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Corporate Taxpayers Take a Big Hit in 1st Circuit's 'Textron' Ruling
The American Lawyer
August 17, 2009
Last week was a good one for the IRS, and not so good for those trying to avoid IRS scrutiny. The agency made big headlines when it finally got UBS to turn over the names of certain U.S. individuals who tried to evade taxes by using foreign accounts. In a less heralded, but potentially significant development, the IRS on Thursday won a ruling by the 1st U.S. Circuit Court of Appeals in U.S. v. Textron (pdf) that may give it much greater access to internal materials prepared by corporate taxpayers.
As Larry Hill of Dewey & LeBoeuf told The Wall Street Journal's Law Blog: "It's a landmark decision that will cause tax directors of public companies to toss and turn in their sleep and will encourage the IRS to be more aggressive in seeking tax accrual work papers."
The dispute extends back to Textron's 2001 tax return, when the company claimed deductions related to a sale-in, lease-out (SILO) transaction. The IRS considers these SILO deals to be potential tax shelters and sought so-called "tax accrual work papers" prepared or reviewed by in-house and outside lawyers for Textron. These documents analyzed the likelihood that the IRS might challenge this transaction, and whether Textron had created adequate reserves to cover any additional tax liability. (The court noted that after Enron and other corporate scandals, the IRS began seeking a company's tax accrual work papers when it thought it was engaged in tax avoidance transactions.) Textron refused, citing work product privilege.
The lower court sided with Textron, and the 1st Circuit upheld the ruling. But the appellate court decided to rehear the case en banc, and reversed, in a decision written by Judge Michael Boudin. Noting the lack of guidance from the U.S. Supreme Court, the 1st Circuit seemed guided in part by public policy dictates favoring the enforcement of tax laws. "The practical problems confronting the IRS in discovering under-reporting of corporate taxes, which is likely endemic, are serious," Boudin wrote. "Textron apparently thinks it is 'unfair' for the government to have access to its spreadsheets, but tax collection is not a game. Underpaying taxes threatens the essential public interest in revenue collection."
The issue, as framed by the en banc panel, was whether work product privilege applies to documents that are not prepared for litigation, but which involve an issue that might lead to litigation. The court said it does not. "Nor is it enough that the materials were prepared by lawyers or represent legal thinking," wrote the court. "Much corporate material prepared in law offices or reviewed by lawyers falls in that vast category. It is only work done in anticipation of or for trial that is protected."
The case was argued for the government by Judith Hagley from the Department of Justice's Tax Division.
John Tarentino of Providence, R.I.'s Adler Pollock & Sheehan argued for Textron. Steptoe & Johnson also helped prepare the briefs.
In an indication of the importance of this case to the corporate legal community, amicus briefs supporting Textron were filed by the Association of Corporate Counsel and by the National Chamber Litigation Center.
A spokesperson for Textron said the company is in the process of studying the decision and is exploring its options.
This article first appeared on The Am Law Litigation Daily blog on AmericanLawyer.com.
