Eaton Corporation is a global manufacturer of electrical and industrial products headquartered in the US. This case concerning the computation of penalties is related to a previous 2017 dispute concerning the cancellation of two advance pricing agreements (APAs) establishing a transfer pricing methodology (TPM) for covered transactions between Eaton Corp and its subsidiaries.
In 2011 IRS determined that Eaton had not complied with the applicable terms of the governing APA revenue procedures and canceled APA I and APA II, effective January 1, 2005 and 2006, respectively. The US Tax Court found that the cancellation of the APAs was an abuse of discretion (US vs Eaton TC opinion from July 2017), and the APAs remained in effect.
Irespective of the ruling related to the cancellation of the APAs, the IRS determined that a section 482 adjustment were still necessary to reflect an arm’s-length result for Eaton’s intercompany transactions, and that the computations should include 40% penalties pursuant to I.R.C. sec. 6662(h).
Section 6662(a) imposes a 20% penalty on an underpayment of tax attributable to any of the reasons listed in section 6662(b). These include “[a]ny substantial valuation misstatement under chapter 1”. Sec. 6662(b)(3). As relevant to this case, a “substantial valuation misstatement” occurs when the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $5 million or 10% of the taxpayer’s gross receipts. When the net section 482 transfer price adjustment for the taxable year exceeds the lesser of $20 million or 20% of the taxpayer’s gross receipts, section 6662(h) increases the penalty to 40 percent of the underpayment.
Eaton held that there were no adjustments pursuant to I.R.C. sec. 482 as the APAs were still in effect and therefore the computation of additional taxes from the transfer pricing adjustment should not include penalties.
The Tax Court held in favor of Eaton. Since the APAs remained in effect, there are no allocation of income and deductions pursuant to section 482 and no “net increase in taxable income for the taxable year * * * resulting from adjustments under section 482 in the price for any property or services”. Accordingly, Eaton is not liable for section 6662(h) penalties for the years in issue.
US vs Eaton USTC Oct 2019