Textron Case Endangers Tax Workpaper Protection

At last count, at least 11 parties have submitted amicus (friend of the court) briefs to the U.S. Supreme Court as it considers whether to hear an appeal from the First Circuit decision in Textron regarding a corporation’s tax accrual workpapers.

The IRS wants to look at workpapers because they document what a company considers its questionable tax positions. In 2002, the Service said it would modify its policy of restraint regarding tax accrual workpapers, and would seek them in certain circumstances where a taxpayer had claimed the benefits of a listed transaction on a return. In Textron’s case, the listed transaction was a SILO (sale-in, lease-out) transaction. The IRS classifies such transactions as listed because it considers them a potential tax shelter subject to abuse by taxpayers.

Although the IRS lost the first two rounds in its test case against Textron, it won the third round at the First Circuit’s en banc (by the entire court) level. (The original First Circuit decision, in Textron’s favor, was by a three-judge panel; the en banc court concluded that Textron workpapers were required and that the work product privilege does not apply).

“The key issue in Textron Inc. et al. v. United States is whether work product privilege extends beyond documents prepared for use in litigation and includes, for example, those created in preparation of a company’s financial statements,” said Scott Burnett Smith, appellate partner at the Huntsville, Ala., office of Bradley Arant Boult Cummings LLP.

“The First Circuit [in its en banc decision] was cavalier in its ruling regarding the protection of what should have been considered to be work product,” said Smith, who is vice chair of the Defense Research Institute, which filed one of the amicus briefs.

“We’re concerned because they’ve formulated a very narrow work product protection that will keep corporations from candidly discussing corporate risk with their clients,” he said. It puts companies in a Catch 22. SOX requires the disclosure of risk to the corporation, but without the protection of that information, the corporation will not be encouraged to discuss it if the situation is prior to litigation. If you know someone is listening in on your conversation, you’re not going to be candid and open.”

Financial Executives International has also filed an amicus brief in support of Supreme Court review. The petition was submitted jointly by FEI’s Committee on Taxation and Committee on Corporate Reporting. The committees maintain that the lower court ruling in favor of Textron appropriately balances the completing interests of the IRS, the investing public, and the fairness considerations that protect attorney work product. This appropriate balancing should permit companies to share candid assessments of potential litigation claims with their outside auditors, for example, without fear that such information would be accessible by competitors or adversaries.

“The issues in the Textron case are extremely important to FEI’s membership, and have a direct effect on all publicly held companies and their ability to prepare financial statements and efficiently file tax returns,” said Matt Miller, FEI’s senior director of government affairs. “We strongly encourage the court to grant review in this case so that the court can clarify the scope of work-product protection.”

The court is expected to act upon the Textron petition in early spring.

Meanwhile, the IRS recently proposed to require some businesses to report uncertain positions on their tax returns, thus staking out a position in advance of the court ruling. The goals of the proposal are to cut down the time it takes to find issues and complete an audit, and ensure that both the IRS and the taxpayers spend time discussing the law as it applies to the facts, rather than looking for information, and to help the IRS prioritize the selection of issues and taxpayers for examination, according to Commissioner of Internal Revenue Douglas Shulman.

“Today, we spend up to 25 percent of our time in a large corporate audit searching for issues rather than having a straightforward discussion with the taxpayer about the issues. It would add efficiency to the process if we had access to more complete information earlier in the process regarding the nature and materiality of a taxpayer‘s uncertain tax positions,” he explained.

For reprint and licensing requests for this article, click here.
Tax practice
MORE FROM ACCOUNTING TODAY