The IRS has clarified its expanded policy of restraint in discovering tax accrual work papers used by companies in preparing financial statements. 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.
In a recent FAQ on Schedule UTP, the IRS clarified that the changes to the policy of restraint announced in Announcement 2010-76 apply to documents requested by Appeals. While it would be very unusual for Appeals to conduct any substantive fact-finding during its case consideration, said the IRS, the changes to the policy of restraint apply to any request for documents during the administrative process of determining the correct tax liability, which includes Appeals’ consideration of proposed audit adjustments. Regarding whether the changes to the policy of restraint applies to documents requested by Counsel after the filing of a Tax Court petition, the IRS said that generally counsel attorneys will not issue discovery requests for documents or information that the IRS would not seek under its policy of restraint.
The IRS also clarified that the changes announced in Announcement 2010-76 apply to any request for documents outstanding on or made after September 24, 2010, in any open examination
The instructions to Schedule UTP state that corporations need not report tax positions for which no reserve is recorded because it was sufficiently certain so that no reserve was required. For a corporation subject to FIN 48, noted the FAQ, a tax position is considered sufficiently certain so that no reserve was required, and therefore need not be reported on Schedule UTP, if the position is highly certain within the meaning of FIN 48.
Finally, the IRS said that a company that records a reserve in an audited financial statement for a tax position it expects to take in its 2010 tax return but later eliminates the reserve in a subsequent interim financial statement issued before the filing of the 2010 return must report the tax position on Schedule UTP. But if the company reconsiders whether a reserve is required for a tax position and eliminates the reserve in an interim audited financial statement issued before the tax position is taken in a return, the corporation need not report the tax position to which the reserve relates on the Schedule UTP.
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. Last year, 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.