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Tax Court Holds It Has Jurisdiction to Review APA Cancellations

Posted on July 22, 2013 by Jaime Arora

This news story was originally published in Tax Notes Today on June 27, 2013.

Finding that it has the jurisdiction to review advance pricing agreement cancellations, the Tax Court on June 26 decided that such cancellations should be reviewed using the abuse of discretion standard.

The opinion by Judge Diane Kroupa in Eaton Corp. v. Commissioner, 140 T.C. No. 18 (2013), made no determination as to whether the IRS had abused its discretion in the cancellations at issue.

In 2011 the IRS canceled two APAs with Eaton Corp. after determining that the company had not complied with the terms and conditions of the agreements. The government then issued Eaton a deficiency notice and proposed assessments of $75 million in additional taxes plus $52 million in penalties primarily for transfer pricing adjustments.

In a motion for partial summary judgment filed in June of 2012, Eaton argued that an APA constitutes a binding contract that the government must honor absent a specific showing that the company violated its obligations under the terms of the APA. The company said the terms of the revenue procedures allowing for the IRS to cancel an APA -- Rev. Proc. 96-53, 1996-2 C.B. 375, and Rev. Proc. 2004-40, 2004-2 C.B. 50 -- are a condition subsequent, meaning there is first and foremost a valid contract between the IRS and the company. (Prior coverage.)

The IRS contended that the applicable revenue procedures govern the APAs and reserve discretion for the government to administer them. Therefore, the IRS argued, the cancellations are administrative determinations within the court's deficiency jurisdiction.

The Tax Court agreed, stating that its deficiency jurisdiction includes reviewing the cancellations because they are necessary to determine the merits of the deficiencies assessed.

Turning to the standard of review that will apply, the court said it will review the cancellations for abuse of discretion. Noting that the APAs themselves provide that the applicable revenue procedures shall govern their administration, the court said it is "unpersuaded that the description of APAs as contracts renders ineffective the explicit terms and conditions that the petitioner and respondent agreed govern the APAs at issue."

Patrick J. Smith of Ivins, Phillips & Barker said it is not surprising that the court concluded both parties are bound by the terms of a revenue procedure as incorporated within the APA. The real issue is how the abuse of discretion standard will be applied at trial, he said, adding, "We won't know what this means until the next stage."

Smith said it will be interesting to see how the case plays out when the dispute is more clearly delineated and the government must explain which terms it believes the taxpayer violated. Although the Eaton decision was not what the taxpayer wanted, it is not necessarily terrible news, he said. The IRS has to live up to the terms of the revenue procedures, and if it has done things that the terms don't permit it to do, the taxpayer "won't be left holding the bag," he said.

The court said a trial will be scheduled in due course.