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One Company’s Cautionary Tale About Advanced Pricing Agreements

23rd March 2022

Advanced pricing agreements (APA) are seen as one of the most reliable forms of tax certainty in today’s world. But here’s the thing: They only work if you honor your part of the agreement. And while that may seem like a no brainer, certain companies still don’t seem to get it. Take Eaton Corp., for example. The multinational company had an APA with the IRS—and the IRS just terminated it, because Eaton didn’t live up to its side of the bargain. Instead of following the transfer pricing agreement, the company overstated its non-U.S. income by $165 million from 2005 to 2008. Here’s how the APA works: The tax authority, in this case, the IRS, lists set transfer prices that the company agrees to—and all the company has to do is adhere to that pricing and in return, the IRS will spend its time scrutinizing other companies. Not a bad deal. Except that in this case, Eaton used what the government called “grossly inaccurate” transfer prices. The APA reports showed transfer prices that didn’t adhere to the agreement and also, the company didn’t disclose the APA multiplier—a factor used to determine the price as a percentage of manufacturing costs. When the IRS issued penalties and canceled the agreements claiming the multinational didn’t live up to them, Eaton took matters to court—and won. It was a short-lived victory, though, because the IRS appealed at the Sixth Circuit Court, which ruled that the IRS was completely justified. While APAs do offer a degree of tax certainty, they are expensive to put together and require a lot of time and effort to negotiate. So, perhaps the moral of the story is when you jump through the hoops to get an APA, why not just go all the way and honor it?