There is a new development in the Textron case worth noting.
For those who need a refresher, way back in August 2007, I reported on the District Court of Rhode Island decision in the Textron tax accrual workplace case, in Textron, Inc.: Tax Accrual Workpapers, Attorney-Cleint Privilege, and Work Product Protection.
The court concluded that tax accrual workpapers generally come under both attorney client privilege and work product protection, but that the company had waived the privilege when sharing materials with the primary auditor. The First Circuit has adopted the ridiculously broad "because of" test from the Second Circuit's Adlman opinion for work product protection. As I noted in that first posting on Textron, that test "turns the prupose of work-product protection on its head, especially in the tax context. Work product protection is supposed to give an attorney a 'zone of privacy' when he is preparing a case for trial, so that he can work through strategies and approaches without revealing his every hand to his adversary. Preparation of tax accrual papers to make the determination of how much funds should be considered reserved in the eventuality that the tax positions taken over time by a company on its returns are not held up after an audit is not an advitivity at that stage of an adversarial process--in fact, it should not be viewed as adversarial at all at that stage." So I argued that tax accrual workpapers should not be entitled to work product protection (and certainly not attorney-client or tax practitioner privilege).
I had hoped that the appellate panel would fix the mess. Regretably, this January the First Circuit three-judge panel affirmed the decision. See Textron: First Circuit Comes to the Wrong Conclusion, with some weak arguments, Jan. 24, 2009 (opinion linked in the posting).
The January posting presents a detailed analysis of the First Circuit's opinion, and a harsh judgment about the panel's reasoning and conclusion. As I said there, "Textron, my friends, is wrongly decided. It is about as bad as the decision in Murphy, where the court simply didn't know how to read a tax statute." I delved into my analysis in the "Tax Advice Before the Return" article, and showed that work product doctrine should not be applied to routine tax-accrual workpapers that must by their very nature consider the possibility that a position could be reversed on audit.
[T]ax accrual workpapers are in no way documents prepared in anticipation of litigation. They are documents prepared on an annual basis by every public company for financial reporting purposes to comply with the securities laws, regardless of whether they expect their aggressive tax positions to be caught by the IRS on audit or not. They are no more work product than any other document that a company prepares throughout its existence, with an eye towards the "what if" of some potential future litigation always shaping the way things are phrased. Tax accrual workpapers are business documents that are not protected by attorney client privilege or the tax practitioner privilege and they are not work product.
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The First Circuit here has created a version of the work-product doctrine that is so broad that it would, as the IRS argued, "afford a 'blanket' protection" that would "swallow the attorney-client privilege". It is a version of the work-product doctrine that applies with special force to tax, where every item must be reported on a tax return, and every item reported on a tax return that is not 100% certain is potentially subject to becoming an issue on audit. It is as though the First Circuit judges were trying to make sure that the IRS could not use its summons power to get any information in the taxpayer's hands that would be relevant, since this blanket work-product protection would leave almost no document having to do with tax positions on a return unprotected! ... As the dissent in Textron noted, it is not the subject matter discussed in materials that controls applicability of the doctrine, but whether documents are prepared in the ordinary course of business or specifically because of litigation potential.
The Textron court completely misunderstands the context here. It said that because the documents had to analyze the possibility of litigation to determine the extent of reserves necessary, it meant that the "driving force" behind the documents was expected disputes with the IRS over tax positions on the return, and therefore the documents were created in anticipation of litigation. It has it backwards. Because the company had reported some positions with less than 100% certainty on its tax returns, it was necessary for the company to calculate appropriate reserves on its books. The driving force behind the documents was the need to calculate reserves for financial accounting purposes, and therefore the documents were not created in anticipation of litigation. Textron: First Circuit Comes to the Wrong Conclusion, with some weak arguments, Jan. 24, 2009
On March 25, 2009 the First Circuit entered an order to rehear this case en banc. The panel opinion and dissent are withdrawn and the panel judgment vacaated. Any supplemental briefs will be filed by April 22, and the rehearing will take place June 9.
So there is hope. Maybe the en banc court will clean up this mess and recognize that tax accrual workpapers are not entitled to protection under the attorney client privilege, the tax practitioner privilege or work product doctrine.
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