In Uncategorized on 07/26/2017 at 17:17

The end of a long trail, with sixteen (count ‘em, sixteen) lawyers for Eaton Corporation and Subsidiaries, 2017 T.C. Memo. 147, filed 7/25/17, versus nine for IRS. Spoiler alert- Eaton’s advance pricing agreements shouldn’t have been canceled by IRS.

Judge Kerrigan has a lot more about circuit breakers than most of us want to know. Eaton also has a bushelbasketful of offshore subsidiaries in the Cayman Islands and Switzerland, with branches in the Dominican Republic and Puerto Rico, the latter fueled by the old Section 936 incentives to go to Puerto Rico.

In addition to breaking circuits, Eaton and the gang were base eroding and profit shifting to beat the cliché, so Eaton entered into advance pricing agreements with IRS, pursuant to a couple Rev. Procs. (hi, Judge Holmes).

Well, the unguided Congressional largesse to Puerto Rico evaporated (along with Puerto Rico’s economy), so Eaton shifted hardware and IP to the Dom Rep via a batch of Section 351 tax-frees.

IRS wanted to hit the whole shebang with a Section 482 unscramble, so IRS and Eaton negotiated the advance pricing agreements (APAs).

If you want to have your head spun real good, read about Eaton’s accounting and reporting methods, and how the comparable uncontrolled price (CUP) method for working out the intercompany hand-offs was derived. I cannot figure this stuff out, but I tipped off a certain blood relative who probably can.

Briefly, “Before its proposal to use a CUP method, petitioner used the cost-plus method.  The cost-plus method evaluates whether the amount charged in an intercompany sale is arm’s length by reference to the gross profit markup realized in comparable uncontrolled transactions.  See sec. 1.482-3(d)(1), Income Tax Regs.  The CUP method evaluates whether the amount charged in a controlled transaction is arm’s length by reference to the amount charged in a comparable uncontrolled transaction.  See id. para. (b).” 2017 T. C. Memo. 147, at p. 35.

But when it came to negotiating the APAs, each side assembled a team, and the resulting negotiations were slightly, but only slightly, less convoluted than certain peace talks of recent memory.

And of course there was “trust, but verify,” built in.

And also, of course, there was a second round of negotiations, with the same mind-numbing complexity, which resulted in APA Number Two.

Next, as we would expect, it turned out that some ratty data got into the mix and the APA numbers were off. When lawyers, accountants and economists work out these wonderful formulations, no one talks to the in-the-trenches grunts who have to make all this applesauce work. So there were more “error” lights at Eaton than at a Brooklyn Cyclones game.

IRS lost patience, claiming “…failure of a critical assumption, misrepresentation, mistake as to a material fact, failure to state a material fact, failure to file a timely annual report, or lack of good faith compliance with the terms and conditions of the APA.” 2017 T. C. Memo. 147, at p. 112.

IRS dumps the APAs, and nine-figure SNODs rain on Eaton.

Meanwhile, Eaton buys out a DE C Corp that makes some kind of gizmo it needs, which said gizmo-maker has a sub in the Emerald Isle, home of leprechauns and tax dodges. And some of the sub’s high-priced execs have stock options out of which they have to be bought.

But the buying-out didn’t take place simultaneously with the buying-out of the rest of the DE C Corp, so Eaton tried to amend its return for the year in question, but IRS said the buying-out bonuses had to be capitalized under Section 263, not as payment of compensation and thus expensed.

As for the bogus APA reports, Eaton claims “whoops, so sorry.” IRS claims “dirty pool.”

APAs are like PLRs, a deal between taxpayer and IRS to prevent an annual argy-bargy about comparables, software and arcana well beyond the scope of mortal intelligence. There are six (count ‘em, six) methods to work out whether intercompany give-and-goes are truly comparable to arms’-length, love-with-the-proper-stranger deals. Judge Kerrigan lists them all at p. 129-131, to which I refer any among you still reading this and suffering from terminal insomnia.

The test here is what the now-defrocked Judge Kroupa decided back in 2013: abuse of discretion. See my blogpost “Advance and Retreat,” 6/26/13.

So Judge Kerrigan trudges through all the negotiations, who said what, what numbers were real and what was “constructed” (mach gresser, mach veiniger, as we say). And IRS got whatever it asked for. If IRS was unhappy, it should have asked for more. Eaton didn’t sandbag.

Yeah, Eaton blew it. But.

“All of petitioner’s seven errors were computational or related to inadvertence, and all were corrected in the amended APA annual reports.  These errors were not deliberate.  The errors were discovered only because petitioner did a comprehensive review after determining that its first error was not an anomaly caused by interim calculations.  Without petitioner’s reporting its errors, they would not have been discovered.

“We do not agree with petitioner’s interpretation that the revenue procedures provide a dividing line regarding the type of error and what type of action should be taken.  Each error needs to be analyzed to determine whether it is material.  The revenue procedures require, upon examination, that the taxpayer may be required to show supporting data and computations; and if this does not occur, the Associate Chief Counsel (International) may decide to enforce, revise, cancel, or revoke the APA consistent with the revenue procedures.  See Rev. Proc. 96-53, sec. 11.03(2) and (3); Rev. Proc. 2004-40, sec. 10.03(2) and (3).  Respondent’s cancellation letter stated: ‘The material deficiencies in APA compliance include numerous examples of noncompliance with the terms and conditions of APA I and APA II, errors in the supporting data and computations used in the transfer pricing methodologies (“TPMs”) specified in APA I and APA II’.” 2017 T. C. Memo. 147, at pp. 175-176.

Except that when you do the numbers, none of the seven make a material difference.

And IRS can’t identify any Section 367(f) outbound intangibles Eaton and the subs were throwing around in their multifaceted 351s.

Oh yes, the Emerald Islanders were employees, entitled to be paid. That was salary and wages, not acquisition costs.

And now an old friend is going to buy me a drink. I need it.


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