On July 26 2017, the US Tax Court issued a memorandum
opinion in Eaton Corp. v. Commissioner, TC Memo
2017-147 that concluded, in part, that cancellation by the IRS
of advance pricing agreements (APAs) was an abuse of
The taxpayer and the IRS entered into two APAs establishing
a transfer pricing methodology for covered transactions between
the taxpayer and its subsidiaries:
- The first APA (APA I) applied for the
2001-2005 tax years.
- The second APA (APA II) applied for the
2006-2010 tax years.
The taxpayer and the IRS agreed that the legal effect and
administration of APA I and APA II were governed by Rev. Proc.
96-53 and by Rev. Proc. 2004-40, respectively.
In 2011, the IRS determined that the taxpayer had not
complied with the terms of the revenue procedures and canceled
APA I, effective January 1 2005, and cancelled APA II,
effective January 1 2006. As a result of cancelling the APAs,
the IRS determined that, under code section 482, an adjustment
was needed to reflect an arm's-length result for the taxpayer's
intercompany transactions. The taxpayer countered and contended
that the cancellation of APA I and APA II by the IRS was an
abuse of discretion because there was no basis for the
cancellation under the applicable revenue procedures.
The IRS asserted that cancelling APA I and APA II was not an
abuse of discretion because the taxpayer did not comply in good
faith with the terms and conditions of either APA I or APA II
and because the taxpayer had failed to satisfy the APA annual
reporting requirements. Specifically, the IRS arguments in
support of cancellation of the APAs fell into two categories:
(1) misrepresentations, mistakes as to a material fact, and
failures to state a material fact during the APA negotiations
and (2) improper implementation and non-compliance with the
The Tax Court held that the IRS's determination to cancel
APA I and APA II was an abuse of discretion. In reaching this
decision, the Tax Court did not see any additional material
facts, mistakes of material facts, or misrepresentations that
would have resulted in a significantly different APA or no APA
at all. Furthermore, the Tax Court found that while the
taxpayer made errors in complying with the APAs, these errors
were inadvertent and were not deliberate attempts to alter the
underlying transfer pricing methodology and would not have
resulted in significantly or materially different APAs, thereby
concluding that there was good-faith compliance with terms of
As an alternative ground for an adjustment, the IRS also
argued that the taxpayer had transferred intangible property
compensable under section 367(d) to the taxpayer's controlled
foreign affiliates for tax year 2006. The Tax Court also held
that the taxpayer did not transfer intangibles subject to
The Tax Court's decision is an important validation of the
integrity of the APA process. Hundreds of US taxpayers who have
entered into APAs with the IRS have wondered whether the IRS
position in the Eaton case undercuts the level of certainty
regarding the transfer pricing issues covered by their APAs.
The Tax Court decision indicates the IRS would need a stronger
case than the errors the IRS found in Eaton in order to cancel
The information contained herein is of a general nature
and based on authorities that are subject to change.
Applicability of the information to specific situations should
be determined through consultation with your tax
This article represents the views of the authors only,
and does not necessarily represent the views or professional
advice of KPMG.
Mark Martin (firstname.lastname@example.org) and Mark
Tel: +1 713 319 3976 and +1 713 319 2840