On Tuesday, June 4, the US District Court for the District of Minnesota issued its order in Wells Fargo & Co. v. United States, consolidated summons enforcement actions in which the taxpayer claimed that its tax accrual workpapers (TAWs) were privileged and therefore shielded from IRS discovery. The case involves many of the same issues presented in the widely followed Textron litigation.1 In Textron, the documents were held to be non-privileged, but here, the taxpayer prevailed.
During an audit of tax returns for 2007 and 2008, the IRS issued a summons for Wells Fargo’s TAW, which consisted principally of its master tax reserve schedules, together with supporting notes and memoranda prepared by the company’s in-house accountants acting in consultation with in-house tax counsel. Separately, the IRS issued a summons to KPMG, the company’s independent financial statement auditor, seeking production of KPMG’s own workpapers and notes. When Wells Fargo asserted that the documents were subject to claims of privilege, the government sought to enforce the summonses in federal district court. The court conducted a four-day hearing and subsequently reviewed all of the contested documents itself.
The principal issue involved in the case is whether the workpapers of Wells Fargo and KPMG were covered by the work product doctrine, which protects documents prepared “in anticipation of litigation.”The various Circuit Courts of Appeal are split on when litigation is anticipated.
- The First Circuit, the court that decided the Textron case, has adopted a very restrictive test requiring a party to demonstrate that the document at issue was “prepared for” use in litigation.
- The Fifth Circuit requires that the “primary motivating purpose” behind the creation of the document was to aid in possible future litigation.
- Many other circuits apply a more lenient test, which merely requires that the document be prepared “because of” the prospect of litigation.
In Wells Fargo, the district court applied the law of the Eighth Circuit, which follows the “because of” test.
The Court’s Analysis
The court conducted a thorough review of the company’s approach to setting tax reserves under FIN 48 (since recodified as ASC 740) and the role of the in-house tax attorneys in interacting with the company’s accountants to (i) identify uncertain tax positions, and (ii) apply FIN 48’s recognition and measurement tests. The court also examined the financial statement audit process and the role of the external auditor in evaluating the company’s reserve for uncertain tax positions. Finally, the court detailed the IRS administrative audit process.
As to Wells Fargo’s TAW, the court divided its inquiry into two parts.
First, the court found that Wells Fargo’s identification or listing of uncertain tax positions and factual information related thereto was not protected because it was compiled in the ordinary course of business, for the most part, before any serious tax inquiry had been made. The court said that the “mere identification of which tax positions a company should analyze under FIN 48 is too far removed from any litigation to be protected work product or considered created ‘because of’ litigation.”
Second, the court concluded that the FIN 48 recognition and measurement analyses performed after the tax positions had been identified are protected. The court freely admitted that the workpapers memorializing these analyses “were not prepared in anticipation of litigation” but rather, “they were prepared to comply with Wells Fargo’s financial statement reporting requirements.” But the court applied a content-based approach, rather than a purpose-based approach, to examine the documents, and concluded that “the recognition and measurement analysis in them reflects the legal analysis conducted by Wells Fargo’s attorneys in anticipation of litigation.” Allowing the IRS access to these recognition and measurement analyses, “would provide a window into the legal thinking of Wells Fargo’s attorneys on active litigation strategy, running counter to the purpose of the work product doctrine.” The court cautioned, however, that its ruling is limited to the unique circumstances of this matter, as Wells Fargo had proved it anticipated litigation with regard to each of its UTPs at the time it created its TAWs.
Moreover, the court concluded that Wells Fargo had not waived its work product protection by sharing its TAW with KPMG, its outside financial auditor. The work product protection, noted the court, is waived only upon a disclosure to an “adversary.” In holding that an independent auditor is not an “adversary” for this purpose, the court fell in line with the holding of the DC Circuit in Deloitte2 and the majority of other district courts, which have reached a similar conclusion. In making this holding, the court also rejected the argument that KPMG was a “conduit” to an adversary.
Finally, the court then analyzed KPMG’s workpapers and notes and reached the same result. Applying its content-based approach, the court found that KPMG’s analyses of the recognition and measurement steps of FIN 48 were “closely tied” to the analyses performed by Wells Fargo’s attorneys and were thus protected as work product.
On most of the important issues, Wells Fargo prevailed. But, stepping back from the case, the IRS might nevertheless claim a measure of administrative victory: the holding of the case could be viewed by some as a vindication of IRS’s recently implemented Schedule UTP reporting regime. Under Schedule UTP—which was not in place for the years involved in the Wells Fargo case—taxpayers generally must disclose a list of their federal uncertain tax positions together with simple facts related thereto, but they are not required to disclose the associated reserve percentages or dollars values. Nor are they required to divulge the legal machinations and support behind reserves. That is essentially the same as the holding in Wells Fargo.