Court Opinion

ID: 4339591
Source: CourtListenerOpinion
Date Created: 2018-11-14 04:34:57.57074+00
Date Added: 2024-06-11T07:49:38.881017
License: Public Domain

EATON CORPORATION AND SUBSIDIARIES, PETITIONER v.
                                             COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
                                                        Docket No. 5576–12.                        Filed June 26, 2013.

                                                  P and R entered into two advance pricing agreements
                                               (APAs) establishing a transfer pricing methodology for covered
                                               transactions between P and its subsidiaries. P and R agreed
                                               in the APAs that the APAs’ legal effect and administration
                                               were governed by certain revenue procedures. R determined P
                                               did not comply with the applicable terms and canceled the
                                               APAs. R issued P a deficiency notice and applied an alter-
                                               native transfer pricing methodology. P filed a petition. P con-
                                               tends the APAs are enforceable contracts. P asserts R must
                                               show that he was entitled to cancel the APAs. R asserts he
                                               canceled the APAs under revenue procedures that reserve cer-
                                               tain discretion to R. Consequently, R contends the cancella-
                                               tions were administrative determinations. R argues that our
                                               deficiency jurisdiction permits us to review for abuse of discre-
                                               tion those administrative determinations necessary to resolve
                                               the merits of a deficiency determination. Held: We have juris-
                                               diction to review the cancellations of the APAs because they
                                               are administrative determinations necessary to determine the
                                               merits of the deficiency determinations. Held, further, an APA
                                               cancellation is reviewed for abuse of discretion. P must show
                                               that R’s cancellations were arbitrary, capricious or without
                                               sound basis in fact.

                                        Joel V. Williamson, John T. Hildy, Charles P. Hurley,
                                      Brian W. Kittle, Erin G. Gladney and Geoffrey M. Collins, for
                                      petitioner.
                                        Daniel Allen Rosen and Travis Vance, III, for respondent.
                                                                                   OPINION

                                        KROUPA, Judge: This matter is before the Court on cross-
                                      motions for partial summary judgment under Rule 121. 1 The
                                      parties agree on the basic facts necessary to resolve a dis-
                                      crete issue of law. Petitioner and respondent entered into two
                                        1 All Rule references are to the Tax Court Rules of Practice and Proce-

                                      dure, and all section references are to the Internal Revenue Code (Code),
                                      as amended and in effect for the years at issue, unless otherwise indicated.

                                      410

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                                      (410)               EATON CORP. & SUBS. v. COMMISSIONER                                     411

                                      advance pricing agreements (APAs) that set a transfer
                                      pricing methodology for certain transactions under section
                                      482 (APAs at issue). Respondent later canceled the APAs at
                                      issue after concluding that petitioner failed to comply with
                                      their terms and conditions (cancellations). Respondent issued
                                      petitioner a deficiency notice and adjusted petitioner’s income
                                      under section 482 for those transactions.
                                         The parties fundamentally disagree on the manner in
                                      which the APAs at issue limit respondent’s authority to
                                      administer and enforce section 482. Petitioner contends that
                                      the APAs at issue are enforceable contracts. Petitioner
                                      argues that respondent must show that the cancellations
                                      were appropriate under contract law before the Court can
                                      redetermine the deficiencies. In contrast, respondent con-
                                      tends that certain revenue procedures govern the legal effect
                                      and administration of the APAs at issue and the cancella-
                                      tions    therefore    are    administrative    determinations.
                                      Respondent further asserts that the cancellations should be
                                      sustained unless petitioner demonstrates that respondent
                                      abused his discretion reserved in the revenue procedures. We
                                      agree with respondent.
                                         We note that we decide the motions on a limited record.
                                      We will therefore decide only the legal standard to be used
                                      in reviewing the cancellations. We do not determine here
                                      whether respondent abused his discretion in canceling the
                                      APAs at issue.

                                                                               Background
                                        The parties agree on the basic facts in the limited record
                                      to decide a discrete question of law. We assume the following
                                      facts solely to resolve the motions.
                                        Petitioner’s principal place of business was in Cleveland,
                                      Ohio 2 when it filed the petition. Petitioner is an industrial
                                      manufacturer that licensed technology to its Puerto Rican
                                      and Dominican Republic subsidiaries to manufacture breaker
                                      products, including circuit breakers, switches and pushbutton
                                           2 An
                                             appeal in this case would lie to the Court of Appeals for the Sixth
                                      Circuit absent stipulation to the contrary and, accordingly, we follow the
                                      law of that circuit. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff ’d,
                                      445 F.2d 985 (10th Cir. 1971).

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                                      412                 140 UNITED STATES TAX COURT REPORTS                                   (410)

                                      controls. Petitioner purchased the breaker products from the
                                      subsidiaries.
                                         Petitioner and respondent entered into the APAs at issue.
                                      The first APA covered 2001 through 2005 (Original APA) and
                                      the second APA covered 2006 through 2010 (Renewal APA).
                                      The APAs at issue contained the parties’ agreement on the
                                      best method for determining arm’s-length prices under sec-
                                      tion 482 for the purchase of the breaker products. In entering
                                      into the APAs at issue, the parties agreed that the terms of
                                      Rev. Proc. 96–53, 1996–2 C.B. 375, and Rev. Proc. 2004–40,
                                      2004–2 C.B. 50 (collectively, applicable revenue procedures)
                                      govern the ‘‘interpretation, legal effect and administration’’ of
                                      the Original APA and the Renewal APA, respectively.
                                         In 2011 respondent canceled the Original APA effective
                                      January 1, 2005 and canceled the Renewal APA effective
                                      January 1, 2006. Respondent determined that petitioner had
                                      not complied with the terms and conditions of the APAs at
                                      issue. (It is unclear from the limited record the specific terms
                                      with which respondent alleges petitioner failed to comply.)
                                      Respondent issued petitioner a deficiency notice in which
                                      respondent determined to increase petitioner’s income under
                                      section 482 by $102,014,000 for 2005 and by $266,640,000 for
                                      2006.
                                         Petitioner timely filed a petition. Petitioner alleges that it
                                      did comply with the terms and conditions of the APAs at
                                      issue and demonstrated that to respondent. Petitioner con-
                                      tends that it demonstrated its compliance to respondent by
                                      disclosing errors in its data to respondent in 2010 and recti-
                                      fying those errors. The parties filed cross-motions for partial
                                      summary judgment. The Court held oral argument at a spe-
                                      cial session.

                                                                                Discussion
                                        We are asked to decide an issue of first impression
                                      regarding whether respondent must show that petitioner vio-
                                      lated the terms and conditions of the APAs at issue. We
                                      begin with an overview of the Commissioner’s advance
                                      pricing agreement program (APA program) for context.
                                        An APA is an agreement between the Commissioner and
                                      a taxpayer in which the parties set forth, in advance of con-
                                      trolled transactions, the best transfer pricing method within

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                                      (410)               EATON CORP. & SUBS. v. COMMISSIONER                                     413

                                      the meaning of section 482 and related regulations. Rev.
                                      Proc. 2004–40, sec. 2.04(1), 2004–2 C.B. at 51. Congress
                                      enacted section 482 to ensure that taxpayers clearly reflect
                                      income attributable to controlled transactions and to prevent
                                      the avoidance of taxes with respect to such transactions. Sec.
                                      482; sec. 1.482–1(a)(1), Income Tax Regs. The Commissioner
                                      developed the APA program to resolve highly factual transfer
                                      pricing issues in a principled, cooperative manner. Announce-
                                      ment 2012–13, 2012–16 I.R.B. 805, 806; Rev. Proc. 2006–9,
                                      sec. 2.02, 2006–1 C.B. 278, 279; Rev. Proc. 2004–40, sec.
                                      2.04(1). A taxpayer voluntarily participates in the APA pro-
                                      gram in exchange for the Commissioner limiting his discre-
                                      tion under section 482 to make transfer pricing adjustments.
                                      See Rev. Proc. 2006–9, secs. 2.01, 2.04, 10.02, 2006–1 C.B. at
                                      279, 289. The APA program is intended to supplement tradi-
                                      tional administrative, judicial and treaty mechanisms.
                                      Announcement 2012–13, 2012–16 I.R.B. at 806.
                                         The Commissioner has entered into more than 1,000 APAs
                                      since establishing the APA program in 1991. Id. at 811. Tax-
                                      payers have applied for APAs in record numbers in recent
                                      years. Id. at 805. The Commissioner canceled or revoked only
                                      nine other APAs in the APA program’s first 20 years. See id.
                                      at 811 Table 1.
                                         We now address the issues raised in the cross-motions,
                                      with this background in mind. Petitioner contends that the
                                      APAs at issue are enforceable contracts. Petitioner asserts
                                      that the party exercising a contractual cancellation provision
                                      must demonstrate that a factual predicate exists to cancel
                                      the contract. Accordingly, under petitioner’s theory, the
                                      transfer pricing methodology in the APAs at issue must
                                      stand unless respondent shows that petitioner failed to
                                      comply with the APAs at issue.
                                         Respondent disagrees with petitioner’s theory. Respondent
                                      contends that the applicable revenue procedures govern the
                                      APAs at issue and reserve discretion to respondent to admin-
                                      ister the APAs. Respondent further contends that he can-
                                      celed the APAs at issue pursuant to that discretion and the
                                      cancellations therefore are administrative determinations.
                                      Respondent argues that the cancellations are within the
                                      Court’s deficiency jurisdiction because they are administra-
                                      tive determinations necessary to determine the merits of the
                                      deficiency determinations. Respondent contends therefore

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                                      414                 140 UNITED STATES TAX COURT REPORTS                                   (410)

                                      that petitioner must show that respondent abused his discre-
                                      tion in canceling the APAs at issue. We agree with
                                      respondent.
                                         We begin with the summary judgment standard. We then
                                      consider whether our deficiency jurisdiction includes
                                      reviewing the cancellations for abuse of discretion. We con-
                                      clude by considering whether respondent must show that the
                                      cancellations were appropriate.
                                      I. Summary Judgment Standard
                                        We now consider whether to grant partial summary judg-
                                      ment on this discrete legal issue. Summary judgment is
                                      intended to expedite litigation and avoid unnecessary and
                                      expensive trials. See, e.g., FPL Grp., Inc. & Subs. v. Commis-
                                      sioner, 116 T.C. 73, 74 (2001). Either party may move for
                                      summary judgment upon all or any part of the legal issues
                                      in controversy. Rule 121(a). A motion for summary judgment
                                      or partial summary judgment will be granted only if it is
                                      shown that there is no genuine dispute as to any material
                                      fact and that a decision may be rendered as a matter of law.
                                      See Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C.
226, 238 (2002). We grant summary judgment cautiously and
                                      sparingly, and only after carefully ascertaining that the
                                      requirements have been met. P & X Mkts., Inc. v. Commis-
                                      sioner, 106 T.C. 441, 443 (1996), aff ’d without published
                                      opinion, 139 F.3d 907 (9th Cir. 1998); Boyd Gaming Corp. v.
                                      Commissioner, 106 T.C. 343, 346–347 (1996).
                                      II. Deficiency Jurisdiction To Review the Cancellations for
                                          Abuse of Discretion
                                         We now turn to the scope and manner of our jurisdiction.
                                      Petitioner invoked this Court’s jurisdiction by filing a peti-
                                      tion challenging respondent’s deficiency determinations that
                                      adjusted petitioner’s income. Respondent’s deficiency deter-
                                      minations resulted from the cancellations. Petitioner
                                      assumes that our deficiency jurisdiction includes jurisdiction
                                      to review the APAs at issue. Respondent emphasizes that the
                                      Court’s jurisdiction is to redetermine the deficiencies. He con-
                                      tends that we may review the cancellations under our defi-
                                      ciency jurisdiction for abuse of discretion because the can-
                                      cellations were administrative determinations that are nec-

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                                      (410)               EATON CORP. & SUBS. v. COMMISSIONER                                     415

                                      essary to determine the merits of the deficiency determina-
                                      tions. We agree with respondent.
                                         The Tax Court is a court of limited jurisdiction and may
                                      exercise jurisdiction only to the extent authorized by Con-
                                      gress. See Kasper v. Commissioner, 137 T.C. 37, 40 (2011);
                                      Naftel v. Commissioner, 85 T.C. 527, 529–530 (1985). The
                                      Tax Court is without authority to enlarge upon that statu-
                                      tory grant. See Phillips Petroleum Co. v. Commissioner, 92
T.C. 885, 888 (1989). We have jurisdiction to redetermine the
                                      correct amount of a deficiency. Sec. 6214(a). Our deficiency
                                      jurisdiction includes the authority to determine whether the
                                      Commissioner’s section 482 allocation was correct. That
                                      allocation must be sustained absent a showing of abuse of
                                      discretion. See, e.g., Veritas Software Corp. & Subs. v.
                                      Commissioner, 133 T.C. 297, 318 (2009); Sundstrand Corp. &
                                      Subs. v. Commissioner, 96 T.C. 226, 353 (1991). To succeed,
                                      therefore, petitioner must show that respondent’s section 482
                                      allocations were arbitrary, capricious or without sound basis
                                      of law or fact. Veritas Software Corp. & Subs. v. Commis-
                                      sioner, 133 T.C. at 318.
                                         Generally, we will not look behind a deficiency notice to
                                      examine the Commissioner’s motives or to examine the
                                      administrative policies or procedures involved in making
                                      those determinations. Greenberg’s Express, Inc. v. Commis-
                                      sioner, 62 T.C. 324, 327 (1974). There is a strong presump-
                                      tion, however, that an act of administrative discretion is sub-
                                      ject to judicial review. Mailman v. Commissioner, 91 T.C.
1079, 1082 (1988). Our deficiency jurisdiction includes
                                      reviewing administrative determinations that are necessary
                                      to determine the merits of the deficiency determinations.
                                      Capitol Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C.
204, 214–215 (1991); see also Mailman v. Commissioner, 91
                                      T.C. at 1083; Estate of Gardner v. Commissioner, 82 T.C.
989, 1000 (1984).
                                         We have held that our deficiency jurisdiction includes
                                      reviewing the Commissioner’s decision to reject the tax-
                                      payer’s application to change its accounting method. Capitol
                                      Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C. at 214. We
                                      held so because that administrative determination was nec-
                                      essary to determine the merits of the deficiency. Id. The tax-
                                      payer contended that the Commissioner had not observed the
                                      terms of the governing revenue procedure. Id. at 215–216.

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                                      416                 140 UNITED STATES TAX COURT REPORTS                                   (410)

                                      We reviewed the Commissioner’s action under the abuse of
                                      discretion standard to determine whether the Commissioner
                                      had observed the self-imposed limits of the revenue proce-
                                      dure. Id. at 214; see also Estate of Gardner v. Commissioner,
                                      82 T.C. at 1000.
                                        Here, the cancellations are administrative determinations
                                      necessary to determine the merits of the deficiency deter-
                                      minations. We will review the cancellations for abuse of
                                      discretion. The parties agree that respondent established the
                                      APA program pursuant to his authority to administer the
                                      Code and ‘‘prescribe all ‘needful rules and regulations.’ ’’ See
                                      sec. 7803(b)(2)(A); Commissioner v. Engle, 464 U.S. 206, 226–
                                      227 (1984) (quoting section 7805(a)). The Commissioner
                                      promulgated the applicable revenue procedures to administer
                                      the APA program. Petitioner and respondent each agreed by
                                      entering into the APAs at issue that the administration and
                                      legal effect of the APAs at issue would be governed by the
                                      applicable revenue procedures. 3 The applicable revenue
                                      procedures provide that the Commissioner will not exercise
                                      his discretion under section 482 to adjust income if the tax-
                                      payer complies with the terms and conditions of the APAs.
                                      See Rev. Proc. 2004–40, sec. 9.02, 2004–2 C.B. at 61; Rev.
                                      Proc. 96–53, sec. 10.02, 1996–2 C.B. at 383.
                                        The applicable revenue procedures detail the limits on
                                      respondent’s discretion to administer the APAs at issue.
                                      Respondent could require petitioner to establish good faith
                                      compliance with the terms and conditions of the APAs, the
                                      validity and accuracy of material representations in the
                                      annual reports required by the APAs and the satisfaction of
                                      critical assumptions set forth in the APAs. Rev. Proc. 2004–
                                      40, sec. 10.03(2), 2004–2 C.B. at 62; Rev. Proc. 96–53, sec.
                                      11.03(2), 1996–2 C.B. at 384. Respondent could revoke,
                                      cancel or revise the APAs at issue if petitioner failed to
                                      comply with any of those requirements. Rev. Proc. 2004–40,
                                      sec. 10.03(3); Rev. Proc. 96–53, sec. 11.03(3). Respondent
                                      could also cancel the APAs at issue due to petitioner’s mis-
                                      representation, mistake as to a material fact, failure to state
                                           3A
                                            revenue procedure is an official statement of a procedure that affects
                                      the rights or duties of taxpayers under the Code and related statutes, trea-
                                      ties and regulations that should be a matter of public knowledge. Rev.
                                      Proc. 89–14, sec. 3.02, 1989–1 C.B. 814.

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                                      (410)               EATON CORP. & SUBS. v. COMMISSIONER                                     417

                                      a material fact, failure to file a timely annual report or lack
                                      of good faith compliance. Rev. Proc. 2004–40, sec. 10.06(1),
                                      2004–2 C.B. at 63; Rev. Proc. 96–53, sec. 11.06(1), 1996–2
                                      C.B. at 385.
                                         The APAs at issue are agreements subject to the discretion
                                      reserved to respondent by the applicable revenue procedures.
                                      Respondent exercised that administrative discretion by can-
                                      celing the APAs at issue. The cancellations therefore were
                                      administrative determinations. The deficiencies resulted from
                                      the cancellations that disregarded the previously agreed to
                                      transfer pricing methodology for the covered transactions.
                                      Respondent then adjusted petitioner’s income under section
                                      482 and issued a deficiency notice. Respondent could not
                                      have altered the transfer pricing methodology had the APAs
                                      at issue remained effective. We hold that our deficiency juris-
                                      diction includes reviewing the cancellations because they are
                                      necessary to determine the merits of the deficiencies. 4 The
                                      relevant inquiry is whether respondent abided by the self-
                                      imposed limitations set forth in the applicable revenue proce-
                                      dures. We consequently will review respondent’s cancella-
                                      tions for abuse of discretion.
                                      III. Whether Petitioner Must Show Cancellations Were Abuse
                                           of Discretion
                                         We turn to petitioner’s assertion that common law contract
                                      principles govern the APAs at issue such that respondent
                                      must show the cancellations were appropriate. Petitioner
                                      emphasizes that respondent has represented that APAs are
                                      ‘‘binding contracts’’ and contract law has been applied to
                                      interpret other agreements between the Commissioner and
                                      taxpayers. We disagree that either argument demonstrates
                                      that the terms and conditions in the APAs at issue are
                                      ineffective. Rather, the parties agreed in the APAs at issue
                                      that the applicable revenue procedures govern the legal effect
                                      and administration of the APAs at issue.

                                           4 Petitioner’s
                                                       assertion that general contract law governs the APAs at
                                      issue conflicts with the parties’ agreement that the legal effect and admin-
                                      istration are governed by the applicable terms of the revenue procedures.
                                      Petitioner ignores the fact that the applicable revenue procedures reserve
                                      respondent’s discretion to administer the APAs at issue.

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                                      418                 140 UNITED STATES TAX COURT REPORTS                                   (410)

                                         Our jurisdiction allows us to consider whether respondent
                                      abused his discretion in canceling the APAs at issue.
                                      Whether the Commissioner has abused his discretion is a
                                      question of fact. Buzzetta Constr. Corp. v. Commissioner, 92
T.C. 641, 648 (1989); Estate of Gardner v. Commissioner, 82
                                      T.C. at 1000. The taxpayer has the burden of proof, except
                                      as otherwise provided by statute or determined by the Court.
                                      Rule 142(a). And the taxpayer assumes the burden of proof
                                      when challenging the Commissioner’s transfer pricing adjust-
                                      ment. See, e.g., Cordes v. Commissioner, T.C. Memo. 2002–
                                      124. We do not substitute our judgment for the Commis-
                                      sioner’s, nor do we permit taxpayers to carry their burden of
                                      proof by a mere preponderance of the evidence. See Buzzetta
                                      Constr. Corp. v. Commissioner, 92 T.C. at 648. Taxpayers
                                      asserting that the Commissioner abused his discretion are
                                      required to show that the Commissioner’s action was
                                      arbitrary, capricious or without sound basis in fact. Veritas
                                      Software Corp. v. Commissioner, 133 T.C. at 318; Sundstrand
                                      Corp. & Subs. v. Commissioner, 96 T.C. at 353. We have pre-
                                      viously rejected the argument that the Commissioner
                                      assumes the burden of proof when the taxpayer contends the
                                      Commissioner acted contrary to a revenue procedure. 5 See
                                      Capitol Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C. at
                                      215–216.
                                         Petitioner nonetheless contends that respondent’s discre-
                                      tion, reserved by the terms of the APAs at issue, is also sub-
                                      ject to general contract law principles because respondent
                                      has described an APA as a ‘‘binding contract.’’ See, e.g.,
                                      Announcement 2011–22, 2011–16 I.R.B. 672. We disagree.
                                      Indeed, a taxpayer may rely on the Commissioner’s revenue
                                      rulings. See, e.g., Alumax, Inc. v. Commissioner, 109 T.C.
133, 162 n.12 (1997), aff ’d, 165 F.3d 822 (11th Cir. 1999).
                                      Petitioner and respondent are bound to the terms upon
                                      which they agreed. The APAs at issue provide that the
                                           5 The
                                               taxpayer argued that its application for a change in accounting
                                      method satisfied the threshold eligibility requirements of the revenue pro-
                                      cedure and the burden of proof shifted to the Commissioner to show
                                      whether the application would have been approved on its merits. Capitol
                                      Fed. Sav. & Loan Ass’n v. Commissioner, 96 T.C. 204, 216 (1991). We re-
                                      jected that argument because the taxpayer assumes the burden of proof
                                      under Rule 142 and instead we reviewed that administrative determina-
                                      tion for abuse of discretion. Id.

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                                      (410)               EATON CORP. & SUBS. v. COMMISSIONER                                     419

                                      applicable revenue procedures shall govern their legal effect
                                      and administration. The applicable revenue procedures
                                      reserve to respondent discretion to cancel the APAs at issue
                                      in certain circumstances. We are unpersuaded that the
                                      description of APAs as contracts renders ineffective the
                                      explicit terms and conditions that petitioner and respondent
                                      agreed govern the APAs at issue.
                                         Petitioner also contends we must apply general contract
                                      law principles to review the cancellations because we have
                                      done so to interpret other Commissioner-taxpayer agree-
                                      ments. See, e.g., Smith v. Commissioner, T.C. Memo. 1989–
                                      87. This argument is inapposite. Here, we are not asked to
                                      determine whether the parties entered into the APAs at
                                      issue or to interpret an ambiguous term. The parties agree
                                      that they entered into the APAs at issue and dispute only
                                      whether there was a factual predicate for the cancellations.
                                      The APAs at issue provide that their legal effect and
                                      administration are governed by the applicable revenue proce-
                                      dures. The applicable revenue procedures reserve to
                                      respondent discretion to cancel the APAs at issue in certain
                                      circumstances. Consequently, petitioner and respondent are
                                      bound to the terms and conditions of the APAs at issue.
                                      IV. Conclusion
                                        In toto, we agree with respondent that the cancellations of
                                      the APAs are reviewed for abuse of respondent’s discretion.
                                      We will grant respondent’s motion for partial summary judg-
                                      ment and concomitantly deny petitioner’s motion for partial
                                      summary judgment. A trial will be scheduled in due course.
                                        In reaching these holdings, we have considered all of the
                                      parties’ arguments, and, to the extent not addressed, we con-
                                      clude that they are moot, irrelevant or without merit.
                                        To reflect the foregoing,
                                                                                 An appropriate order will be issued.

                                                                               f

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