On May 20, 2015, the US District Court for the Northern District of California denied the IRS’ petition to enforce its summons, which sought two memoranda prepared by Sanmina Corporation’s tax department counsel and distributed to members of Sanmina’s internal tax team and accountants (Ernst & Young and KPMG) to obtain tax advice.26 The government sought the memoranda in connection with a claimed worthless stock deduction totaling roughly $500 million.
Sanmina filed its 2009 federal income tax return and attached a reportable transaction disclosure statement related to Sanmina’s claimed worthless stock deduction. The deduction was approximately $500 million for its shareholders in Sanmina AG. The IRS issued an information document request to examine the worthless stock deduction, and in response, Sanmina produced a valuation report drafted by its outside counsel. The valuation report relied, in part, on two Sanmina internal memoranda to support the conclusion that Sanmina’s accounts receivable should be disregarded.
Sanmina’s tax department counsel prepared the memoranda and distributed them to members of Sanmina’s internal tax team and accountants Ernst & Young and KPMG. The 2006 memorandum contained legal analysis supporting the execution of certain agreements among Sanmina and its subsidiaries, including the reason for the agreements, their legal enforceability and their tax treatment. The 2006 memorandum included citations to, and analysis of, certain IRS letter rulings and tax court decisions. The second memorandum, prepared in 2009, analyzed the tax effect of the liquidation of Sanmina, and cited IRS revenue rulings, tax code provisions and court decisions. Sanmina refused to produce the two memoranda and asserted that the documents were privileged.
The IRS has “broad latitude” when adopting enforcement mechanisms to perform tax collection and assessment. Under United States v. Powell, to enforce a summons, the government must show that (1) its investigation has a legitimate purpose; (2) the inquiry may be relevant to that purpose; (3) the information sought is not already in the possession of the government; and (4) the administrative steps required by the Internal Revenue Code have been followed. The government may make a prima facie case for enforcement by showing good faith compliance with summons requirements, once the government has met this burden, the taxpayer may rebut the government’s prima facie case by showing that the Powell requirements were not met or that enforcing the summons would be an abuse of the court’s enforcement powers.
The IRS satisfied the required Powell showing and Sanmina in turn properly raised the attorney-client privilege and the work product doctrine and timely provided a privilege log. Thus, the questions determined by the court were whether the attorney-client privilege applied; if so, whether it was waived and whether the work product applied, and if so, whether it was waived. The District Court upheld Sanmina’s privilege claim and found no evidence of waiver.
The IRS argued that Sanmina did not establish that the memoranda were prepared for legal, rather than business, purposes and that the communications related to business advice. The court found that both memos contained legal analysis, were prepared by Sanmina’s tax department lawyers and were provided confidentially to company employees who had a need to know the legal advice. On the question of waiver, Sanmina did not waive the privilege by producing the valuation report to the IRS, which cited and relied on the memoranda. The Court found that the valuation report did not summarize or disclose the content of the memoranda. Nor did distribution to Sanmina’s accountants or federal tax practitioners waive the attorney-client privilege.
Work Product Doctrine
Sanmina established that both memoranda were properly withheld from production under the work product doctrine. The court applied a “because of” standard to determine if the documents were created in anticipation of litigation and considered the totality of the circumstances surrounding the documents creation. The IRS argued that the documents were not created in anticipation of litigation because no litigation or audit was pending at the time the memoranda were drafted. The Court stated:
Sanmina’s description of the memoranda indicates an analysis of complex business and legal issues that ultimately supported Sanmina’s decision to take a worthless stock deduction arising from its ownership of Sanmina International AG. The size of the worthless stock deduction meant that Sanmina could reasonably have anticipated that the IRS would scrutinize and challenge Sanmina’s tax treatment of its holdings in Sanmina International AG, as the IRS has here.27
The Court also rejected the IRS’ claim of waiver. The standard for determining waiver of work product is whether the disclosure to a third party is consistent with maintaining secrecy against an adversary. The Court concluded that Sanmina did not waive work product because the valuation report provided to the IRS merely referenced the two memoranda, rather than summarize them.