Textron Wins Battle Over Internal Tax Accrual Workpapers

On August 28, the U.S. District Court for the District of Rhode Island dismissed a summons enforcement action against Textron, Inc. brought by the Department of Justice on behalf of the Internal Revenue Service. The IRS had sought Textron's internal tax accrual workpapers. The district court held that Textron's workpapers were work product created by its in-house counsel and accountants and that the work product protection was not waived by Textron.1 The dismissal, if upheld on appeal, would limit the Government's use of the threat of forcing taxpayers to turn over tax accrual workpapers as a tool in its attack against alleged tax shelters.

In June 2005, the IRS issued a summons to Textron seeking its workpapers for the 2001 tax year. The summons sought not only the workpapers relating to the remaining issue on audit (involving what is commonly known as a SILO, Sale-In Lease-Out, transaction) but all tax accrual workpapers for the 2001 tax year. In issuing the broad request for tax accrual workpapers, the IRS was implementing its current tax accrual workpaper policy, as described in Announcement 2002-63, which requires an examining agent to request workpapers relating to a listed transaction entered into by the taxpayer under audit, and, in the case of multiple listed transactions entered into by the taxpayer, all tax accrual workpapers for the relevant tax years.

The summons came on the heels of an extended audit of Textron's 1998-2001 tax years in which more than 500 Information Document Requests (IDRs) were issued by the examining agents. Textron responded to all other IDRs, but refused to respond to an IDR seeking the tax accrual workpapers, and so the IRS backed up the IDR with an administrative summons. The focus of the summons was on the workpapers of Textron, Inc., the parent company, and one of its subsidiaries, Textron Financial Corporation or TFC. Textron took the position that the workpapers were protected from disclosure under the attorney-client privilege, the tax practitioner privilege (IRC Section 7525) and the work product doctrine.

As described by the district court, the workpapers, which were created after the corporate tax returns were filed, consisted of two parts. The first part was a spreadsheet that listed (i) each tax position considered by Textron's counsel to be arguable, (ii) estimates of litigation risks with respect to these position, and (iii) tax reserve amounts for each position. The second part comprised backup documents including the prior year spreadsheet, a draft spreadsheet, and accompanying memos from Textron's in-house counsel reflecting opinions regarding litigation risks.

The workpapers were prepared by Textron's in-house attorneys or in-house accountants under the ultimate supervision of...