The eventual outcome of the Textron case concerning the disclosure of workpapers during an audit could have implications for all companies that have to comply with the FIN 48 accounting standard.
A US court ruled last week that the tax authorities should not be allowed see company documents relating to a series of what government officials describe as listed transactions. The government believes taxpayers use listed transactions to avoid tax.
The Internal Revenue Service demanded to see the tax accrual workpapers relating to nine sale-in lease-out transactions involving and telecommunications and rail equipment that Textron, an industrial conglomerate of aerospace, defence,finance and manufacturing businesses, entered into during 2001. A sale-in lease-out deal typically describes a transaction where a company buys a piece of infrastructure from a municipal authority, either in the US or abroad, and leases it back to them to generate tax deductions.
The workpapers were spreadsheets that contained views from Textron's in-house tax counsel about the possibility of the IRS taking the company to court over inconclusive issues under audit and the risk it faced if the tax authorities did so. The information also included estimates, in percentage terms, from the in-house tax counsel of the company's chances of success if any of the issues did reach litigation and how much being defeated in court would cost the company.
Textron refused to comply with the summons because it claimed the workpapers were privileged. The company also argued that the request was improper because the IRS would only use the workpapers against it in settlement negotiations and because the request made after the audit was mostly complete.
Judge Ernest Torres, of the US District Court in Rhode Island, decided on August 30 that the IRS could not see the workpapers because they were subject to work product protection, which applies to information prepared in anticipation of litigation.
The judge ruled that the workpapers also came under attorney-client privilege and tax practitioner privilege, because the information was legal, rather than accounting advice, and because the information was a communication between a taxpayer and a tax practitioner.
However, these protections were lost, Torres decided, because the workpapers had been shown to the company's auditors, Ernst & Young in this case.
"We are gratified that the court agreed with Textron on this important matter of principle," said Kim Reingold, a Textron spokesperson. "The court's decision simply applies the law to the facts, and is consistent with basic fairness in the legal process."
The IRS has not yet decided if it is going to appeal the verdict to the US First Circuit Court of Appeals
The issue of the confidentiality of workpapers is relevant for compliance with FIN 48, the accounting standard that requires taxpayers to explain uncertain tax positions in their company accounts. Advisers expect any further court action in Textron will address whether publicising any information under FIN 48 will mean that the protection of workpapers will be lost.
"The Textron case would seem to provide taxpayers with support for asserting that the work product privilege applies to tax accrual workpapers that were provided to the taxpayer's independent auditors," said one adviser who did not want to be identified. "While the case involved pre-FIN 48 years, the basic concepts of the work product privilege would seem available to those years as well. The issue will involve satisfying the work product privilege requirements."
