IRS cancellation of advance pricing agreement was abuse of discretion, US Tax Court rules

The US Tax Court has ruled that the IRS abused its discretion when it cancelled two advance pricing agreements (APAs) that it had entered into with a multinational group taxpayer.

In the case, Eaton Corp. v. Commissioner, T.C. Memo 2017-147 (July 26, 2017), the IRS cancelled two APAs covering Eaton’s intercompany transactions because Eaton had not complied with the terms of  Rev. Proc. 96-53 and Rev. Proc. 2004-40.

The IRS argued that the cancellations were justified because Eaton did not comply with the APAs’ terms and conditions in good faith and because Eaton failed to satisfy the APA’s annual reporting requirements.

After cancelling the two APAs, the IRS made transfer pricing adjustments with respect to Eaton’s intercompany transactions to reflect an arm’s length result.

The Tax Court, in a decision filed July 26, disagreed with the IRS’s action, calling it arbitrary and unreasonable. The Court said that though the taxpayer made some errors related to the APAs, these were not material within the meaning of the governing revenue rulings.

The Court also noted the IRS had opportunities to not renew the APAs or enter into the second APA if it disagreed with the transfer pricing methods agreed to in the APAs.

In the decision, the Court also concluded that Eaton did not transfer intangibles subject to 367(d). The Court also ruled that Eaton was entitled to a section 167(a) deduction for certain bonus payments because they were employee compensation.


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