On July 26, 2017, the United States Tax Court (Tax Court) handed a complete victory to Eaton Corporation (Eaton) relating to the Internal Revenue Service’s (IRS) cancellation of two Advance Pricing Agreements (APA). Eaton Corporation v. Commissioner, TC Memo 2017-147. The Tax Court held that the IRS had abused its discretion in cancelling the two successive unilateral APAs entered into by Eaton and its subsidiaries with respect to the manufacturing of circuit breaker products in Puerto Rico, and it found no transfer of any intangibles subject to Internal Revenue Code (Code) Section 367(d). In 2011, the IRS cancelled Eaton’s first APA effective January 1, 2005, and the renewal APA effective January 1, 2006, on the ground that Eaton had made numerous material misrepresentations during the negotiations of the APAs and during the implementation of the APAs. As a result of the APA cancellations, the IRS issued notice of deficiencies for 2005 and 2006 determining that a transfer pricing adjustment under Code Section 482 was necessary to reflect the arm’s-length result for the related party transactions. Eaton disputed the deficiency determinations, contending that the IRS abused its discretion in cancelling the two APAs.
The Tax Court considered whether Eaton made misrepresentations during the negotiations or the implementation. With respect to the APA negotiations, the court established the standard for misrepresentation as “false or misleading, usually with an intent to deceive, and relate to the terms of the APA.” Based on the evidence of the negotiations presented at trial, the court concluded that there were no grounds for cancellation of the APAs; “Eaton’s evidence that it answered all questions asked and turned over all requested material is uncontradicted.” Additionally, the court rejected the IRS’s contention that more information was needed; “The negotiation process for these APAs was long and thorough.” Thus, the IRS “had enough material to decide not to agree to the APAs or to reject petitioner’s proposed TPM and suggest another APA. Cancelling the APAs on the grounds related to the APA negotiations was arbitrary.” (more…)