Concomitant with requiring companies to file an uncertain tax position statement on Schedule UTP, and addressing an issue that has roiled the federal courts, the IRS expanded its policy of restraint and will forgo seeking particular documents that relate to uncertain tax positions and the work papers that document the completion of Schedule UTP. IRS Announcement No. 2010-76. Thus, if a document is otherwise privileged under the attorney-client privilege, the tax advice privilege in section 7525 of the Code, or the judicially-created work product doctrine, and the document was provided to an independent auditor as part of an audit of the company’s financial statements, the Service will not assert during an examination that privilege has been waived by such disclosure.
However, the IRS’ exercise of restraint will not apply if the company has engaged in any activity or taken any action that would waive the attorney-client privilege, the tax advice privilege in section 7525 of the Code, or the work product doctrine; or a request for tax accrual work papers is made under IRM 220.127.116.11 because unusual circumstances exist or the taxpayer has claimed the benefits of one or more listed transactions.
Schedule UTP requires companies to provide a concise description of each uncertain tax position for which they have recorded a reserve in their financial statements, or for which no reserve has been recorded because of an expectation of litigation. These uncertain tax positions are identified by corporations during the process of preparing financial statements for SEC filing under applicable FASB accounting standards, such as FIN 48. In reviewing and verifying financial statements for compliance with FIN 48, independent auditors may ask for copies of legal opinions and other documents in order to understand transactions, to understand the legal bases for the treatment of transactions, and to determine the adequacy of reserves for contingent tax liabilities.
The issue of whether the IRS can discover tax accrual work papers is extremely contentious and has divided the federal courts. Recently, a panel of the DC Circuit Court of Appeals ruled that a memo prepared by a company’s outside audit firm recounting the thoughts of corporate counsel on the prospect of tax litigation over company partnerships could be protected attorney work product. Similarly, the panel said that a company’s disclosure to the independent auditor of a tax opinion on company partnerships by outside counsel did not constitute a waiver of the work product privilege. Disclosure to an adversary or a conduit to an adversary could waive the privilege, noted the panel, but a company’s independent outside auditor of its financial statements is neither an adversary of the company nor a conduit to its adversaries. The government sought production of the documents in connection with ongoing tax litigation with the company. (US v. Deloitte LLP, US Court of Appeals for the DC Circuit, No. 09-5171, June 29, 2010).
Earlier, the US Supreme Court declined to review the First Circuit’s en banc opinion in the Textron case, thereby leaving intact a 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. 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.
A number of amici briefs had urged the Supreme Court to take the case. In its brief, Financial Executives International said that company management has a powerful incentive to provide an independent auditor with all information the auditor deems necessary to evaluate the adequacy of the corporate financial statements. Moreover, the interests of investors in having access to accurate financial statements requires that the tax work papers be protected. More broadly, the integrity of the securities markets requires that published financial statements filed with the SEC fairly reflect a public company’s financial position. It follows that, in providing assurance that a company’s financial statements fairly reflect its financial position, an independent auditor serves the public interest.
In earlier remarks, IRS Commissioner Douglas Shulman assured that the new regulations would not require companies to disclose how strong or weak they regard their tax positions or report the amounts they reserved on the books regarding those positions. He said that the IRS would otherwise retain its longstanding policy of restraint as it applies to tax accrual work papers. The IRS is looking only for a brief description of the issue and the maximum amount of US income tax exposure, he noted, and there is no requirement that the taxpayer disclose its risk assessment or tax reserve amounts. He also pointed out that the IRS is asking for a list of issues that the company has already prepared for financial reporting purposes.