Focus On Tax Controversy And Litigation July 2013

In First Case Involving Privilege Related to UTPs, District Court in Wells Fargo Protects Opinion Work Product in Tax Accrual Workpapers

This month's newsletter also features articles discussing Revenue Procedure 2013-32, which restricts PLRs for spin-offs and other corporate nonrecognition transactions, a Florida district court's holding that the Administrative Procedure Act did not bar its review of IRS adjustments made to partnership returns that included penalties despite an IRS Announcement providing waiver of penalties, and the SEC's novel, but successful effort to seek disgorgement in the form of unpaid federal income taxes in SEC v. Wyly.

District Court Protects Opinion Work Product Contained in Tax Accrual Workpapers in Wells Fargo

The US District Court for the District of Minnesota granted in part and denied in part Wells Fargo's petition to quash three summonses relating to tax accrual workpapers ("TAWs") issued to Wells Fargo and its independent auditor, KPMG, after Wells Fargo refused to provide its TAWs for tax years 2007 and 2008.1 The government sought to obtain information regarding Wells Fargo's financial reporting and uncertain tax positions ("UTPs").


Wells Fargo participated in sale-in-lease-out ("SILO") transactions between 1997 and 2003. Since 2004, Wells Fargo had not taken any tax deductions for transactions designated as listed transactions at the time of the filing of its returns. Nevertheless, Wells Fargo filed claims for refunds related to its SILO transactions in 2005 and 2006

and had, at the time the summonses in question were issued, informed the Internal Revenue Service ("IRS") that it potentially would file refund claims with respect to the transactions for 2007 and 2008. In 2011, the Federal Circuit affirmed a decision of the Court of Federal Claims ruling against Wells Fargo with respect to its SILO claims. After the appellate court's decision, Wells Fargo informed the IRS that it would not file refund claims for listed transactions in the 2007 and 2008 tax years. The government did not withdraw its summonses for Wells Fargo's tax accrual workpapers.

Legal Standard

The IRS has "broad latitude" when adopting enforcement mechanisms to perform tax collection and assessment.2 Under United States v. Powell,3 to enforce a summons, the government must show that (1) its investigation has a legitimate purpose; (2) the inquiry may be relevant to that purpose; (3) the information sought is not already in the possession of the government; and (4) the administrative steps required by the Internal Revenue Code have been followed. The government may make a prima facie case for enforcement by showing good faith compliance with summons requirements, and once the government has met this burden, the taxpayer may rebut the government's prima facie case by showing that the Powell requirements were not met or that enforcing the summons would be an abuse of the court's enforcement powers.

Improper Purpose

As an initial matter, Wells Fargo argued that the government had an improper purpose in issuing the summonses. The court found that the IRS has established a legitimate purpose in requesting Wells Fargo's TAWs, namely, verifying that Wells Fargo's tax return was substantially correct. This was especially true in the case of Wells Fargo because it had engaged in abusive tax avoidance techniques in the past. The court also rejected Wells Fargo's claims that the IRS could identify Wells Fargo's UTPs on the Schedule M-3 or the Reportable Transaction Disclosure Statements, or use other methods to verify Wells Fargo's statements on its returns. The documents identified by Wells Fargo as providing the same information were not as comprehensive and the government only needed to show that the TAWs were relevant to the audit under the Powell standard.

The court did not find that the IRS wanted to punish or deter Wells Fargo for its past behavior but found instead that the government had a proper purpose for its summonses and did not violate its own policy of restraint in issuing the summonses. "Even if deterring tax avoidant behavior was one motivating factor in issuing the summons," the court held that "[a]s long as there is a legitimate purpose in issuing a summons, the existence of another purpose does not render the summons illegitimate."4

Work-Product Doctrine

Wells Fargo contended that much of the information sought was protected by the work-product doctrine. The court reiterated the near absolute protection for opinion work product and closely followed Simon v. G.D. Searle & Co.,5 in which the Eighth Circuit discussed the "because of" test that it applies to work-product cases. In that case, a company was required to disclose aggregate data from business documents but could redact individual case reserve figures that revealed attorney mental impressions, thoughts, and conclusions. The Eighth Circuit in Simon explained:

"'Although the [. . .] documents were not themselves prepared in anticipation of litigation, they may be protected from discovery to the extent that they disclose the individual case reserves calculated by [Defendant]'s attorneys. The individual case reserve figures reveal the mental impressions, thoughts, and conclusions of an attorney in evaluating a legal claim. By their very nature they are prepared in anticipation of litigation and, consequently, they are protected from discovery as opinion work product.'"6 The court analyzed whether the information contained in Wells Fargo's TAWs was prepared in anticipation of litigation and whether it was protected opinion work product. Because attorneys were not initially involved in identifying UTPs, the district court held that identifying the UTPs was done in the ordinary course of business, not in anticipation of litigation. The court also found that it was unlikely that Wells Fargo would litigate every UTP because Wells Fargo stated that it would not enter into a transaction related to a UTP unless it had a seventy percent or greater certainty that a court would uphold the tax benefits from the transaction and the IRS and Wells Fargo would not litigate every UTP.

The court held that Wells Fargo's recognition and measurement analysis reflected in the TAWs constituted protected work product. Although the TAWs were created in the ordinary course of business to comply with financial reporting requirements, the recognition and measurement analysis was sufficiently tied to possible litigation and not merely created for FIN 48 analysis. Because this analysis was sufficiently tied to possible litigation, the court held that these documents were prepared in anticipation of litigation. The court rejected the government's claims that Wells Fargo had waived work-product protection by disclosing the TAWs to KPMG. The government had argued that KPMG was Wells Fargo's adversary or a conduit to Wells Fargo's adversary and, under Eighth Circuit precedent, disclosure to an adversary constituted a waiver. The court held that Wells Fargo must disclose the identity of its UTPs, the process for identifying its UTPs, and underlying facts regarding the UTPs, but not its recognition or measurement analysis.

The Wells Fargo decision is a departure from the Textron case. In Textron, the First Circuit held that work-product protection did not extend to preparing tax accrual work papers because they were required by audit even though in house tax lawyers were involved in their preparation and the tax reserve amounts would not have been prepared but for the fact that Textron anticipated the possibility of litigation. Although the Wells Fargo court cited to the Textron decision in support of certain conclusions and did not go so far as to extend the protection to cover tax accrual workpapers in their entirety, it acknowledged that the tax accrual workpapers contained opinion work product and protected that information.

Attorney-Client Privilege

Wells Fargo claimed attorney-client privilege with respect to eight emails that had not been disclosed to anyone outside Wells Fargo in which a Wells Fargo attorney was either a sender or recipient. The documents fell into three categories: (1) emails identifying the UTPs with drafts of UTP cover sheets, including recognition and measurement analysis; (2) allegedly...

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