Summary

On August 13, 2009, the U.S. Court of Appeals for the First Circuit (“Court of Appeals”) ruled 3-2 to overturn the U.S. District Court for the District of Rhode Island’s (“District Court”) decision in United States of America vs. Textron, Inc. and Subsidiaries. As a result, Textron’s income tax accrual workpapers are subject to an IRS summons.

Background

• In 2005, the Internal Revenue Service (“IRS”) issued an administrative summons for “all of the tax accrual workpapers” for Textron’s tax year ending in 2001. Textron refused to produce its tax accrual workpapers, asserting they were privileged and that the summons was issued for improper purposes. Textron’s tax accrual workpapers included:
   1. A spreadsheet that contained:
     a. Lists of items on Textron’s tax returns, which, in the opinion of Textron’s counsel, involved issues on which the tax laws are unclear and, therefore, may be challenged by the IRS;
     b. Estimates by Textron’s counsel expressing, in percentage terms, their judgments regarding Textron’s chances of prevailing in any litigation over those issues; and
     c. The dollar amounts reserved to reflect the possibility that Textron might not prevail in such litigation.
   2. Backup workpapers consisting of the previous year’s spreadsheet and earlier drafts of the spreadsheet together with notes and memoranda written by Textron’s in-house tax attorneys reflecting their opinions as to which items should be included on the spreadsheet and the percentage that should apply to each item.

• Textron is a publicly-traded company and is required by federal securities law to have public financial statements are certified by an independent auditor. Ernst & Young (“E&Y”) are Textron’s independent auditors. E&Y accessed and reviewed Textron’s tax accrual workpapers in conjunction with Textron’s financial statement audit for the year ending in 2001. The workpapers provided E&Y with evidence supporting Textron’s assertion that they had recorded an adequate reserve for uncertain tax positions in their financial statements.

District Court Ruling

In 2007, the District Court ruled that Textron did not have to comply with the IRS’ summons. The District Court found that the tax accrual workpapers were covered by work-product privilege. Work-product privilege applies to materials prepared or gathered by an attorney in anticipation of litigation.
The District Court agreed with Textron that the tax accrual workpapers would not have been prepared at all but for the fact that Textron anticipated the possibility of litigation with the IRS. If Textron had not anticipated a dispute with the IRS, they would have had no reason to record a reserve for potential tax liabilities and would not have had to prepare tax accrual workpapers for E&Y to audit.

Court of Appeals Ruling

On August 13, 2009, the Court of Appeals overturned the District Court ruling. The Court of Appeals agreed with the IRS that Textron did not prepare the tax accrual workpapers in anticipation of litigation, but to support their financial filings and gain auditor approval. As such, the tax accrual workpapers did not qualify for work-product privilege and are subject to the IRS summons.
Textron has until October 12, 2009 to file a petition for a writ of certiorari seeking review by the Supreme Court.

Planning

In light of the Court of Appeals’ decision, it may be difficult to withhold tax accrual workpapers from taxing authorities. However, implementing the following procedures may add some protection and/or limit the scope of what the IRS requests.
   1. Create a separate set of workpapers for each uncertain tax position.
   2. Within each set of workpapers, create multiple folders – separate the attorney’s analysis from the accountant’s analysis; separate all analysis from the determination of potential reserves.
   3. Do not allow financial statement auditors to keep copies of tax accrual workpapers.
   4. Require a signed confidentiality statement from financial statement auditors that specifically references the tax accrual workpapers.

Full Text

U.S. District Court for the District of Rhode Island http://www.rid.uscourts.gov/opinions/torres/08282007_1-06CV0198T_USA_V_TEXTRON_INC_P.pdf
U.S. Court of Appeals for the First Circuit
http://www.ca1.uscourts.gov/ (Click on Opinions, Search using keyword, “Textron”)

It is with pleasure that we announce that Rebecca Godkin has joined TaxOps, LLC as a Director. Rebecca’s primary area of emphasis is accounting for income taxes, in accordance with both U.S. GAAP and IFRS. She has extensive experience preparing and reviewing income tax provisions and is intimately familiar with the income tax provision complexities associated with uncertain tax positions, business combinations, share-based compensation, foreign subsidiaries and affiliates, foreign currency transactions and translations, intraperiod and interperiod tax allocations, detailed tax planning strategies and the evaluation of valuation allowances. Rebecca has worked with some of the largest publicly-held companies in the world as well as local privately-held enterprises. Rebecca has developed and delivered training, nationally and locally, for both FAS 109 and IAS 12. Rebecca’s income tax provision expertise is built upon a strong foundation of technical tax compliance, including tax accounting for natural resources.  See Rebecca’s full bio at www.taxops.com/team

Please join us in welcoming Rebecca to the TaxOps team!

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