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Eaton versus the IRS: Uncertainty in US APAs

Eaton, an electrical component manufacturer, is contesting an IRS decision to revoke an advance pricing agreement it made with the taxpayer and a transfer pricing adjustment against the company for $127 million.

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The demand comprises additional taxes of $75 million and a $52 million penalty primarily for transfer pricing adjustments on products made in the company's facilities in Puerto Rico and the Dominican Republic and sold to affiliated companies in the US.

“The company has set its transfer prices for products sold between these affiliates at the same prices that the company sells such products to third parties,” said the Eaton 2011 annual report.

The IRS issued a Notice for Eaton's 2005 and 2006 tax years at the end of the fourth quarter of 2011.

Eaton said the issuance of the Notice was “despite the IRS having previously recognised the validity of the company's transfer pricing methodology by entering into two successive binding advance pricing agreements (APA) that approved and, in fact, required the application of the company's transfer pricing methodology for the 10 year period of 2001 through 2010”.

“For the years 2001 through 2004, the IRS had previously accepted the transfer pricing methodology related to these APAs after a comprehensive review conducted in two separate audit cycles,” the report added. “On December 16 2011, immediately prior to the Notice being issued, the IRS sent a letter stating that it was cancelling the APAs.”

Eaton said it considers the proposed assessments to be “without merit” and, on June 11, requested a quick judgement by the Tax Court on part of the case.

APA trends will be up for discussion at this year’s International Tax Review and TPWeek Global Transfer Pricing Forum in Paris September 24 & 25.

When the number of jurisdictions offering APAs is increasing, the panel will look at the demand from taxpayers for this type of certainty and if there is anything tax authorities can do to improve how they work.

The Eaton Corp case is not the first example of a revoked APA. The IRS has made void nine other APAs since the programme’s inception in 1991. But, the IRS doesn’t have a good track record in court over such cases.

In recent years it has lost twice: in 2009, when it was challenged by Veritas Software and in a trial in 2005 and appeal in 2010 against semiconductor maker Xilinx.

Panellists on the APA panel at the Global Transfer Pricing Forum, which include Sarah Fahy from Sony, Eric Lesprit from the French Tax Administration and advisers from the UK and Japan, are likely to discuss the viability of APAs and consider this trend to revoke them, which is not only apparent in the US.

In the Netherlands, an APA renewal case, with similar facts, went through the courts last year after it was denied by the authorities.

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