BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Facebook Doesn't Pay Taxes On Its Profits: So What?

This article is more than 10 years old.

We've a rather breathless report designed to stir up outrage over the manner in which Facebook isn't going to pay the corporate income tax on the $ billion or so of profits that it has announced for last financial year. Not only won't it not pay taxes on that amount it appears to have a tax refund from previous years. Sadly the story is simply an example of how some people just do not understand the taxation system:

Earlier this month, the Facebook Inc. released its first “10-K” annual financial report since going public last year. Hidden in the report’s footnotes is an amazing admission: despite $1.1 billion in U.S. profits in 2012, Facebook did not pay even a dime in federal and state income taxes.

Instead, Facebook says it will receive net tax refunds totaling $429 million.

Facebook’s income tax refunds stem from the company’s use of a single tax break, the tax deductibility of executive stock options.

All of that is true and there's two things going on here.

The first is that refund from past years, and the fact that they have further tax allowances of a couple of billion to take forward into future years.

Well, yes, of course they do. Facebook is a very young company and it made losses for a number of years. Corporations do not get taxed on profits purely in any one tax year. They get taxed on cumulative profits over time. The system simply has to be this way. Two examples: a company starts up and makes losses for the first few years as it refines its technology, finds customers and so on. Then it breaks into profit: should we tax purely that profit when it finally arrives or should they be allowed to carry forward those losses to offset against the profits? Well, think of someone doing exactly the same thing but as a part of an extant company rather than being independent. That section of a company will find all those expenses of technology, those losses while looking for customers, are written off profits of the larger company. They must be: they're expenses of the company doing business. If the larger company is spending $10 million a year building this new business then obviously their profits are $10 million lower while they do that and thus their tax bill is lower.

So, if we don't allow a new business to carry forward tax losses then we're crippling the new business as against the section of an established company. That wouldn't be sensible: as well as being most un-American in favouring the big guy over the little.

The second is this idea of the tax deductibility of share options themselves. Well of course they're tax deductible: they're a cost of doing business. That's just how Facebook pays its people and paying the staff is indeed a cost of doing business.

....but there’s nothing illegal about the breaks the company is claiming. Companies like Facebook are allowed to treat the cost of non-cash compensation, such as stock options, as an expense that reduces profits, essentially the way they treat cash compensation such as salaries.

The difference is that Facebook—unlike, say, General Motors (GM)—relies heavily on stock options and restricted stock units as a form of compensation. It paid out a lot during its years as a private company that it must now recognize on its income statement and balance sheet.

Quite, there's nothing odd or strange about this.

There is one area where I do have some sympathy for the complaint though:

That’s because the oddly-designed rules require the value of the stock options for book purposes to be calculated — or guessed at — when the options are issued, while the tax deductions reflect the actual value when the options are exercised.

Which leads to this:

Some members of Congress have recently taken aim at this remaining tax break. In July of 2011, Senator Carl Levin (D-MI) introduced the “Ending Excess Executive Corporate Deductions for Stock Options Act,” to require companies to treat stock options the same for both book and tax purposes.

There are often differences in the way that things are treated under tax accounting and public corporate accounting rules. Things like depreciation, investment in R&D, these stock option accounting rules are all examples. And I agree that it probably would be better to have a move to just one set of such rules. It would, of course, be the tax rules that win in such circumstances. Which would lead us to rather a strange result.

Companies like Facebook wouldn't pay any more in taxes as a result for of course they're currently compliant with those tax rules. But they would be reporting an awful lot less in profits as a result of reporting options under the tax rules in their public accounts. In fact, in this case, Facebook's $1.1 billion profit last year would have been a loss if it had had to report under the tax laws. That might be a good thing and it might be a bad one but I'm pretty sure that would be the result.

Finally, something that really should be pointed out. Yes, it's true that as a result of this treatment of stock options Facebook itself didn't pay any tax for last year. But then corporations never do actually pay tax. It's always shareholders or the workers who carry the actual burden of the corporate income tax. In this case, sure, Facebook paid no tax. But all those who exercised those stock options most certainly did pay tax. At one point Mark Zuckerberg was reported as owing $500 million in taxes for 2012 as a result of exercising his options. He sold stock in the IPO to that value specifically (so the IPO offer documents said) in order to pay those taxes due.

So the true effect of this treatment of stock options is not to reduce the amount of tax paid at all. It's just to shift who is nominally paying it. From the company that has granted the options to the people who exercise them. And, most interestingly, it hasn't even lowered the amount of tax to be paid either. Standard corporate income tax on $1.1 billion in profits would be $385 million. Looks like Zuckerberg alone should be paying more than that and there's many others who cashed out at the IPO and since who will be swelling the tax coffers.

That the reporting rules for tax and for public company accounts should be equalised has some possible merit to it. The rest of it I would, charitably, put down to people not understanding how the tax system works.