EATON CORPORATION AND SUBSIDIARIES, Petitioner-Appellee/Cross-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant/Cross-Appellee.
Nos. 21-1569/2674
United States Court of Appeals for the Sixth Circuit
Argued: July 21, 2022; Decided and Filed: August 25, 2022
22a0202p.06
DONALD, BUSH, and NALBANDIAN, Circuit Judges.
RECOMMENDED FOR PUBLICATION Pursuant to Sixth Circuit I.O.P. 32.1(b). Appeal from the United States Tax Court; No. 5576-12—Kathleen M. Kerrigan, Judge.
COUNSEL
ARGUED: Judith A. Hagley, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant/Cross-Appellee. Shay Dvoretzky, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Washington, D.C., for Appellee/Cross-Appellant. ON BRIEF: Judith A. Hagley, Francesca Ugolini, Arthur T. Catterall, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellant/Cross-Appellee. Shay Dvoretzky, Raj Madan, Nathan Wacker, Parker Rider-Longmaid, Sylvia O. Tsakos, SKADDEN, ARPS, SLATE, MEAGHER & FLOM LLP, Washington, D.C., Brian Kittle, MAYER BROWN LLP, New York, New York, for Appellee/Cross-Appellant.
NALBANDIAN, Circuit Judge. Taxes may well be “what we pay for civilized society,” Compania Gen. de Tabacos de Filipinas v. Collector of Internal Revenue, 275 U.S. 87, 100 (1927) (Holmes, J., dissenting), but that doesn‘t mean the tax collector is above the law. This case arises from the IRS‘s efforts to circumvent basic contract law.
Eaton Corporation and the IRS entered into two contracts: a pair of advance pricing agreements (“APAs“) meant to govern Eaton‘s tax calculations from 2001 through 2010. A few years after entering in to the APAs, Eaton reviewed its records and caught some inadvertent calculation errors. After letting the IRS know, Eaton corrected the mistakes. But the IRS thought that Eaton‘s mistakes were serious enough to warrant its unilateral cancellation of the APAs for tax years 2005
The Tax Court sided with Eaton on the major issues, concluding that the IRS had wrongfully cancelled the APAs. The parties raise a much-narrowed subset of arguments in their dueling appeals. For the reasons below, we affirm in part and reverse in part, siding with Eaton on all issues presented.
I.
A. The Tax Framework
Many corporations have overseas affiliates. This presents a challenge for the IRS. An American corporation can exploit its international network to minimize its income-tax liability in the following way: Rather than purchase products that it needs through an arm‘s-length transaction like everyone else (e.g., for $50 million), it can instead buy the products from its foreign subsidiary at an inflated price (e.g., $100 million). This inflated “transfer price” allows the corporation to Trojan Horse a chunk of its taxable income (and its income tax liability) into a lower-tax jurisdiction. In this example, the corporation‘s cost of goods sold in the U.S. increases by $50 million. And because cost of goods sold is a deductible, the corporation‘s taxable income in the U.S. decreases by that same amount. Meanwhile, the other $50 million ends up taxed at a lower rate in some other country.
To tackle this problem, Congress furnished the IRS with
Not surprisingly, the IRS and taxpayers frequently disagree over how to calculate these arm‘s-length prices. To help minimize the number of these disputes, the IRS introduced APAs in 1990. Under the scheme, the IRS and a taxpayer can agree on a calculation method in advance and embed it into a contract. As the IRS‘s Revenue Procedures confirm, “[a]n APA is a binding agreement between the taxpayer and the Service.”
B. Eaton and the IRS
That brings us to the parties in this case. Eaton is an Ohio corporation with a global footprint. It manufactures a wide range of electrical and industrial products. These include what Eaton calls “Breaker Products“: important safety components, such as circuit breakers, which feature in a broad spectrum of electromechanical devices. (R. 735, July 26, 2017 Op., p. 13.) During the relevant period—2005 and 2006—Eaton had its foreign subsidiaries in Puerto Rico and the Dominican Republic (the “Island Plants“) manufacture these Breaker Products. Afterwards, Eaton sold the Breaker Products to its other affiliates and third-party customers.
In 2002, Eaton applied for an APA. And in 2004, after eighteen months of negotiation and investigation, the IRS and Eaton entered into the first of their two APAs (“APA-I“). APA-I covered tax years 2001 through 2005. Then in 2006, after two more years of intensive negotiation and investigation, the parties entered into their second APA (“APA-II“). APA-II covered tax years 2006 through 2010. Both APAs incorporated the IRS‘s Revenue Procedures. More specifically, “Revenue Procedure
In simplified terms, the APAs spell out a transfer-pricing methodology (“TPM“) that requires Eaton to calculate the transfer price using two steps. First, both APAs adopted a comparable uncontrolled price (“CUP“) method, which pegs the transfer price at levels that third parties pay when purchasing Eatоn‘s Breaker Products. Before moving on to the second step, Eaton would use the CUP to calculate hypothetical profits. The second step required Eaton to calibrate the CUP using a comparable profits method (“CPM“). More specifically, the CPM compares Eaton‘s CUP-yielded hypothetical profits against the profits of similarly situated companies. The CPM measures these profits using something called the “Berry ratio“: namely, the ratio of gross profits to operating expenses. If Eaton‘s Berry ratio came out too high (by exceeding the permissible range specified in the APAs), Eaton had to dial down the transfer price accordingly.
On top of this, the APAs required Eaton to file annual reports. These reports are part and parcel of the typical APA bargain. Specifically, “the taxpayer is required to file an annual report demonstrating compliance with the APA for each covered APA year, and putting the Service on notice if critical assumptions have been violated or material facts have changed.” IRS Announcement 2000-35, 2000-1 C.B. 922, 943.
Skip forward to 2007, when things started to turn south. That‘s when the IRS began auditing Eaton‘s 2005 and 2006 tax returns. These audits continued through 2009, at which point the IRS expanded its review to Eaton‘s APA implementation. That same year, Eaton began its own review of company records. And it discovered a series of inadvertent miscalculations, some that generally favored the IRS and others that favored Eaton.3
What, then, is the APA Multiplier? Importantly, it is not part of the TPM itself. Rather, it‘s an algebraic fаctor that exists because the TPM and Eaton‘s internal records use different accounting language. The APA Multiplier translates the TPM-calculated prices into numbers that slot into Eaton‘s bookkeeping. More specifically, it does this by “express[ing] the transfer price as a percentage of manufacturing costs,” consistent with the rest of Eaton‘s records. (Id., p. 92.) Using the APA Multiplier in this way allowed Eaton to “generate invoices on a day-to-day and month-to-month basis” and satisfy quarterly reporting requirements even when only interim transfer prices were available. (R. 601, Aug. 31, 2015 Dep. Tr., pp. 1506-07.) Eaton would calculate “a preliminary APA multiplier” based on interim transfer prices. (R. 735, July 26, 2017 Op., pp. 93-94.) And when the final transfer price became available, Eaton would true-up on the back end with “a final APA multiplier.” (Id.)
Eaton used these translated numbers to complete its tax returns. But just one problem: Eaton inadvertently used the wrong denominator when calculating the APA Multipliеr. This, in turn, inflated the transfer price reported on the tax returns (by about five percent) and deflated Eaton‘s tax liability. Although Eaton‘s tax returns ended up with the wrong numbers in this way, its annual reports contained the accurate TPM-calculated prices. That‘s because the numbers on the annual reports didn‘t go through the APA Multiplier-translation process that yielded Eaton‘s tax returns. With that said, the annual reports still contained some misrepresentations—namely that Eaton‘s tax returns listed the correct numbers.
In April 2010, Eaton informed the IRS of its unintended errors. By October, Eaton had corrected the errors and submitted amended tax returns. Nevertheless, in December 2011, the IRS went on to cancel the APAs for tax years 2005 and 2006. In a letter, the IRS explained that several “material deficiencies in APA compliance” warranted cancellation, including “mistake as to a material fact,” “failure to state a material fact,” and “errors in the supporting data and computations used in the transfer pricing methodologies.” (R. 41, Dec. 16, 2011 Letter, p. 1.) Shortly after that, the IRS sent a deficiency notice claiming that Eaton owed $19,714,770 for 2005 and $55,323,229 for 2006. And the IRS assessed
C. Proceedings Below
In February 2012, Eaton filed a petition in the United States Tax Court to challenge the deficiencies. Before the case reached trial, the Tax Court disposed of two threshold issues. To begin with, the Tax Court held that its “deficiency jurisdiction includes reviewing the [IRS‘s] cancellations [of the APAs] because they are necessary to determine the merits of the deficiencies.” (R. 76, June 26, 2013 Op., p. 13.) And next, it held that an abuse-of-discretion standard governs the cancellation question, with Eaton bearing the burden of proof. In other words, the court held, Eaton had to “show that the Commissioner‘s action was arbitrary, capricious
The case proceeded to trial. The IRS raised no fewer than 17 justifications for cancelling the APAs. After trial, the Tax Court issued a 202-page opinion. To begin with, it declined to revisit Judge Kroupa‘s holding that Eaton had the burden to show abuse of discretion. But the Tax Court went on to find that Eaton had carried its burden and rejected all 17 grounds advanced by the IRS. In the Tax Court‘s view, not only were Eaton‘s errors “inadvertent,” they also did “not fit the APA governing revenue procedures’ definition of ‘material.‘” (R. 735, July 26, 2017 Op., p. 193.) And thus, the Tax Court concluded, “it was an abuse of discretion for [the IRS] to cancel [the APAs].” (Id., pp. 192.)
In a follow-up order, the Tax Court rejected the IRS‘s claim for 40 percent penalties under
One final order rounds out the set. Invoking
The IRS appealed to challenge the Tax Court‘s holdings on cancellation and penalties. It now asserts substantially fewer grounds for cancellation. As the IRS sees it, Eaton‘s (alleged) failure to disclose its use of the APA Multiplier, its miscalculation of that same multiplier, and the representations in its annual reports (to the effect that Eaton‘s tax returns contained acсurate numbers) constituted “failure to state” or “mistake as to” “material fact[s].” (First Br., p. 54 (internal quotation omitted).) Eaton cross-appealed to reassert its
II.
“We review the Tax Court‘s interpretation and application of law de novo, and its factual findings for clear error.” Losantiville Country Club v. Comm‘r, 906 F.3d 468, 472 (6th Cir. 2018) (citation omitted).
III.
A. Wrongful Cancellation: Burden of Proof
The threshold question is this: Who has the burden? Both APAs incorporated the Revenue Procedures, which say that the IRS “may cancel” the agreement for various enumerated grounds, including, among other things, “mistake as to a material fact” or the “failure to state a material fact.”
To begin with, the IRS‘s own Revenue Procedures confirm that APAs are contracts: “An APA is a binding agreement between the taxpayer and the Service.”
And the caselaw makes it quite clear that “[w]hen the United States enters into contract relations, its rights and duties therein are governed generally by the law applicable to contracts between private individuals.” United States v. Winstar Corp., 518 U.S. 839, 895 (1996) (quoting Lynch v. United States, 292 U.S. 571, 579 (1934)). This principle naturally extends to the IRS‘s dealings with taxpayers. See, e.g., Rink v. Comm‘r, 47 F.3d 168, 171 (6th Cir. 1995) (“A closing agreement [between the IRS and a taxpayer] is a contract, and generally is interpreted under ordinary contract principles.“); Dutton v. Comm‘r, 122 T.C. 133, 138 (2004) (holding that an offer-in-compromise between a taxpayer and the IRS “is governed by general principles of contract law“).
So contract law applies, but what does it say? It requires a party to prove the exception that allows it to back out of contractual promises. See Meacham v. Knolls Atomic Power Lab‘y, 554 U.S. 84, 91 (2008) (“[W]hen a proviso . . . carves an exception out of the body of a statute or contract[,] those who set up such exception must рrove it.” (quoting Javierre v. Cent. Altagracia, 217 U.S. 502, 508 (1910) (Holmes, J.))); New Britain Mach. Co. v. Yeo, 358 F.2d 397, 406 (6th Cir. 1966) (“[T]he law as to the burden of proof is that [a] party who seeks advantage of an exception in a contractual stipulation as the basis of his claim is charged with the burden of proving facts necessary to bring himself within such exception.” (internal quotation omitted)).
Courts have applied this principle in a wealth of cases involving the government. For example, the government carries the burden when it seeks to terminate a contract with a private party for default. See Johnson Mgmt. Grp. CFC, Inc. v. Martinez, 308 F.3d 1245, 1249 (Fed. Cir. 2002) (“The government bears the burden of proof in establishing the validity of a default termination.“); Lisbon Contractors, Inc. v. United States, 828 F.2d 759, 765 (Fed. Cir. 1987) (“[T]he government should bear the burden of proof with respect to the issue of whether termination for default was justified . . . .“). The same goes for a party that wants to void an agreement
In response, the IRS rehashes the Tax Court‘s logic: namely, that administrative deference governs because the parties “agree[d] that the legal effect and administration are governed by the applicable terms of the revenue procedures.” (Third Br., p. 41 (quoting R. 76, June 26, 2013 Op., p. 13 n.4.).) Or put another way, “the APAs—by their express terms—are subject to the discretion reserved to the IRS by the applicable Revenue Procedures.” (Id.)
But the problem is that the Revenue Procedures never “reserved” discretion in this way. On the contrary, they confirm that “[a]n APA is a binding agreement between the taxpayer and the Service,” which circles the analysis back to contract law.
This case is not so different from Oakland Bulk & Oversized Terminal, LLC v. City of Oakland, 960 F.3d 603 (9th Cir. 2020). At issue there was a contract between the City of Oakland and a developer. Id. at 607. Under the contract‘s express terms, Oakland could apply additional regulations against the developer only if “substantial evidence” showed a need. Id. at 608. Oakland tried to use that language to sneak in administrative law principles. More precisely, it argued that “the district court should have . . . adhered to administrative law review principles by limiting evidence to the record before the city council when it enacted the disputed [language].” Id at 609. But in the developer‘s view, the City‘s interpretation ran afoul of both the provision‘s express terms and “the traditional rules that govern a breach of contract case.” Id. The Ninth Circuit agreed with the developer, not least because the contract “refer[red] to ‘substantial evidence,’ not ‘substantial evidence review.‘” Id. at 609–10.
Or take another example, this time from the Federal Circuit. In Stockton East Water District v. United States, a pair of California water agencies entered into contracts with the federal government. 583 F.3d 1344, 1348 (Fed. Cir. 2009). Under the bargain, the federal government had to provide certain quantities of water to the agencies. Id. The federal government failed to perform, and the agencies sued for breach. In response, the federal government claimed that the contracts were, “by their inherent nature[,] subject to changes” in “future federal lаw or policy.” Id. at 1357. In other words, infused into the contracts were “background principles” arising from “the basic nature of
Similar logic plays out here. The parties could have specified a more pro-government burden in the APAs. But they didn‘t. Instead, they embedded cancellation language that reads similar to something out of a mine-run contract. To be sure, the parties incorporated the Revenue Procedures’ text. But that text says nothing about lopsided burdens of proof. After all, it makes little sense that a sophisticated party like Eaton would expend years negotiating over the minutiae of its convoluted bargain, only to leave so much in the hands of the government. Little surprise, then, that none of the cases that the IRS marshals on this front involve contracts.
Nor does the IRS‘s invocation of Tax Court Rule 142(a) change things. That rule says that “[t]he burden of proof shall be upon the petitioner, except as otherwise provided by statute or determined by the Court.” T.C. R. 142(a). But this rule does no more than set the default principle for routine tax disputes. It says nothing about contract law questions that are before the Tax Court. And indeed, to reiterate, the Tax Court has historically deferred to contract law principles (as it must) when assessing burdens in contract disputes. See, e.g., Vulcan Oil Tech. Partners, 110 T.C. at 163-64; Tree-Tech, Inc., 102 T.C.M. (CCH) at 31. In other words, the Tax Court‘s precedents “provide[]” “otherwise.” T.C. R. 142(a).
Thus, the IRS has the burden here, consistent with contract-law principles. To be sure, the government has broad discretion to enter into contracts with private partiеs. But once it enters into a contract, the government must play by the rules like everyone else. And that‘s precisely why the IRS‘s related claim that the Tax Court “erroneously substituted its judgment for that of the IRS” gets nowhere. (First Br., p. 57.) It wasn‘t the Tax Court that displaced the IRS‘s discretion; the IRS did that to itself by entering into a contract. To say otherwise here risks “creat[ing] an escape hatch for the government to walk away from contractual obligations.” Oakland Bulk, 960 F.3d at 612. “The house (of government) would always win,” and good-faith bargains would end up as something else entirely. Id.
B. Wrongful Cancellation: Merits
The principal question raised in this appeal is next: Has the IRS established grounds to cancel the APAs? The IRS says yes, pointing to Eaton‘s alleged failure to disclose the APA Multiplier, its calculation errors, and its representations in the annual reports. The IRS‘s arguments miss the mark.
Defining the grounds for cancellation. The first step is to define the grounds for cancellation. As previewed above, the Revenue Procedures provide exhaustive lists in a subsection called “Cancelling the APA.”
It stands to reason that these lists are exhaustive. After all, under the expressio unius canon, “[t]he expression of one thing implies the exclusion of others.” Antonin Scalia & Bryan Garner, Reading Law: The Interpretation of Legal Texts 107 (2012). And neither can the IRS scavenge out additional cancellation grounds from elsewhere in the Revenue Procedures. After all, why would the Revenue Procedures carve out a subsection for cancellation but then hide additional grounds somewhere else?
But be that as it may, the IRS urges us to look beyond the cancellation subsection. It claims that a subsection called “Examination” provides extra grounds for cancellation. It points in particular to that subsection‘s language concerning errors in “the supporting data and computations” used in applying the TPM.
It‘s well-established that the “use of ‘explicit language’ in one provision ‘cautions against inferring’ the same limitation in another provision.” Delek US Holdings, Inc. v. United States, 32 F.4th 495, 501 (6th Cir. 2022) (quoting State Farm Fire & Cas. Co. v. United States ex rel. Rigsby, 137 S. Ct. 436, 442 (2016)). Or put another way, “particular language in one section” but not another shows that the “disparate inclusion or exclusion” was purposeful. Russello v. United States, 464 U.S. 16, 23 (1983) (internal quotation omitted). So that must mean the items listed in the “Examination” subsection can justify cancellation only insofar as they coincide with the conditions listed in the cancellation subsection. The highly specific language regarding after-the-fact calculation errors appears in the former but not the latter. And so it follows that the IRS cannot seize on these errors to cancel.
The rest of the “Examination” subsection is consistent with this interpretation. The subsection goes on to say that “if the taxpayer has not satisfied any requirement in the prior paragraph,” the IRS “may decide to enforce, revise (see section 10.05), cancel (see section 10.06) or revoke (see section 10.07) the APA.”
This reading coheres with “the rule of reddendo singula singulis,” the distributive canon which says that “words and provisions are referred to their appropriate objects.” Sandberg v. McDonald, 248 U.S. 185, 204 (1918). The language here juxtaposes “cancellation” with “(§ 10.06),”
Confronted with this distributive principle, the IRS responds that “the audit provisions emphasize that if the taxpayer fails to establish any of thе requirements listed[,] . . . the IRS may decide on several alternative consequences, including deciding to cancel the APA.” (Third Br., p. 26 (internal quotation omitted).) In other words, the IRS says, “[t]he word ‘any’ precludes an interpretation that only some taxpayer failings identified during an audit merit cancellation.” (Id.) But this mischaracterizes things. All that language says is that if “any requirement” listed in the Examination section has not been “satisfied,” the IRS must refer the matter to the APA Director (Revenue Procedure 2004-40) or the Associate Chief Counsel (Revenue Procedure 96-53).
In short, the grounds for cancellation do not extend beyond the four corners of the cancellation subsection. And by extеnsion, that means they do not include errors in “the supporting data and computations” used in applying the TPM (that is, unless they otherwise coincide with the criteria listed in the cancellation subsection).
Grounds for cancellation: application. This all means the IRS may only cancel an APA for “the failure of a critical assumption,” “the taxpayer‘s 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.”
The analysis thus collapses into whether Eaton‘s conduct here was “material.” If it wasn‘t, that is the end of the rope for the IRS. To define that key term, we can look to the Revenue Procedures’ text: “Material facts are those that, if known by the Service, would have resulted in a significantly different APA (or no APA at all).”
This echoes the prevailing contract-law definition. See Universal Health Servs., Inc. v. United States, 579 U.S. 176, 193 (2016) (“Under any understanding of the concept, materiality ‘look[s] to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation.‘” (quoting 26 R. Lord, Williston on Contracts § 69:12 (4th ed. 2003))); In re Sallee, 286 F.3d 878, 897 (6th Cir. 2002) (“A material fact is a fact that affects the conduct of a reasonable person and is likely an inducement of the contract.“); Restatement (Second) of Contracts § 162(2) (1981) (“[A] misrepresentation is material if it would be likely to induce a reasonable person to manifest his assent.“). And under this definition, none of Eaton‘s inadvertent errors and purported omissions are material.
First, the IRS points to Eaton‘s alleged failure to disclose the APA Multiplier. The IRS‘s argument here fails for the simple reason that Eaton did in fact disclose the APA Multiplier. More specifically, after the parties finalized APA-I, the IRS audited Eaton‘s annual reports. The IRS sent Eaton an Information Document Request, and “[a]s part of its response[,] [Eaton] explained how the APA I multiplier was computed and applied.” (R. 735, July 26, 2017 Op., p. 70.) What‘s more, at least one of the members of that audit team (David Votaw) went on to participate in the negotiations for APA-II. So clearly, the IRS knew about the APA Multiplier. But then it went on to execute a materially identical APA-II anyway. And neither Votaw nor anyone else raised any objections. Evidently, Eaton‘s use of the APA Multiplier had no effect on whether the IRS would “manifest [its] assent.” Restatement (Second) of Contracts § 162(2) (1981).
In response, the IRS makes much of the fact that Eaton failed to mention the APA Multiplier in its formal application for APA-II. But this is a red herring. True, the Revenue Procedures set out certain steps that a taxpayer must follow when requesting an APA. More specifically, “[t]he taxpayer must submit copies of any documents relating to the proposed TPM” and make certain that all information submitted in its application is “properly labeled, indexed, and referenced in the request.”
It‘s worth noting as well that the APA Multiplier was simply “an implementation mechanism that incorporated the transfer price into [Eaton‘s] financial statements.” (R. 735, July 26, 2017 Op., p. 93.) That is to say, it “was not used to compute or modify the transfer price determined under the APA TPM.” (Id.) And so it‘s natural that the APA Multiplier didn‘t feature prominently in Eaton‘s negotiations with the IRS. After all, the whole point of the APA is “to rеach agreement on a TPM,” of which the APA Multiplier plays no direct part. (Id., p. 152.) In any event, the IRS knew about the APA Multiplier, and it cannot disclaim that knowledge now.
Second, the IRS highlights Eaton‘s inadvertent miscalculation of the APA Multiplier. The IRS‘s argument on this front falls short as well. To begin with, as explained above, errors in “the supporting data and computations” do not qualify as grounds to cancel. See supra at 12-15. This is enough to resolve the issue. But putting that to one side, after-the-fact miscalculations like these cannot be “material” in any event. Again, “[m]aterial facts are those that, if known by the Service, would have resulted in a significantly different APA (or no APA at all).”
Third, and last, the IRS points to Eaton‘s annual reports to support cancelling the APAs. The IRS claims that Eaton‘s reports “contained three critical representations that are invalid and constitute mistakes as to material facts.” (First Br., p. 39.) It calls out Eaton‘s representations that it “complied with all APA terms and conditions,” “its transfer pricing [as listed
And that means the annual reports argument rises and falls with its math error argument. Because the latter misses the mark, so does the former. To convince us otherwise, the IRS must offer some sort of delta between the calculation errors and its annual reports. The IRS tries to make that distinction by claiming that Eaton‘s representations in the reports go towards a “failure to actually verify whether its tax reporting complied with the APAs.” (Third Br., p. 12.) But that sounds exactly like ensuring the “correctness of the supporting data and computations used to apply the TPM,” which of course falls into enforcement, not cancellation.
And thus, for all of these reasons, the IRS cаnnot carry its burden. It was never entitled to cancel its bargain.
C. 26 U.S.C. § 6662 Penalties
The penalty question comes with a convoluted posture, and thus some housekeeping is necessary to set the scene. Eighteen months after trial, the IRS claimed 40 percent penalties under
Before trial, the IRS sought to assess
In response to the IRS‘s post-trial penalties claim, Eaton argued three things. First, the IRS forfeited the claim by failing to raise it at or before trial. Second, the IRS failed to get written approval for the assessment as required by
On appeal, Eaton says the Tax Court got the outcome right but the reasoning wrong. It now concedes that its self-corrections were
Section 482. The threshold question is whеther Eaton‘s self-corrections count as
But the Tax Court never explained why that distinction matters. Nor did it cite any authorities to that end. In fact, the APAs themselves confirm they are extensions of the IRS‘s allocation authority under
Forfeiture. The Tax Court may impose penalties (or any other “additions to the tax“) only “if [a] claim therefor is asserted . . . at or before the hearing or a rehearing.”
How, then, is a court to determine if the post-trial penalties claim is the same or not? The answer is a fairly straightforward one: If the penalty doesn‘t cover the same
In response, the IRS attempts a semantic maneuver. It claims that “there is only one adjustment at issue—Eaton‘s erroneous pricing of the Products.” (Third Br., p. 44 n.14.) And thus, the argument goes, the IRS “asserted penalties on the adjustment at issue” well before trial. (Id., p. 44.) But the IRS conflates the fact of an error with the specific adjustments (and underpayments) that form the basis of its penalties claim. Or put another way, the IRS asks us to forget that it advanced one set of calculations before trial and an entirely different set after trial. But the IRS can‘t do that—its changeup clearly implicates “the presentation of different evidence.” Sanderling, Inc., 66 T.C. at 758. Under the IRS‘s proposed rule, the government is free to mix and match an infinite number of theories—before trial, after trial, and anywhere in between—so long as everyone agrees that Eaton made some sort of error in its transfer pricing for 2005 and 2006. That is a bridge too far.
In fact, the IRS explicitly rejected Eaton‘s APA-based self-corrections at first. It did this by rejecting Eaton‘s amended tax returns, which were calculated using the TPM. Instead, the IRS continued to insist on its own, non-APA method. That is, of course, until after trial. And now, the IRS must take the bitter with the sweet. It cannot reject Eaton‘s adjustment method before trial, but then claim after trial that it was arguing the same thing all along.
In short, the adjustments that give rise to the IRS‘s post-trial penalties claim were “neither placed in issue by the pleadings, addressed as an issue at trial, nor discussed by [the Tax Court] in its prior opinion.” Molasky v. Comm‘r, 91 T.C. 683, 686 (1988). And that means the IRS forfeited the claim.
D. Double Taxation Relief
The final issue—double taxation relief—is more cut and dry. In fact, both parties now agree that Eaton is entitled to relief from double taxation under
The only thing left to clarify are procedural next steps. Section 5 of
IV.
For these reasons, we affirm in part and reverse in part.