On June 4, 2013, the U.S. District Court for the District of Minnesota ruled that Wells Fargo’s measurement of and analysis with respect to its so-called uncertain tax positions, or UTPs, is entitled to work product protection, but that the identification of the types of UTPs is not.
On September 1, 2010, Wells Fargo & Company asked the District Court of Minnesota to quash a summons issued by the Internal Revenue Service (IRS) to Wells Fargo’s outside auditor, KPMG LLP, seeking all tax accrual workpapers for tax years ending December 31, 2007, and December 31, 2008 (the KPMG Summons). The KPMG Summons sought ‘‘any and all analyses, computations, opinions, notes, summaries, discussions, and other documents relating to such [tax] reserves and any footnotes.’’ On November 1, 2010, the government filed a response seeking to enforce the KPMG Summons and asked the court for an evidentiary hearing. Simultaneously, in a related case, the government asked the court to enforce summonses issued directly to Wells Fargo seeking the same types of documents and corresponding witness testimony.
The court consolidated the two cases and held a four-day evidentiary hearing. In addition, the court reviewed the responsive documents in camera.
On June 4, 2013, the court issued its decision. The court first determined that the IRS had a legitimate purpose for issuing the summonses: to verify the accuracy of Wells Fargo’s returns. The court was unpersuaded by Wells Fargo’s argument that the IRS was motivated to deter or punish Wells Fargo, and that the summonses lacked a legitimate purpose. The court also dismissed concerns that the IRS had violated its published “policy of restraint,” which states that the IRS will request tax accrual workpapers only if a taxpayer has claimed the benefits of a listed transaction. The court reasoned that whether or not the IRS violated its policy of restraint was irrelevant in determining whether the summonses lacked a legitimate purpose because “the policy of restraint does not purport to be an interpretation of the law or a definition of ‘legitimate purpose’.” The court further noted that even if the IRS intended its policy of restraint to limit its authority when seeking tax accrual workpapers, the IRS has a “somewhat inconsistent posture” on when it will request tax accrual workpapers.
The court focused on whether Wells Fargo’s tax accrual workpapers were protected by the work product doctrine. The work product doctrine, as fashioned by the Supreme Court of the United States in Hickman v. Taylor, 329 U.S. 495 (1947), protects from disclosure materials prepared in anticipation of litigation by or for a party or for that party’s representative (including a consultant or agent). Over time the work product doctrine has evolved. When applying the “in anticipation of litigation” standard to dual-purpose documents, for example, most courts analyze the putatively privileged materials employing the “because of” test. This judicial standard focuses on whether “in light of the nature of the document and the factual situation in a particular case, the document can fairly be said to have been prepared or obtained because of the prospect of litigation.” United States v. Adlman, 134 F.3d 1194, 1202 (2d Cir. 1998). The U.S. Court of Appeals for the Eighth Circuit, the court to which an appeal from the District Court for Minnesota would lie, has adopted the “because of” test. See Simon v. G.D. Searle & Co., 816 F.2d 397 (8th Cir. 1987); PepsiCo, Inc. v. Baird, Kurtz & Dobson LLP, 305 F.3d 813 (8th Cir. 2002).
In determining whether Wells Fargo and KPMG prepared the disputed tax accrual workpapers in “anticipation of litigation,” the District Court for Minnesota faced a divergence of opinion among Circuit Courts with respect to the underlying legal issue. For example, the Fifth Circuit in United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982), and the First Circuit in United States v. Textron Inc., 577 F.3d 21 (1st Cir. 2009) (en banc), both held that tax accrual workpapers that are prepared by the taxpayer and that reflect a lawyer’s analysis of the likelihood of success in litigation were not prepared in anticipation of litigation because such workpapers were created as part of an independent audit.
In 2010, however, the D.C. Circuit held in United States v. Deloitte, LLP, 610 F.3d 129 (D.C. Cir. 2010), that a document prepared by an independent auditor containing the impressions of the taxpayer’s attorneys was protected by the work product doctrine because “the question is not who created the document or how they are related to the party asserting work-product protection, but whether the document contains work product — the thoughts and opinions of counsel developed in anticipation of litigation.” In addition, the Second Circuit in Adlman held that a memorandum from a tax advisor assessing the litigation risk associated with undertaking a proposed corporate transaction was prepared in anticipation of litigation, notwithstanding the memorandum was primarily intended to inform a business decision. 134 F.3d at 1200.
Perhaps in an attempt to reconcile the Circuit Courts’ decisions in Textron, Deloitte and Adlman, the District Court for Minnesota rejected Wells Fargo’s argument that all tax accrual workpapers, by their nature, are created “because of litigation,” but ultimately held that the recognition and measurement analyses reflected in the tax accrual workpapers of both Wells Fargo and KPMG were prepared in anticipation of litigation, and therefore are protected by the work product doctrine. The District Court for Minnesota emphasized that its ruling was limited to the unique circumstances of Wells Fargo’s case. The court specifically noted that Wells Fargo had substantially limited the number of tax positions it subjected to a FIN 48 analysis and proved its anticipation of litigation with regard to each of its UTPs. The court further emphasized that the tax accrual workpapers at issue (including those prepared by KPMG) contained or responded to the legal thinking of Wells Fargo’s attorneys regarding their active litigation strategy.
In reaching its holding of non-disclosure, the court rejected the government’s argument that Wells Fargo had waived its privilege by disclosing work product to a potential adversary, its auditor KPMG. The court was persuaded by the fact that Wells Fargo and KPMG had never opposed each other in litigation and there was no evidence that any non-litigation dispute then existed. However, it is unclear whether the court’s analysis turned on the potential for any future litigation (e.g., a billing dispute) or only litigation with respect to the UTPs described in the tax accrual workpapers themselves. In Deloitte, the D.C. Circuit stated that the only relevant litigation in determining whether work product has been disclosed to an adversary is “the sort of litigation” described in the documents at issue. 610 F.3d at 140.
The court further held that eight of Wells Fargo’s documents were protected by the attorney-client privilege and that the government had failed to show how certain state and local tax accrual workpapers were relevant to the federal income tax examination and other certain workpapers of Wachovia, which it acquired in 2008.
Although the Wells Fargo decision represents a significant defeat for the IRS in its attempts to “peek behind the curtain,” it was not a complete loss for the government. The court determined that the work product doctrine did not protect from disclosure the identification of UTPs and related factual information because that information is created in the ordinary course of business.
Whether or not intended, by declining to extend work product doctrine protection to the identification of UTPs, the court endorsed the transparency that has been required of taxpayers who join the IRS’ Compliance Assurance Process program, or CAP. The Wells Fargo decision also appears to bless the validity of the IRS’ new Schedule UTP which, in its current form, requires certain corporations to identify UTPs as part of their tax return. Of interest is the fact that the IRS’s original draft Schedule UTP required a disclosure of the reserve amount for each UTP. Such a requirement would appear to be in direct conflict with the court’s decision. However, in response to comments arguing that the reserve amount for a UTP is protected by the work product doctrine, the IRS removed the requirement and replaced it with a ranking of the UTPs.