Open Reserve-ations: United States v. Textron Inc. and Its Application to International Tax Accounting

INTRODUCTION It has been described as an "upheaval" of established law. (1) It will open up a "Pandora's box" and "turn the tables" on previous legal understandings. (2) It "eviscerates" long-standing legal doctrine. (3) What sort of revolutionary event could invoke such grim language? Surely, "It" must be a headline case involving a high-profile social issue like the constitutionality of same-sex marriage, (4) corporate contributions to political campaigns, (5) or restrictions on First Amendment rights. Instead, "It" is the First Circuit's opinion in United States v. Textron Inc., (6) a case involving an Internal Revenue Service (IRS) summons for tax accrual workpapers and Textron's attempts to protect the documentation under the work-product doctrine. The First Circuit reversed the Federal District Court of Rhode Island and set aside a First Circuit panel's holding the workpapers as privileged, instead holding that, because the workpapers were prepared "to support financial filings and gain auditor approval," (7) and not for use in litigation, the IRS could freely discover the tax accrual workpapers. The corporate world immediately criticized the controversial ruling, as critics rushed to assert that the ruling makes it more difficult to protect their clients in an increasingly opaque tax system. (8) Why such strong criticism? First, corporate tax departments and IRS auditors have engaged in a tug-of-war over the IRS's ability to access a corporation's tax accrual workpapers, which are generally prepared both to support tax calculations published in its financial statements and its tax return and to gain insight into certain transactions whose tax effects may not have found their way onto the corporation's tax return. Textron, by rejecting the argument that tax accrual workpapers are prepared "in anticipation of [future] litigation" with the IRS, serves as the latest blow to the corporate world's hopes of work product protection. In addition, the First Circuit's conclusions in Textron have ramifications beyond the current financial reporting regime; as early as 2014, U.S. companies may be required to implement new international standards for income tax accounting, particularly when accounting for uncertain tax positions. This Note attempts to lay the foundation for how (if at all) these new international standards, in conjunction with the Textron decision and recent IRS Announcement 2010-75, will affect corporate tax departments across the United States. Part I of this Note briefly provides the foundational background on financial statement preparation and the current rules regarding tax accrual calculations. Part II then discusses the current status of work-product doctrine with respect to tax accrual documentation, including an analysis of the First Circuit's Textron decision. Part III lays out the major policy arguments both for and against discoverability of tax accrual documentation. Finally, Part IV considers the upcoming transition to International Financial Reporting Standards (IFRS) and hypothesizes the consequences of the Textron decision with respect to these new rules. I. THE NECESSARY BACKGROUND: FIN 48 AND THE WORKPRODUCT PRIVILEGE As a general matter, all publicly held companies in the United States are required to file financial statements with the Securities and Exchange Commission (SEC), (9) and the SEC requires that an independent auditor must audit all financial statements in accordance with Generally Accepted Auditing Standards (GAAS). (10) The independent auditor evaluates the company's financial statements relative to Generally Accepted Accounting Principles (GAAP), which the Financial Accounting Standards Board (FASB) promulgates, and then expresses an opinion on whether the financial statements fairly present the financial condition of the firm. (11) A. Accounting for Uncertain Tax Positions and FIN 48 More specific to tax accounting, GAAP requires publicly held corporations to provide a reserve (12) for contingent tax liabilities and uncertain tax benefits, (13) which includes estimates of potential liabilities to the IRS if the IRS decides to challenge a corporation's positions in its annual tax return. …