United States

Court rules IRS abused discretion trying to cancel Eaton's APAs

TAX ALERT  | 

In a decision issued on July 26, 2017, U.S. Tax Court Judge Kathleen Kerrigan ruled it was an abuse of discretion for the IRS to cancel two advanced pricing agreements entered into by Eaton Corporation.

The ruling (Eaton Corp. v. Commissioner, T.C. Memo. 2017-147, T.C., No. 5576-12, 7/26/17) stated that the IRS missed its opportunities to change the transfer pricing methodologies during advanced pricing agreement negotiations and could not change its method after the fact to arrive at a different profit split. The advanced pricing agreements involved the sale of products from Eaton’s manufacturing sites in Puerto Rico and the Dominican Republic to its U.S. affiliates. The IRS’ attempt to cancel the agreements retroactively in 2011 would have increased Eaton’s taxable income by more than $368 million.

The IRS argued Eaton failed to comply in good faith with the terms and conditions on the APAs and failed to satisfy annual reporting requirements associated with the APAs. Eaton argued it did not omit or misrepresent any reporting requirements. Judge Kerrigan disagreed with the IRS stating the IRS had multiple opportunities previously to disagree with Eaton’s APAs. 

Kerrigan stated, “An APA is a binding agreement and it should be canceled only according to the terms of the revenue procedures. It should not be canceled because of a desire to change the underlying methodology of a method that would result in a significantly different profit split.”

As Eaton is also challenging the IRS on other income adjustments related to the cancellation of the APAs, taxpayers should track the outcomes of these other adjustments to see if this ruling holds because it may inform future transfer pricing approaches.

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