This content is from: United States

US Inbound: Tax Court decision raises attorney-client privilege questions

Jim Fuller
David Forst
The IRS made a transfer pricing adjustment in its examination of Eaton Corporation. As it often does in transfer pricing disputes, the IRS also asserted that a transfer pricing penalty was due. Eaton disputes the adjustment and the penalty. The case is docketed in the US Tax Court.

In a surprising development, the court held that in asserting the standard reasonable-cause defence to the penalty, Eaton had put at issue material otherwise protected by attorney-client privilege that would reveal the expertise and knowledge and state of mind of those who acted on Eaton's behalf regarding its transfer pricing. The court stated that a reasonable cause/good faith defence under section 6664(c) is dependent upon a review of all the pertinent facts and circumstances, and that Eaton's communications with its attorneys and tax practitioners may be the only probative evidence of the state of mind or knowledge of the persons who acted on Eaton's behalf.

Accordingly, the court held that Eaton had waived attorney-client privilege and work-product protections regarding the documents in dispute.

This does not seem appropriate: Congress cannot have intended in enacting the penalty rules that attorney-client privilege must be waived as the price of asserting that a penalty should not apply. The attorney-client privilege is a common law privilege that is deeply ingrained in the US legal system.

While there may or may not be a connection with Eaton, Illinois Tool Works' subsequently conceded that in its pending Tax Court case the reasonable cause defence to penalties had no application. Illinois Tool Works also involves international tax issues, although not transfer pricing.

Inbound taxpayers (and other taxpayers) should be guided by this development in determining their transfer pricing and developing their transfer pricing documentation, as well as in considering other tax matters. This Tax Court holding also likely will increase the IRS's interest in asserting penalties in future transfer pricing and other tax disputes.

Jim Fuller ( andDavid Forst (
Fenwick & West

Tel: +1 650 335 7205; +1 650 335 7274