Tax News

CCH (cch.taxgroup.com) reports:

  The U.S. Court of Appeals for the First Circuit has upheld a federal court's decision that the taxpayer's tax accrual workpapers, the contents of which were communicated to an independent auditor, were not revealed to an adversarial party and, therefore, did not forfeit protection under the work product privilege. However, the court vacated and remanded the lower court's determination that the communications were not a complete waiver of the privilege. On remand, the lower court must decide to what extent the independent auditor's own workpapers can be disclosed without violating the taxpayer's work product privilege.

  CCH Comment. Kevin Kenworthy, partner, Miller & Chevalier, Washington, D.C., commented immediately after the release of the First Circuit's opinion that "while the Appeals Court has ruled largely affirming the decision in favor of Textron, the fight is not over yet. While in many respects the court made a favorable decision for taxpayers, the dust has not settled. The case could go as far as the U.S. Supreme Court and Textron could end up losing. Corporate taxpayers need to continue watching the case because a final verdict against Textron could give the IRS an extra tool to find out what companies really believe about their tax returns."

Work Product Protection Applied

  The First Circuit upheld the district court's ruling that documents prepared by Textron for the purpose of calculating its tax reserves were protected by the work product privilege. The taxpayer prepared its tax accrual workpapers in anticipation of litigation because they would not have been created "but for the prospect of litigation." The taxpayer's tax accrual workpapers would not have been prepared "but for" the need to estimate the likelihood of success in litigation in order to establish a reserve fund to cover positions for which the taxpayer could foresee disputes with the IRS. Anticipation of a tax dispute with the IRS could qualify as anticipation of litigation for purposes of the work product doctrine. The resolution of disputes through adversarial administrative processes such as proceedings before the IRS Appeals Board met the definition of litigation.

  The IRS's argument that the taxpayer's legal requirement to calculate and report a tax reserve fund rendered the tax accrual workpapers as prepared in the ordinary course of business versus in anticipation of litigation was rejected. The workpapers were "dual purpose" documents protected by the work product doctrine because "the business purpose derives from and is inextricably relate to anticipating litigation."

No Specific Litigation Reporting Required

  The court also ruled that the taxpayer should not be required to report a particular instance of litigation for each prepared tax accrual workpaper in order to prevent the work product doctrine from growing so broad as to swallow the attorney-client privilege. Such a requirement would offer protection under the work product privilege to only "the cantankerous and combative taxpayer who intends to thoroughly litigate every position. "

Independent Auditor

  The taxpayer did not waive protection under the work product privilege by showing its tax accrual workpapers to an independent auditor. The taxpayer's relationship with the auditor did not waive this protection, as it was not adversarial but, rather, cooperative in nature. The appellate court reasoned that this was different from a previous case ( Massachusetts Institute of Technology, CA-1, 97-2 USTC ¶50,955), where an auditor reviewed a client's financial statements to identify litigious disputes it would subsequently have with the client.

  However, despite the work product protection of the taxpayer's tax accrual workpapers, the independent auditor itself may be required to disclose its own resulting workpapers. The IRS argued that, despite any professional confidentiality obligations, the auditor may be required to disclose information to the Securities and Exchange Commission to protect stockholders or respond to valid subpoenas. While this is true, the court found that the remaining issue was whether disclosure of the auditor's workpapers to the IRS would substantially increase the risk that the contents of the taxpayer's workpapers would be disclosed to "an adversary."

  Although the IRS had requested the auditor's tax accrual workpapers, the lower court made no factual rulings on their contents. Thus, the court remanded to the case to the lower court to perform an in camera inspection or testimonial proceeding on the documents to make this assessment.

  Affirming in part, reversing in part and remanding a DC R.I. decision, 2007-2 USTC ¶50,605.

  By Torie Cole, CCH News Staff

Textron Inc., CA-1, 2009-1 USTC ¶50,167

Other References:

 
Code Sec. 7525

  CCH Reference - 2009FED ¶42,816F.25

 
Code Sec. 7602

  CCH Reference - 2009FED ¶42,827.33

  CCH Reference - 2009FED ¶42,827.5036

  Tax Research Consultant

  CCH Reference - TRC IRS: 21,400

  CCH Reference - TRC IRS: 21,402.35

  CCH Reference - TRC IRS: 21,404