Washington Legal Foundation Urges Supreme Court to Protect Tax Accrual Work Papers Used for SEC Filings from IRS Discovery
Tax accrual work papers used to help counsel and auditors assess a company’s tax positions in SEC mandated filings must be protected from IRS discovery since counsel’s conclusions, opinions and legal theories on uncertain tax position rest at the very heart of the work product privilege, the Washington Legal Foundation said in a Supreme Court amicus brief in the Textron case. For over 60 years, noted the WLF, the Court has recognized that a company should be able to have its in-house counsel candidly assess its legal position on tax and other business issues without fear that such legal evaluations may later be used against the company by the IRS or others.
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 WLF urged the Court not to allow the First Circuit’s decision to set a dangerous precedent that would significantly chill corporate counsel’s ability to prepare candid legal assessments of the company’s position in anticipation of litigation, not only in the specific, tax-related context of this case, but well beyond.
Citing the Supreme Court’s 1947 ruling in Hickman v. Taylor, the brief asserts that the Supreme Court has long embraced the view that discovery, including IRS discovery, has ultimate and necessary boundaries. Hickman never suggested that the work-product privilege was limited to materials prepared for use in litigation, argued the WLF, much less to those prepared for use at trial. Rather, the Court announced a much broader protection for materials prepared in the course of counsel’s legal duties. When Hickman did speak of litigation, it expressed its concern for protecting materials prepared merely with an eye towards litigation, not for use in litigation as curiously required by the First Circuit.
In the view of the WLF, nothing in the First Circuit ruling refutes the established fact that Textron prepared the relevant materials with an eye towards a potential tax dispute with the IRS. Prudent companies such as Textron routinely anticipate such controversies and begin legal preparation well in advance of the time an appeal or litigation is formally commenced. In fact, the IRS has audited every Textron tax return since 1980, said the brief, and in seven of its past eight audit cycles Textron has appealed disputed tax matters to the IRS, with three of these disputes ultimately resulting in litigation.
Further, exam and appeals stages of a tax dispute can be very adversarial and, even if settled, can result in significant additional tax liability for the company. The matters identified in Textron’s work papers concerned issues on which federal tax law was unclear.
In addition, the WLG argued that the mere fact that tax accrual documents may also serve a separate business-related purpose of preparing audited SEC filings is irrelevant to the question whether they are entitled to protection under the Hickman ruling. It is a reality of modern times that documents prepared for a business purpose are frequently prepared in anticipation of litigation. As a result, continued amicus, the First Circuit’s novel ``for use’’ in litigation standard is contrary to more than 60 years of precedent and cannot be reconciled with the Court’s longstanding work-product doctrine.
The Court has historically fully appreciated the fact that an adversary system cannot function without a healthy culture of candor and confidentiality, noted the WLF, and allowing a party to gain inside knowledge of its opponent’s legal strategy weakens the system. The IRS seeks the work papers to obtain a roadmap for evaluating Textron’s tax return, asserted the brief, since such documents would identify weak spots and allow the government to know exactly how much Textron should be willing to spend to settle each item. In the view of amicus, this is precisely the motivation that the Court rejected over 60 years ago. And, the Court recognized more recently that tax accrual work papers pinpoint the soft spots on a corporate tax return by highlighting those areas in which the firm has taken a position that may, at some later date, require the payment of additional taxes.