Seventh Circuit Limits Scope of Federal Tax Practitioner Privilege
There is no accountant-client privilege recognized by the common law. U.S. v. Frederick, 182 F.3d 496, 500 (7th Cir. 1999); FREV 501. In 1998, Congress provided a limited shield of confidentiality between a federally authorized tax practitioner and his client. This privilege is no broader than the existing attorney-client privilege. This is set forth in §7525, and in particular §7525(a)(1), which provides that "…with respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. This federally recognized privilege can only be asserted in any noncriminal tax matter before the Internal Revenue Service; and any noncriminal tax proceeding in Federal court brought by or against the United States. §7525(a)(2). Moreover, the relatively new privilege does not apply to the rendering of business advice, accounting advice or tax return preparation advice. On the other hand, communications on legal matters raised in litigation or in anticipation of litigation are privileged by application of the work product doctrine. See FRCP 26(b). On the other side of the spectrum, communications about legal questions raised in litigation (or in anticipation of litigation) are privileged. The policy rationales under the attorney client privilege and the work product doctrine are distinctly different. As to the former, the courts give a narrow construction to the scope of the attorney client privilege inasmuch as such privilege runs contra to the search for truth. See U.S. v. Evans, 113 F.3d 1457, 1461 (7th Cir. 1997).
The Seventh Circuit, in Valero Energy Corp. v U.S., affirmed the U.S. District Court’s for the Northern District of Illinois, Eastern Division, order partially granting enforcement of an IRS summons issued to a company's tax advisers and directing the company to produce documents previously withheld under the tax practitioner privilege, upholding the court's finding that the tax shelter exception to the privilege applies. The tax issue pertained to a merger of Valero Energy and a Canadian company in 2001. Arthur Andersen LLP rendered tax and accounting advice on the transaction, including structure a purchase and disposition of certain financial instruments or positions which would generate large foreign source tax losses to offset gain realized in the acquisition. After finding out about the strategy in the financial press reporting the strategy saved Valero approximately $46M in taxes, the IRS issued a third party administrative summons on Arthur Andersen under §7609. Valero moved to quash the enforcement of the summons.
The lower court held that the tax practitioner privilege applied to some documents and the government had failed to meet its burden of showing that the tax shelter exception to the privilege applied. In a second ruling, the same district court found the government had established that some documents were discoverable under the "promotion" of tax shelter exception. Valero appealed to the Seventh Circuit.
The Seventh Circuit affirmed the district court's ruling. First, it agreed that certain documents were not privileged on the grounds that such documents were in the nature of business or accounting advice. Moving to the more noteworthy aspect of its opinion, the Appeals Court found that the exception under §7525(b)(2) did apply to certain materials sought to be produced. The appellant-Valero argued that to apply §7525(b)(2) there had to be a finding that the documents pertained to the "promotion of the direct or indirect participation of the person in a tax shelter". Here, Valero argued, there was no promotion since Arthur Andersen presented the tax strategy to it alone in order to reduce the tax impact of the merger and not as part of a pre-packaged promotion to various persons.
The appeals court rejected Valero’s argument which it found to create a conflict as far as Congress’ intent in defining tax shelter in §6662(d)(2)(C)(ii). "Nothing in this definition limits tax shelters to cookie-cutter products peddled by shady practitioners or distinguishes tax shelters from individualized tax advice," the court wrote. "Instead, the language is broad and encompasses any plan or arrangement whose significant purpose is to avoid or evade federal taxes." It also distinguished the case from Textron, 507 F. Supp. 2d 138 (2007), on the basis that the tax accrual workpapers involved in that case were not to be evaluated in the same light as pre-transactional documents and written advises rendered by a tax practitioner in the case before it. The Seventh Circuit added additional ingredients to its holding by stating in its opinion that the summons power held by the IRS goes to the "flip side of [the] coin" of our country’s self-reporting system. The section 7525 privilege "chips away at the IRS's summons power: we will not broaden it by narrowly interpreting exceptions without clear direction from Congress," the court stated.
The Seventh Circuit’s decision in Valero Energy reaches an opposite conclusion from the Tax Court’s recent decision in Countryside Limited Partnership et al.,132 T.C. No. 17 (June 8, 2009). In Countryside, Tax Court Judge James Halpern held that the section 7525(b) privilege exception for tax shelter promotion while not clear perhaps on its face did find support for the thought that it was not intended to apply to "routine relationships" between advisers and taxpayers as present before the Court.
In short, Valero Energy Corp. provides the government with a clear victory in its continued efforts to obtain tax opinions and related materials issued to clients by federal tax practitioners through the use of its summons power. Since the various courts that have looked at this issue previously gave the §7525(b)(2) exception a more narrow read, it will be interesting to follow how the issue continues to be received by the courts.
