The IRS has imposed increasing disclosure demands on large, multinational taxpayers, requesting filing of a slew of additional documents and forms.
Question: How will the Schaeffler case affect the IRS' ability to require additional disclosure documents from taxpayers?
Answer: In the last decade, the Internal Revenue Service (IRS) has shifted its compliance focus from domestic issues to multijurisdictional tax transactions. Indeed, transfer pricing and complex cross-border transactions have consumed a significant portion of the IRS' resources and attention. This is evident in the number of international cases that the IRS has pursued in the last decade, (1) as well as the programs and guidance that the IRS has instituted to make audits more efficient and effective. Examples include the transfer pricing audit road map issued by the IRS in 2014, the expansion of the use of outside experts in transfer pricing, and hiring private law firms to assist the IRS with complex international tax cases. (2)
The IRS, however, often believes that it is at a substantial disadvantage. In an effort to level the playing field, the U.S. government has sought to increase the "transparency" of sophisticated taxpayers and secure information-sharing agreements with foreign tax authorities. (3) The IRS is likely to receive more encouragement and additional ideas for transparency from overseas, such as the recent proposal in the United Kingdom's 2015 summer budget that would require all large businesses to publish their United Kingdom-related tax strategies. The resulting compliance and disclosure demands for large, multinational taxpayers are monumental and keep increasing. For example, U.S. corporate taxpayers are required to file Schedule M-3 to explain book-tax differences on the face of the return; Schedule UTP to describe so-called "uncertain tax positions"; Form 8886 to disclose their involvement in reportable transactions; Form 5471 to disclose foreign-controlled corporations; Form 5472 to disclose transactions between related, multijurisdictional subsidiaries; and perhaps country-by-country reporting in the near future. Given this web of disclosures, the IRS is, in a very real sense, in "disclosure overload." Nonetheless, these requirements highlight the government's ongoing quest to obtain a road map of the potential issues on a given taxpayer's return, including the legal basis for and weaknesses of the reported positions.
Clearly, tension exists between ensuring that taxpayers pay the correct amount of tax owed and placing excessive tax compliance burdens on corporate America. Often this tension is highlighted when the IRS seeks documents or information revealing the tax advice given to a taxpayer--which the IRS believes is the holy grail of disclosures--subject to taxpayer privilege claims. These tensions have intensified in recent years, and the IRS has increased summons enforcement cases, including some with very aggressive positions on whether, for example, a document is protected from disclosure by some privilege claim--attorney-client, tax practitioner, or work product. From the IRS perspective, these claims hinder its access to information and the effective administration of the Internal Revenue Code. For taxpayers, the IRS already has access to tremendous amounts of factual and transactional detail and its own personnel to analyze the tax issues in any given examination. Fundamentally, taxpayers correctly recognize that the ability to preserve confidential legal advice and analysis from disclosure is a bedrock principle of our legal system that must be preserved.
Federal law recognizes several privileges that may apply to protect confidential information from disclosure. The hallmark of privilege law is the attorney-client privilege, which protects confidential communications made by and between attorney and client. Internal Revenue Code Section 7525 extends the common law attorney-client privilege to certain confidential communications made between a taxpayer and a federally authorized tax practitioner. Additionally, the work-product doctrine protects information and documents prepared "in anticipation" of litigation. (4) Although these protections are strong, they are not absolute and can be lost or waived if the protected material is shared with third parties. (5)
The attorney-client privilege is generally waived upon disclosure to third-parties; however, the...