Audit Work Papers Were Discoverable by IRS Since They Were Done for SEC-Required Financial Statements Not Litigation

The full First Circuit Court of Appeals has ruled that the attorney work product doctrine does not shield from an IRS summons tax accrual work papers prepared by a company’s lawyers to support the calculation of tax reserves for audited financial statements filed with the SEC. In a 3-2 opinion, the court held that the purpose of the tax audit work papers was not to prepare for litigation, but rather to make book entries, prepare financial statements and obtain a clean audit. This was the testimony of IRS expert and former PCAOB Chief Auditor Douglas Carmichael, who said that tax accrual work papers include all the support for the tax assets and liabilities shown in the financial statements.

From the company's perspective, said the former Chief Auditor, they are created because the key officers of the company sign a certification saying that the financial statements are fairly presented; and they need support for that. From the auditor's perspective, the auditors need to record in the workpapers what they did to comply with GAAP. So the workpapers are the principal support for the auditor's opinion, testified the former PCAOB official.

The court emphasized that the tax work papers were independently required by statutory and audit requirements and that the work product privilege does not apply. It is not enough to trigger work product protection that the subject matter of a document relates to a subject that might conceivably be litigated. A set of tax reserve figures, calculated for purposes of accurately stating a company's financial figures, has in ordinary parlance only that purpose, said the en banc court, which is to support a financial statement and the independent audit of it.

Moreover, the tax work papers have to be prepared by exchange-listed companies to comply with federal securities regulations and accounting principles for certified financial statements. The compulsion of the federal securities laws and auditing requirements assure that they will be carefully prepared, in their present form, even though not protected, noted the court, and IRS access serves the legitimate and important function of detecting and disallowing abusive tax shelters.

The Supreme Court has not squarely ruled on the issue. The Fifth Circuit, the only other federal circuit to rule, denied protection for the work papers because the court recognized that the company in question was conducting the relevant analysis because of a need to bring its financial books into conformity with generally accepted auditing principles. The Fifth Circuit, which employs a primary purpose test, found that the work papers' sole function was to back up financial statements. Here, too, said the First Circuit, the only purpose of Textron's papers was to prepare financial statements.

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