Shifting Burden of Proof Would Upend Eaton Case: IRS

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Dolores W. Gregory

Oct. 21 — Eaton Corp. stands to gain an unfair advantage in its transfer pricing dispute with the IRS if the U.S. Tax Court overturns a 2013 opinion by former Judge Diane L. Kroupa, an attorney for the government said.

John M. Altman, Cincinnati area counsel with the IRS, told the court at an Oct. 21 hearing that overturning Kroupa’s opinion would wreak havoc for the government ( Eaton Corp. v. Commissioner, T.C., No. 5576-12, hearing 10/21/16 ).

Kroupa had ruled that advance pricing agreements aren’t binding contracts and that, therefore, the IRS wasn’t obligated to show breach of contract before it canceled two APAs with Eaton in 2011. Eaton sought to revisit the ruling on the ground that Kroupa was facing criminal tax evasion charges in an unrelated matter. At an Oct. 21 hearing in her criminal case, the former judge pleaded guilty to the six counts against her, including conspiracy to defraud the U.S., tax evasion, making and subscribing a false tax return and obstruction of the IRS.

Altman argued the IRS built its defense on the understanding that the burden of proof fell to Eaton to show that the agency had abused its discretion in canceling the APAs. It wasn’t up to the IRS to create an affirmative case against the company, he said.

Had the IRS known it would have the burden of proof to show that Eaton had made material misrepresentations, it would have conducted discovery in a very different manner, Altman said. The IRS would have changed its answer to the original petition, setting out the facts and grounds differently. It would have interviewed more employees of the company and would have sought access to work product that was otherwise privileged, he said.

In the underlying case, Eaton challenged a deficiency notice for tax years 2005 and 2006. With the APAs no longer in effect, the IRS found that Eaton had understated its income by $368.8 million for the period and owed $127 million in back taxes and penalties as a result.

No Connection to Criminal Case

Oral argument in the underlying case has concluded, but Eaton cited Kroupa’s tax woes as a special circumstance that would allow the court to revisit her opinion three years later.

An attorney for Eaton declined to link Kroupa’s criminal conduct to her ruling on the APAs, instead revisiting the company’s earlier arguments that Kroupa was wrong in ignoring a fundamental principle of contract law. The party seeking to set aside an agreement bears the burden of proving that there is a basis for doing so, said Raj Madan, a partner with Skadden, Arps, Slate, Meagher & Flom in Washington.

“This rationale applies with equal force regardless of the type of agreement,” Madan said.

Altman countered that Eaton was focusing on the wrong issue. Whether an APA is a binding agreement isn’t the point, he said. “Nowhere does the taxpayer show where the court erred as a matter of law.”

The company cited no case in which the burden of proof falls to the IRS to show that its actions were correct, he added.

The current presiding judge, Kathleen Kerrigan, noted that the grounds for cancellation include a misrepresentation of material facts and lack of good faith compliance with the APA. Regardless of who has the burden of proof, she asked, wouldn’t the IRS be looking at evidence that is already in the record? What additional information would be needed?

Altman stressed that the party that has the burden of proof must create a record that will make its case. One critical issue, he said, relates to the timing of when Eaton discovered certain errors in its tax returns. It appears to have been earlier than the company suggested, he said.

“That would be very material to the government’s case,” Altman said. If the burden of proof fell to the IRS, “there would be additional evidence that we would want to develop.”

As it stands, the record in the case wouldn’t be adequate for the government to make an affirmative case against Eaton, he said.

To contact the reporter on this story: Dolores W. Gregory at

To contact the editor responsible for this story: Molly Moses at

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