D.C. Circuit jabs First Circuit - work product means something in the nation's capital.

• Author: Pawlow, Jean A.

On and off for the last 26 years, the Internal Revenue Service It has gone toe to toe with taxpayers to try to obtain a "cheat sheet" to understand how corporate America handicaps the positions it takes on its federal income tax returns. Ever since the Supreme Court of the United States affirmed the IRS's right to obtain tax accrual workpapers prepared by a taxpayer's independent auditors, (1) the IRS has increasingly flexed its muscles in search of "smoking gun" documents that may reveal a taxpayer's assessment of weaknesses in its own case. After the IRS ultimately prevailed after three rounds in Textron, (2) taxpayers wondered whether the fight was over.

Ding, ding, ding ... Round Four has gone to the taxpayer. On June 29, 2010, the U.S. Court of Appeals for the District of Columbia Circuit counter punched the First Circuit and its decision in Textron, holding that audit work papers can contain protected work product and disclosure of documents to an outside auditor does not waive work product protection. (3) After reviewing the development of the law since Arthur Young, this article discusses the new Deloitte decision.

A Short History Lesson

Despite the IRS's victory in Arthur Young, the government adopted a self-imposed policy of restraint, requesting tax accrual workpapers only in "unusual circumstances." (4) The proliferation of so-called tax shelters, however, convinced the IRS that the key to efficient tax administration was to routinely request tax accrual workpapers where a taxpayer engaged in "listed transactions." (5)

Not all taxpayers acceded to the IRS's routine "Information Document Requests" seeking tax accrual workpapers. Indeed, recently there have been several battles between the IRS and corporate America over the disclosure of tax accrual work papers." The most recent clash involved Textron, Inc.

In Textron I, the district court sided with the taxpayer holding that Textron had not waived work-product privilege with respect to documents that included spreadsheets containing in-house counsel's lists of return items that involved unclear law, "hazards of litigation" percentages, tax reserve amounts, and the backup. (7) In Textron II, the U.S. Court of Appeals for the First Circuit affirmed the decision of the trial court, permitting Textron to resist the prying eyes of the IRS. (8) Much to the dismay of corporate taxpayers everywhere, in Textron III, a divided en banc First Circuit reversed the appellate panel holding that the workpapers were not protected from disclosure by the work-product doctrine. (9) Underlying the en basic court's opinion was a concern that the IRS is disadvantaged in its war against large corporate tax dodgers. Despite a scathing dissent by the author of the panel opinion in Textron 11, the Supreme Court declined an invitation to join the fray. (10)

Deloitte Resists IRS Request for Dow Chemical's Workpapers

A recent decision of the D.C. Circuit Court of Appeals suggests a fundamental difference of perspective. Corporate taxpayers and their advisers are studying the decision to glean some understanding of the current state of the law.

In 2005, Dow Chemical Company filed a refund suit challenging adjustments made by the IRS to partnership returns filed by two partnerships owned by Dow. During discovery the IRS sought the work papers of Dow's independent auditor, Deloitte & Touche LLP. Deloitte turned over all of the documents requested with the exception of three documents that Dow claimed were protected by the attorney work-product privilege. The government sought to compel the production of the documents and the battle ensued. (11)

The documents for which the government sought disclosure included a 1993 draft memorandum prepared by Deloitte during a meeting between Dow's employees, Dow's outside counsel, and Deloitte employees over the potential for litigation "recording the thoughts and impressions of Dow's attorneys concerning tax issues related to" certain transactions engaged in by the partnerships ("Deloitte Memorandum"). The remaining disputed documents were a 1998 legal and tax analysis and "flow...