Monday, October 25, 2010

KPMG Survey Finds that New IRS Uncertain Tax Position Disclosure Regime Could Create Tension with Outside Auditor

Almost half of senior corporate executives surveyed by KPMG believe that the IRS’s new reporting regime for uncertain tax positions will create tensions among or between their outside audit firm, tax advisors and tax department. The survey also revealed that an enhanced policy of restraint in discovering tax accrual work papers used to prepare corporate financial statements, announced by the IRS concomitant with the new Schedule UTP, left corporate executives divided over their comfort level. The survey, conducted by KPMG’s Tax Governance Institute, found that 45 percent of the senior officers remain uncertain about how uncertain tax positions might impact privilege but are confident in their ability to resolve the issue with appropriate IRS personnel, while 42 percent said the expanded policy of restraint in IRS Announcement No. 2010-76. does not remove their concern that IRS agents will demand information which may impinge on privilege.

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.

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.

The KPMG survey also found that almost half of senior executives polled are most concerned about the prospect of providing a concise description of their uncertain tax positions in order to comply with the new disclosure requirement. Their biggest concern was providing the concise description for a disclosed UTP. Other major concerns cited centered on the IRS’s ability to effectively administer the UTP program and on the scope of taxpayers required to file UTPs under the new rule.

Commenting on the survey results, Hank Gutman, director of the Tax Governance Institute, and former chief of staff of the U.S. Congressional Joint Committee on Taxation, said that, while the IRS went to considerable lengths to ease corporate taxpayer concerns about specific elements of the original Schedule UTP proposal, and incorporated many of the suggestions offered during the public comment period, the implementation of the new disclosure regime will invariably produce practical questions and issues. Mr. Gutman noted that it is not too early to begin an analysis of the potential impact of the Schedule.

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. 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.

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