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The US Tax Court has approved an agreement between Eaton Corp. and the IRS noting a maximum USD 8.8 million tax liability for Eaton's open tax years 2005 and 2006. This liability is approximately 7% of the original IRS assessment. Initially, the IRS assessed tax deficiencies of USD 19.7 million and USD 55.3 million, as well as penalties of USD 14.3 million and USD 37.3 million for 2005 and 2006, respectively, for a total liability of USD 126.7 million. Excluding penalties, which the court also invalidated, the liability approved by the court is still only 12% of the original deficiency assessment.
This appears to bring to conclusion a dispute going back a decade. Eaton Corp., a vehicle component manufacturer, established Advance Pricing Agreements (APA) with its subsidiary manufacturing plants in the Dominican Republic and Puerto Rico for the years 2001-2005 and 2006-2010. After entering the APAs, Eaton reviewed its records and disclosed to the IRS certain calculation errors through the APA annual compliance reports, correcting its mistakes. The IRS viewed these mistakes as material and concluded that Eaton's APAs should be canceled retroactively. The IRS further issued a Notice of Deficiency for the 2005 and 2006 tax years to adjust the intercompany prices in the aforementioned amounts. The IRS argued that Eaton made material misrepresentations while negotiating the APAs and, further, that it had made errors in implementation. However, the Tax Court concluded that cancellation of an APA should be done only when there are valid reasons that are consistent with the revenue procedures which set forth rules for canceling or revoking an APA. Here, the Tax Court found that the IRS did not follow its own revenue procedures. An August 2022 decision by the Sixth Circuit to uphold the Tax Court's 2017 decision in Eaton Corp. v. Commissioner noted that the IRS can only cancel an APA under ordinary contract law principles. The decision notes that "[t]he parties could have specified a more pro-government burden in the APAs. But they didn't. Instead, they embedded cancellation language that reads similar to something out of a mine-run contract." (Emphasis in original). Furthermore, the Sixth Circuit noted that nothing in the language in the revenue procedures establishes a materiality threshold for the cancelation of APAs. In light of the IRS's loss in this case, practitioners expect that the revenue procedures governing APAs and Mutual Agreement Procedures (MAPs) will be revised to more clearly protect the IRS's interests in entering into APAs and MAPs with taxpayers. "Knowing that that case has either just come to an end or may be about to come to an end, and knowing that the IRS is thinking about what to do in revisions to the APA rev proc, I would be shocked if they are not doing some thinking about whether they want to do anything to the rev proc in light of that case," said Chris Bello, senior counsel for international tax in Treasury's Office of Tax Policy. Likewise, Peter Blessing, IRS associate chief counsel (international), stated in October 2022 that due to the Eaton case, the IRS intends to revise the APA revenue procedure.
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