The U.S. Supreme Court will decide within the next few weeks on whether to consider the Textron Inc. appeal of a First Circuit opinion regarding tax accrual workpapers. Although the Internal Revenue Service lost at the first two levels in its test case against Textron, it won the third round at the First Circuits en banc level.
The case arises out of the IRS seeking to subpoena tax accrual workpapers provided to auditors to assist with the approval of the companys financial statements, according to Sara Jane Shanahan, a partner in Boston-based Sherin and Lodgen LLP.
When the case was originally considered last winter, the First Circuit held the documents should not be produced because they were protected by the work product doctrine, which is in both case law and the Federal Rules of Civil Procedure. The doctrine provides that documents prepared in anticipation of litigation do not need to be produced to an adversary, she said. The policy is that the adversary should not have the opportunity to build a case by taking a peek at the other sides thoughts and strategies.
The government wants to look at the workpapers, naturally, because they document what the company itself considers its questionable tax positions.
In the governments brief filed in April urging the Supreme Court not to hear the case, Solicitor General (and now Supreme Court nominee) Elena Kagan stated, By characterizing essentially any interaction between a taxpayer and the IRS as litigation, petitioner [Textron Inc.] and its amici [friends of the court] fail to appreciate the dynamics of our self-assessing tax system. In an administrative tax proceeding, the parties are not adversaries, but rather two elements of the tax regulatory regime, with one party reporting its self-assessed tax liability and the other party attempting to verify that self-assessment.
The First Circuits en banc panel held that the workpapers were not protected by the doctrine because they were prepared for ordinary business purposes and not for use in litigation. Under this view, dual-purpose documents such as tax accrual workpapers would likely never be protected because the fact that litigation is anticipated is not enough.
An issue on the same playing field is IRS Announcement 2010-9, which proposes to require business taxpayers to disclose their uncertain tax positions on a schedule attached to their federal tax returns, said Shanahan. There is opposition on this from the business community about providing a roadmap on positions they have taken on their tax return that they recognize they may not be likely to win if litigated.
While the information might give the government a head start on where to look on the return, it would not be as detailed as the information sought in the Textron case, according to Shanahan.
Basically, it would provide them with the big picture without having to go through the subpoena process as they have in Textron, she said. Announcement 2010-9 does not make the ultimate Textron decision any less crucial, because it asks taxpayers to flag issues and then, procedurally, the IRS would take the second step to issue a subpoena for the tax accrual workpapers. The two work hand in hand.
If the court does not decide to hear the case, it would lead to confusion in the short term for businesses operating in the First Circuit on what is protected by the work product doctrine, Shanahan observed.
If they dont take the case, it could be that the First Circuit will back away from the decision in subsequent decisions, she said. The public policy consideration for the en banc decision was that its not fair for taxpayers to hide information from the IRS, but the language they used to get to that result is much broader. In reaching its result in the Textron case, the judges narrowed the work product doctrine to protect only documents prepared for use in litigation.
The work product doctrine protects mental impressions of a party or its counsel in anticipation of litigation, she said. Certainly there will be times when counsel will consult with CPAs in providing both legal advice and performing analyses that they would expect to be covered by the work product doctrine.
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