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Watershed Judgment on Working Papers

01 July 2007   (0 Comments)
Posted by: TaxFind™
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Watershed Judgment on Working Papers
The ability of a revenue service authority to break the rules and take privileged information from a taxpayer has been severely curtailed in a watershed judgment involving the international giant, Textron.
The powers of the IRS and other revenue service authorities around the world are extensive when it comes auditing the self-assessment tax laws imposed on taxpayers in order to ensure that these taxpayers are compliant. In addition, taxpayers are now also open to SOX 404, FIN 48 and IFRS, the protectors, that compel public company taxpayers to report any material weaknesses to other regulators, or they are compelled to report the extent of their tax liability to the IRS where there is a 50% or more chance that a tax dispute emanating from such a potential liability or tax uncertainty may arise.

For taxpayers to make these assessments, they are forced to circulate and generate sensitive information for their advisors and corporate officials to consider.The question is: Is the IRS entitled to this sensitive information?

Textron judgment

The recent Textron judgment regarding the disclosure of working papers during an audit that were prepared for FIN 48 compliance purposes, sheds light on the question.

The US Court ruled in August 2007 that tax authorities may not see company documents relating to a series of 'listed transactions' that may have been used for tax avoidance purposes. In this case the IRS had demanded to see the working papers in relation to certain sale-in lease-out transactions, where the taxpayer had acquired a piece of infrastructure from a municipal authority,  leased it back to them to generate tax deductions and in that manner reduced the cost of finance raised to pay the municipality in the first place.
The working papers in question contained the views of the taxpayer's in-house counsel on the tax risks associated with the transaction and the prospects of a tax court dispute, including percentages of the chances of success. 

Refusal to hand over papers

The taxpayer refused to hand over the working papers, stating that they were privileged. Argument was also raised that the IRS had an ulterior motive in attempting to attach the papers, in that they would use the working papers against the taxpayer in any settlement negotiations.

The court held that the IRS could not see the working papers as the working papers fell under the legal privilege and tax practitioner privilege in the USA, because the information was of a legal nature, and was information prepared in anticipation of litigation.In FIN 48 uncertain tax positions must be reported by public companies in the USA where there is a 50% or more chance that the IRS may win, as assessed by the taxpayer. Working papers are necessary to make such a determination. The IFRS standards are not far behind the FIN 48 requirements.It is essential that this proactive internal tax risk management process take place under the legal privilege.

In most revenue service audits, the authorities attempt to get hold of the working papers relating to the implementation of a particular transaction, including any advice or opinions generated by counsel.Now, the outcome of this case may be used to support the contention that the revenue service may not do so,provided that the working papers fall under the management and direction of an attorney, and in the USA, a tax practitioner as well.

Where a tax dispute may emerge

The revenue service may not attach working papers for a transaction prepared by an attorney where it is contemplated that a tax dispute may emerge in the future.The Textron judgment in the USA supports this contention.
The principle is sound and equally applicable in other jurisdictions in the absence of legislation expressly stated to the contrary.

Readers and taxpayers should be slow to merely hand over all documents during a revenue service audit and should not part with documents worked up by attorneys with tax advisors, relating to the structure, planning and implementation of a transaction.Here it is of the utmost importance to get the appropriate advice.

The advantage of taking this information and applying it in practice to a revenue service audit will result in taxpayers being more discerning with the information they part with. 

The less the information that may self-incriminate the taxpayer, the more difficult it is for the revenue service to jump to a conclusion that taxes have been underpaid as the facts on which they would like to base their conclusion will be wrapped up in the legal privilege.  
Source: By TaxTALK


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