The IRS issued an action on decision (AOD) announcing its nonacquiescence to the Sixth Circuit’s decision in Roxworthy, 457 F3d 590 (6th Cir. 2006). In that case, the Sixth Circuit held that certain memos a corporation received from an outside accounting firm were privileged under the work-product privilege. In the AOD, the Service stated that it intends to continue to vigorously pursue the enforcement of its summons and to challenge taxpayers’ privilege claims where appropriate.
Background and District Court Litigation
As part of an audit, the IRS
issued an informal document request to Yum! Brands, Inc. (Yum).
Yum claimed that seven of the items requested were protected by
the work-product privilege. An administrative summons seeking
the production of these documents was served on Patrick J.
Roxworthy (Roxworthy) in his capacity as vice president of tax
at Yum. Roxworthy refused to produce two of these documents,
which were memos prepared by a Big Four accounting firm
analyzing the tax consequences of certain transactions entered
into by Yum pertaining to the creation of a captive insurance
company and the subsequent sale of the captive’s stock at a
substantial loss; they included arguments that the IRS might
assert against Yum’s treatment of the transaction and possible
The IRS filed a petition in district court to enforce the summons as it related to the two opinion letters, arguing that the documents were not created in anticipation of litigation, so the work-product privilege did not apply. The case was referred to a magistrate judge. In his defense, Roxworthy filed affidavits from an in-house Yum attorney and a partner from the accounting firm asserting that the documents were produced in anticipation of litigation and therefore were privileged under the work-product privilege.
The magistrate judge applied the because of test to determine whether the memos were created in anticipation of litigation. In addition to proving that the documents in question were created for litigation purposes, under the because of test, the party claiming privilege must show that it subjectively believed that litigation was possible, and the belief must be objectively reasonable. The magistrate judge found that the affidavits did not include any information to back up the assertions that the memos were created in anticipation of litigation and that the other evidence surrounding the memos’ creation suggested that the documents were not created in anticipation of litigation. In particular, the magistrate judge stated that several issues regarding the timing of the actual transaction and the creation of the memos, as well as some language in the memos, suggested that it was likely the memos were created to support the positions taken in Yum’s tax return. Furthermore, the court found that because the memos were created before the IRS even initiated an audit of Yum, the prospect of litigation was so remote that the creation of the documents could not be reasonably said to be in anticipation of litigation.
Roxworthy objected to this finding and requested that the district court include additional affidavits in the record. The district granted the request. The affidavits described in more detail Yum’s reasons for anticipating litigation: the huge difference between its book and tax loss due to the transaction, the certainty of audit due to Yum’s size, the unsettled nature of the law in the area, and Yum’s belief that the IRS was inclined to litigate over the transaction. In his objection, Roxworthy also pointed out several factual errors made by the magistrate judge in his report. However, after considering the new affidavits and the errors’ effect on the magistrate judge’s findings, the district court decided to adopt the magistrate’s report and recommendation as the court’s opinion. Roxworthy appealed the decision to the Sixth Circuit.
Sixth Circuit Decision
The Sixth Circuit reversed the district court and held that the work-product privilege applied to the memos. Like the district court, the circuit court focused on the function that the documents served in determining whether the anticipation of litigation standard was met. However, the circuit court held that Yum’s additional affidavits were sufficient to prove that the memos were created in anticipation of litigation, unless they were shown to be false by other evidence, because they were made by individuals with personal knowledge of the situation and provided plausible reasons for Yum’s anticipation of litigation. Contrary to the district court, the circuit court also found that the timing of the memos’ creation did not necessarily suggest that the memos were not created in anticipation of litigation. It further concluded that the errors in the magistrate judge’s report cited by Roxworthy invalidated the report’s other conclusions. Having effectively eliminated all the evidence in the magistrate judge’s report, the circuit court found that there was no evidence in the record that disproved the affidavits of Yum personnel that Roxworthy had provided. Therefore, it held that the affidavits proved that the memos were created in anticipation of litigation and were protected by the work-product privilege.
The IRS has announced that it does not acquiesce to the Sixth Circuit’s decision in Roxworthy and “will continue to aggressively seek the enforcement of summonses, challenging unjustified assertions of the work-product doctrine (and other privileges) in all appropriate cases, including those that would be appealable to the Sixth Circuit.” In agreement with the district court, the Service argues that the possibility of litigation was too remote for the work-product privilege to apply. Further, the IRS contends that the district court correctly determined that the evidence in the record, particularly regarding the timing of the memos’ creation, suggested that they were not created in anticipation of litigation and that this evidence was sufficient to controvert the “after-the-fact, self-serving statements of Yum personnel involved in planning and executing the transaction.” In addition, according to the IRS, the circuit court should have remanded the case to the district court for further consideration rather than substituting its evaluation of the evidence in place of the district court’s evaluation.
Action on Decision 2007-04, 2007-40 IRB (10/1/07)