On 28 October 2019, the U.S. Tax Court published an order in the case of Eaton Corp. v. Commissioner related to advance pricing agreements (APAs).

In that case, Eaton Corporation (P-Petitioner) and Commissioner of Internal Revenue (R-Respondent) entered into two advance pricing agreements (APAs) establishing a transfer pricing methodology for covered transactions between Eaton Corporation and its subsidiaries. The first APA (APA I) applied for P’s 2001-05 tax years, and the second APA (APA II) applied for P’s 2006-10 tax years. P and R agreed that the legal effect and administration of APA I and APA II were governed by Rev. Proc. 96- 53, 1996-2 C.B. 375, and Rev. Proc. 2004-40, 2004-2 C.B. 50, respectively.

In 2011 Commissioner determined that Eaton Corp. had not complied with the applicable terms of the revenue procedures and canceled APA I, effective January 1, 2005, and APA II, effective January 1, 2006. As a result of canceling the APAs, commissioner determined that under I.R.C. sec. 482 an adjustment was necessary to reflect an arm’s-length result for Eaton’s intercompany transactions. As a result of canceling the APAs respondent determined that section 482 adjustments were necessary to reflect an arm’s-length result for petitioner’s intercompany transactions. On December 19, 2011, respondent issued to petitioner a notice of deficiency determining deficiencies of $19,714,770 and $55,323,229, and penalties pursuant to section 6662(h) of $14,281,960 and $37,329,600, for tax years 2005 and 2006, respectively. The notice made section 482 adjustments and stated that in order to properly reflect an arm’s-length result for intercompany transactions, petitioner’s taxable income for tax years 2005 and 2006 was increased by $102,014,000 and $266,640,000, respectively.

Eaton Corp. contends that Commissioner’s cancellation of APA I and APA II was an abuse of discretion because there was no basis for the cancellation under the applicable revenue procedures.

The tax court found that no adjustments were made pursuant to section 482 to support imposition of section 6662(h) penalties, and that the taxpayer was not liable for the penalties under section 6662 for the tax years 2005 and 2006.