Tax Law and Business Organization Strategy

IRS Refuses to Follow the 6th Circuit

It’s almost as if the IRS is trying to prove my recent personal commentary correct. In a recent action on decision (AOD 2007-004,10/01/2007), the IRS announced that it won't acquiesce in the Sixth Circuit's holding in U.S. v. Roxworthy, (2006, CA6) 98 AFTR 2d 2006-5964, 457 F3d 590. That case reversed a district court order enforcing an IRS summons on a corporate taxpayer's vice president for memoranda prepared by the company's outside audit/consulting firm. The Appeals Court found that the memoranda were prepared in anticipation of litigation and were protected by the work product doctrine. IRS disagreed with that conclusion and stated that a document prepared in anticipation of an audit is not prepared in anticipation of litigation.

This puts the IRS out of line, not only with the Sixth Circuit, but with a recent district court decision which rejected the IRS's request to examine “tax accrual workpapers.” In a case involving Textron, Inc. and its subsidiaries,  the found that the workpapers were privileged under the work product privilege (see U.S. v. Textron INC. and Subsidiaries, (DC RI 8/28/2007) 100 AFTR 2d 2007-5848. Since the IRS now says that it will not follow these decisions, even in the 6th Circuit, one must hope that any taxpayer with the resources to fight the IRS over the privilege issue will be rewarded, not only with a victory, but with attorneys fees as well.

More Details on Roxworthy Case. The IRS served an administrative summons on Patrick J. Roxworthy in his capacity as Vice President of Tax at Yum! Brands, Inc. (Yum), seeking production of certain documents. Roxworthy ultimately declined to produce two documents, which were described by Yum as tax opinions prepared by KPMG, LLP, analyzing the tax consequences of certain transactions entered into by Yum pertaining to the creation of a captive insurance company and the subsequent sale of the captive's stock at a substantial loss. The IRS filed a petition in district court to enforce the summons. Roxworthy filed a response and a petition to quash, claiming the KPMG opinion letters were protected from disclosure by the work product doctrine. In support of the motion to quash, Roxworthy submitted affidavits from a Yum in-house attorney and a KPMG partner. The affidavits maintained that the two opinion letters were prepared in anticipation of litigation.

A magistrate judge found that Roxworthy did not meet his burden of establishing that the opinion letters were protected by the work product doctrine and concluded that they were not created “because of” the prospect of actual litigation, but were intended to be used to assist Yum in the preparation of its taxes and yearly audit and to avoid understatement penalties. Consistent with these findings and conclusions, the magistrate judge issued a Report and Recommendation that the summons be enforced.

Roxworthy filed objections to the Report and Recommendation in the district court, and moved to expand the record to include additional affidavits and deposition testimony. The district court allowed Roxworthy to submit additional affidavits that stated that the KPMG opinion letters were prepared because Yum anticipated litigation in light of the size of the transaction, IRS's history of litigating captive insurance company cases, and the unsettled law in the area. Despite this additional evidence, the court adopted the magistrate’s Report and Recommendation.

Roxworthy appealed. The Sixth Circuit reversed because it found that the KPMG opinion letters were prepared “in anticipation of litigation” for purposes of the work product doctrine.

The IRS then took exception to that decision in the form of the AOD, claiming the Sixth Circuit's decision is incorrect. Basically, the AOD takes the position that the issue was factual, and the Circuit Court should not have disturbed the factual findings of the lower courts --  the Circuit Court erred in reversing the district court.

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