More on the Textron Decision, In-House Lawyers? Latest Worry

[WSJ Law Blog]

We wrote last week about this long-awaited decision concerning a dispute between the IRS and Providence, R.I.-based Textron. Initially, we were a bit embarrassed by our rather breathless tone — showcased rather visibly in the post’s title — but we feel a bit vindicated today by the WSJ’s Law Journal column, which gives a good explanation as to why this Textron decision is causing a buzz among in-house legal counsel.

To recap: an en banc federal appeals court in Boston voted 3-2 that the IRS could gain access to documents created by Textron to determine whether the company’s calculation of its tax liabilities would pass muster during a possible IRS audit. Click here for the opinion.

To some lawyers who represent corporations, the decision signaled an attack by the courts on the work-product doctrine, the rule that shields a business from having to turn over documents created “in anticipation” of litigation. In its ruling, the court said the documents at Textron weren’t protected under the doctrine because they weren’t prepared specifically “for use” in litigation.

Thomas Sabatino, general counsel of Schering-Plough Corp., worries the court’s decision could transcend the tax arena and make in-house lawyers wary of providing complete assessments of future legal trouble in a variety of areas, from product-liability litigation to patent disputes.

Some tax experts say the concern is misplaced. Corporate lawyers are “trying to expand the work-product doctrine far beyond its original intent,” says Dennis Ventry, a law professor at the University of California, Davis, whose analysis of the Textron case was cited by the court in its opinion. “The IRS operates with significant information deficiencies,” he says, “and some companies bury things into a large tax return and try to obscure what they’re doing.”

The debate is playing out as the IRS in recent years has sought to hunt down illegal tax shelters. As part of that push, the agency increasingly is asking to review documents that show companies’ analysis of how much they should set aside in reserves for additional tax payments, should the IRS identify questionable tax accounting. In most instances, the documents, known as tax-accrual papers, include the company lawyers’ determination of the likelihood that it will win or lose future tax disputes with the IRS.

Judge Michael Boudin, writing for the majority on the court, said: “Textron apparently thinks it is ‘unfair’ for the government to have access to its spreadsheets, but tax collection is not a game. Underpaying taxes threatens the essential public interest in revenue collection.”