U.S. Tax Court memorandum opinion | KPMG | US

United States: Cancellation of APAs by IRS, abuse of discretion

U.S. Tax Court memorandum opinion

The U.S. Tax Court today issued a memorandum opinion that concluded, in part, that cancellation by the IRS of advance pricing agreements (APAs) was an abuse of discretion.

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Related content

The case is: Eaton Corp. v. Commissioner, T.C. Memo 2017-147 (July 26, 2017). Read the Tax Court’s 202-page memorandum opinion [PDF 646 KB]

Summary

The following summary, provided by the Tax Court in today’s opinion, reveals that 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 2001-05 tax years.
  • The second APA (APA II) applied for the 2006-10 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 canceling 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, however, asserted that the determination to cancel both 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. Alternatively, the IRS determined 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 today held that the IRS’s determination to cancel APA I and APA II was an abuse of discretion. The Tax Court also held that the taxpayer did not transfer intangibles subject to section 367(d).

Stock purchase agreement issue

The facts reveal that on July 15, 2005, the taxpayer entered into a stock purchase agreement to purchase all of the outstanding stock of an entity (THI) which had planned to enter into bonus agreements with certain executives that provided for stock option grants. THI entered into agreements with certain executives to provide them with cash bonuses in exchange for their release ofclaims related to any stock options.

For tax year 2005, the taxpayer claimed a deduction for the bonus amount payments. The IRS determined that the taxpayer was not entitled to the deduction and that the bonus payments were to have been capitalized under section 263. The taxpayer claimed that it was entitled to a deduction under section 162(a) because the bonus payments represented additional employee compensation.

The Tax Court held that the bonus payments represented employee compensation, entitling the taxpayer to a deduction under section 162(a).

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