[edited to add link to case]
In a 3-2 en banc ruling in United States v. Textron, the First Circuit today reversed the earlier three-judge panel decision on the accessibility of Textron's tax accrual work papers to the government. It held that the IRS should have access to tax accrual workpapers prepared in 2001, at the time that the aerospace conglomerate had undertaken various SILO (sale-in, lease-out) tax shelters, involving telephone networks and an overseas railway system, to lower its tax liability. The IRS, the court noted, "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters." See, e.g., Saunders & Levitz, Court Lets IRS Access Textron Leasing Papers, Wall St. Journal (Aug. 14, 2009) (subscription required); Donmoyer, Textron Ordered by Appeals Court to Give IRS Tax Shelter Papers, Bloomberg.com (Aug. 14, 2009).
Textron had claimed (among other claims) that the papers were protected work product--i.e., prepared in anticipation of litigation. The First Circuit adheres to a lax work product standard, first set forth by the Second Circuit in the Adlman case, that merely requires that the material be prepared "because of" litigation. Since tax standards require an assessment of the likelihood of success on the merits, success on this claim would likely result in most any materials prepared in connection with accounting issues about tax accruals being protected. At trial, Textron had produced testimony that its workpapers were used to determine "whether Textron was adequately reserved with respect to any potential disputes or litigations that would happen in the future. On appeal, the First Circuit panel treated resolution of disputes even in preliminary administrative proceedings before the IRS--which are often cooperative and at best only quasi-adversarial-- as satisfying the definition of "litigation" for work product purposes and the need to estimate success to determine accrual reserves as "anticipation of litigation," rejecting the government's position that business and regulatory objectives for preparation of material per se defeats a work product claim.
The en banc court, however, recognized that the doctrine "does not protect from disclosure documents that are prepared in the ordinary course of business" rather than for litigation. That is the right answer, and in accord with Supreme Court precedent. Further, the court acknowledged that the IRS "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters" (see Bloomberg.com)--something very important, in these days of right-wing tax-protest mobs who apparently don't understand the centrality of taxes, and an adequately informed IRS, to their well-being.
This is an important decision and one that was correctly decided. It is time the court's recognized the boundaries to work-product protection. Tax accrual workpapers do not merit protection. Textron should hand over the workpapers and determine to engage in less aggressive tax planning in the future.
Aside: The company was faced with another lawsuit today, as investors complain that it faked back orders to make its business look better. Sounds like the company could use a primer in basic integrity--after all, buying telephone networks is not exactly germane to the business of the world's largest corporate jet manufacturer, is it?
Some background on the Textron challenge to the IRS workpapers summons:
The district court case, United States v. Textron INc., 507 F. Supp. 2d 138 (D.R.I. 2007) held that the tax accrual workpapers were protected. For contemporary commentary summarizing the case, see, e.g., McDermoot, Will & Emery, Textron Protects Tax Accrual Workpapers from IRS Summons (Sept. 4, 2007); Pawlow, Ryan & Spencer, Hands Off My Tax Accrual Workpapers: Textron, Fin 48, and Related Issues, Fall 2007 The Tax Executive Magazine 421. For my own analysis (and a link to the district court's decision), see ataxingmatter, Textron, Inc: Tax Accrual Workpapers, Attorney-Client Privilege, and Work Product Protection (Aug. 30, 2007)
The First Circuit heard the case on appeal with two circuit judges and one district court judge. The panel affirmed the trial court's decision on general applicability of work product doctrine to tax accrual workpapers, but remanded for consideration of waiver. See, e.g., Greenhouse, Spencer, and Selby, Textron Decision Deems Tax Accrual Workpapers Protected Work-Product, Mondaq Business Briefing (Feb. 16, 2009). Circuit Judge Boudin dissented, arguing that "tax accrual work papers are not protected because they are prepared for reasons independent of the need to prepare for or conduct litigation."
The First Circuit vacated the opinion and ordered rehearing en banc on March 25, 2009 (No. 07-2631). See, e.g., Sullivan & Cromwell, First Circuit to Reconsider Work Product Privilege for Tax accrual Workpapers (Mar. 27, 2009).