Though down approximately $30 million from the end of 2021, Facebook’s (FB) unrecognized tax benefit accrual increased approximately $440 million to $9.7 billion in the latest quarter versus the third quarter 2021. The company’s unrecognized tax benefits are primarily for the uncertainties related to transfer pricing with its foreign subsidiaries, which include licensing of intellectual property, providing services and other transactions that are supposed to be transacted at arms-length prices.

The uncertain tax benefits have increased 10.5% and 12.8% in 2020 and 2021 respectively.

We suspect the increased accruals are in anticipation of receiving a significant tax bill from the IRS related to transfer pricing. It’s an issue we’ve been tracking for two years after the IRS signaled increased transfer pricing scrutiny was on the horizon. In April 2020, the IRS issued guidance outlining best practices and common mistakes in preparing transfer pricing documentation.

Since then, we’ve detailed how Coca-Cola (KO) may owe $13 billion in a transfer pricing dispute in which the beverage giant says the IRS has reneged on a previously agreed upon transfer pricing methodology that would exempt it from penalties going forward. Likewise, Edwards Lifesciences (EW) received a $180 million tax bill related to transfer pricing dispute the company says breaks with previously agreed upon transfer pricing methodologies.

It’s not the first time Facebook transfer pricing has been scrutinized.

In 2016 and 2018, the IRS issued formal assessments related to Facebook’s transfer pricing with foreign subsidiaries for tax years 2010 through 2013 tax years. The matter has yet to be resolved or, to our knowledge, quantified other than in the aforementioned accruals.

In the company’s most recent annual report, Facebook’s auditor cited the company’s uncertain tax positions related to transfer pricing methodologies as a critical audit matter. The auditor also warned the IRS is now examining tax years other than those previously disclosed:
“The IRS has stated that it will also apply its position to tax years subsequent to those examined.”

If Facebook receives a Notice of Proposed Adjustment (NOPA) from the IRS equal to the company’s $9.7 billion accrual, it would be the equivalent of 114% of the current quarter’s operating income and 20.7% of 2021’s operating income. It’s also nearly equivalent to the $10 billion revenue hit Facebook attributed to Apple’s privacy changes that helped send shares down 24% when announced with last quarter’s earnings.