A U.S. Tax Court judge said Wednesday that he's unlikely to find that the intercompany debt U.S.-based Eaton Inc. owed its Irish parent was unreal and should be recharacterized as equity, all but dismissing an alternative argument raised by the Internal Revenue Service.
The government's primary position is that U.S.-based Eaton Inc. overpaid interest on loans from its newly formed parent, Eaton PLC, after acquiring an Irish global electrical products manufacturer and inverting in 2012, allowing Eaton Inc. to reap significant tax deductions. If that argument fails, the IRS has said it plans to argue the debt should be considered equity — a position Judge Albert Lauber said Wednesday has little chance of success.
"Based on what I've heard, the chance that I'm going to find this is equity is microscopically small," the judge said.
Judge Lauber urged attorneys not to spend "undue amounts of time" on that argument when the trial resumes Dec. 4.
To win its case, Eaton must show that the IRS abused its discretion when assessing deficiencies to the company for the interest payments as well as for guarantee fees paid to Eaton PLC on debt issued to third parties in the United States. Much of the expert testimony during the first weeks of the trial was based on financial information that didn't exist at the time of the IRS' examination, and Eaton didn't think it could be generated in a timely fashion in 2012, Judge Lauber noted.
Eaton expert Jonathan Rush of Ankura Consulting Group LLC, who was hired to assess the creditworthiness of the U.S. borrowing entities, created what the judge called "new financials" from historical financial statements of both Eaton Corp. and Cooper Industries, the Irish entity it acquired. Rush's data was also used by Eaton's expert Shannon Anderson, a professor at University of California, Davis Graduate School of Management, to develop cash flow projections.
Given that they weren't created until much later, Judge Lauber asked, "Can the IRS be said to have abused its discretion by not considering the Rush financials?"
On Monday, the judge questioned an Eaton expert about how he arrived at a lowered credit rating for the U.S. group that, according to the company, justified the guarantee fees and high interest rates paid to the parent. On Wednesday, Judge Lauber said that even if Eaton PLC and Eaton Inc. had had the same credit rating, the guarantees might still have provided a benefit in the form of "ease of marketing" to potential investors.
When Eaton held a "road show" for potential buyers of $4.9 billion in acquisition notes, the judge said, a number of investors asked questions about guarantees — even "repeat customers" who had previously invested with the company. Given those comments from investors, he said, "I can imagine some benefit" from the guarantees, even if the company's credit rating had been as high as its parent's.
The trial over the financing of the Cooper acquisition is just one part of Eaton's larger case against the government, in which it contests total deficiencies of more than $600 million and $76 million in penalties for 2012 and 2013. No penalties are at issue regarding the interest rates and guarantee fees, and the deficiency amount related to those items is roughly $291 million.
Eaton is represented by Rajiv Madan, Nathan Wacker, Royce L. Tidwell, Melinda H. Gammello, Juliana D. Hunter, Elizabeth J. Smith, Ryan K. Fackler, Dominic M. Reilly, Paige Levenberg, Tanushree Bansal and Rachel D. Harper of Skadden Arps Slate Meagher & Flom LLP.
The IRS is represented by Timothy L. Smith, Jeannine Zabrenski, Emily Snider, Elizabeth Turnbull, Steven Balahtsis, Shannon Bambery, Mark Frazer, Trevor Maddison, John Altman, Blake Corry, John Guarnieri and Ronald S. Collins Jr.
The cases are Eaton Corp. & Subsidiaries v. Commissioner of Internal Revenue, docket numbers 2607-23 and 2608-23, in the U.S. Tax Court.
Nov 19
Deal Summary
