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Court Denies IRS Request For Tax Working Papers

by Leroy Baker, for, New York

31 August 2007

The US government suffered a setback in its fight against abusive tax sheltering when a federal judge ruled that the Internal Revenue Service was not entitled to examine internal tax documents belong to the aircraft manufacturing company Textron Inc.

Federal judge Ernest C. Torres, of the Rhode Island court circuit, ruled on Wednesday that Textron should not be made to hand over working papers on a sale-in lease-out (SILO) transaction because they were protected by work-product privilege, and to do so would give the IRS an unfair advantage in the case.

Requests for tax-accrual working papers, which contain legal analysis of transactions that could be subject to an IRS challenge, are rare. However, since the US government began its recent crackdown on abusive tax shelters in response to a rise in 'aggressive' corporate tax planning in the 1990s, the IRS has changed its policy to demand working papers in cases involving the 31 transactions it has specifically identified as abusive tax shelters, of which SILO is one. The agency also argued in the case that its has legal precedent on its side, resulting from a 1984 Supreme Court ruling

However, in rejecting the IRS summons on Textron, Judge Torres wrote that disclosure of the legal opinions would "put Textron at an unfair disadvantage in any dispute that might arise with the IRS, just as requiring the IRS to disclose the opinions of its counsel regarding areas of uncertainty in the law or the likely outcome of any litigation with Textron would place the IRS at an unfair disadvantage".

SILO transactions help companies create huge depreciation deductions through the purchase of public infrastructure, frequently from a foreign government, and then leasing them back to the public authority. In the case in question, Textron had bought a foreign railroad system and several telephone networks, and leased them back to the sellers.

In February 2005, the Treasury Department and the IRS issued guidance which designated SILO arrangements as abusive tax avoidance transactions, stemming from provisions passed by Congress as part of the American Jobs Creation Act of 2004 on the deductibility of losses from SILO transactions.

According to the Wall Street Journal, the Justice Department, which litigated that case on behalf of the IRS, is reviewing the case and has not yet decided whether to press ahead with an appeal, which could ultimately result in the Supreme Court reevaluating its previous decision.

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