United States: Sixth Circuit affirms taxpayer not liable for 40% penalty upon cancellation of APAs

The U.S. Court of Appeals for the Sixth Circuit today affirmed in part and reversed in part a decision of the U.S. Tax Court involving a dispute stemming from the cancellation of two advance pricing agreements (APAs) by the IRS, and in so doing sided with the taxpayer on all issues presented.

The case is Eaton Corp. v. Commissioner, Nos. 21-1569/2674 (6^th Cir. August 25, 2022). Read the Sixth Circuit’s decision [PDF 245 KB]  

The taxpayer and the IRS entered into two APAs governing the taxpayer’s tax calculations from 2001 through 2010. A few years after entering in to the APAs, the taxpayer reviewed its records and caught some inadvertent calculation errors. After letting the IRS know, the taxpayer corrected the mistakes.

The IRS asserted that the taxpayer had failed to comply with the terms of the APAs and unilaterally cancelled them for tax years 2005 and 2006. As a result, the IRS determined that section 482 adjustments were needed to reflect an arm’s length result for the taxpayer’s intercompany transactions.

The IRS then issued a notice of deficiency determining deficiencies of approximately $19.7 million and $55.3 million for tax years 2005 and 2006, respectively, and penalties under section 6662(h) of approximately $14.3 million and $37.3 million for 2005 and 2006, respectively.

The taxpayer filed a petition in the Tax Court, challenging the deficiency notice and the IRS’s cancellation of the APAs.

The Tax Court in a 2013 opinion held that the IRS’s decision to cancel the APAs was an abuse of discretion. Subsequently, in a 2019 opinion, the Tax Court held that no adjustments were made pursuant to section 482 to support the imposition of the section 6662(h) penalties, and that the taxpayer was not liable for the penalties under section 6662 for the tax years at issue.  Read TaxNewsFlash

Although the Tax Court decided in the taxpayer’s favor on the significant issues, both sides appealed various aspects of the Tax Court’s decision.

The Sixth Circuit in its opinion today found for the taxpayer on all issues presented, including the issue of whether the taxpayer was entitled to double taxation relief under Rev. Proc. 99-32. The Tax Court had held that the taxpayer’s self-corrections did not constitute section 482 adjustments and thus Rev. Proc. 99-32 could not apply. The Sixth Circuit, however, found that such corrections were in fact section 482 adjustments and thus that the taxpayer was entitled to double taxation relief under the revenue procedure.