New England Legal Foundation Asks Supreme Court to Shield Tax Accrual Work Papers Created for Audited SEC Financial Statements from IRS Discovery
The US Supreme Court has been asked to end an intolerable split among the federal circuits and hold that tax accrual work papers prepared for the dual purpose of anticipating litigation and assisting auditors in vetting SEC required financial statements were protected from IRS discovery. In doing so, said an amicus brief filed in the Textron case by the New England Legal Foundation, the Court would also be reaffirming the validity of a federal procedural rule protecting from discovery documents prepared in anticipation of litigation or for trial. While the First Circuit Court of Appeals did partially rely on the ground that disclosure was appropriate and desirable because of the difficulties the IRS faces in tax administration, the Foundation argued that any disadvantages the IRS confronts in litigation should not be remedied through the judicial rewriting of Rule 26(b)(3).
The brief was filed in a case where the Court has been asked to review an en banc First Circuit Court of Appeals ruling 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. Textron Inc. v. United States, Dkt. No. 09-750. In a 3-2 opinion, the full appeals 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.
The IRS has unfettered access to the facts necessary for it to audit the company’s return and to form its own conclusions about the propriety of the company’s reporting, noted the brief. But, emphasized the Foundation, in subpoenaing the company’s litigation tax reserve estimate work papers, including spreadsheets, supportive e-mails and notes, the IRS is seeking the mental impressions of the company’s tax attorneys, including assessments of the likelihood and possible outcomes of litigation. These documents disclose confidential attorney judgments concerning facts, law, and adversarial priority and strategy, noted the brief, and are the essence of what Rule 26(b)(3) is designed to protect. Further, disclosure of these attorney judgments would give an adversary an unfair advantage in settlement negotiations, in its pre-trial budgeting, and in its own trial risk assessment.
The company and its auditors were not adversaries, said the Foundation. In fact, the auditors had an interest in common with the potential litigant, while not in common with a potential adversary of the company. That a company has an independent legal obligation of disclosure to its auditors is of no consequence, reasoned the brief, as the district court below recognized when it correctly held that Textron had not waived work product protection.
Moreover, the fact that the auditor’s own reserve calculations may be discoverable under the Supreme Court’s ruling in United States v. Arthur Young & Co., 465 U.S. 805 (1984), which rejected an accountant-client privilege, is no reason to ignore the text of a federal rule as applied to a company lawyer’s work product disclosed in confidence to the auditor. Indeed, stressed the Foundation, the availability of auditor-created information under Arthur Young should negate any need for an exception to the protection of the corporate tax lawyer’s work product under Rule 26(b)(3).
Finally, the brief noted that Rule 26(b)(3) expressly protects from discovery documents prepared in anticipation of litigation or for trial. But the First Circuit ruled that documents drafted because of potential litigation qualify for work product protection only if they are prepared for use in possible litigation. Thus, argued the Foundation, the practical effect of the ruling is that tax reserve litigation assessment documents are not protectable because they are prepared to support tax figures for the audited SEC-filed financial statements and not for use in litigation. The Foundation contended that the First Circuit’s for use test is inconsistent with the federal rule because it ignores the protection expressly afforded documents prepared in anticipation of litigation.
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