Eaton Corp. Argues Burden on IRS to Justify Cancellation of APAs

On June 9, 2016, Eaton filed a Motion for Reconsideration of Findings or Opinion Pursuant to Rule 161 related to Judge Kroupa's June 26, 2013, Opinion and Order ("Motion for Reconsideration"). In response to Eaton's Motion for Reconsideration, Respondent filed the Response. Eaton respectfully requests the opportunity to reply to the Response.

In Eaton's reply, which is being e-lodged simultaneously with this motion for leave, Eaton:

(1) addresses the significant attention Respondent dedicates to the purported procedural inadequacies in Eaton's Motion for Reconsideration by demonstrating that Eaton meets the standards for reconsideration;

(2) responds to Respondent's arguments regarding undue prejudice and evidentiary considerations, neither of which were addressed in Eaton's Motion for Reconsideration or its memorandum in support of that motion; and

(3) addresses Respondent's mischaracterization of Eaton's argument and of the relevant legal questions under applicable precedent.

Respondent objects to the granting of this motion for leave.

Dated: August 16, 2016

First, as set forth in Eaton's Motion for Reconsideration, the Opinion³ rests on substantial errors of law. Whether Respondent's unilateral cancellation of his APAs with Eaton was warranted is a central question in this case. Indeed, if the Court determines that Respondent was not permitted to repudiate the APAs, this case would be resolved in Eaton's favor. Accordingly, which party bears the burden of proof on the cancellation issue is an important issue, and any legal error regarding that burden would necessarily be a "substantial error[ ] of . . . law." Estate of Quick, 110 T.C. at 440.⁴ Respondent's argument that this Court should not even consider the proper burden of proof because Eaton "does not establish that the Court's ruling was in error" puts the proverbial cart before the horse. See Response at 7. The question of whether the Opinion rests on a substantial error of law can only be determined after considering the substantive issue raised by Eaton's Motion. And where such a substantial error of law has been made, it is important that the Court reconsider and correct that error.

Second, reconsideration is appropriate because of the same unusual circumstances described in Eaton's motion to seek reconsideration out of time. See Docket No. 654. In such unusual circumstances, the Court's typical justification for limiting reconsideration -- i.e., promoting judicial efficiency -- is outweighed by the need to take a fresh look at the Court's prior decision. Cf. Whitney v. Comm'r, 60 T.C.M. (CCH) 525, 525 (1990) (policy reason for limiting reconsideration is "efficient performance of judicial work"). That second look is warranted here given the circumstances set forth in Eaton's motion to seek reconsideration out of time.

First, no party can be prejudiced by the correction of a legal error. To the contrary, it would be Eaton who would suffer "undue prejudice" if the legally incorrect burden of proof were applied simply because Respondent allegedly would have tried his case differently.

Second, Respondent's assertion that he would have presented his case differently at trial if he bore the burden of proof is difficult to understand. Respondent identifies no additional evidence he would have sought to introduce at trial, and Eaton is aware of no such evidence. Indeed, all exhibits related to the cancellation issue were ultimately admitted by the Court when Respondent withdrew his objection under Fed. R. Evid. 408. Additionally, several people involved in the APA processes (both for IRS and Eaton) were called as witnesses at trial. Indeed, many of these same witnesses were on Respondent's own witness list. The IRS questioned or had the opportunity to question each of these witnesses, and there is no indication that Respondent held back in his questioning of the witnesses because of the burden of proof.

Third, Respondent's suggestion that a shift in the burden of proof would "revive the privilege issues that the Court previously resolved" takes Judge Guy's prior holdings out of context. Response at 11. Judge Guy's privilege orders related to the question of whether Eaton could withhold certain documents as privileged while asserting the reasonable cause and good faith defense to penalties and must be read in that context.⁵ Judge Guy's privilege orders did not address the applicability of privileges to advice received in the course of negotiations with a counterparty. The law is clear that such advice remains privileged where, as here, the party has not put its state of mind at issue. See, e.g., U.S. Fire Ins. Co. v. City of Warren, No. 2:10-cv-13128, 2012 WL 2190141 (E.D. Mich. June 14, 2012); Medtronic, Inc. v. Intermedics, 162 F.R.D. 133, 135 (D. Minn. 1995) (specifically noting that the party was not relying on advice of counsel as a defense); cf. In re Lott, 424 F.3d 446, 454 (6th Cir. 2005) ('"[T]he attorney-client privilege cannot at once be used as a shield and a sword.' But, while the sword stays sheathed, the privilege stands.") (citation omitted).

Fourth, even if a change in the burden of proof would cause a need for additional proceedings -- which it does not for the reasons set forth above -- that would not be a valid reason for refusing to reconsider the Opinion. If the legal standard adopted by Judge Kroupa is indeed wrong, such additional proceedings (if any) would also be necessary if the Sixth Circuit reversed on appeal. Accordingly, it is appropriate for the Court to reconsider the issue and ensure that the appropriate legal standard is employed at the trial-court level, before any potential appeal.

Importantly, Ingram obviates the need to choose between contract law and the Revenue Procedures because Ingram gives effect to all three key governing rules: (i) the Revenue Procedures' provisions that an APA is binding,⁷ (ii) the Revenue Procedures' criteria for cancellation of a binding APA,⁸ and (iii) longstanding Tax Court precedent establishing that the party who invokes criteria permitting them to exit a binding agreement bears the burden of proof on that criteria. Thus, Respondent's attempt to create a black-and-white choice between contract law and the Revenue Procedures directly conflicts with the Ingram precedent, which does not require any such choice.⁹ The only question that is relevant in deciding whether to apply the Ingram precedent is whether the APAs are binding agreements. That question is directly and explicitly answered in the affirmative by the IRS's own guidance, as discussed further below.

In presenting the Court with the wrong question, Respondent also mischaracterizes Eaton as advancing "the simplistic proposition that the common law of contracts supersedes the applicable revenue procedures." Response at 13. Eaton is not arguing that the common law of contract or any other law "supersedes" the APA Revenue Procedures. Rather, Eaton's argument primarily rests on Tax Court precedent -- i.e., Ingram and its progeny. Moreover, Eaton agrees that the APA Revenue Procedures are governing. See, e.g., Eaton Mem. at Response at 14. Under Ingram what matters is simply that APAs are binding. 12. It is Respondent who ignores the terms of the APA Revenue Procedures. As discussed further below, the APA Revenue Procedures plainly and unambiguously provide that an APA is a "binding agreement between the taxpayer and the Service." Rev. Proc. 96-53 § 10.01; Rev. Proc. 2004-40 § 9.01. Respondent ignores that language, contending against his own administrative guidance and without support that an APA is not binding on the Service. See Eaton Mem. at 11-19.

First, Respondent argues that he did not have authorization to be bound by the APAs, therefore they cannot be binding agreements. See Response at 13-15. Respondent's argument is confusing, as there is no dispute that the IRS promulgated the Revenue Procedures based on its statutory authority to administer the Code and "prescribe all needful rules and regulations." I.R.C. § 7805(a). As the Revenue Procedures themselves describe APAs as "binding agreements," and Respondent was authorized to promulgate those Revenue Procedures, there is no basis for arguing that Respondent lacks authority to be bound by APAs. Respondent, moreover, is bound to follow is own guidance describing the APAs as binding agreements. See Eaton Mem. at 16-17.

Second, Respondent argues that APAs are not binding agreements because "[t]he Secretary has only authorized the Commissioner to enter into binding agreements relating to a person's pre-petition tax liability in specified cases that do not include APAs." Response at 14. Respondent's argument is legally irrelevant. There is no dispute that the procedures applicable to a closing agreement provided by section 7121 are invoked when IRS and a taxpayer resolve a "tax liability." But, an agreement resolving a "tax liability" is not the only type of agreement the IRS enters into with taxpayers and section 7121 is not the exclusive provision governing agreements the IRS executes with taxpayers. See Eaton Mem. at 18. APAs are governed by Revenue Procedures -- not by section 7121 -- because APAs do not resolve the amount of a "tax liability." Rather, APAs resolve a different type of dispute between a taxpayer and the IRS -- a transfer-pricing dispute -- by establishing an agreed-upon transfer pricing methodology that applies to certain related-party transactions. As such, APAs are governed by the applicable Revenue Procedures, not by section 7121. In sum, while APAs resolve a different type of dispute from closing agreements (amount of tax liability vs. transfer-pricing methodology) and their legal effect is determined under different authority (APA Revenue Procedures vs. section 7121), neither of these distinctions is legally relevant for purposes of deciding whether Ingram applies. See Eaton Mem. at 20-23.

Third, Respondent argues that the APA Revenue Procedures give him unilateral discretion to repudiate his agreements with taxpayers. Specifically, Respondent isolates a provision in the APA Revenue Procedures providing that "the Associate Chief Counsel (International) may decide to . . . cancel . . . the APA." Response at 16 (quoting Rev. Proc. 2004-40 § 10.03(3)). A provision that gives one party to a binding agreement the right to cancel the agreement in certain circumstances does not make the cancellation of an APA an "administrative decision" subject to abuse-of-discretion review. See Eaton Mem. at 24-25. The same decision must be made by IRS officials when Respondent seeks to exit a closing agreement, yet that decision is reviewed by a Court with the IRS -- not the taxpayer -- carrying the burden of proof. See id.

Respondent's argument that the delineated circumstances in which he is allowed to exit an APA grant him the discretion to unilaterally determine if those conditions have been met also cannot be reconciled with Respondent's statement in the Revenue Procedures that an APA is a "binding agreement."¹¹ If Respondent intended to retain a right to cancel an APA in his sole discretion rather than be bound by the terms of the agreement, then the Revenue Procedures and the APA would necessarily have included language such as "the Associate Chief Counsel (International) may decide to . . . cancel in his sole discretion." Or, the description of the arrangement in the APA would provide that "the taxpayer agrees the transfer pricing method identified in the APA is the best method, but the IRS reserves judgment as to whether such transfer pricing method is, in fact, the best method." No such language exists in the APAs or the APA Revenue Procedures.

Contrary to Respondent's argument, therefore, APAs cannot be distinguished from closing agreements in any legally relevant way; both are binding agreements established at the time of the parties' execution, subject to cancellation based on information later identified that justifies cancellation. The Ingram precedent therefore applies to both closing agreements and APAs.

Dated: August 16, 2016

²Ingram v. Comm'r, 32 B.T.A. 1063 (1935), aff'd, 87 F.2d 915 (3d Cir. 1937).

³ Unless defined herein, all capitalized terms have the meaning set forth in Eaton's Memorandum in Support of Motion for Reconsideration.

⁴ Indeed, Respondent's own arguments that a shift in the burden of proof may require additional evidentiary proceedings, while ultimately unpersuasive, illustrate that Respondent himself recognizes the significance of this legal issue. Response at 11-12.

⁵ Eaton is no longer asserting a penalty defense, rendering the language quoted by Respondent irrelevant.

⁶Ingram v. Comm'r, 32 B.T.A. 1063, 1065 (1935) (holding that "he who seeks to set [an agreement] aside under the exception must prove the fact upon which the exception is conditioned"), affd, 87 F.2d 915 (3d Cir. 1937).

⁷See Rev. Proc. 96-53 § 10.01, 1996-2 C.B. 375; Rev. Proc. 2004-40 § 9.01, 2004-2 C.B. 50.

⁸See Rev. Proc. 96-53 § 10.05; Rev. Proc. 2004-40 § 9.05.

⁹ Put simply, Ingram is not premised on treating closing agreements as contracts. Indeed, Respondent himself argues that "a closing agreement is not a contract" and, therefore, Respondent cannot take the position that application of Ingram is dependent on the existence of a contract.

¹⁰See, e.g., Ex. 1-J at ¶ 13 ("This contract binds . . . any successor in interest to Taxpayer."); Ex. 2-J at ¶ 13 (same); Rev. Proc. 96-53 § 10.01 (an APA is a "binding agreement between the taxpayer and the Service"); Rev. Proc. 2004-40 § 9.01 (same); Announcement 2012-13, 2012-16 I.R.B. 805, 806 ("[a]n APA is a binding agreement between the IRS and a taxpayer"); Announcement 2011-22, 2011-16 I.R.B. 672, 672 (same); Announcement 2000-35, 2000-1 C.B. 922, 923 ("[a]n APA is a legally enforceable agreement").

¹¹ Indeed, Respondent has conceded that if his position is adopted, then APAs are legally meaningless. Mem. of Law in Support of Resp't's Notice of Obj. to Pet'r's Mot. for Partial Summ. J. at 7 (Aug. 1, 2012) ("For the same reasons that Eaton cannot secure Court enforcement of the Original and Renewal APAs against Respondent, Respondent could not secure Court enforcement of the Original and Renewal APAs against Eaton.").