating

income to P with respect to the PCT payment to the extent

of the wrong inputs.

3. Held, further, with reliable inputs, the income method

is the best method and produces an arm’s-length PCT

payment value.

4. Held, further, Temp. Treas. Reg. § 1.482-7T reasonably

implements I.R.C. § 482 and is not invalid.

5. Held, further, Temp. Treas. Reg. § 1.482-7T(i)(6) does

not operate as a safe harbor and therefore does not

preclude R from making a PCT allocation under paragraph

(i)(3).

6. Held, further, R did not abuse his discretion under

I.R.C. § 482 by adjusting P’s and S’s RAB shares to

determine the required CST payment.

7. Held, further, R’s method for calculating RAB shares is

consistent with Temp. Treas. Reg. § 1.482-7T and provides

the most reliable estimate of reasonably anticipated

benefits, using corrected inputs.

—————

Andrew P. Crousore, Scott H. Frewing, Mark A. Oates, Susan E. Ryba,

George M. Clarke III, Mark T. Roche, Robert C. Hammill, Cameron C.

Reilly, Courtland L. Roberts, Amanda T. Kottke, Julia T. Chiao, Yea-Jin

A. Chang, Parisa Manteghi Griess, Ashley H. Zepeda, Eric M. Biscopink,

Don Crawford, Gregory G. Garre, Miriam Louise Fisher, Melissa A.

Sherry, Eric J. Konopka, Shannon C. Fiedler, Robert S. Walton, and

Ronald Gee Ming Dong, for petitioner.

Justin L. Campolieta, Michael S. Coravos, Ronald S. Collins, Jr., Victor

W. Zhao, Laurie A. Humphreys, Timothy L. Smith, Eli Hoory, Christine

S. Irwin, Elizabeth C. Turnbull, John M. Altman, Kathryn F. Patterson,

Richard L. Wooldridge, Travis Vance, Henry C. Bonney, Huong T. Bailie,

Katelynn M. Winkler, and Meenu Kapai, for respondent.

TABLE OF CONTENTS

FINDINGS OF FACT ............................................................................ 13

Facebook’s social networking platform .......................................... 15

Users ........................................................................................ 16

Product development ....................................................... 17

User growth ..................................................................... 17

User operations and privacy ........................................... 18

Monetization............................................................................ 18

Digital advertising ........................................................... 19

Ads Manager ............................................................ 19

International playbook ............................................ 22

II.

Ad sales team .................................................... 23

ii.

Resellers ............................................................ 23

Advertising agencies ................................................ 25

Nonadvertising revenue .................................................. 25

Facebook’s brand and other marketing intangibles .............. 27

Business strategy challenges.................................................. 27

Pre-CSA agreements ...................................................................... 30

2009 Agreements..................................................................... 30

Sales and Marketing Service Agreements ............................. 32

Statement of Rights and Responsibilities .............................. 33

Octazen acquisition ................................................................. 33

III. CSA agreements ............................................................................. 34

The CSA................................................................................... 34

FOP technology license and UBMI license ............................ 36

IV. Financial projections ...................................................................... 38

LRP financial projections........................................................ 38

LRP development............................................................. 40

Key projections in the final LRP Base Case ................... 41

User growth .............................................................. 41

Financial projections ................................................ 42

Ads and Credits Revenue ................................. 42

ii.

Other Revenue .................................................. 43

iii. Discount rates ................................................... 44

iv. Projected expenses ............................................ 44

Internal use of the LRP ................................................... 45

Investment bank’s equity investment .................................... 45

Financial results ..................................................................... 47

Transfer pricing documentation and payments ............................ 47

VI. Respondent’s allocations ................................................................ 49

Notice ....................................................................................... 49

Amended Answer .................................................................... 50

OPINION................................................................................................ 50

Burden of proof ............................................................................... 51

II.

Posttransaction evidence................................................................ 53

III. Scope and standard of review ........................................................ 54

IV. 2009 cost sharing regulations generally ........................................ 56

Classification of contributions ................................................ 58

Platform contributions ............................................. 59

Operating contributions........................................... 59

Contributions internal to the CSA.................................. 60

Cost contributions .................................................... 60

Operating cost contributions ................................... 60

Summary.......................................................................... 60

PCT Payment valuation methods........................................... 61

Contributions external to the CSA ................................. 59

Income method................................................................. 62

Mechanics of the income method............................. 63

When the income method is preferred .................... 64

Residual profit split method............................................ 65

Unspecified method ......................................................... 65

PCT Payment .................................................................................. 65

Respondent’s PCT Payment determination ........................... 66

Dr. Newlon’s key economic considerations ..................... 66

Dr. Newlon’s method ....................................................... 67

Application of 2009 cost sharing regulations ......................... 71

Method selection .............................................................. 71

Classifying initial contributions .............................. 71

Octazen technology .................................................. 73

Facebook Ireland’s contributions ............................ 74

Aggregation ...................................................................... 76

Income-method inputs ..................................................... 77

Financial projections ................................................ 77

ii.

Other Revenue .................................................. 77

The Base Case was not a probabilityweighted average forecast. ....................... 78

Projections excluding Other Revenue

more reliably reflect Facebook US’s

platform and operating contributions. ..... 82

Acquisition expenditures .................................. 85

Discount rate ............................................................ 87

Market-correlated risk ..................................... 88

ii.

Beta ................................................................... 90

iii. Dr. Newlon’s discount rate(s) ........................... 91

iv. Petitioner’s proposed beta ................................ 94

Our discount rate options ................................. 96

Best realistic alternative ....................................... 101

Dr. Newlon’s cost-plus markup for Facebook

Ireland’s ad sales and marketing contribution

......................................................................... 102

ii.

Dr. Unni’s 21.3% Reseller commission .......... 105

Respondent’s corroboration test ............................ 108

Conclusion: arm’s-length result............................. 109

Dr. Unni’s unspecified method and Dr. Reichert’s

RPSM ............................................................................. 111

Validity of the 2009 cost sharing regulations ...................... 116

Origin of the arm’s-length standard ............................. 117

The arm’s-length standard and economic profits ......... 120

Other legal challenges to the 2009 cost sharing

regulations............................................................................. 123

Major questions doctrine ............................................... 123

Nondelegation doctrine ................................................. 124

Intangible property under section 936(h)(3)(B) ........... 124

“Ex post” adjustments ................................................... 124

Commensurate with income “range” ............................ 124

VI. CST Payments .............................................................................. 127

APPENDIX A: EXPERT WITNESSES ............................................... 131

APPENDIX B: DEFINED TERMS...................................................... 140

PUGH, Judge: The Internal Revenue Service (IRS or respondent)

determined a deficiency in petitioner’s federal income tax for 2010 in a

Notice of Deficiency dated July 26, 2016 (Notice). This deficiency arose

because respondent reallocated income between petitioner’s domestic

and foreign affiliates under section 482 2 in connection with

intercompany agreements they entered into, effective September 15,

2 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect at all relevant times, regulation references are to the

Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and

Rule references are to the Tax Court Rules of Practice and Procedure. We round

monetary amounts and percentages as appropriate.

2010 (transaction date). 3 Effective that date, Facebook, Inc. (Facebook

US), 4 entered into a cost sharing arrangement (CSA) and two related

license agreements with its Irish subsidiary, Facebook Ireland Holdings

Unlimited (FIH). 5 We refer to FIH and its wholly owned Irish

subsidiary, Facebook Ireland Limited (FIL), together as “Facebook

Ireland.” We refer to Facebook, Inc., and subsidiaries together as

Facebook or petitioner, and the CSA and associated licenses as the

“transaction.” Petitioner timely challenged respondent’s determination.

We begin, as we always must, with the statute. Section 482 in

effect for 2010 provides in full:

In any case of two or more organizations, trades, or

businesses (whether or not incorporated, whether or not

organized in the United States, and whether or not

affiliated) owned or controlled directly or indirectly by the

same interests, the Secretary may distribute, apportion, or

allocate gross income, deductions, credits, or allowances

between or among such organizations, trades, or

businesses, if he determines that such distribution,

apportionment, or allocation is necessary in order to

prevent evasion of taxes or clearly to reflect the income of

any of such organizations, trades, or businesses. In the case

of any transfer (or license) of intangible property (within

the meaning of section 936(h)(3)(B)), the income with

respect to such transfer or license shall be commensurate

with the income attributable to the intangible.

The regulations promulgated under section 482 authorize

commonly controlled entities to enter into a CSA. 6 Facebook US and

Facebook Ireland entered into the CSA pursuant to the cost sharing

regulations in effect for 2010. See Temp. Treas. Reg. § 1.482-7T. We refer

3 Because of the number of defined terms and acronyms we must use, we have

included in Appendix B a glossary to aid the reader.

4 Facebook US originally was incorporated under the name “TheFacebook, Inc.”

It later changed its name to “Meta Platforms, Inc.” We use “Facebook” to refer to the

worldwide affiliated group, to be consistent with the trial record.

5 The CSA was executed on November 12, 2010.

6 The regulations under section 482 commonly are referred to as the “transfer

pricing regulations.” Section -7 of the transfer pricing regulations commonly is referred

to as the “cost sharing regulations.”

to these regulations as the “2009 cost sharing regulations.” 7 This is the

first time we apply them. 8

In a CSA, controlled (i.e., related) participants commit to bear the

ongoing costs of developing certain intangibles in proportion to their

respective shares of reasonably anticipated benefits from exploiting

those cost shared intangibles (RAB shares). Temp. Treas. Reg. § 1.4827T(a)(1), (b)(1)(i). By bearing its RAB share of the ongoing intangible

development costs (IDCs) going forward, a controlled participant in a

CSA comes to own, in its designated territory, the “cost shared

intangibles” that it helps develop through that shared funding. Id. para.

(b)(1)(iii), (4)(i). In addition to the annual “cost sharing transaction”

payments (CST Payments) during the CSA, controlled participants

must compensate each other for the value of any upfront noncash

contributions in proportion to their RAB shares. Id. paras. (a)(2),

(b)(1)(ii). The 2009 cost sharing regulations label the upfront transaction

in which CSA participants make contributions a “platform contribution

transaction” (PCT), the noncash contribution a “platform contribution,”

and the payment for the upfront noncash contribution a “PCT Payment.”

See id. paras. (a)(2), (b)(1)(ii), (c)(1).

In the CSA, Facebook US and Facebook Ireland agreed to

codevelop future versions of the hardware and software systems

underlying Facebook’s Online Platform (FOP technology). 9 They divided

The 2009 cost sharing regulations were effective January 5, 2009, as

temporary regulations. See T.D. 9441, 74 Fed. Reg. 340 (Jan. 5, 2009), 2009-7 I.R.B.

460. Initially proposed in 2005, see Prop. Treas. Reg. § 1.482-7, 70 Fed. Reg. 51,116

(Aug. 29, 2005), they were made final effective December 16, 2011, see T.D. 9568, 76

Fed. Reg. 80,082 (Dec. 22, 2011), 2012-12 I.R.B. 499.

8 The 2009 cost sharing regulations replaced the 1995 cost sharing regulations

and redesignated them Treasury Regulation § 1.482-7A (Treas. Reg.). See 74 Fed. Reg.

352. The 1995 cost sharing regulations were at issue in Amazon.com, Inc. & Subs. v.

Commissioner (Amazon I), 148 T.C. 108 (2017), aff’d, Amazon.com, Inc. & Subs. v.

Commissioner (Amazon II), 934 F.3d 976 (9th Cir. 2019), and Veritas Software Corp.

& Subs. v. Commissioner, 133 T.C. 297 (2009). The 2009 cost sharing regulations

replaced the term “buy-in payment” (in Treas. Reg. § 1.482-7A(g)) used in those cases

with “PCT Payment.”

As in many cases we must use, and take care using, terminology. For

example, the term “platform” has four meanings in this case that we must keep distinct

in our discussion:

all interests in the cost shared intangibles into two nonoverlapping

geographical territories; the U.S. and Canada (domestic territory) was

assigned to Facebook US, and the rest of the world (ROW territory) was

assigned to Facebook Ireland. See id. para. (b)(1)(iii), (4)(i). Facebook

Ireland also committed to bear its RAB share of IDCs through CST

Payments.

In connection with the CSA, Facebook US and Facebook Ireland

licensed to each other their existing rights in the FOP technology for use

in their respective territories. Additionally, Facebook US licensed to

Facebook Ireland the rights associated with Facebook US’s existing

user, advertiser, and developer relationships (user community rights)

and its marketing intangibles, including trademarks, in the ROW

territory.

The transfer pricing documentation provided that Facebook

Ireland would make contingent annual payments to Facebook US (over

a period of years) for the existing FOP technology, user community

rights, and marketing intangibles that Facebook US contributed to the

CSA. The documentation used the value of Facebook US’s upfront

contributions as the starting point for computing the contingent annual

payments made by Facebook Ireland. The Petition challenges the

adjustment respondent made in the Notice to the total contingent

annual payments Facebook Ireland made for 2010 (calling them gross

royalties). 10

(1) the 2009 cost sharing regulations’ definition of assets contributed to a

CSA—“platform contributions”—that must be compensated through a

PCT, see Temp. Treas. Reg. § 1.482-7T(c)(1);

(2) the technology stack that Facebook operates—the “FOP technology” for

purposes of our analysis—that enables communication by users,

advertising by advertisers, and software application (app) development by

third-party app developers, which was transferred in connection with and

was to be developed further under the CSA;

(3) an economic description of a business—a “platform business”—that

facilitates interactions between or among participants and often exhibits

network effects; and

(4) the product name—“Facebook Platform” (capital P)—for Facebook’s set of

application programing interfaces (APIs) that allows third-party

developers to build apps and offer them to Facebook users.

10 Respondent does not challenge the form of payment (contingent and annual)

adopted in the transfer pricing documentation.

The parties use various terms to refer to the value of Facebook

US’s upfront contributions and Facebook Ireland’s contingent annual

payments computed on the basis of that value. Petitioner sometimes

refers to the value of the “PCT and other intangibles” and also “PCT and

royalty.” Respondent often uses the defined term in the regulations,

“PCT Payment.” Consistent with the regulations, we adopt the term

PCT Payment to mean the value of Facebook US’s upfront contributions

to the CSA, which in turn is the value to be used for computing the

amount of the contingent annual payments owed by Facebook Ireland

for 2010 and subsequent years. This PCT Payment value is the main

dispute between the parties that we must resolve. Facebook used an

estimated net present value (NPV) of $6.3 billion. 11 Respondent

contends that the NPV is $19.945 billion.

The parties disagree over the best method for valuing the PCT

Payment under the 2009 cost sharing regulations. See Temp. Treas. Reg.

§ 1.482-7T(g). The parties also disagree over the inputs to be used in

whatever method we adopt. 12 Respondent’s transfer pricing valuation

expert, T. Scott Newlon, 13 selected the income method in paragraph

(g)(4) as the best method. Petitioner argues that the income method is

not appropriate and urges us to adopt an unspecified method under

paragraph (g)(8) offered by its primary valuation expert, Sanjay Unni.

Dr. Unni’s unspecified method is an amalgam of the income method and

a method he derived from cases applying prior regulations. Petitioner

also offers an alternative valuation by another of its valuation experts,

Timothy Reichert, using the residual profit split method (RPSM) in

paragraph (g)(7). Petitioner also contends that Dr. Newlon used the

11 Although petitioner states that the NPV was $6.3 billion, the transfer pricing

documentation did not include a total (it listed a percentage for the marketing

intangibles, not a value). Respondent’s Notice stated that Facebook determined an

NPV of $6.7 billion. We need not resolve this curious discrepancy as the initial

valuation Facebook used does not affect our ultimate holding, but to avoid confusion

we will use the $6.3 billion figure.

12 A third issue involves the interaction between the provisions in the 2009 cost

sharing regulations governing respondent’s adjustments to the value of the PCT

Payment, under Temporary Treasury Regulation § 1.482-7T(i)(3) (Temp. Treas. Reg.),

and the rules governing periodic adjustments that respondent adopted to implement

the commensurate with income standard of section 482, in paragraph (i)(6). Petitioner

argues that these rules provide an implicit safe harbor protecting it from respondent’s

proposed adjustments under paragraph (i)(3).

13 Appendix A to this Opinion includes thumbnail sketches of the experts who

testified in this case. We discuss their testimony only to the extent it is relevant to our

analysis.

wrong values for three key inputs needed for the income method (and

Dr. Unni’s unspecified method): revenue projections for the ROW

territory, the appropriate discount rate for those projected revenues, and

Facebook Ireland’s best realistic alternative to cost sharing. These are

the key factual disputes we must resolve. At the same time, petitioner

argues that the income method and the other methods specified in the

2009 cost sharing regulations are invalid insofar as they mandate

valuation methods that do not produce an arm’s-length result. We take

up petitioner’s three challenges (to Dr. Newlon’s method, Dr. Newlon’s

key inputs, and the regulations themselves) in turn.

The parties also disagree over how to estimate Facebook Ireland’s

RAB shares for purposes of computing its CST Payments. Petitioner

reported an RAB share of 44% for Facebook Ireland for 2010; 14

respondent contends that it should be 53.5%. We therefore must

determine how to estimate Facebook Ireland’s RAB shares as well.

In deciding these issues, our focus is on what was reasonably

anticipated as of the transaction date. Unless otherwise specified, the

facts we find are as of the transaction date. To put the valuation inputs

used by the experts into context and to evaluate their reliability we will

go back further in time. We do not need to dwell on Facebook’s origins.

But we do need to understand its business model, products, and

international growth leading up to the transaction.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. Facebook

US is the U.S. parent of a group of affiliated corporations that joined in

the filing of a consolidated federal income tax return for 2010.

Incorporated in Delaware in 2004, Facebook US maintains its principal

place of business in Menlo Park, California. 15 Facebook operates an

online social networking platform and makes money primarily by selling

advertisements shown to its users. 16

14 For simplicity we use the RAB share identified in petitioner’s posttrial brief

but note that the Petition stated that the percentage reported was 43%.

15 Absent stipulation to the contrary, this case is appealable to the U.S. Court

of Appeals for the Ninth Circuit. See § 7482(b)(1)(B).

16 The Court issued protective orders adopting procedures to protect certain

confidential information, including trade secrets and proprietary technology, during

the pretrial, trial, and posttrial phases of this case. We have determined that the facts

As of the transaction date, Facebook was a privately held, venture

capital (VC)-backed company. It received funding by issuing stock to

private investors in financing rounds that took place in 2004, 2005,

2007, and 2009. It completed an initial public offering (IPO) of its

common stock in May 2012. Before the IPO, its stock could be traded on

secondary markets only.

Facebook formed its first international entity, an advertising

sales office, in the United Kingdom in August 2007. This was its only

foreign subsidiary as of June 2008 when it started considering locations

for its international headquarters. In October 2008 Facebook announced

that it planned to open its international headquarters in Dublin,

Ireland. Among other reasons—including access to a talented labor force

and proximity to markets it wanted to develop—it chose Ireland to help

reduce its global effective tax rate.

FIL was incorporated as an Irish corporation resident in Ireland

in October 2008. FIH was incorporated as an Irish corporation with a

registered address in Ireland and its stated place of management and

control in the Cayman Islands in January 2009. FIH was a holding

company and did not have any employees. As noted above, we refer to

FIH and FIL together as Facebook Ireland. Both were wholly owned

subsidiaries of Facebook US, with FIH wholly owning FIL. Facebook

first capitalized FIH with a $10 million contribution in August 2009,

made an additional contribution of nearly $4 million later in 2009, and

another, of $20 million, in August 2010. Effective September 1, 2010,

FIL elected to be treated as a disregarded entity for U.S. federal income

tax purposes pursuant to Treas. Reg. § 301.7701-3, after which it no

longer was a separate entity for U.S. federal income tax purposes.

In December 2009 Facebook US and Facebook Ireland executed a

series of intercompany agreements (2009 Agreements), in which

Facebook Ireland obligated itself to perform certain functions, and

certain market development expenses were allocated to it by Facebook

US.

Although Facebook Ireland had nearly 200 employees by the

transaction date, it lacked the financial and accounting systems

necessary to record third-party revenue before September 1, 2010.

Facebook US therefore booked all revenue before the transaction.

we find in this Opinion do not constitute confidential information warranting

protection.

Facebook Ireland did not record any intangible property leading up to

the transaction; it recorded only cash and intercompany receivables.

Facebook Ireland established the necessary financial and

accounting systems on September 1, 2010 (the day FIL elected

disregarded entity status), that allowed it to begin recording revenue.

Two weeks later, in connection with the CSA, the ROW territory became

Facebook Ireland’s territory and Facebook Ireland began funding its

RAB share of the IDCs.

The main factual disagreements between the parties relate to

their valuation experts’ choices of valuation methods and key valuation

inputs. To evaluate Facebook’s revenue projections, we need to

understand its idiosyncratic business opportunities and risks. To select

an appropriate discount rate for those projected revenues, we need to

consider the market-correlated risks for similar companies. And to

determine Facebook Ireland’s best realistic alternative to cost sharing,

we need to understand the role of Facebook’s ad sales team and compare

it to the third-party ad resellers (Resellers) and advertising agencies

used by the valuation experts as comparables. Finally, Facebook’s preCSA international activities and the 2009 Agreements are relevant to

the parties’ dispute over what each controlled participant brought to the

CSA, which in turn dictates which valuation method is appropriate and

how it applies.

Facebook’s social networking platform

Facebook’s stated mission is 17 to “[g]ive people the power to share

and make the world more open and connected.” Its technology enables

individuals to create a user profile (Profile), through which they can

share information, establish connections with other users (friends), 18

communicate with those users, and view and post content. It also

enables businesses and other organizations to create public profiles

(Pages). Its third-party developer platform, Facebook Platform, allows

developers to integrate their apps into the site and interact with users.

We generally use the present tense for factual descriptions that are not

specific to a time period and the past tense for facts that are specific to a particular

period; however, our findings are as of the transaction date unless we otherwise

specify.

18 It has become common to use the noun “friend” as a verb, abandoning the

previously useful verb “befriend”; thus at trial witnesses referred to befriending

someone on Facebook as “friending.”

Facebook collects data on its users. It collects demographic data

(age, gender, location, interests, etc.) as well as contextual data (how

users interact with content on its site). Facebook’s goal in collecting this

data is to map digitally the “social graph.” The social graph is a

conceptual representation of the real-world connections between people

and their friends and interests. Facebook uses this data in developing

and improving products, and targeting ads for users.

Facebook’s business strategy is first to grow, retain, and engage

users on its site and then to monetize them (that is, earn revenue).

Facebook measures its success in each part of this strategy with

different metrics. For user growth and engagement, it generally uses

monthly active users (MAUs) and daily active users (DAUs). 19 To

measure its ability to monetize the users, it uses average revenue per

user (ARPU).

Facebook operates a platform business because it facilitates

interactions between, and among, users, advertisers, and app

developers. Platform businesses often exhibit network effects. Network

effects are positive when the value of the platform to one user is

enhanced by the presence of other users of the platform. Positive

network effects can accelerate the growth of a platform. Negative

network effects can accelerate the decline of a platform.

Facebook was exhibiting positive network effects as of the

transaction date. These positive network effects provided a “tailwind”

for user growth and gave Facebook a competitive advantage. Facebook’s

positive network effects did not insulate it from competition, however,

because users could switch to another platform or use multiple

platforms at once. We now turn to a description of the platform business

and participants, along with the tailwinds, then address the perceived

headwinds (the market risks and challenges) as of the transaction date.

Users

Leading up to the transaction date, Facebook was succeeding on

the first part of its business strategy, growing an engaged user

community. Users grew rapidly after Mark Zuckerberg launched

19 MAUs reflect the number of people who have logged in and visited the

Facebook site, or have taken an action to share content or activities with their

connections through integrated third-party websites in the last 30 days of the date of

measurement. DAUs are measured the same way as MAUs but look to activity in the

last 24 hours of the date of measurement.

Facebook in February 2004. Initially restricted to students at a few

colleges, by the end of 2006 registration was open to anyone with a valid

email address who was at least 13 years old. By the transaction date,

Facebook had over 500 million global MAUs. Approximately 384 million

MAUs were located outside the United States and Canada (growing

from 94 million in January 2009).

Product development

Facebook’s user growth reflects the popularity of its core user

products, launched early in its history. Profile, launched in 2004,

enables users to create an online identity. Photos, launched in 2005,

allows users to upload and share photos and to “tag” the people shown

in them. News Feed, launched in 2006, is the user “landing page” and

displays content including user stories, photos, videos, and status

updates from friends, groups, and followed Pages.

Facebook’s products are developed, maintained, and improved by

its software engineers, often using user data to inform their work. In

addition to observing user behavior as they develop products, Facebook’s

engineers sometimes build products that solicit user input. For example,

in late 2007 and early 2008, Facebook translated the site’s user interface

elements into different languages. Facebook’s engineers accomplished

this by developing a translation tool that used crowdsourced responses

about how to translate. Through this translation tool, users could

submit translations of words from Facebook’s user interface into other

languages and rank (vote on) translations submitted by other users.

Like any consumer data, Facebook’s user data can be used to

identify problems and opportunities, but in isolation does not provide

technical solutions or designs for a new or improved product. User data

are inputs Facebook uses to build products and make decisions.

User growth

Facebook understood that two of its biggest levers for user growth

were its scalable products and network of users. Facebook aimed for its

user products to be “scalable” (that is, expand automatically to fit

demand as demand grows). Its site was, for the most part, a uniform

global product that could scale anywhere it was not blocked. Facebook

also understood the importance of “product-market fit” (i.e., having a

product that people find valuable and want to continue using). From

2008 through 2010, a cross-functional group of employees, the “Growth

Team,” focused on building a scalable product to grow users.

One product that the Growth Team used to grow users was People

You May Know (PYMK). PYMK recommended potential new friends to

Facebook users. It relied on user data, including the user’s existing

friends, demographic data, and prior interactions with PYMK. Facebook

saw PYMK as its number one lever for growth. “Contact importer”

technology enabled users to transfer their contacts from email and

instant messaging services into their Facebook accounts, which PYMK

then used to recommend other users to “friend.”

Facebook also used scalable technologies (e.g., Groups, Pages, and

Facebook Platform) to provide content to users specific to their location.

Through these technologies, users could create groups for local events,

local businesses and organizations could communicate with users, and

developers could create apps that appealed to local users. Many users’

friends were local, and their News Feed content was inherently local

because it was personalized to them. This product-driven “scalable

localization” was more cost efficient than nonscalable “custom

localization.” In a few markets (such as Japan) Facebook needed, and

devoted resources including local employees to provide, a more localized

approach.

User operations and privacy

As the number of users grew, so too did the need for a user

operations team that could moderate the content users posted and

provide technical support. As Facebook collected user data, the need for,

and importance of, a data controller that could comply with any countryand region-specific regulations also grew. So too did the need to address

data privacy concerns.

Monetization

Leading up to the transaction date, Facebook also made strides

on the second part of its business strategy: monetization. Facebook

monetized its users primarily by displaying targeted ads to them on its

site. It also generated non-ad revenue by charging a fee when users

redeemed its virtual currency, Facebook Credits (Credits), on an app

using the Facebook Platform. In 2010 Facebook generated 95% of its

revenue (approximately $1.9 billion) from selling online digital

advertising. 20 Credits accounted for the other 5% of Facebook’s 2010

20 By contrast, offline, or traditional, advertising includes print (newspaper,

direct mail, magazines), broadcast (television, radio), and outdoor (billboards).

revenue. We go through Facebook’s ad sales team functions in some

detail for two reasons. First, ad revenue made up the bulk of the

projected revenue that the valuation experts used to value the PCT

Payment. Second, the experts disputed the appropriate comparable for

this function (as Facebook Ireland’s hypothetical “best realistic

alternative”) when applying the income method.

Facebook’s ad sales team was divided into a Direct Sales

Organization (DSO), Inside Sales Organization (ISO), and Online Sales

Operations Organization (OSO). The DSO provided high-touch services

to the largest advertisers. The ISO serviced mid-tier (small- and midsize) business advertisers with a “lighter touch” than the DSO. ISO

representatives generally engaged with clients through emails, phone

calls, and video conferences, with occasional marketing trips to meet in

person. The OSO mainly provided customer support services to

advertisers that used Facebook’s “self-service” ad platform, called Ads

Manager.

Digital advertising

Early on, Facebook’s ad sales team sold ads through insertion

orders (IOs). An IO is a contract, signed by an advertiser and Facebook,

that specifies the details of the advertiser’s campaign. The DSO sold IOs

to large brand advertisers.

Generally, IOs are used for ad “impressions” (the times an ad is

shown to a user), specifying the number to be purchased. To place an IO,

the advertiser typically must spend above a minimum threshold and is

guaranteed the number of ad impressions it purchases. Ad impressions

generally are associated with brand advertising—ads used to promote

awareness of a brand. 21

Ads Manager

In 2007 Facebook launched two products that transformed its

advertising business. One, Facebook Pages, allowed organizations and

businesses to create Profiles and engage with users, who could become

“fans” of their Pages. The other, Ads Manager, was an online platform

that allowed prospective advertisers to purchase and manage ad

campaigns on Facebook without having to interact with a salesperson;

for this reason it also was referred to as the “self-service” ad platform.

21 Digital ads also could be priced on a “cost per click” basis; most of the ads

sold through Ads Manager were priced on that basis.

Ads Manager did not require an advertiser to spend a minimum amount

and did not require an IO. It was priced through an online auction

system.

Ads Manager made advertising on Facebook more accessible

globally. Any advertiser anywhere in the world with an internet

connection (where Facebook was not blocked) could use Ads Manager to

run an ad campaign on the site. Advertisers who were managed by

Facebook’s ad sales team could and did use Ads Manager. And

advertisers could run ad campaigns using Ads Manager without ever

interacting with a Facebook salesperson. Ads Manager also made

advertising on Facebook accessible to small and mid-sized businesses

who would not meet the minimum threshold for purchasing ads through

IOs.

Ads Manger made Facebook’s advertising business more efficient.

First, advertisers using Ads Manager required less sales and marketing

support. Before it was launched, a Facebook employee had to

communicate with prospective advertisers about whether they wanted

to run an ad campaign. After it was launched, Facebook could promote

Ads Manager in its own internet-based marketing, including on-site

merchandising (i.e., marketing on its own site), search engine

marketing, search engine optimization (e.g., ensuring Facebook was

listed as a top search result on search engine sites), email marketing,

and paid ads on other websites. And advertisers could use those links to

place ads on their own.

Ads Manager advertisers also generally required less operational

support from Facebook’s ad sales team. Before it was launched, a

Facebook employee had to execute an IO reflecting the terms of an ad

campaign. After it was launched, advertisers could select and adjust the

terms of their ad campaigns on Ads Manager. Facebook’s ad sales team

could focus on helping them manage and optimize their accounts and

addressing any issues they had. These services helped Facebook retain

advertisers and reduce churn.

The ISO steered advertisers towards Ads Manager and the OSO

supported advertisers using Ads Manager through the Ticket Processing

System, an email-based response support system, as well as through

one-to-many support systems, such as webinars and FAQ.

Some advertisers were not managed by a member of Facebook’s

ad sales team at any point in their advertising lifecycle. Revenue from

these advertisers was assigned to the OSO. In the third quarter of 2010,

29% of Facebook’s total ad revenue was completely unmanaged.

From 2008 through 2010 revenue from Ads Manager increased

relative to total ad revenue, growing from 35.3% ($96 million) of

Facebook’s total ad revenue in 2008, to 45.5% ($353.8 million) in 2009,

to 66.9% ($1.253 billion) in 2010. 22 As of the transaction date, Facebook

expected the percentage of revenue from Ads Manager to continue

growing. It anticipated that all ads eventually would be purchased on

Ads Manager because its auction pricing system provided a marketplace

with fair prices.

From

January

through

September

2010

Facebook’s

approximately $1.2 billion in ad revenues was distributed across the

DSO, ISO, and OSO, and between Ads Manager and IOs as follows:

Organization

Revenue

(millions) and

percentage of

total ad revenue

Percentage of

revenue from

Ads Manager

Percentage of

revenue from

IOs

DSO

$464.3 (38%)

20%

80%

ISO

212.2 (18%)

90%

10%

OSO

532.0 (44%)

100%

In the third quarter of 2010, 71% ($329 million) of Facebook’s

total ad revenue was from managed accounts. These were the

advertisers that had at any point been assigned a dedicated account

manager from the DSO, ISO, or OSO. The “managed revenue” included

purchases via Ads Manager ($187 million) and by IOs ($142 million).

The advertisers that accounted for the managed revenue received

varying levels of support depending upon how actively they were

managed. The following chart summarizes “Facebook ad revenue by

purchase tool and sales and marketing involvement” in the third quarter

of 2010: 23

22 It is unclear from the record whether this computation of total ad revenue

includes revenue from Resellers; we assume it does not for purposes of our analysis

and note that the small Reseller volume would not affect the numbers materially.

rebuttal.

Anja Lambrecht, one of petitioner’s experts, included the chart in her

International playbook

Facebook had an “international playbook” for selling and

marketing ads in the ROW territory, summarized in a September 2010

presentation titled “International Sales Prioritization.” The

international playbook took a “market coverage approach.” It assigned

one of four levels of sales coverage to a country by considering whether

that country met certain criteria. The table below, from a slide titled

“International Playbook - Minimum Target Criteria,” details the four

coverage levels and associated criteria.

These criteria—the ratio of MAUs to total internet users within a

country, the number of active users, the amount of revenue generated

from Ads Manager, ARPU, and the size of the online ad market—reflect

how monetizable Facebook projected a given market to be. More

monetizable markets received greater coverage, and therefore a greater

commitment of resources from Facebook’s ad sales team.

Ad sales team

By the transaction date, Facebook had nine international sales

offices located in highly monetizable markets, where it wanted its ad

sales team physically located in the markets of the advertisers and ad

agencies with whom they worked: London (Facebook UK), Paris

(Facebook France), Milan (Facebook Italy), Hamburg (Facebook

Germany), Madrid (Facebook Spain), Stockholm (Facebook Sweden),

Sydney (Facebook Australia), Auckland (Facebook New Zealand), and

Singapore (Facebook Singapore). 24 These offices were staffed by

members of Facebook’s DSO. We refer to these offices collectively as the

“FB Foreign Sales Affiliates.”

The DSO provided ad sales and account management services for

the largest advertisers in the international markets, as in the domestic

ad market. In countries that met the criteria for the second-highest

monetization level, Facebook’s ad sales team serviced advertisers

through a nearby office functioning as a regional hub. Before the

transaction date, for example, Facebook Sweden employees covered

Norway, Denmark, and Finland, and Facebook Germany employees

covered Switzerland and Austria.

As for the remaining markets that did not warrant coverage from

an in-country team or from a regional hub, Facebook used both the ISO

and the OSO to provide customer service support. Facebook Ireland

“housed” the international members of the ISO and OSO ad sales teams.

ii.

Resellers

In the lower priority markets, Facebook also contracted with

Resellers to “resell” ads. Its general goal was that after two or three

years of coverage by a Reseller, a market would be ready to graduate to

coverage by a regional hub. An in-country office required more resources

than a regional hub, which in turn required more resources than

contracting with a Reseller.

Facebook entered into Network Affiliate Agreements (NAAs) with

Resellers. 25 Resellers took a revenue-based commission specified by the

24 The record is unclear as to whether the Auckland, New Zealand, office was

open as of the transaction date.

25 The NAAs predating the transaction were between Resellers and “Facebook,

Inc., a Delaware corporation.” They were assigned to Facebook Ireland as part of the

applicable NAA. NAAs covered the following countries (with specific

commissions noted in parentheses): South Africa, Nigeria, Kenya, and

Ghana (30%); Czech Republic (20%); Poland (20%); Saudia Arabia,

United Arab Emirates, Bahrain, Oman, Qatar, Kuwait, Yemen,

Lebanon, Jordan, Egypt, Tunisia, and Morocco (30%); Mexico, Central

America, South America, and the Caribbean (30%); Singapore,

Malaysia, Indonesia, Taiwan, Philippines, Thailand, Vietnam, South

Korea, Japan, Cambodia, Myanmar, East Timor, Brunei, and Laos (25%

originally, 30% as amended); and Israel (30%).

In 2010 Facebook’s ARPU in the Resellers’ countries ranged from

$0.03 to $0.73, with a median ARPU of $0.10. By comparison, its ARPU

for all international markets was $2.38. Resellers were limited to selling

in their designated markets. Under some NAAs, Facebook reserved the

right to remove countries from a Reseller’s “territory” upon written

notice. Under others, Facebook and the Reseller could agree to add

countries to the Reseller’s territory.

Resellers had to deliver to Facebook an executed IO that was

subject to Facebook’s prior review and approval. Additionally, each IO

had to meet a monthly minimum sales threshold unless Facebook

approved an exception in writing. These thresholds ranged from $4,350

to $10,000 in net monthly sales. Resellers could make these IO sales

only to a select group of advertisers, a dedicated list controlled by

Facebook. The Resellers’ limited sales role reflects the third-tier status

of their markets in Facebook’s international playbook.

Under the NAAs, Facebook was not restricted from selling ads in

the Resellers’ markets. It could, and did, cover these markets

concurrently with Ads Manager, serviced by the ISO and the OSO,

reflecting Ads Manager’s global accessibility. Facebook paid Resellers a

commission only for sales made through IOs. Facebook did not

compensate Resellers for any of the ads sold through Ads Manager even

if the Resellers were involved in the sales.

The NAAs varied in duration, but they generally were short term

(one year) and could be terminated by either party for any or no reason

upon 30 days’ prior written notice. This reflected the Resellers’

temporary role in Facebook’s expansion in international markets.

transaction. The Assignment Agreement was undated, but we assume it was signed

around the same time as the CSA (on November 12, 2010). The NAAs have different

effective dates, but those details are not relevant to our analysis.

Reseller activities accounted for less than 3% of Facebook’s 2010 total

ad revenue in the ROW territory. 26

Advertising agencies

Advertising agencies also purchase ads for advertisers, working

as intermediaries between the media owner (here, Facebook) and

advertisers. They work with the advertiser to plan the proper

advertisement, channel, and budget. Facebook built long-term

relationships with global advertising agencies. It preferred working

with large agencies because they matched its scale.

Nonadvertising revenue

Facebook generated almost all of its non-ad revenue

(approximately 5% of total revenue) from a 30% fee on redemptions of

Credits. “Credits” refers to Facebook’s virtual currency that allowed

Facebook users to use a single form of payment across apps on Facebook

Platform.

Launched in May 2007, Facebook Platform, is a collection of

external APIs and tools that enable third-party developers to develop

apps that link to and operate with or within the Facebook site.

Developer apps accessible through Facebook Platform contributed to

user engagement on Facebook. Some of the most popular developer apps

on Facebook were for social games, such as FarmVille and Tiki Resort

(depicted below).

26 Petitioner’s valuation expert, Dr. Unni, estimated the amount to be $22

million (2.7%) and respondent’s internet advertising expert, Ian Maude, estimated it

to be $21 million (2.6%). Either way it was a small fraction of the total revenue.

Facebook gave developers access to certain user data, and

required developers to comply with the terms and conditions set forth in

Facebook’s Platform Policy. Facebook did not charge developers any fees

for access to Facebook Platform.

Both Facebook and the developers could earn revenue by serving

ads to Facebook Platform users. Facebook could display ads on the side

bar, and developers could display ads on Facebook’s framed Canvas page

that shows the developers’ content (the part that displays the game in

the screenshot above).

Facebook also sought to monetize Facebook Platform through

Credits. Users bought Credits from Facebook that they then could use

to purchase virtual goods in-app. Facebook retained a 30% fee when a

user paid with Credits. The third-party developer that created the app

received the remaining 70%. Facebook settled on this revenue split after

reviewing what competing platforms (e.g., the Google Play and Apple

iTunes stores) charged. Facebook believed this familiar model was the

simplest for developers to accept.

Facebook began rolling Credits out to certain developers’ apps in

May 2009, two years after it launched Facebook Platform. As of the

transaction date, Credits were not available to all developers, and their

use was not mandatory.

Facebook’s brand and other marketing intangibles

Facebook expected its marketing intangibles, including its

trademark and brand, to contribute to its growth. Facebook developed

its brand around connecting and sharing, openness, and “authentic

identity” (that users provide their real names and are who they say they

are). Facebook’s users and its marketing intangibles strengthened each

other—users enhanced the brand and the brand contributed to

Facebook’s ability to attract more users.

Facebook’s branding also extended to employee recruiting; there

its brand championed aspects of working for Facebook, including

hacking, innovation, and impact. In this context, “hacking” refers to an

engineer’s freedom to develop products and technology. Facebook

showcased its distinct technical challenges and innovation capabilities

by, for example, open sourcing its code (making it available to the public

for free). Facebook emphasized that its engineers could make changes to

the product soon after starting, and could have an impact (because of

the comparatively small engineering team and large user base).

Facebook anticipated that this recruitment brand would attract

engineers.

Business strategy challenges

Notwithstanding its success growing and monetizing users,

Facebook was worried that it would become a fad—that users might

engage less on Facebook in favor of trendy new social or technological

platforms. This was how Facebook displaced MySpace.com, a competing

social networking site, around 2008 to 2009. Facebook faced competition

from other social networking sites both in the United States and globally

in growing its user base and keeping users engaged. It also faced

competition for users’ attention from traditional and online media.

Facebook subscribed to the mantra that “only the paranoid survive.” For

example, Facebook held a “lockdown” in July 2010 to address the

introduction of another social media product, Google+.

Facebook’s ability to attract, retain, and serve its users depended

upon the attractiveness and reliability of its products and the quality of

their underlying technical infrastructure. The rapid pace of change in

technology forced Facebook to adapt to maintain and grow its user

community and to keep users engaged.

During 2010 Facebook’s user base grew rapidly from

approximately 350 million to 600 million MAUs, causing scaling

challenges. Storing and making use of exponentially expanding user

data strained Facebook’s software and hardware infrastructure,

requiring it to innovate constantly. Facebook’s global hardware and

software infrastructure as of the transaction date were inadequate to

support the number of MAUs it was projecting—its infrastructure would

not be able to handle the increase in data from more users and the richer

content they were sharing (such as videos). 27 Facebook knew its

infrastructure would need to improve to support the growing number of

users and to avoid disruptions in site performance.

Another opportunity for (and risk to) Facebook’s achieving its

user projections was the “platform shift” from desktop to mobile. At the

time Facebook still was primarily a desktop destination. Facebook’s

2010 mobile offerings included a text-only (no photos) site, a mobile

browser site, and rudimentary web-based mobile apps. These offerings

were popular with users; more than 190 million MAUs accessed

Facebook through mobile products, including nearly 160 million MAUs

in the ROW territory. But these mobile products provided significantly

fewer features than its desktop product, and the diminished experience

was not a viable long-term mobile solution to attract and retain users.

Developing an engaging mobile product would require Facebook

to adapt its infrastructure, development process, and workforce. As of

the transaction date, Facebook’s infrastructure almost exclusively

supported desktop services, and the existing developer tools and product

release process did not facilitate mobile development. Most of Facebook’s

574 engineers did not know mobile-specific programming languages

such as Objective-C or Java.

Facebook’s first attempt to build an engaging mobile app at scale,

Faceweb, launched in fall 2010, failed. In late 2011 Facebook began

hiring new engineers and retraining existing engineers to develop a

native mobile product that did not depend on the desktop site. It finally

launched true native mobile products in 2012.

27 The risk of managing growing demand is familiar. See Amazon I, 148 T.C. at

126–27 (noting need to increase scale was a driving factor in Amazon’s need for

technological innovation and discussing scale limitations of its technology).

Facebook also faced pressure to further develop artificial

intelligence and machine learning (AI/ML) capabilities to curate content

for users (including ads they would find engaging) and to protect users

from spam or inappropriate content as the universe of potential content

continued to expand. Facebook’s AI/ML capabilities were insufficient to

address the challenges it anticipated. The rise of rich media, such as

photos and videos, heightened the challenges and risks. In the following

years, Facebook rewrote or replaced much of the AI/ML technologies it

possessed as of the transaction date.

As with users, Facebook’s ability to attract, retain, and serve

advertisers depended upon the attractiveness and reliability of the

Facebook ad products and their underlying technical infrastructure. To

achieve its ad revenue projections, Facebook anticipated that it would

need to innovate its advertising technology.

Advertisers were intrigued by the size of Facebook’s user

community (its “reach”) and its demographic data on those users (its

ability to target people based on their authentic identity). But

advertisers remained skeptical of the effectiveness of advertising on the

Facebook site because social media was still new and because Facebook

at the time lacked the ability to show advertisers the metric they cared

most about: their return on investment (the money spent advertising on

the site). At the time of the transaction, Facebook had not developed an

effective ads conversion tracking tool that could follow users after they

left the Facebook site to determine whether the ad shown to them

induced the action desired by the advertiser.

In 2010 Facebook sold desktop advertising exclusively; it did not

display ads on its mobile website or its then-existing mobile apps. Until

Facebook started monetizing mobile users, it faced the risk that its

mobile user growth would “cannibalize” its desktop revenue—that

increasing unmonetized mobile use would consume its monetizable

desktop business. To display mobile ads, Facebook also would need a

place to put them. But the screen on mobile devices was smaller and

Facebook’s mobile site did not have a side bar, unlike the desktop site.

That left News Feed as the only option. Facebook had tried ads in News

Feed in 2006 through an ad product, Sponsored Stories, that it later

abandoned. And with the shift to mobile, the ability to track users’

activity after they left Facebook’s site (or mobile app) could become more

difficult and therefore posed an additional risk to Facebook’s ad

business.

II.

Pre-CSA agreements

The fight over how to value the platform contributions hinges, in

part, on what Facebook Ireland contributed to the CSA. We discuss next

what Facebook Ireland was doing before the CSA. We then discuss the

CSA and related agreements.

As of the transaction date, Facebook Ireland had 171 Dublin

employees in the following cost centers: 28

Cost center

Employees

User Operations

OSO

Advertising Operations

ISO

Finance

Risk Operations

Recruiting

Platform Ops

Other

Total

171

2009 Agreements

The 2009 Agreements included: the “Intangible Property License

Agreement” (IPLA), the “Growth and Development Services Agreement”

(GDSA), the “General and Administrative Services Agreement” (GASA),

the “Expense Reimbursement Agreement” (ERA), and the “Sales Costs

Reimbursement Agreement” (SCRA). FIH and FIL were parties to the

28 These figures are petitioner’s; respondent’s opening brief stated that 329

people were employed by FIL or the FB Foreign Sales Affiliates. In any event, the

precise numbers are not critical to our analysis.

ERA. The other 2009 Agreements were between FIH and Facebook US.

The 2009 Agreements were executed in December 2009 but generally

had a stated effective date in January 2009. Petitioner has not taken the

position that it intended the 2009 Agreements to constitute a CSA. Nor

did Facebook prepare transfer pricing documentation for any

transactions between Facebook US and Facebook Ireland for tax year

2009. The 2009 Agreements called for various written reports to be

prepared. None were. They terminated as of the transaction date.

Under the IPLA, Facebook US granted Facebook Ireland a

nonexclusive license to use the Facebook System, Marks, 29 and

Confidential Information (as those terms were defined) “to develop,

promote, expand and maintain online social networking communities of

users, advertisers and developers” outside the United States and

Canada (the ROW territory). 30 The IPLA provided that Facebook US

was “the owner, or authorized licensee, of all rights, title and interests

in and to all of the Facebook System, Marks and . . . Confidential

Information” and that Facebook Ireland “shall acquire no rights

whatsoever” to the licensed rights “except as specifically provided” in the

IPLA. With limited exceptions, immediately upon termination (which

either party could do without cause upon 90 days’ prior written notice),

Facebook Ireland had to “cease all use of the Facebook System, Marks

and . . . Confidential Information.”

The IPLA stated that Facebook Ireland would pay Facebook US

royalties of 25% of Facebook Ireland’s net revenues. Facebook Ireland

did not pay Facebook US any royalties pursuant to the IPLA. And

because Facebook US recorded all revenue from international markets

for the duration of the IPLA, Facebook Ireland did not owe royalties to

Facebook US.

Through two other agreements—the GDSA and the GASA—

Facebook US agreed to perform certain development and general and

administrative (G&A) services for Facebook Ireland, for which Facebook

Ireland agreed to reimburse Facebook US. Facebook US did not submit

names.

29 The term “Marks” generally included trademarks, service marks, and trade

30 Facebook generally used the term “international territory” for this; we will

use ROW territory to avoid implying that the 2009 Agreements and the CSA covered

different territories.

written reports or invoices to Facebook Ireland pursuant to the these

agreements, or upon their termination.

Sales and Marketing Service Agreements

Under the Sales and Marketing Service Agreements (SMSAs),

Facebook Ireland contracted with certain FB Foreign Sales Affiliates for

their in-country ad sales services, agreeing to pay an 8% markup on

costs. The FB Foreign Sales Affiliates with whom Facebook Ireland had

SMSAs included: Facebook UK, Facebook Australia, 31 Facebook

Sweden, Facebook Italy, Facebook Spain, Facebook Germany, and

Facebook Singapore. Because before September 2010, Facebook Ireland

lacked the accounting systems to book revenue, through a separate

agreement, Facebook US agreed to bear the expense of paying the FB

Foreign Sales Affiliates for their ad sales services. 32

31 The Australian Tax Office (ATO) audited Facebook Australia for tax years

2009 through 2013. At issue was whether consideration received by Facebook

Australia for providing certain sales, marketing, and other support services to related

parties (Facebook US and Facebook Ireland) was arm’s length. From May 1, 2009, to

January 1, 2010, Facebook US compensated Facebook Australia at cost plus 10% for

those services. From January 1, 2010, through the transaction date, Facebook Ireland

compensated Facebook Australia on a cost-plus-8% basis. Facebook represented to the

ATO “that a mark-up on costs of 8% is arm’s length.”

32 Under the ERA between FIH and FIL, FIL and FIH intended that Facebook

US would bear the “Direct Sales Expenses” related to current revenue generation by

reimbursing FIL directly or indirectly (reimbursing FIH after it reimbursed FIL), and

FIH would bear “Market Development Expenses” related to future revenue generation

in the “Territory” (defined as the international market). To the extent that FIL’s

reimbursements under the SMSAs were Market Development Expenses, FIH agreed

to bear those costs. The ERA defined Market Development Expenses as

costs incurred by [FIL] in connection with activities performed by [FIL]

or by an Affiliate related to market development of the Territory,

including . . . marketing and demonstrating the Facebook website,

advertising system, developer platform, community features and

procedures; providing market and strategic analysis; and other similar

activities which are intended to develop or support future revenues to

advertisers . . . in the Territory.

Under the SCRA between Facebook US and FIH, Facebook US, in turn, agreed

to reimburse FIH for the Direct Sales Expenses FIH was incurring (or rather, was

being allocated). The SCRA defined Direct Sales Expenses as

selling costs, including commissions paid to sales employees for

advertising sales and that portion of commissions or fees paid to an

Affiliate, which are incurred by [FIH] but which are directly allocable

Statement of Rights and Responsibilities

Before the transaction date, Facebook had in place terms and

policies that governed its relationship with users, advertisers, and

developers; by early 2009, these were contained in Facebook’s Statement

of Rights and Responsibilities (SRR). The SRR included by reference

Facebook’s Platform Policies, which applied to developers, and

Facebook’s Advertising Guidelines, which applied to advertisers. For a

time, the SRR also included by reference Facebook’s Privacy Policy; the

registered for and used Facebook agreed to comply with its terms and

policies. As of August 2010, the agreement was with Facebook US if the

user was in the United States or Canada, and with Facebook Ireland if

the user was in the ROW territory.

Octazen acquisition

In February 2010 Facebook acquired Octazen Solutions

(Octazen). Octazen had developed technology that could import contacts

from various email domains (Octazen technology). Acquiring the

Octazen technology (and the engineers who developed it) significantly

improved Facebook’s contact importing capabilities. Facebook US

acquired Octazen through a stock purchase, by its U.S. subsidiary

Facebook Global Holdings II, LLC, of Bonus Energy Sdn Bhd (the

company that owned Octazen in February 2010) for $375,000 and three

milestone payments in the future. 33

In February 2010 Facebook US recorded an intangible asset

purchase for $375,000 under the description “Octazen acquisition.” 34

Facebook Ireland had not recorded any entries on its books and records

relating to the Octazen acquisition as of the transaction date. In

December 2010 FIL and Facebook Malaysia executed two agreements

with a March 2010 effective date (approximately six months before FIL

elected disregarded entity status in September 2010). In one, Facebook

to the external gross revenue derived from advertising sales to

advertisers with invoicing or billing addresses in the Territory which

is recognized by [Facebook US].

33 In June 2010 Bonus Energy Sdn Bhd changed its name to Facebook Malaysia

Sdn Bhd (Facebook Malaysia).

34 The financial accounting experts, Michelle Hanlon (for respondent) and

Robert Wentland (for petitioner), both noted issues with this entry, namely, that it

reflects an asset purchase rather than a stock purchase and it does not say to whom

the $375,000 cash was paid.

Malaysia agreed to assign rights in intangible property to FIL. In the

other, FIL retained Facebook Malaysia as an intangible property

developer. Accounting entries for FIL and Facebook Malaysia dated

December 31, 2010, appear intended to record these agreements, but on

that same date the recorded entries were then reversed. In October 2011

FIL recorded the Octazen intangible property for financial accounting

purposes. 35

III.

CSA agreements

The CSA

The CSA was embodied in the “Agreement to Share Costs and

Risks of Online Platform Intangible Property Development.” Under the

CSA, Facebook US and Facebook Ireland agreed to share IDCs in

proportion to their respective RAB shares. 36 They divided all interest in

cost shared intangibles into two nonoverlapping territories—Facebook

US’s domestic territory and Facebook Ireland’s ROW territory—and

assigned the perpetual and exclusive right to exploit the cost shared

intangibles accordingly. 37

Cost shared intangibles were defined to include the following

intangible property reasonably anticipated to be developed under the

CSA: “[i]mprovements, updates, adaptations, or other modifications to,

or a complete replacement of, the [FOP technology],” and related

intangible property. 38 The FOP technology was defined, in part, as

35 Facebook Malaysia was still named Bonus Energy Sdn Bhd as of the March

2010 effective date. It changed its name three months later, in June 2010. Thus, it was

named Facebook Malaysia as of the December 2010 execution date.

36 See Temp. Treas. Reg. § 1.482-7T(b) (“A cost sharing arrangement is an

arrangement by which controlled participants share the costs and risks of developing

cost shared intangibles in proportion to their RAB shares.”).

37 See id. subparas. (1)(iii) (“Each controlled participant must receive a non-

overlapping interest in the cost shared intangibles without further obligation to

compensate another controlled participant for such interest.”), (4)(ii) (permitting and

providing method for territory-based divisional interests).

38 See id. paras. (j)(1)(i) (“Cost shared intangible means any intangible, within

the meaning of § 1.482-4(b), that is developed by the IDA, including any portion of such

intangible that reflects a platform contribution.”), (k)(1)(ii)(B) (requiring a CSA to

“[d]escribe the scope of the IDA to be undertaken and each reasonably anticipated cost

shared intangible or class of reasonably anticipated cost shared intangibles”).

the hardware and software system, . . . in existence on [the

transaction date], . . . that facilitates the sharing of data

between users for social networking purposes, sales of

credits and virtual items, development of applications by

developers, delivery of targeted advertisements to user

pages, and any related processes or technology that relates

to facilitating communication and social networking among

users and serving advertisements.

The CSA’s definition of cost shared intangibles explicitly excluded the

user community rights and marketing intangibles transferred in the

“User Base Transfer and Marketing Intangibles License Agreement”

(UBMI license).

The CSA specified the functions and risks that Facebook US and

Facebook Ireland would undertake in their respective territories. 39 In

connection with the CSA, Facebook Ireland would pay its RAB share of

IDCs for each year by making CST Payments, and would bear the risk

associated with making those payments.

Facebook US and Facebook Ireland committed to share

“Aggregate Allocable IDCs.” The Aggregate Allocable IDCs did not

include “Territory Specific IDCs,” which were individually borne by a

participant and pertained solely to the territory that participant

exploited. The CSA provided a method for calculating RAB shares for

purposes of sharing the Aggregate Allocable IDCs. RAB shares were

measured by “the ratio of the [NPV] of the aggregate gross profit of [one

p]arty divided by the [NPV] of the aggregate total gross profit of both

[p]arties.” In this context, the gross profit amounts were the gross profits

in the current fiscal year plus projected gross profits for the following

two fiscal years. 40

Facebook US and Facebook Ireland agreed to “review the actual

and projected financial data” from the use of the cost shared intangibles

“[f]rom time to time.” They also agreed to “amend the cost sharing

methodology as necessary on a prospective basis to reflect changes in”

39 See id. para. (k)(1)(ii)(C) (requiring a CSA to “[s]pecify the functions and risks

that each controlled participant will undertake in connection with the CSA”).

40 See id. subdiv. (ii)(E) (requiring a CSA to “[p]rovide a method to calculate

the controlled participants’ RAB shares, based on factors that can reasonably be

expected to reflect the participants’ shares of anticipated benefits, and require that

such RAB shares must be updated, as described in paragraph (e)(1) of this section”).

their RAB shares “and/or the reliability of the measure provided [under

the CSA] as the most reliable estimate of those benefits.”

Facebook Ireland agreed to perform certain functions in the ROW

territory, including to: “develop and manage the user, application

developer, and advertiser communities”; “perform marketing activities”;

“perform administrative functions such as facilities management,

information services activities, human resource management, and tax

and legal department activities”; “perform all operational functions that

enable and maintain the performance of” the FOP technology, including

ad operations, user operations, support, and user growth and

optimization; “select, hire, and supervise employees . . . to perform”

these functions; and “operate or manage data centers as necessary.”

Facebook Ireland also agreed to bear risks in the ROW territory,

including: “[m]arket risks”; “[l]egal and regulatory risks associated with

operating an on-line business”; “[i]ntellectual property protection risks

and . . . infringement risks”; “[b]usiness risks relating to [the ROW

territory] including . . . credit risk, collections risk, market risk, and

asset risks”; and “[r]isk associated with political unrest and foreign

exchange rate fluctuation.”

The CSA had an initial term of five years. It automatically

renewed for successive one-year terms thereafter unless terminated.

FOP technology license and UBMI license

In connection with the CSA, Facebook US and Facebook Ireland

concurrently entered into two additional agreements that conveyed

resources or rights to Facebook Ireland: the “Online Platform Intangible

Property Buy-In License Agreement” (FOP technology license) 41 and the

UBMI license.

In the FOP technology license, Facebook US granted Facebook

Ireland the existing rights to the FOP technology through an exclusive,

perpetual, irrevocable license in the ROW territory. Specifically, it

licensed to Facebook Ireland the “Facebook US PCT Property,” defined

as “all Intangible Property [(as defined in Treas. Reg. § 1.482-4(b),

excluding the user community rights and marketing intangibles)],

including computer software, relating to the [FOP technology] existing

41 See id. para. (b)(3) (“The controlled participants must enter into a PCT as of

the earliest date on or after the CSA is entered into on which a platform contribution

is reasonably anticipated to contribute to developing cost shared intangibles.”).

and owned or licensed by Facebook US,” in the ROW territory as of the

transaction date. Facebook Ireland then could develop the FOP

technology as part of the CSA and otherwise use and exploit it

commercially, “in particular by providing services to users, application

developers, and advertisers located in” the ROW territory. The FOP

technology license also required that Facebook Ireland transfer to

Facebook US any “Facebook Ireland PCT Property” (defined the same

way as Facebook US PCT Property, but belonging to Facebook Ireland).

As consideration for the rights and licenses granted to it under

the FOP technology license, Facebook Ireland agreed to pay Facebook

US “such arm’s length amounts as required by Treas. Reg. § 1.482-4 and

Temp. Treas. Reg. § 1.482-7T” in the form of contingent annual

payments. Those payments were to be net of any amount due from

Facebook US to Facebook Ireland relating to the Facebook Ireland PCT

Property.

In the UBMI license, Facebook US granted to Facebook Ireland

the rights to the existing Facebook “User Base” and “Marketing

Intangibles” in the ROW territory. User Base was defined as “the

contracts and other relationships with persons comprising the various

user communities developed and maintained by the [p]arties,

information about such users, and networks developed by users on the

various Facebook sites.” “User communities” here appears to refer to the

user, advertiser, and developer communities together. We use the term

“user community rights” to distinguish the rights covered by the UBMI

from “users” or the “user base” (which frequently appeared to mean only

the individuals using the site to connect and share, not the advertisers

or developers). Marketing Intangibles were defined as

trademarks, service marks, trade names, trade dress,

domain names, business marks, designs, packaging,

marketing strategies, customer lists, other marketing

information, registrations, pending registrations and

copyrights to logos or pictorial depictions, any intangible

property associated with any such marks (such as

marketing intangibles and brand name quality control

standards), and other similar marketing intangible

property.

(We similarly adopt the term “marketing intangibles.”) Facebook US

also “contribute[d] to Facebook Ireland all goodwill and going concern

value associated with the User Base and Marketing Intangibles” in the

ROW territory.

As consideration for the user community rights and marketing

intangibles licensed to Facebook Ireland under the UBMI license,

Facebook Ireland agreed to pay Facebook US “such arm’s length

amounts as required by Treas. Reg. § 1.482-4” in the form of contingent

annual payments.

In addition to the core agreements, 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%. We refer to all of the agreements

executed as part of the transaction together as the “CSA agreements.”

The parties also entered into an “Assignment Agreement”

effective September 15, 2010, transferring Facebook US’s rights and

obligations under certain NAAs to Facebook Ireland. 42

IV.

Financial projections

Both parties’ valuation experts value the upfront contributions to

the CSA, and the PCT Payment required in exchange, by projecting

relevant financial items (cashflow or operating income and expenses) for

Facebook Ireland’s ROW territory and then discounting them back to

present value at a rate intended to reflect the market-correlated risks of

participating in the CSA. But they dispute which inputs—including

which financial projections and which discount rate—should be used.

Both parties use Facebook’s Long Range Plan (LRP), Facebook

management’s three-year-projections for September 2010 through the

end of 2013, as a starting point for their financial projections. We too use

the LRP as our starting point for evaluating Facebook’s opportunities

and risks as of the transaction date and the inputs the valuation experts

chose.

LRP financial projections

The LRP is a 110-slide deck that Facebook management

presented to its board of directors (Board) in August 2010. A slide titled

42 We assume the assignment is part of the transaction but do not group it with

the CSA agreements. We note that an amendment to an NAA between Facebook US

and one Reseller, Fox Latin American Channel, Inc., was executed (and made effective)

after the transaction date but before the date the CSA was executed.

“3-Year Financial Plan: Why Do This?” listed the reasons for creating it:

to “[i]dentify financial goals,” “[p]rovide context to guide certain

decisions (e.g. facilities needs, financing needs, hiring plans) and enable

alignment across the company,” and to “[o]btain Board feedback and

identify areas for additional consideration.” This slide also stated that

Facebook sought to “[m]inimize resources invested in putting the plan

together (primarily a top-down exercise)” and to “[r]espect [the]

impossibility of predicting the future with anything resembling

precision.”

The LRP presented multiple financial scenarios, each with an

associated set of financial projections. The parties dispute which set of

projections contained in the LRP “reflect[s] the best estimates of the

items projected (normally reflecting a probability weighted average of

possible outcomes)” for 2010 through 2013. See Temp. Treas. Reg.

§ 1.482-7T(g)(2)(vi). They do not dispute how the projections divided

revenue between the domestic and ROW territories.

Respondent, through Dr. Newlon, adopts the projections for the

“Base Case” financial scenario. The Base Case projected revenue from

Facebook’s then-existing sources—digital advertising (Ads Revenue)

and redemptions of Credits on Facebook Platform (Credits Revenue)—

and from Other Revenue (revenue not attributed to a known source). For

2013, Ads Revenue and Credits Revenue amounted to approximately

$8.1 billion and Other Revenue made up the remaining $1.9 billion, for

a total of $10 billion. Other Revenue thus “plugged” the gap between the

revenue Facebook projected from existing sources and the $10 billion

total revenue forecast for 2013. Petitioner adopts the “Downside, Excl.

‘Other’ Revenue” financial scenario that, as its title indicates, excluded

Other Revenue from projected revenue (this is the only way in which it

differs from the Base Case).

Because we must decide which set of financial projections in the

LRP should be used to estimate the value of the upfront contributions

and the PCT Payment required to compensate for those contributions,

we detail how the LRP was developed, how it reflected the opportunities

and risks that Facebook perceived at the time, how Facebook used the

Base Case internally, and how an investment bank treated the Base

Case when conducting due diligence for a potential equity investment in

Facebook.

LRP development

Facebook’s finance team, led by its chief financial officer, David

Ebersman, started working on the LRP in early 2010. It began by

hosting a “hackathon” to brainstorm what the LRP would include. In the

following months, members of Facebook’s management team (referred

to as the “M team”) provided input on various items projected in the

LRP, including users, revenue, and operating costs (namely, capital

expenditures and headcount).

Susan Li, one of the finance team’s analysts responsible for

preparing revenue projections, developed a detailed forecast for 2011

through 2013. This involved projecting revenue from advertising,

Credits, and an “other” category containing virtual gifts and other

miscellaneous, de minimis revenue streams (amounting to

approximately $13 million each year). The finance team strove to

produce a 50/50 forecast, in which Facebook would exceed or miss the

forecast equal parts of the time. As of June 2010 this bottoms-up forecast

projected just over $8 billion in worldwide revenue for 2013. Facebook’s

chief operating officer, Sheryl Sandberg, expressed hesitancy over

Facebook’s ability meet these targets. In a June 2010 email exchange

that included Mr. Ebersman, she stated: “My gut—and this is pure gut—

tells me that our current trajectory is to hit $1.9 [billion] or less this year

and then grow by 50% next year and less in 2012.”

In mid-June 2010 Mr. Ebersman provided a draft of the LRP to

Mr. Zuckerberg, Facebook’s founder, chairman, chief executive officer,

and controlling shareholder, in anticipation of meeting with him to

discuss it. He told Mr. Zuckerberg that the plan was to build around the

medium revenue case in the draft, which reflected the bottoms-up

forecast of just over $8 billion in worldwide revenue in 2013.

Mr. Zuckerberg set the 2013 revenue forecast at $10 billion,

instructing Facebook’s finance team to add Other Revenue to the Base

Case forecast to produce that number. Mr. Zuckerberg’s decision to

increase the 2013 revenue target was contentious internally. But Mr.

Zuckerberg generally viewed Board meetings as an “open

conversation”—an opportunity to discuss Facebook’s biggest issues, both

opportunities and challenges, even if he did not yet have a solution.

Mr. Zuckerberg understood that the finance team was forecasting

how Facebook’s existing products were going to perform. He also

acknowledged that the finance team’s revenue projections had been

accurate in the past and thought that their projection here may have

been a little optimistic. Nonetheless, he thought that Facebook should

perform better. He wanted to challenge the M team and other Facebook

employees to do better. And he wanted to avoid the tendency to forecast

just the things that existed. He believed Facebook “could create new

things, and over a multi-year period, they could ramp up to be something

meaningful” and ultimately deliver a better result.

Drafts of the LRP after Mr. Zuckerberg’s mid-June 2010 input

projected $10 billion in revenue in 2013 as a top-down estimate. In the

breakout of revenue by segment, the “Other” category was increased

from a de minimis revenue stream ($13 million in 2013) to an amount

that represented the difference between the bottoms-up (approximately

$8 billion) and top-down ($10 billion) forecasts. At least one of these

drafts asked whether Facebook was “comfortable with a ~$2Bn ‘tbd’ plug

for the 2013 revenue forecast?” and listed “$2bn ‘other’ revenue” as an

item for followup.

In the final LRP presented to the Board in August 2010 the “Base

Case” scenario included an Other Revenue “plug” amount of zero for

2011, approximately $100 million for 2012, and approximately $1.9

billion for 2013. The final LRP also retained questions about the $10

billion revenue forecast for 2013, as we detail below.

In addition to the Base Case, the final LRP included three other

scenarios. The downside scenario labeled “Excl. ‘Other’ Revenue” simply

excluded Other Revenue (as its label implies). It forecast $3.5 billion,

$5.9 billion, and $8.1 billion for 2011, 2012, and 2013, respectively. The

scenario labeled “Excl. ‘Other’ & Credits Rev.” excluded both Other

Revenue and Credits Revenue. The scenario labeled “Upside” adopted

revenue figures of $5 billion, $10 billion, and $15 billion for 2011, 2012,

and 2013, respectively.

Key projections in the final LRP Base Case

User growth

The LRP projected that Facebook’s global MAUs would grow from

519 million in September 2010 to 600 million by the end of 2010, 834

million by 2011, 1.025 billion by 2012, and 1.195 billion by 2013. This

reflected Facebook’s strong position in the social media industry in 2010;

it was the largest social network in the world. Overall Facebook was in

a dominant position in its industry because it possessed the largest user

community and its user community was rapidly growing. But the LRP

also identified risks to user growth and engagement including

“[s]aturation points in key countries,” “[d]ecreased engagement,” and

“[c]ompetition.”

The LRP reflected Facebook’s concern about user churn, which

hurt user growth. Churned users were those who became “stale” (users

whose last action was over 30 days ago) or “deactivated” (users who

deactivated, but did not delete, their accounts). The LRP noted that,

despite increasing user churn, Facebook added 30 million MAUs in July

2010 and mobile growth “reaccelerated.” It stated that Facebook’s team

was “focused on reducing churn, better engaging new and low-activity

users, and combatting fake accounts/spam across the site.”

The LRP also mentioned the risks of site reliability, user

discomfort with sharing personal information, and safety concerns as

challenges to maintaining and growing its user base. To achieve its user

growth projections in the LRP, Facebook anticipated that it would need

to surmount various risks through innovations to the FOP technology.

The LRP made assumptions and projections regarding Facebook’s

users. It stated: “Mobile helps drives [sic] adoption around the world.” It

assumed that global internet growth would continue each year through

2013 to more than 2.5 billion users. And that the “plan ends 2013 with

1.2B users (compared to ~900M for Google and ~600M for Yahoo today).”

It also “assume[d] average user engagement (ad opportunities per user)

[would] stay[] relatively flat.”

Financial projections

Ads and Credits Revenue

For 2013 the LRP projected revenue from two existing sources,

Ads and Credits. Together, Ads Revenue and Credits Revenue were

projected to grow from approximately $1.9 billion in 2010 to

approximately $8.1 billion by 2013. Ads Revenue was projected by

taking the product of the user projections and ARPU. It was projected to

grow from approximately $1.8 billion in 2010 to approximately $6.7

billion in 2013, for a compound annual growth rate (CAGR) of 55%. The

LRP projected Credits Revenue to grow from under $100 million in 2010

to approximately $1.4 billion in 2013, reflecting a CAGR of 148%. It also

listed the ability to ramp up Credits Revenue at this rate as a risk.

The LRP indicated that Facebook’s ads business would grow

significantly. It stated that “[o]verall online ads spend should continue

to grow at a healthy pace.” It noted that while Facebook then only

accounted for “3% of online ad spend (vs. ~$50% for Google and 15% for

Y[ahoo]!),” it anticipated that by 2013 it would grow its share to 7%. The

LRP stated that Facebook predicted its ads revenue growth would be

driven in equal parts by user growth and ads ARPU growth. It also

stated that in the future Facebook planned to monetize its mobile

platform, framing the shift to mobile as a “key strategic area.”

The LRP also listed “[a]dvertiser [return on investment],

particularly in the direct response business” as a risk. The LRP noted

that in monetization Facebook still lagged behind competitors,

especially those in the search advertising business. It noted, as an

example, that in August 2010, Facebook had roughly the same number

of active users as Google and Yahoo! had had three years earlier, but

Google and Yahoo! were three to six times more effective at monetizing

them. And it included a slide titled “Churn analysis for advertisers”

which highlighted increased net churn even as total accounts grew.

ii.

Other Revenue

Other Revenue was the third source of revenue in the Base Case.

The LRP framed the Other Revenue target as aspirational. “Achieve

$10B in annual revenue in 2013” was listed as a “proposed financial

goal[].” The first bullet point on the slide titled “Key questions for

discussion” asked: “Are we comfortable planning towards a $10B

business?” It noted that this would require “~$3B from Credits and

Other sources” to supplement “~$7B in ads.” Like the ability to ramp up

Credits, the ability to ramp up Other Revenue was listed as a risk.

In describing the Base Case revenue forecast, the LRP stated that

Other Revenue “reflects the expectation that we will identify additional

revenue opportunities over the coming years” and that it “[c]ould come

from expanding [Facebook’s] existing Ads or Credits strategies and/or

from new sources.” “Begin considering ideas for $2B in ‘other’ revenue

by 2013” was listed on the “[f]ollow-up items and next steps” slide.

These caveats were included because Mr. Ebersman wanted to

ensure the Board understood that Other Revenue was a meaningful

portion of the forecast for 2013 but Facebook did not have a plan for

achieving it. Facebook had identified neither a product to generate

Other Revenue nor a market in which it would earn Other Revenue. The

need to explain these caveats was the most memorable part of the

August 2010 presentation for Mr. Ebersman.

iii.

Discount rates

The LRP offered discount rates of 12.5%, 15%, and 17.5% on slides

titled “Illustrative valuation ranges ($ per share),” “DCF valuation

comparison ($ per share),” and “Illustrative valuation range detail ($ per

share).” It used these discount rates as part of its discounted cashflow

(DCF) analysis in computing an estimate for the (then) current value of

Facebook’s stock. It listed Baidu, Tencent, and Google as comparables.

iv.

Projected expenses

The two primary drivers of Facebook’s projected expenses in the

LRP were capital expenditures and employee headcount. The LRP

projected that Facebook’s capital expenditures would grow from $709

million in 2010 to $1.294 billion in 2013. It projected an increase in

headcount from approximately 2,140 employees in 2010 to

approximately 7,760 employees in 2013. The LRP also included among

its key assumptions “M&A and Other Contingency” of $50 million, $250

million, and $750 million, for 2011 to 2013, respectively. A cashflow

statement included these business acquisition expenses together with

capital expenditures for purposes of computing cashflows from investing

activities; neither was included in the computation of cashflows from

operating activities.

Facebook did not associate material projected expenses with

Other Revenue. The LRP stated that 2013 free cashflow “could be

overstated if the ‘other’ revenue is not generated from Ads or Credits”

because Facebook “ha[d] not aggressively planned for significant

increased expenses (beyond ~250 heads) to support an entirely new

revenue stream.” Mr. Ebersman and the finance team thought that

planning for expenses attributable to Other Revenue would be a more

useful exercise once Facebook figured out what Other Revenue was

going to be. Comparing the Base Case and the Downside Excluding

Other Revenue indicates that the operating margin for Other Revenue

would have been 94% (92% when accounting for the costs of 250

additional full-time employees).

Internal use of the LRP

Soon after Facebook’s M team presented the LRP to the Board, 43

Facebook used it for internal decision-making purposes, and shared it

with employees.

Facebook also provided the Base Case to an accounting firm,

KPMG LLP (KPMG), to value its common stock for compensation

purposes under section 409A. KPMG produced a section 409A valuation

report for the third quarter of 2010 and for quarters thereafter. In these

reports KPMG employed various valuation methods—DCF method,

secondary market transaction method, guideline public company

method—to establish the FMV of Facebook’s common stock. In the

section 409A valuation report for the quarter ending September 30,

2010, it employed a DCF method that incorporated the Base Case

projections. KPMG viewed the Base Case projections as projecting

significant growth that Facebook might not be able to realize.

Accordingly, it added a “[c]ompany specific risk premium” of 6% to the

discount rate it used to convert cashflows to present value, resulting in

a weighted average cost of capital (WACC) of 17%. 44 It employed the

secondary market transaction method as a corroboration method.

Investment bank’s equity investment

In December 2010, Goldman Sachs (investment bank or bank)

considered an investment in Facebook’s common stock. 45 As part of its

43 It is unclear from the record whether formal Board approval was sought or

required.

44 “The WACC provides the expected rate of return for a company on the basis

of the average portion of debt and equity in the company’s capital structure, the current

required return on equity (i.e., cost of equity), and the company’s cost of debt.”

Amazon I, 148 T.C. at 184 n.35 (quoting Veritas, 133 T.C. at 324 n.33).

At trial, the details of the bank’s process for evaluating the prospective

investment was sealed but its identity was not. The investments made by the bank, its

affiliates, and its clients, through a vehicle the bank managed, in December 2010 and

January 2011, significantly exceeded $1 billion. They were disclosed in the Form S–1,

Registration Statement Under the Securities Act of 1933, for Facebook’s IPO. We have

concluded that the high-level details relevant to our analysis need not be sealed given

the age of the transaction and what already is public.

We use the term “investment bank” to focus on what is relevant to the analysis:

Roughly contemporaneously to the transaction, an unrelated potential investor

evaluated an investment in Facebook for itself, and for its clients, on the basis of

information provided by Facebook along with its own knowledge, experience, and

expertise.

due diligence before making the investment, the bank met with

members of the M team. It reviewed updated Base Case projections

shared by Facebook, historical financials, and business strategy and

prepared a confidential memorandum for its investment committee

summarizing its analysis. 46 The investment bank conducted an analysis

of its required returns for making an investment considering

comparable companies and how those companies traded publicly, and

contemplating Facebook’s future earning potential at selected future

points. The investment bank selected two points—early 2012 (assuming

that an IPO was most likely in this timeframe) and late 2014. It

anticipated that Facebook would be more comparable to some of its

publicly traded peers at those future dates.

In its returns analysis the investment bank used Facebook’s

projections as a starting point to create its own base case. For its base

case the investment bank reduced the revenue projections in Facebook’s

Base Case for each year: by $696 million (18.56%) in 2011, $1.667 billion

(27.78%) in 2012, and $3.235 billion (32.35%) in 2013. The investment

bank applied this haircut to Facebook’s projected Base Case revenue for

two reasons, explained at trial by a former vice president in the bank’s

technology, media, and telecom investment banking group, involved in

evaluating the Facebook investment. First, the bank thought Facebook’s

projections for its current and identifiable revenue streams (Ads and

Credits Revenue) were aggressive. It thought Facebook took an

“optimistic” view of the Facebook Credits business and was generally

“bullish” on the growth of its advertising business. Second, it was

uncomfortable with Facebook’s projections because there was no plan

for generating Other Revenue. The investment bank therefore scaled

back total revenue to produce a more “middle-of-the-road” case for which

it would be willing to invest.

The bank concluded that an internal rate of return (IRR) in the

range of the “high teens to mid-20s” was necessary for the risk it was

taking by investing in Facebook in 2010. An IRR can generally be viewed

as a “hurdle rate,” or the return an investor aims to achieve. It used a

46 Facebook’s December 2010 presentation to the bank increased its revenue

projections for 2011 to $3.75 billion to reflect increased ads revenue from Ads Manager

but left the revenue projections for 2012 and 2013 unchanged.

20% discount rate to compute an NPV of $47B, as of December 2010, of

Facebook’s “[i]mplied” market cap in 2014 of $97B. 47

Financial results

Facebook’s actual revenue, as reported in its Forms 10–K, Annual

Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of

1934, for subsequent years, was $3.711 billion for 2011, $5.089 billion

for 2012, and $7.872 billion for 2013. The actual revenue thus exceeded

the investment bank’s projections but fell short of Facebook’s LRP

projections for 2012 and 2013, even after excluding Other Revenue in

those years. Facebook’s actual revenue did exceed the $10 billion in

2014; Facebook reported revenue of $12.466 billion for that year. This

58% revenue increase from 2013 to 2014 is slightly more than the 55%

increase from 2012 to 2013.

The table below compares the revenue projections in the LRP

Base Case, the LRP Downside Excluding Other Revenue, the

investment bank’s base case, and Facebook’s actual revenue (expressed

in billions).

Year

LRP Base

Case

LRP Downside

Excluding Other

Revenue

Investment

bank’s base case

Facebook’s

actual revenue

2011

$3.5

$3.054

$3.711

2012

5.9

4.333

5.089

2013

8.1

6.765

7.872

Transfer pricing documentation and payments

Facebook, with the help of Ernst & Young LLP (EY), prepared

transfer pricing documentation for the transaction, which was finalized

in September 2011. 48 This transfer pricing documentation consisted of

Respondent points to other projections by the investment bank: a DCF

analysis to arrive at an intrinsic equity value and a public companies comparables

analysis to compute Facebook’s average implied equity value.

48 To prepare transfer pricing documentation, EY extended the 2010 LRP

projections through 2020. EY projected operating margins to decrease by 0.5% each

year after 2013 and determined a long-term growth rate of 3% for the terminal value

of Facebook’s expected future cashflows. The parties’ valuation experts cited these

assumptions in preparing their own analyses.

three separate reports: a CSA report, an intercompany PCT and license

payments report, and an intercompany service transactions report.

For 2010 Facebook Ireland paid Facebook US (and Facebook US

included in income) total royalties of roughly $100 million. This figure

comprised approximately $60 million for the FOP technology, $38

million for the user community rights, and $3 million for the marketing

intangibles. (The UBMI license did not specify separate royalties for the

user community rights and the marketing intangibles; rather this

appears to be the product of EY’s transfer pricing analysis.) Of the $100

million, Facebook Ireland paid $5 million cash and a $95 million

intercompany note. The royalty amounts were based on the following

NPVs for each category (expressed in millions):

License

NPV

FOP technology

$1,685

User community rights

4,078

Marketing intangibles (1%) 49

Total

545

$6,308

In preparing its valuation analysis for the required PCT

Payment, EY included Other Revenue but used a lower operating

margin based on the LRP Downside Excluding Other Revenue scenario.

EY applied the income method to compute the NPV for the rights

transferred by Facebook US to Facebook Ireland under the FOP

technology license using a discount rate of 17.7%, which it derived by

adding a 0.7% international risk premium to KPMG’s 17% WACC for

Facebook.

Facebook and EY concluded that Facebook Ireland would pay the

FOP technology license royalties over four additional years (2011

through 2014), and royalties for user community rights over six

additional years (2011 through 2016). Facebook Ireland made these

49 The transfer pricing documentation prepared by EY states, in part, that

“FIH has agreed to pay FBUS 1% of total international revenue for rights to the

Facebook marketing intangibles under the User and Marketing IP Agreement, which

is within the arm’s length range of results from the CUT search described” in that

documentation. We infer that EY’s reference to the “User and Marketing IP

Agreement” is to the UBMI license which it attached as an appendix. The UBMI

license does not specify a 1% royalty for the marketing intangibles but broadly states

that “Facebook Ireland shall pay to Facebook US such arm’s length amounts as

required by Treas. Reg. § 1.482-4.”

payments. Facebook Ireland also was expected to pay the 1% trademark

license royalty in perpetuity (and did pay it throughout the period

covered by the record). 50

EY concluded that Facebook Ireland’s 2010 RAB share was 44%

(and Facebook US’s was therefore 56%). Following the method specified

in the CSA, EY computed this percentage by dividing the NPV of current

and projected gross profit in the ROW territory into worldwide gross

profit. To compute the NPV it again used KPMG’s estimated WACC of

17% for Facebook.

In 2010 Facebook’s total cost sharing pool (i.e., the total amount

of aggregate allocable IDCs paid by both Facebook US and Facebook

Ireland) totaled approximately $49 million. Facebook Ireland bore its

stated RAB share of these costs. After deducting some IDCs that it had

directly incurred, Facebook Ireland made a net CST Payment to

Facebook US of approximately $21 million for 2010.

In October 2013, during the IRS’s examination for Facebook’s

2010 tax year, Facebook responded to an information discovery request

from the IRS broadly describing the Base Case projections in the LRP

as “the most likely scenario to occur.”

VI.

Respondent’s allocations

Notice

The Notice, issued in July 2016, reallocated income on the basis

of respondent’s determination that the NPV of the assets transferred—

the FOP technology, user community rights, and marketing

intangibles—and therefore the NPV of the PCT Payment was $13.88

billion, not the $6.3 billion that Facebook used for computing its 2010

royalties. This reallocation resulted in an increase of approximately $85

million in Facebook US’s gross royalty income for 2010. The Notice did

not separate the adjustment into the three royalties FIH paid Facebook

US pursuant to EY’s documentation.

The Notice also determined that Facebook Ireland’s RAB share

should be increased (and Facebook US’s decreased) which in turn

increased Facebook Ireland’s required CST Payment and reduced

50 It is unclear how Facebook Ireland made these payments (i.e., whether

through a note or cash), but respondent does not dispute that Facebook Ireland paid

some royalties or that it paid the 1% trademark license royalty.

Facebook US’s by a corresponding amount. The Notice therefore

decreased Facebook US’s deductions for IDCs by $5.39 million for

2010. 51 Petitioner timely petitioned for redetermination.

Amended Answer

A month before trial respondent filed a First Amendment to

Answer (Amended Answer), 52 increasing his asserted NPV for the PCT

Payment from $13.88 billion to $21.15 billion, on the basis of Dr.

Newlon’s opening expert report. This assertion in turn increased

petitioner’s 2010 deficiency by approximately $2.4 million. The $21.15

billion NPV is the top of the range that Dr. Newlon opined would be

arm’s length in his opening expert report. In his posttrial opening brief

respondent argues that a PCT Payment of $19.945 billion is

appropriate. 53

Respondent also has adopted Dr. Newlon’s calculation of

Facebook Ireland’s RAB share for 2010 (53.5%), which is slightly lower

than the RAB share respondent determined for Facebook Ireland in the

Notice. This adjustment resulted in a decrease of $4.66 million (rather

than the $5.39 million in the Notice) to Facebook US’s deductions for

IDCs for 2010, resulting in a reduced deficiency of $735,020 attributable

to this item.

OPINION

Before we tackle the parties’ legal arguments we address

threshold evidentiary and procedural matters. We first address

petitioner’s contention that respondent raised a “new matter” under

This $13.88 billion NPV determination also resulted in collateral

computational adjustments to Facebook’s net operating loss, a domestic production

activities deduction, and general business credits.

52 Two months earlier, we gave respondent a deadline to move for leave to file

an amended answer if he planned to seek an increased deficiency for 2010. This came

after respondent indicated that he might be seeking an increased deficiency on the

basis of what he “intend[ed] to present at trial.” Respondent then filed a Motion for

Leave to File First Amendment to Answer. In our Order granting respondent’s Motion,

we stated that we would allow petitioner to identify any prejudice during the course of

trial and we deferred ruling on the effect of respondent’s amendment on the burden of

proof.

53 Dr. Newlon presents this as the median result falling within a range from

$18.757 billion to $21.147 billion that he determined under his method; respondent

argues that a PCT Payment falling within Dr. Newlon’s range is reasonable and chose

the midpoint.

Rule 142(a), shifting the burden of proof to respondent. We then discuss

the extent to which we will consider posttransaction evidence. Finally,

we address the scope and standard of review under section 482.

Burden of proof

The taxpayer generally bears the burden of proving that the

Commissioner’s determinations in a Notice of Deficiency are erroneous.

See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The

Commissioner bears the burden of proof with respect to “any new

matter, increases in deficiency, and affirmative defenses[] pleaded in the

answer.” Rule 142(a)(1). The Commissioner raises a new matter when

“a notice of deficiency fails to describe the basis on which the

Commissioner relies to support a deficiency determination and that

basis requires the presentation of evidence that is different than that

which would be necessary to resolve the determinations that were

described in the notice of deficiency.” Shea v. Commissioner, 112 T.C.

183, 197 (1999).

In his Amended Answer, respondent asserted an increased

deficiency for 2010 on the basis of Dr. Newlon’s opening expert report.

The parties agree that respondent bears the burden of proof with respect

to the increase. But petitioner contends that respondent’s Amended

Answer also raised a new matter and he therefore has the burden of

proof as to the entire deficiency.

The Amended Answer did not change the statutory basis for

respondent’s (now-increased) deficiency determination. See Abatti v.

Commissioner, 644 F.2d 1385, 1390 (9th Cir. 1981), rev’g T.C. Memo.

1978-392. In the Notice, respondent invoked section 482 to reallocate

income in connection with the transaction. In his Amended Answer, he

also relies on section 482, now reallocating a greater amount of income.

The main issues—the arm’s-length PCT and CST Payments—

remain the same. Respondent now supports his determination with a

different valuation methodology. For reallocations under section 482,

“[t]he fact that the Commissioner relies on alternative theories at trial,

supported by methodology different from that used in the notice of

deficiency, does not necessarily place the burden on the Commissioner.”

Altama Delta Corp. v. Commissioner, 104 T.C. 424, 458 (1995) (citing

Sundstrand Corp. & Subs. v. Commissioner, 96 T.C. 226, 354–55

(1991)); see also Stewart v. Commissioner, 714 F.2d 977, 990 (9th Cir.

1983) (“It is well settled that the assertion of a new theory that merely

clarifies the original determination, without requiring the presentation

of different evidence, does not shift the burden of proof.” (citing Achiro

v. Commissioner, 77 T.C. 881, 890 (1981))), aff’g T.C. Memo. 1982-209.

In a posttrial hearing we asked petitioner what different evidence

it would have presented had respondent not amended his Answer.

Petitioner confirmed that it would not have selected a different best

method for estimating the arm’s-length PCT Payment in its case-inchief. Petitioner did note that its experts had to respond, on rebuttal, to

a different method (Dr. Newlon’s income method) that applied different

inputs (financial projections, discount rate, best realistic alternative)

from the method and inputs underlying the Notice. But a rebuttal expert

report should respond to the other side’s case-in-chief expert witness and

the arguments made and evidence presented at trial by the other side

through their expert(s). 54

We have treated a party’s reliance on new expert witness

methodologies in a transfer pricing case as analogous to pursuing

alternative legal theories. See Altama Delta Corp., 104 T.C. at 458.

Changes to expert witness methodologies do not “necessarily” shift the

burden of proof to the Commissioner. See id. (ruling that the

Commissioner’s revisions at trial to the section 482 reallocations in the

Notice of Deficiency did not warrant shifting the burden of proof).

Raising a new statutory provision (e.g., dropping an economic substance

challenge in favor of section 482), by contrast, would shift the burden of

proof. See Achiro, 77 T.C. at 891. Here, petitioner had sufficient notice

of the basis of respondent’s deficiency determination (a section 482

reallocation in connection with the transaction). Shifting the burden of

proof with respect to the entire deficiency therefore is inappropriate.

We conclude that petitioner retains the burden of proof for the

deficiency determined in the Notice and respondent bears that burden

for the increase to that amount in the Amended Answer. Regardless, the

record before us allows us to resolve all issues on a preponderance of the

evidence. The assignment of the burden of proof is not dispositive.

54 Respondent moved to exclude some of petitioner’s rebuttal experts’ reports

as containing “untimely opening opinions.” We denied respondent’s Motion because the

changes that petitioner’s experts made to their valuation methodology and inputs

directly or indirectly challenge respondent’s opening expert reports on the same

subject matter—generally, the arm’s-length amount charged in a PCT.

II.

Posttransaction evidence

In resolving the issues before us our focus is on the transaction

date and what was “reasonably anticipated” as of that date. See Temp.

Treas. Reg. § 1.482-7T(c)(1), (j)(1)(i) (defining compensable contributions

by whether they are “reasonably anticipated to contribute to” either

development of cost shared intangibles or exploitation of them). 55 For

example, the regulations direct the parties to use financial projections

that reflect a “probability weighted average of possible outcomes,” and a

discount rate that reflects “the market-correlated risks of activities or

transactions . . . based on all the information potentially available at the

time for which the present value calculation is to be performed.” Id.

para. (g)(2)(v) and (vi). Likewise, estimating RAB shares requires

selecting reliable projections to measure the reasonably anticipated

benefits. Id. para. (e)(1).

Evidence from after the transaction date can help us evaluate

what was reasonably anticipated or expected then. To that extent,

therefore, posttransaction evidence may be relevant. Fed. R. Evid. 401

and 402. We have looked to posttransaction evidence for this purpose in

valuation cases. See, e.g., Estate of Gilford v. Commissioner, 88 T.C. 38,

52 (1987) (permitting consideration of posttransaction date events “for

the ‘limited purpose’ of establishing what the willing buyer and seller’s

expectations were on the valuation date and whether these expectations

were ‘reasonable and intelligent’” (quoting Estate of Jephson v.

Commissioner, 81 T.C. 999, 1002 (1983))). We have considered

posttransaction evidence for this purpose in prior cost sharing cases. See

Amazon I, 148 T.C. at 168 (noting “ex post data” of a contract

amendment that postdated the CSA transaction by 18 months “may

provide a reference point or sanity check”); Veritas, 133 T.C. at 326–27

(comparing Veritas Ireland’s actual growth rate with the growth rate

employed by the Commissioner’s valuation expert during a period

following the tax years in issue and looking to its role in the

international markets during the CSA).

Throughout the trial, respondent objected to petitioner’s

questions about posttransaction events as irrelevant. We overruled this

objection but observed that posttransaction evidence has its limits

55 See also Treas. Reg. § 1.482-1(f)(2)(iii)(A and B) (explaining that “results of

a controlled transaction ordinarily will be compared with the results of uncontrolled

comparables occurring in the taxable year under review” but in certain circumstances

multiyear data may be considered).

(affecting weight more than admissibility). 56 Respondent expressed

concern about petitioner’s using posttransaction evidence to highlight

the risks Facebook anticipated as of the transaction date (e.g., the shift

from desktop to mobile) and downplay the corresponding opportunities

(e.g., growing number of mobile users), reminding us that Facebook

encountered these “supposed hiccups” on its way to becoming one of the

world’s most valuable companies.

Petitioner contends that posttransaction evidence is relevant

precisely because respondent disputes testimony from Facebook’s

management and employees about the risks they saw as of the

transaction date. For example, petitioner points to its struggle to

develop a native mobile app, such as the Faceweb failure, to

demonstrate that Facebook was reasonable to view the shift to mobile

as a risk in 2010.

At trial, both parties focused on what was reasonably anticipated

or expected as of the transaction date. They agree that we may look to

what happened after the transaction date to assess the reasonableness

of Facebook’s expectations at the time. Both parties also introduced

evidence and elicited fact-witness testimony about events after the

transaction date as part of their cases-in-chief. And both adopt the

opinions of experts who relied on information from after the transaction

date.

The parties’ fight shows how posttransaction evidence may be

helpful to our evaluation of the parties’ divergent views on Facebook’s

prospects when it entered into the CSA, even as it also illustrates the

limits to its usefulness. We consider posttransaction evidence within

those limits.

III.

Scope and standard of review

We now turn to the scope and standard of review, and a bit of

semantics. The parties agree that we review deficiencies resulting from

the Commissioner’s section 482 allocations de novo, under section 6213.

Instead their focus is on the standard of review; they disagree over the

deference we should afford respondent’s determination.

56 At trial we permitted testimony about posttransaction developments but

cautioned the parties that the more distant the development was the less relevant it

would be.

The Commissioner has broad discretion under section 482, and an

allocation will be set aside only if the taxpayer shows it to be arbitrary,

capricious, or unreasonable. DHL Corp. & Subs. v. Commissioner, 285

F.3d 1210, 1216 (9th Cir. 2002), aff’g in part, rev’g in part and

remanding T.C. Memo. 1998-461; Coca-Cola Co. & Subs. v.

Commissioner, 155 T.C. 145, 201–02 (2020); see also Sundstrand Corp.,

96 T.C. at 353. However, we have not given the Commissioner deference

akin to the “arbitrary and capricious” standard of review for agency

actions that developed under the Administrative Procedure Act (APA).

See Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins.

Co., 463 U.S. 29, 43 (1983). In reviewing a section 482 allocation, we

afford the Commissioner deference in that we focus on the

reasonableness of the Commissioner’s reallocation. Guidant LLC v.

Commissioner, 146 T.C. 60, 73 (2016). Reasonableness is measured by

reference to the arm’s-length range. If a result falls within the arm’slength range, it should not be adjusted. Treas. Reg. § 1.482-1(e)(1). A

taxpayer may show that the Commissioner reached an unreasonable

result by establishing that its income as reported reflects “the results

that would have been realized if uncontrolled taxpayers had engaged in

the same transaction under the same circumstances.” Id. para. (b)(1).

But that typically requires evidence of comparable uncontrolled

transactions that support the taxpayer’s return position. Coca-Cola, 155

T.C. at 202 (citing Lufkin Foundry & Mach. Co. v. Commissioner, 468

F.2d 805, 807–08 (5th Cir. 1972), rev’g and remanding on other grounds

T.C. Memo. 1971-101).

For some transactions—namely, those involving high-profit

intangibles—comparable transactions between unrelated parties simply

do not occur in normal business settings. To show that the

Commissioner has reached an unreasonable result in these cases, the

taxpayer usually must establish that the Commissioner employed an

unreasonable methodology to reach his result. See id. at 203. A taxpayer

may do this by showing that the Commissioner’s methodology

implicated significant legal error or that the Commissioner

implemented the methodology in an unreasonable manner (e.g., by

employing erroneous assumptions, incorrect data, or internally

inconsistent analysis). See id. at 203 & nn.32 & 33.

We engage in our own factfinding and legal analysis to

redetermine the proper allocation of income. See Sundstrand Corp., 96

T.C. at 354. If the taxpayer demonstrates that the Commissioner’s

allocation is unreasonable but fails to prove an alternative allocation

that is arm’s length, the Court, using its best judgment, “must

determine from the record the proper allocation of income.” Coca-Cola,

155 T.C. at 203–04 (first quoting Sundstrand Corp., 96 T.C. at 354; then

citing Hosp. Corp. of Am. v. Commissioner, 81 T.C. 520, 596–97, 601

(1983); and then citing Nat Harrison Assocs., Inc. v. Commissioner, 42

T.C. 601, 617–18 (1964)). We may make partial allocations to the extent

“the evidence shows that neither side is correct.” Id. at 204 (first quoting

Eli Lilly & Co. v. Commissioner, 856 F.2d 855, 860 (7th Cir. 1988), rev’g

in part on other grounds and remanding 84 T.C. 996 (1985); and then

citing Amazon I, 148 T.C. at 163–214).

IV.

2009 cost sharing regulations generally

We now turn to the regulations themselves before we dig into the

experts’ opinions and our opinion of them. 57 As often is the case, the

devil lies in their details.

The first sentence of the regulations states their objective: “The

arm’s length amount charged in a controlled transaction reasonably

anticipated to contribute to developing intangibles pursuant to a [CSA],

as described in paragraph (b) of this section, must be determined under

a method described in this section.” Temp. Treas. Reg. § 1.482-7T(a).

For PCT Payments, the “method[s] described” in Temp. Treas.

Reg. § 1.482-7T are “the method or methods applicable under the other

section or sections of the section 482 regulations, as supplemented by

paragraph (g).” Id. para. (a)(2). Paragraph (g)(1) lists six methods to be

used for “evaluating the arm’s length amount charged in a PCT.” These

methods then are described in subparagraphs (3) through (8). 58

For CST Payments, the “method described” in Temp. Treas. Reg.

§ 1.482-7T is the “RAB share method.” Id. para. (a)(1). Under the RAB

share method, controlled participants share IDCs in proportion to their

respective RAB shares through CSTs. Id. paras. (a)(1), (b)(1)(i).

The valuation methods in the 2009 cost sharing regulations also

coordinate with the general transfer pricing rules. “Each method must

57 Rather than summarize the experts’ opinions in the facts, we review them

after setting the regulatory context because of the central role the regulations play in

our assessment.

58 “Each method will yield a value for the compensation obligation of each PCT

Payor consistent with the product of the combined pre-tax value to all controlled

participants of the platform contribution that is the subject of the PCT and the PCT

Payor’s RAB share.” Temp. Treas. Reg. § 1.482-7T(g)(1).

be applied in accordance with the provisions of § 1.482-1, except as those

provisions are modified in this section.” Id. para. (a).

Under section 482, as articulated in the regulations, the

Commissioner “may make allocations between or among the members

of a controlled group if a controlled taxpayer has not reported its true

taxable income.” Treas. Reg. § 1.482-1(a)(2). Section 482 is intended to

“place[] a controlled taxpayer on a tax parity with an uncontrolled

taxpayer by determining the true taxable income of the controlled

taxpayer.” Treas. Reg. § 1.482-1(a)(1). The true taxable income is

determined as if the parties to the controlled transaction had conducted

their affairs as unrelated parties “dealing at arm’s length.” Id. para.

(b)(1).

The arm’s-length standard generally is met “if the results of the

transaction are consistent with the results that would have been

realized if uncontrolled taxpayers had engaged in the same transaction

under the same circumstances.” Id. “[B]ecause identical transactions

can rarely be located, whether a transaction produces an arm’s length

result generally will be determined by reference to the results of

comparable transactions under comparable circumstances.” Id.

The 2009 cost sharing regulations define what constitutes an

arm’s-length result in connection with a CSA. Temp. Treas. Reg. § 1.4827T(a)(4) provides:

A CSA produces results that are consistent with an arm’s

length result within the meaning of § 1.482-1(b)(1) if, and

only if, each controlled participant’s IDC share . . . equals

its RAB share, each controlled participant compensates its

RAB share of the value of all platform contributions by

other controlled participants, and all other requirements of

this section[59] are satisfied.

The regulations then authorize the Commissioner to make allocations

to adjust the results of a PCT or CST so that they are consistent with

this arm’s-length result. See id. para. (i)(2) (CST allocations) and

(3) (PCT allocations). The Commissioner also may make “periodic

adjustments.” See id. subpara. (6).

59 These “other requirements” include contractual, documentation, accounting,

and reporting administrative requirements for a CSA. See id. para. (k).

PCT allocations are intended to ensure that each controlled

participant compensates the RAB share value of any platform

contributions made by other participants. Id. subpara. (3) (crossreferencing paragraph (a)(2), which cross-references paragraph

(b)(1)(ii)). Respondent made a PCT allocation, asserting (in his posttrial

opening brief) that Facebook US made platform contributions for which

Facebook Ireland was obligated to compensate it by making payments

computed using an NPV of $19.945 billion for the PCT Payment. We

analyze respondent’s PCT allocation infra Part V, PCT Payment.

CST allocations are intended to ensure that each controlled

participant bears IDCs in proportion to its RAB share. See id.

para. (i)(2). They may result from adjustments to the basis used for

measuring the anticipated benefits and to the projections used to

estimate RAB shares. Id. para. (i)(2)(i)(C) and (D). Respondent made a

CST allocation, increasing Facebook Ireland’s (and decreasing Facebook

US’s) RAB share. Respondent accepted the basis petitioner selected for

measuring benefits (gross profit) but projected gross profit into

perpetuity rather than the three years specified in the CSA. We analyze

respondent’s CST allocation in Part VI, CST Payments.

The 2009 cost sharing regulations also create a system for

classifying the types of assets that CSA participants contribute to a

CSA, and the types of costs they commit to bear under it. See id. paras.

(c)(1), (d)(4), (j)(1)(i). Which valuation method is preferred for valuing

the PCT Payment (and how it applies) turns on how assets and costs are

classified, and which controlled participant contributed them. See id.

para. (g). We therefore turn to the classification system next, before

considering the methods.

Classification of contributions

The regulations divide potential contributions to a CSA into four

categories: (1) platform contributions, (2) operating contributions,

(3) cost contributions, and (4) operating cost contributions. See id. paras.

(c)(1), (d)(4), (j)(1)(i). These contributions can be nonroutine or routine,

depending on whether market returns can be identified for them. See id.

para. (j)(1)(i) (defining nonroutine and routine contributions).

To classify the contributions here we use a few more terms from

the regulations. First, the CSA Activity is defined as “the activity of

developing and exploiting cost shared intangibles.” Id. The intangible

development activity (IDA) means specifically “the activity under the

CSA of developing or attempting to develop reasonably anticipated cost

shared intangibles.” Id. para. (d)(1)(i). And IDCs are those costs that

“are directly identified with, or are reasonably allocable to, the IDA.” Id.

subdiv. (iii). A “reasonably anticipated cost shared intangible” is “any

intangible, within the meaning of § 1.482-4(b), that, at the applicable

point in time, the controlled participants intend to develop under the

CSA.” Temp. Treas. Reg. § 1.482-7T(d)(1)(ii). This concept is used in the

definitions of IDA and platform contributions. Id. paras. (c)(1), (d)(1)(i).

Contributions external to the CSA

Platform contributions

“A platform contribution is any resource, capability, or right that

a controlled participant has developed, maintained, or acquired

externally to the [IDA] (whether prior to or during the course of the CSA)

that is reasonably anticipated to contribute to developing cost shared

intangibles.” Id. para. (c)(1). A participant making a platform

contribution must be compensated by the other parties for the benefits

of that contribution. See id. paras. (a)(4), (b)(1)(ii), (c)(1). This

compensation is made through the PCT Payment. Id. para. (b)(1)(ii).

Operating contributions

“An operating contribution is any resource or capability or right,

other than a platform contribution, that a controlled participant has

developed, maintained, or acquired prior to the CSA Start Date that is

reasonably anticipated to contribute to the CSA Activity within the

controlled participant’s division.” Id. para. (j)(1)(i) (emphasis added).

Because operating contributions cannot include platform

contributions, they by definition contribute to the exploitation of the cost

shared intangibles in a CSA participant’s territory rather than

development. They are borne by the CSA participant with the exclusive

right to exploit the intangibles in that territory. See id. para. (a)(1)

(requiring parties to share IDCs in proportion to RAB shares),

(2) (requiring arm’s-length consideration for PCTs), (3)(iii) (requiring

arm’s-length consideration for cross operating contributions, which

benefit another CSA participant’s territory, see id. para. (j)(1)(i), but not

operating contributions or operating cost contributions).

Contributions internal to the CSA

Cost contributions

Costs incurred in connection with developing cost shared

intangibles are classified as cost contributions; they essentially are

synonymous with IDCs. See id. para. (d)(4) (“A controlled participant’s

cost contribution for a taxable year means all of the IDCs initially borne

by the controlled participant, plus all of the CST Payments that the

participant makes to other controlled participants, minus all of the CST

Payments that the participant receives from other controlled

participants.”).

Operating cost contributions

Operating cost contributions, like operating contributions, are

reasonably anticipated to contribute to exploiting cost shared

intangibles as part of the CSA Activity but are incurred after the CSA

begins. Operating cost contributions are defined in paragraph (j)(1)(i) as

all costs in the ordinary course of business on or after the

CSA Start Date that, based on analysis of the facts and

circumstances, are directly identified with, or are

reasonably allocable to, developing resources, capabilities,

or rights (other than reasonably anticipated cost shared

intangibles) that are reasonably anticipated to contribute

to the CSA Activity within the controlled participant’s

division.

Summary

Platform contributions and operating contributions are external

to the CSA while cost contributions and operating cost contributions are

made as part of the CSA. See id. paras. (c)(1), (d)(4), (j)(1)(i). Platform

contributions and cost contributions contribute to developing cost

shared intangibles whereas operating contributions and operating cost

contributions contribute to exploiting them. See id. paras. (c)(1), (d)(1)(i),

(4), (j)(1)(i).

The matrix below summarizes the types of contributions, whether

a contribution is related to exploitation or development, and its relation

to the CSA.

Contribution

type

Exploitation or

development

Relation to the CSA

Platform

contribution

Development

External to the CSA

FOP technology

Operating

contribution

Exploitation

External to the CSA

User community rights

and marketing

intangibles

Cost

contribution

Development

Part of CSA Activity

and part of IDA

RAB share of IDCs

Operating cost

contribution

Exploitation

Part of CSA Activity

but not part of IDA

Ad sales and marketing

on or after CSA start

date in ROW territory

Examples 60

PCT Payment valuation methods

With contributions classified, the regulations then provide rules

for selecting one of the six methods they specify for calculating an arm’slength PCT Payment. These six methods are (1) the comparable

uncontrolled transaction (CUT) method described in Treas. Reg. § 1.4824(c) or the comparable uncontrolled services price (CUSP) method

described in Treas. Reg. § 1.482-9(c); (2) the income method; (3) the

acquisition price method; (4) the market capitalization method; (5) the

RPSM; and (6) unspecified methods. Temp. Treas. Reg. § 1.482-7T(g)(1),

(3)–(8).

The regulations also “provide[] supplemental guidance on

applying the methods.” Id. para. (g)(1). “Each method must be applied

in accordance with the provisions of § 1.482-1, including the best method

rule of § 1.482-1(c), the comparability analysis of § 1.482-1(d), and the

arm’s length range of § 1.482-1(e), except as those provisions are

modified in this paragraph (g).” Temp. Treas. Reg. § 1.482-7T(g)(2)(i).

The best method rule requires that “[t]he arm’s length result of a

controlled transaction must be determined under the method that,

under the facts and circumstances, provides the most reliable measure

of an arm’s length result.” Treas. Reg. § 1.482-1(c)(1). “[T]he two primary

factors to take into account are the degree of comparability between the

60 These examples are not meant to be exhaustive but rather to illustrate the

application of the definitions. See detailed discussion infra Part V.B.1.a.

controlled transaction (or taxpayer) and any uncontrolled comparables,

and the quality of the data and assumptions used in the analysis.” Id.

subpara. (2). Factors for determining the degree of comparability include

those listed in Treas. Reg. § 1.482-1(d)(1): functions, contractual terms,

risks, economic conditions, and property or services. See id. para.

(c)(2)(i). Treas. Reg. § 1.482-1(c)(2)(iii) also provides that “in evaluating

different applications of the same method, the fact that a second method

(or another application of the first method) produces results that are

consistent with one of the competing applications may be taken into

account.”

Additional principles include rules regarding realistic

alternatives and aggregation of transactions. Temp. Treas. Reg. § 1.4827T(g)(2)(iii) and (iv). The aggregation rule in paragraph (g)(2)(iv)

coordinates with the general aggregation rule in Treas. Reg. § 1.4821(f)(2)(i). And the discount rate and financial projections rules provide

guidance for selecting inputs into methods. Temp. Treas. Reg. § 1.4827T(g)(2)(v) and (vi). 61

The parties appear to agree that the CUT/CUSP, acquisition

price, and market capitalization methods are not the best methods for

valuing the PCT Payment. The reasons are obvious: The CUT/CUSP

method does not apply because there is no comparable for the CSA as a

whole; the acquisition price method does not apply because there was no

acquisition; and the market capitalization method does not apply

because Facebook was not publicly traded at the time of the CSA (a

requirement for the method). 62 That leaves the income method, RPSM,

and unspecified methods. We address the income method first because

both parties’ experts adopted it in some form.

Income method

The income method generally requires a controlled participant

that does not make a nonroutine platform contribution (the PCT Payor)

to pay another CSA participant (the PCT Payee) for (1) all of the

financial benefits that the PCT Payee’s nonroutine platform

contribution is projected to generate in the PCT Payor’s territory, minus

61 The remaining supplemental rules include those under Temp. Treas. Reg.

§ 1.482-7T(g)(2)(vii) (“Accounting principles”), (viii) (“Valuations of subsequent PCTs”),

(ix) (“Arm’s length range”), and (x) (“Valuation undertaken on a pre-tax basis”).

62 As we discuss later, respondent does argue that market valuations may be

used to corroborate other methods.

(2) a market-based return for (a) the functions and risks the PCT Payor

commits to perform and bear in its territory under the CSA (its

operating cost contributions), and (b) the IDCs it commits to pay each

year to further develop the cost shared intangibles in the CSA (its cost

contributions).

The income method values the nonroutine contributions to the

CSA (ones for which no market return can be identified) by projecting

all expected value in a territory and then subtracting contributions for

which market returns may be identified (routine contributions). The

income method thus gives the PCT Payor a routine return on its

operations to exploit the cost shared intangibles in its territory and on

the funds it invests in the CSA to develop (or further develop) the cost

shared intangibles. The remaining projected expected benefits—the

projected nonroutine or residual benefits—go to the PCT Payee through

the PCT Payment.

Mechanics of the income method

“The income method evaluates whether the amount charged in a

PCT is arm’s length by reference to a controlled participant’s best

realistic alternative to entering into a CSA.” Id. subpara. (4)(i)(A). It

thus solves for the PCT Payment, which it explains “will be an amount

such that a controlled participant’s present value, as of the date of the

PCT, of its cost sharing alternative of entering into a CSA equals the

present value of its best realistic alternative.” Id.

The PCT Payor’s “cost sharing alternative” is “the actual CSA” in

which it commits to make an arm’s-length PCT Payment and commits

to bear the risk of intangible development by making cost contributions

for the duration of the CSA. Id. subdiv. (i)(B). The present value of the

PCT Payor’s cost sharing alternative is “the present value of the stream

of the reasonably anticipated residuals over the duration of the CSA

Activity of divisional profits or losses, minus operating cost

contributions, minus cost contributions, minus PCT Payments.” Id.

subdiv. (ii).

The PCT Payor’s “best realistic alternative” generally is “to

license intangibles to be developed by an uncontrolled licensor [the PCT

Payee] that undertakes the commitment to bear the entire risk of

intangible development that would otherwise have been shared under

the CSA.” Id. subdiv. (i)(A). “The licensing alternative is derived on the

basis of a functional and risk analysis of the cost sharing alternative,

but with a shift of the risk of cost contributions to the licensor,” the PCT

Payee, hypothetically acting as an uncontrolled licensor. Id. subdiv.

(i)(C). The PCT Payor still bears “the risks of any existing resources,

capabilities, or rights, as well as of the risks of developing other

resources, capabilities, or rights that would be reasonably anticipated to

contribute to exploitation within the parties’ divisions.” Id. (emphasis

added). These are the risks related to the PCT Payor’s operating

contributions and operating cost contributions. The income method thus

values the functions that the PCT Payor still would perform had it

simply licensed the intangibles (rather than agreeing to license and

further codevelop them as under the actual CSA) by determining what

an uncontrolled licensee would receive (or an uncontrolled licensor

would pay) for them, and then discounting this arm’s-length

compensation at an appropriate discount rate. See id. subparas. (2)(v),

(4)(i)(A).

In other words, under the licensing alternative the PCT Payor

performs the same functions and bears the same risks that it commits

to bear under the actual CSA except for its RAB share of IDCs (cost

contributions). The PCT Payment excludes the value of the

benchmarkable (i.e., routine) functions and risks performed by the PCT

Payor, reflecting the principle that the PCT Payor need not pay for the

value of activities that it is committing to perform in its territory. The

present value of these activities (the best realistic alternative) may be

determined using the CUT method as described in Treas. Reg. § 1.4824(c)(1) and (2), or the comparable profits method (CPM) as described in

Treas. Reg. § 1.482-5. See Temp. Treas. Reg. § 1.482-7T(g)(4)(iii)(A)

(“Evaluation based on CUT”) and (B) (“Evaluation based on CPM”).

With this general framework established in paragraph (g)(4)(i),

subdivisions (ii) through (iv) then “describe specific applications of the

income method, but do not exclude other possible applications of this

method.” Id. para. (g)(4)(i)(A).

When the income method is preferred

The income method applies when only one CSA participant makes

nonroutine platform contributions. See id. subdiv. (i)(D). Routine

platform or operating contributions by the PCT Payor do not foreclose

use of the income method. See id. subdiv. (v)(E). Any operating

contributions by the PCT Payor should be accounted for in any

comparable used for pricing the income method’s licensing alternative

(along with operating cost contributions made on or after the start of the

CSA), as explained above. See id.

Finally, the income method “may be used even if the PCT Payor

furnishes significant operating contributions, or commits to assume the

risk of significant operating cost contributions, to the PCT Payor’s

division,” but any CUT method or CPM for valuing those “should be

consistent with such contributions (or reliable adjustments must be

made for material differences).” Id.

Residual profit split method

The RPSM is preferred if more than one CSA participant makes

a nonroutine platform contribution. See id. subpara. (7)(i). The RPSM

“evaluates whether the allocation of combined operating profit or loss

attributable to one or more platform contributions subject to a PCT is

arm’s length by reference to the relative value of each controlled

participant’s contribution to that combined operating profit or loss.” Id.

Unspecified method

An unspecified method is one not specified in Temp. Treas. Reg.

§ 1.482-7T(g)(3) through (7). Id. subpara. (8). An unspecified method

“may be used to evaluate whether the amount charged for a PCT is arm’s

length.” Id. It must be applied consistent with paragraph (g)(2) and

Treas. Reg. § 1.482-1. Temp. Treas. Reg. § 1.482-7T(g)(8). It is preferred

if “it provides the most reliable measure of an arm’s length result under

the principles of the best method rule.” Id. (citing Treas. Reg. § 1.4821(c) (best method rule)).

PCT Payment

Against this regulatory backdrop we turn to the main dispute

before us: whether respondent’s adoption and application of the income

method, through his expert, Dr. Newlon, to determine the PCT Payment

was reasonable, or whether we instead should adopt the unspecified

method espoused ultimately by petitioner’s expert, Dr. Unni. 63

Petitioner also challenges the 2009 cost sharing regulations on their

63 Petitioner relies primarily on Dr. Unni’s unspecified method, arguing that

Dr. Reichert’s RPSM and result confirm that Dr. Unni’s method and result are superior

to Dr. Newlon’s.

face; we take that up after wading through their application to the facts

that we have found.

Respondent’s PCT Payment determination

Dr. Newlon’s key economic considerations

Dr. Newlon identified two “Key Economic Considerations” that he

then used to define the parties’ cost sharing and best realistic

alternatives: (1) the value of Facebook US’s platform contributions

should be evaluated in the aggregate (a package deal) and (2) Facebook

Ireland had a weak bargaining position because Facebook US could have

replaced it (effectively a “no deal” scenario). Because he framed these

economic considerations as important factors that would affect how

uncontrolled parties would evaluate the terms of the CSA, and what

PCT Payment would be arm’s length, we start with them.

Dr. Newlon first posited that a separate arm’s-length charge

cannot be reliably determined for each of the three assets transferred

because the CSA was “a package deal in which Facebook US transferred

to Facebook Ireland the aggregate benefits from the [ROW territory]

that derive from all the assets and capabilities of Facebook’s business.”

He defined the CSA, which he called the “Cost Sharing Deal,” as the

three September 15, 2010, agreements—the CSA, the FOP technology

license, and the UBMI license. He adopted his package-deal approach

because, in his opinion, that is how an uncontrolled party would have

valued the assets transferred by the three agreements.

Relying on his package-deal approach, Dr. Newlon arrived at a

PCT Payment amount by valuing all projected cashflows for the ROW

territory that Facebook US would forgo by entering into the CSA

agreements. Citing the aggregation rule in Temp. Treas. Reg. § 1.4827T(g)(2)(iv), respondent adopts Dr. Newlon’s opinion that the assets

interact with, and complement, each other and therefore together are

worth substantially more than the sum of their separate values. In

respondent’s view, the transaction’s use of separate agreements to

license distinct intangible assets, and Facebook’s separate valuation of

each (reporting separate royalty amounts in its transfer pricing

documentation), was contrary to commercial reality. (Respondent also

criticizes a separate valuation by Dr. Unni on this basis.)

Dr. Newlon also claimed that Facebook Ireland was in a weak

bargaining position compared to Facebook US because it had minimal

workforce and fixed assets as of the transaction date, whereas Facebook

US owned the largest social network in the world. Facebook Ireland

owned no rights to the expected ROW territory revenue and could not

generate for itself more than a routine market return for providing

routine services without Facebook US. Dr. Newlon thus presumed that

“Facebook US had the realistic alternative of retaining [the] expected

future stream of benefits [from the ROW territory] by replacing

Facebook Ireland,” and that it could do this by replicating Facebook

Ireland’s workforce and fixed assets as of the transaction date. Dr.

Newlon therefore opined that Facebook Ireland could not have

negotiated a better outcome than compensating Facebook US for the

present value of the ROW territory revenue Facebook Ireland expected

to receive under the CSA, and being compensated as a routine service

provider as it had been before the CSA.

Dr. Newlon’s method

With his two key economic considerations established, Dr.

Newlon selected and applied the income method. He did not classify the

initial contributions to the CSA as either platform or operating

contributions. In his view, labels “would make no difference” to an

uncontrolled party. What would matter to an uncontrolled party is that

it receive compensation for “the future benefits it was to forgo by

entering into the deal.” Nonetheless, to simplify his analysis he referred

to the “aggregate payments” he computed “as PCT payments.” He also

concluded that the 2009 license of intangibles to Facebook Ireland

(through the IPLA) would not significantly affect the arm’s-length

amount that Facebook Ireland otherwise would have been willing to pay

under the CSA (as PCT Payor) and Facebook US otherwise would have

been willing to accept (as PCT Payee).

Dr. Newlon estimated the arm’s-length payment as the difference

between the present value of the cashflows Facebook US would have

received under his package “Cost Sharing Deal” and a services

alternative which he considered Facebook Ireland’s best realistic

alternative. 64 In his package “Cost Sharing Deal” Facebook US

transferred all ROW territory benefits to Facebook Ireland. Under his

services alternative, he assumed that Facebook US would retain the

64 Dr. Newlon acknowledged that the income method uses operating income

rather than cashflows. He nevertheless discounted cashflows because, in his opinion,

a DCF method “is consistent with standard valuation practices and the economic

premise underlying those practices, which is that the value of a business asset is

derived from the cash it is expected to generate, adjusted for risk and the timing of the

receipt of that cash.”

rights to the benefits from the FOP technology in the ROW territory and

replace the functions and risks that Facebook Ireland committed to

perform and bear under the CSA with the terms in the SMSAs. With

respect to the sales and marketing functions Facebook Ireland

committed to perform in the ROW territory under the CSA, he first

applied a CPM analysis that used the profit levels of advertising

agencies and produced a median return of cost-plus-13.9% for this

function. He then rejected this return in favor of the cost-plus-8% he

identified in the SMSAs. He concluded that Facebook US could have

funded the FB Foreign Sales Affiliates at the same rate as it had before

the CSA. He viewed the SMSAs as a “natural” realistic alternative to

the sales and marketing functions that Facebook Ireland committed to

perform under the CSA. 65 Dr. Newlon also concluded that the G&A

functions that Facebook Ireland committed to perform in the ROW

territory under the CSA could have been replaced at cost-plus-8%.

Finally, to replace the data center management or operation services

that Facebook Ireland committed to perform in the ROW territory, Dr.

Newlon adopted the cost-plus-10% compensation specified in the DHSA.

To project the cashflows for purposes of calculating the present

value of the actual CSA and his services alternative, Dr. Newlon adopted

the LRP Base Case projections for 2010 through 2013 (that is, he

included $1.9 billion in Other Revenue). For 2014 through 2020 he relied

on certain assumptions from EY’s transfer pricing documentation, with

two significant adjustments. First, he adopted a 2013 operating margin

(i.e., the ratio of operating income to revenue) from the LRP Base Case,

whereas EY used a lower operating margin based on the LRP Downside

Excluding Other Revenue. He then applied that operating margin

forward through 2020 using the same assumption as EY, that the

operating margin would decrease by 0.5% each year because of

increasing competition. Second, he included substantial “acquisition

expenditures” on the assumption that Facebook US would make future

acquisitions for which Facebook Ireland would need to compensate it

(thereby reducing the cashflow forgone by Facebook US by entering into

the CSA). To estimate Facebook’s future acquisition expenditures, he

relied on key assumptions in the LRP along with Facebook’s net

investment expenditures for 2010 through 2018, including its actual

acquisition expenditures, as reported in its financial statements for later

years. For the terminal value of expected future cashflows, he selected

a 1% long-run real growth rate for Facebook’s ROW territory business

65 We infer from Dr. Newlon’s description that he means the SMSAs when he

discusses Facebook’s pre-CSA agreements.

and added a 2% inflation rate, which was equal to the Federal Reserve

target for annual inflation.

Dr. Newlon next estimated discount rates for converting the

actual CSA and his services alternative cashflows to present value by

estimating the WACC for those cashflows. For the CSA cashflows, he

estimated the WACC by using the capital asset pricing model (CAPM) 66

to estimate Facebook’s cost of equity capital. To estimate Facebook’s

beta, 67 he calculated the median beta of a set of eight U.S.-traded public

companies that earned most of their revenue from advertising and

operated some form of online platform business: Alphabet Inc. (Google),

Altaba Inc. (Yahoo!), Baidu, Inc., Local Corporation, SINA Corporation

(Weibo), Travelzoo, WebMD Health Corp., and XO Group Inc. He did not

“unlever” these comparables by adjusting for the cash and debt they

held. 68 The resulting beta of 1.178, combined with his selected risk-free

rate (3.55%) and equity risk premium (6.7%), produced a cost of equity

of 11.44%. 69

Dr. Newlon then made two adjustments to this cost of equity.

First, because Facebook was a private company as of the transaction

date, he added 2%. To derive this “pre-IPO adjustment,” he started with

an estimate for the cost of capital premium for VC over public firms of

2.9% to 3.3% (or 3.3% to 6.9% gross of fees), excluding small

capitalization firms, citing Andrew Metrick & Ayako Yasuda, Venture

Capital and the Finance of Innovation 76, 79 (2d ed. 2011) (Metrick &

Yasuda) as his source. He then decreased these estimated premia to 2%

because he concluded that Facebook’s business as of the transaction date

was more advanced than that of the average recipient of a VC

investment. Second, he added a 1% “international adjustment” because

66 “CAPM is a standard and widely used method to determine a company’s cost

of equity capital. Under the CAPM the expected rate of return for a company’s equity

is generally the risk-free rate of return plus the product of beta and an equity risk

premium.” Amazon I, 148 T.C. at 184 n.34.

67 Beta represents the magnitude of systematic risk of an investment as

compared to the market. We discuss beta in some detail infra Part V.B.3.b.ii.

68 Dr. Newlon explained the idea of unlevering as based on the premise that

cash has a zero beta so it can be separated from the beta for the operating business.

Once the combined beta for the cash and the operating business is known, the beta for

the operating business alone can be derived.

69 Dr. Newlon selected his risk-free rate by looking to the yield on 20-year U.S.

Treasury bonds. He selected his equity-risk premium by looking to data from Ibbotson

Associates.

he concluded that Facebook’s business in the ROW territory was at a

“somewhat” earlier stage of development and therefore would be subject

to “somewhat” greater risk than the overall business. Applying these

two adjustments, Dr. Newlon concluded that the discount rate for the

CSA cashflows was 14.44%.

For his services alternative cashflows, Dr. Newlon estimated the

WACC for three categories of services: sales and marketing services

(8.81%), data center services (9.63%), and G&A services (8.31%). He

estimated these WACCs by reference to comparable third-party service

providers for these categories in the United States, Canada, and

Western Europe.

Applying the specified income method with these inputs, Dr.

Newlon concluded that the arm’s-length PCT Payment value falls within

a range of $18.757 billion to $21.147 billion (using different discount

rates he identified as permitted); using his median discount rates stated

above he computed a PCT Payment value of $19.945 billion. Respondent

submits that this is the arm’s-length PCT Payment value.

Dr. Newlon tested the reasonableness of his two key valuation

inputs—the financial projections in the ROW territory and the

appropriate discount rates for each alternative—by using them to

estimate the present value of Facebook’s global business as of the

transaction date (approximately $30 billion), and then comparing that

enterprise value estimate to various contemporaneous valuations of

Facebook. These contemporaneous valuations include section 409A

valuations prepared by KPMG in 2010 (after the transaction date) which

estimated Facebook’s enterprise value to be approximately $28.5 billion,

and financial news stories, which estimated Facebook’s market

capitalization to be around $30 billion (based on secondary market

transactions and equity investments in Facebook in 2010). Dr. Newlon

observed that the enterprise value implied by his inputs is “not high”

compared to one contained in a November 2010 Bloomberg article ($41

billion) or compared to the implied equity value used by the investment

bank for its investment evaluation in December 2010. In his view, the

PCT was akin to a transfer of the entire business, which justified testing

his valuation inputs against these contemporaneous enterprise

valuations. He therefore contended that lowering his financial

projections or increasing his discount rate would lead to a result that is

inconsistent with contemporaneous valuations of Facebook.

Respondent offers two other experts, Ilya Strebulaev and Carl

Saba, who also estimated Facebook’s market capitalization as of the

transaction date to be above $30 billion using secondary market

transactions.

Application of 2009 cost sharing regulations

As we explained supra Part III, under Coca-Cola we must decide

whether Dr. Newlon’s methodology, adopted by respondent, was

reasonable before we consider petitioner’s competing methodology.

Applying the regulations to evaluate Dr. Newlon’s valuation, we

conclude that the income method is the best method but Dr. Newlon

used erroneous inputs and therefore reached an unreasonable result.

Method selection

A threshold question is which method—the income method, the

RPSM, or an unspecified method—should be applied. This turns on

whether Facebook Ireland (and not just Facebook US) made a

nonroutine platform contribution to the CSA, as petitioner contends. See

Temp. Treas. Reg. § 1.482-7T(g)(4)(i)(D). If Facebook Ireland also made

such contributions, then the RPSM is favored over the income method.

See id.

To resolve this issue, we first classify the contributions made to

the CSA as either platform or operating contributions. We then decide

whether Facebook Ireland made any nonroutine platform contributions.

Classifying initial contributions

The parties agree that the existing FOP technology contributed

to the CSA on the transaction date, through the FOP technology license,

would contribute to the development of future versions of the FOP

technology under the CSA. It therefore is a plat

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