February 10, 2023
Tax Court approves agreement by Eaton Corporation and the IRS resolving APA cancellation case
On February 3, 2023, the Tax Court issued a stipulation approving an agreement between Eaton Corp. (Eaton) and the IRS to adjust Eaton's tax bill for 2005 and 2006 to $8.8 million.1 The proposal follows lengthy litigation in both the Tax Court and the Sixth Circuit Court of Appeals.
The case originated with Eaton's inadvertent errors in calculating its transfer pricing methodology for its Advance Pricing Agreement (APA) annual reports in 2005 and 2006 (see Tax Alert 2022-1334 for an in-depth history). The IRS used these inadvertent errors to justify cancelling Eaton's APAs and propose a $75 million adjustment plus $51 million in IRC Section 6662 penalties.
The Tax Court held that the IRS was not authorized to cancel Eaton's APAs and rejected the IRS's assertion of penalties. The IRS appealed the Tax Court's decision to the Sixth Circuit, but the appeals court ruled in favor of Eaton, finding that the IRS had the burden of proving that it had grounds to cancel the APAs under contract-law principles and failed to do so. In November 2022, Chief Judge Kerrigan ordered Eaton and the IRS to submit a proposed decision on or before January 20, 2023.2 The proposed decision determined deficiencies of $4.7 million in 2005 and $4.6 million in 2006, with no penalties. On February 3, 2023, Chief Judge Kerrigan issued a stipulated order identical to the proposed decision, which also took into account overpayments of tax for each year to result in the final $8.8 million adjustment.3
Taxpayers should pay attention to how the IRS revises Revenue Procedure 2015-41 (which provides guidance on requesting and obtaining APAs) while keeping in mind that every dispute concerning an APA depends on the facts of the particular case. The IRS rarely cancels APAs,4 and taxpayers can often resolve mistakes in an APA annual report while keeping the APA intact. The IRS has indicated that it intends to rewrite Revenue Procedure 2015-41 in light of the Sixth Circuit's ruling in Eaton, although no timeline has been given on when the revised revenue procedure will be released.5 Until new guidance is released, APAs are binding under contract-law principles, and the IRS has the burden of proving the grounds supporting an APA cancellation.
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor
1 Alexander F. Peter, U.S. Tax Court Issues $8.8 Million Stipulated Decision in Eaton, Tax Notes (February 9, 2023).
2 Eaton Corp. & Subs. v. Commissioner, No. 5576-12 (T.C. Nov. 22, 2022).
3 Peter, U.S. Tax Court Issues $8.8 Million Stipulated Decision in Eaton.
4 Between 1991 and 2021, the IRS executed 2,191 APAs; only 11 APAs were cancelled or revoked during that same time period (2021 APMA Statutory Report, IRS (March 22, 2022)).
5 Alexander F. Peter, Eaton Defeat Prompts IRS to Rewrite Underlying APA Guidance, Tax Notes (October 17, 2022).