At last count, 11 parties have submitted amicus curiae briefs to the U.S. Supreme Court as it considers whether to hear an appeal from the First Circuit decision in the highly charged Textron case, which centers on a corporation's tax accrual workpapers.
The Textron case is the first to test a new Internal Revenue Service policy of a more aggressive position in requesting tax accrual workpapers.
In August 2007, a federal district court held that the workpapers for Textron, an aerospace concern, were protected by work-product privilege. On appeal in January 2009, a panel of the First Circuit affirmed the district court. However, the full court reversed the panel decision in August 2009, holding that the tax accrual workpapers were not protected. The case is currently before the Supreme Court on a petition for certiorari, seeking review of the First Circuit decision. The High Court is expected to act upon the petition in late April.
The Internal Revenue Service wants to look at workpapers because they document what a company considers its questionable tax positions. In 2002, the service said that 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 sale-in/lease-out, or SILO, transaction. The IRS classifies such transactions as listed because they consider 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 level. (The original First Circuit decision, in Textron's favor, was by a three-judge panel; the en banc, or entire, court concluded that Textron workpapers were required and that the work-product privilege does not apply).
"This is a case of truly exceptional practical importance and obviously of importance to the accounting industry, as well as to companies such as Textron," said Kannon Shanmugam, a partner at Williams & Connolly, which is representing Textron before the Supreme Court. "We believe that the lower court incorrectly narrowed the work-product privilege, and for that reason, this case warrants Supreme Court review."
"The key issue in Textron Inc. et al. v. U.S. 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," explained Scott Burnett Smith, appellate partner at the Huntsville, Ala., office of Bradley Arant Boult Cummings.
"The First Circuit 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 Amicus Committee, 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. The Sarbanes-Oxley Act 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, the 15,000-member group of senior finance executives, has also filed an amicus brief in support of Supreme Court review. The petition was submitted jointly by FEI's Committees on Taxation and Corporate Reporting, and prepared by Washington-based Miller & Chevalier. The committees maintain that the lower court ruling in favor of Textron appropriately balances the competing 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 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."
"One of the points our brief makes is that the fight over tax accrual workpapers is not logically limited to the tax arena," said Kevin Kenworthy, a member at Miller & Chevalier. "It could have implications for all kinds of contingent liabilities that publicly traded companies have to evaluate as part of their financial reporting obligations."
The IRS's new disclosure rules requiring that information on uncertain tax positions be reported on tax returns, proposed in January, raises some of the same considerations, according to Kenworthy. "It would require the same kind of analysis as tax accrual workpapers. If it turns out that tax accrual workpapers are protected [under Textron], it's not too big a stretch to say that the IRS is asking for protected information."
The IRS proposal would require some businesses to report uncertain positions on their tax returns, thus staking out a position in advance of the court ruling.
"Since affected taxpayers are already required to establish tax reserves for uncertain tax positions in determining their financial statement income under U.S. or foreign accounting standards, the proposal will not be an added burden on taxpayers," said Commissioner of Internal Revenue Douglas Shulman at the recent New York State Bar Association Taxation Section Annual Meeting.
The proposal would not change the IRS position regarding tax accrual workpapers, according to Shulman. "Just to be clear again, this proposal would not require that taxpayers disclose how strong or weak they regard their tax positions, or report to us the amounts they reserved on the books regarding those positions," he said. "And, as a very important part of this proposal, the IRS would otherwise retain its longstanding policy of restraint as it applies to tax accrual workpapers."
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