Facebook Has Figured Out How to Pay $0 in Foreign Taxes. Here's How.

The news: Facebook exploited tax loopholes that enabled it to reduce its tax payments in the UK, where it earned over $1 billion last year, to zero, according to reports by the Guardian. The scheme involves two holding companies in Ireland, subsidiaries in the Cayman Islands, and tax-evasion practices perfected by technology multinationals like Apple and Google. 

A Facebook spokesman maintained that the company, “complies with all relevant corporate regulations,” and suggested that its Dublin location was selected based on Ireland’s skilled and multilingual workforce, and not for the sake of dodging payments. Member of Parliament Magaret Hodge countered that the setup appears to be a, “deliberate manipulation of accounts of economic activity to deprive the British taxpayer of a rightful tax contribution.”

The background: The Cayman Islands have long been a popular tax haven, providing individuals and corporations with the ability to shield their earnings from home country taxes, and enabling organized crime groups to launder their profits. Last week, the United States government signed an agreement with the Cayman Islands called the Foreign Account Tax Compliance Act that will require the country, and companies in it, to provide greater transparency.

Ireland’s role in tax avoidance, referred to as the “double Irish,” is more recent. It was pioneered by Apple, and according to a congressional hearing in May, the double Irish has saved Apple at least $74 billion in U.S. taxes since 2009. Tech companies like Intel, Google, LinkedIn, and Oracle have all adopted the practice, and are benefiting from similar savings. In the scheme, companies establish two Irish subsidiaries, one of which is held in a tax haven, usually the Cayman Islands. The non-Cayman subsidiary can then collect payments, which it pays to the Cayman subsidiary as royalties. Those royalties are written off as business expenses, reducing the share of taxable income in Ireland and avoiding U.S. taxes entirely. 

The takeaway: Both Facebook and Hodge are likely right. Facebook’s exploitation of the tax loophole was almost certainly legal in nature, but there’s no question that the convoluted setup is explicitly geared toward avoiding taxes in highly profitable advertising markets like the UK. While Facebook shouldn’t necessarily be faulted for taking advantage of a known flaw, it’s also entirely fair for governments to exert pressure on Ireland in an attempt to rectify the situation.  

To that end, the EU recently launched a probe into Ireland’s taxation practices and their role in sapping European countries of tax revenue. As international pressures increase, Ireland is considering eliminating the loophole, even though doing so will remove one of the engines powering the country’s economic recovery.