In Reply to US Brief, Textron Urges Supreme Court to Protect from IRS Discovery Work Papers Used to Assess Uncertain Tax Positions in SEC Filings

Tax accrual work papers used to assess a company’s uncertain tax positions as a prelude to preparing SEC-mandated financial statements should be protected from IRS discovery, the company argued to the Supreme Court. In a reply to the government’s brief, Textron refuted the government’s suggestion that review of the issue is unwarranted because the IRS seeks to obtain tax accrual work papers only in unusual circumstances. The company pointed out that in 2002 the IRS adopted a more aggressive policy giving it the discretion to seek all of a taxpayer’s work papers under specified circumstances. Moreover, since the First Circuit’s decision in this case, the IRS has declared that it will pursue such work papers even more aggressively in the future.

Similarly, the company refuted the government’s suggestion that, for purposes of federal procedural rules protecting attorney work papers, only litigation in federal court qualifies as “litigation,” and antecedent IRS administrative proceedings do not. The company said that it has presented evidence below that there was a reasonable prospect of federal-court litigation. In any event, there is no basis for excluding IRS administrative proceedings from the scope of the rules of procedure. The government’s assertion that IRS administrative proceedings are cooperative rather than adversarial would come as a surprise to anyone who has had dealings with the IRS, noted the company.

A main government assertion is that the work product privilege in the federal rules does not protect any document that was prepared for the purpose of complying with a statutory or regulatory requirement. And, said the government, the tax accrual work papers are used by a company’s accountants and lawyers in assessing uncertain tax positions for inclusion in SEC-mandated filings.

The company, however, said that the critical point is that, while the documents at issue here were prepared for the purpose, among others, of assisting the company auditor in reviewing the amount set aside in reserve for potential tax liabilities, the company was not required to generate those documents. Although the government contends that legal or auditing requirements mandate that tax accrual work papers be created, noted the company, it cites no authority for the proposition that the company was obligated to create the documents at issue in this case. Quite the contrary, the company could have complied with any applicable SEC obligations by conveying all of the same information to its auditor orally or in less detail.

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 First Circuit conditioned the protection on the tax accrual work papers being prepared for use in litigation. The company described the court’s “for use” standard as patently flawed. Such a narrow interpretation of the work-product privilege would hardly be in the government’s institutional interest, argued the company, because the government concedes the work product privilege in litigation at least as often as it seeks to pierce it. Thus, the government’s conspicuous failure to explicitly defend the First Circuit’s “for use” standard is not surprising, said the company.

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