This paper was prepared for the International Bar Association Conference, Madrid, Spain, October 2009
1.1 There is widespread concern among companies who prepare their financial statements in accordance with United States Generally Accepted Accounting Principles (“U.S. GAAP”) that FIN 48’s disclosure requirements “lift the veil” on an entity’s tax planning strategies and doubtful or uncertain tax positions. This is thought to be undesirable in the context of a voluntary-compliance tax system in which disputes are dealt with under a model that is essentially adversarial. Questions have arisen in the US as to how much information the Internal Revenue Service (“IRS”) should rightly have access to, how privilege applies to such information, and what strategies an entity can employ to best safeguard itself against untoward disclosure. The recent decision in United States of America v Textron Inc. , in the United States Court of Appeals for the First Circuit, limiting the application of litigation privilege (in the US called the work product doctrine) applicable to tax accrual work papers, makes this issue all the more pertinent.
1.2 In this paper, I consider how such concerns arise and apply in a New Zealand context, given the International Accounting Standards Board’s (“IASB”) proposal to adopt disclosure requirements similar to those of FIN 48. It is possible that the New Zealand revenue authorities may soon be able to gain access to detailed documentation as to a taxpayer’s doubtful tax position and use that information as a basis for investigation, negotiation and litigation.
2. WHAT IS FIN 48 AND WHAT DOES IT REQUIRE?
2.1 In June 2006, the US Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 - Accounting for Uncertainty in Income Taxes (“FIN 48”) to provide specific guidance as to how to address uncertainty in accounting for income tax assets and liabilities.
2.2 It is generally accepted that the benefit of a tax position should be recognized in an entity’s financial statements when there is a high degree of confidence that it will be upheld upon examination by a taxing authority. However, such a determination involves an evaluation of how relevant tax law will apply, which is not always straight forward. Accordingly, there may be some uncertainty as to whether a tax position will ultimately be sustained.
2.3 FIN 48 applies to all companies using U.S. GAAP. The standard is intended to provide consistent criteria for the evaluation, recognition and measurement of a company’s uncertain tax positions, as is required by Financial Accounting Standard 109 (“FAS 109”).
2.4 FIN 48 prescribes a recognition threshold whereby a tax benefit may not be recognised in a company’s financial statements unless it is more likely than not that the tax position will be sustained, based on all available sources of tax authority. If the fifty percent recognition threshold is crossed, the benefit to be recorded is measured as the largest amount that is likely to be realised upon settlement.
2.5 That means entities are required to prepare an inventory of their doubtful or uncertain tax positions, which they must then analyse, document and measure in a detailed manner. Tax accrual work papers may include written assessments of specific strengths and weaknesses, and a quantification of likely outcomes including the likelihood of litigation and the estimated chance of success. Specialist tax and litigation counsel may be required to undertake such an analysis.
2.6 It is likely company auditors will request that they review documentation prepared to support an entity’s uncertain tax positions in order to determine whether the financial statements are accurate and tax benefits have been appropriately recognised and valued.
3. DOES FIN 48 APPLY IN NEW ZEALAND? IF NOT, WHAT IS THE NEW ZEALAND EQUIVALENT STANDARD AND WHAT DOES IT REQUIRE?
3.1 New Zealand has recently adopted International Financial Reporting Standards (“IFRS”). Accordingly, U.S. GAAP and FIN 48 do not apply to most New Zealand companies. However, similar requirements will soon apply if proposed changes to make IFRS and U.S. GAAP more consistent with each other come into effect. The equivalent New Zealand standard is New Zealand International Accounting Standard 12; Income Taxes (“NZ IAS 12”). This provides guidance as to the recognition of current and future tax consequences in an entity’s financial statements.
3.2 NZ IAS 12 does not currently contain any guidance as to the recognition and measurement of doubtful or uncertain tax positions as FIN 48 does. It simply applies a probable test for the recognition of deferred tax assets and liabilities. Once the “probable” recognition standard is met, the principle of measurement is simply the best estimate of an asset or liability at balance date. Accordingly, the standard does not currently require detailed documentation of uncertain tax positions.
3.3 However, the IASB released an exposure draft for comment in March 2009 proposing changes to IAS 12 . If confirmed the proposals are likely to apply to reporting periods commencing during 2011, at which time uncertain tax positions will be required to be accounted for and reported.
3.4 In the exposure draft the IASB proposed that the “probable” recognition standard be changed to “more likely than not”. It requires that a valuation allowance be created to reduce the deferred tax asset recognised in an entity’s financial statements to the highest amount that is “more likely than not” to be realisable, which is same approach as that required by FIN 48.
3.5 Uncertainty would be reflected by measuring current and deferred tax assets using the probability-weighted average amounts of possible outcomes, assuming that the tax authorities will examine the amounts reported to them by the entity and have full knowledge of all relevant information.
3.6 In summary, it is likely this will require an entity to take the following steps:
a) determine what constitutes an “uncertainty” and identify the tax positions taken during any applicable limitation period under the relevant tax law;
b) determine the possible outcomes for each tax position and the probabilities of each occurring;
c) calculate the weighted-probability amount for the position;
d) compare the calculated amount to the amount submitted to the tax authority and recognise the difference as a liability in the financial statements;
e) recognise any interest and penalties the entity would be liable for if a tax position is not sustained; and
f) disclose “estimation uncertainties” in the financial statements.
3.7 The IASB’s exposure draft indicates that it does not intend that entities should need to obtain additional information from third parties to meet the requirements of the standard when preparing financial statements. However, in practice, many entities are likely to require expert tax advice to determine accurately the range of possible outcomes for each uncertain tax position and the probability of each of those outcomes occurring.
4. WOULD NZ IAS 12, AS PROPOSED, PRESENT THE SAME RISKS OF INFORMATION DISCLOSURE TO THE NEW ZEALAND INLAND REVENUE DEPARTMENT (“IRD”) AS FIN 48 DOES IN THE UNITED STATES?
4.1 There has been widespread concern since FIN 48 came into force that its disclosure requirements supply to US revenue authorities a “road map” of areas of potential dispute with taxpayers. Further, because companies are required to prepare detailed documentation supporting their uncertain tax positions, the question arises whether revenue authorities can rightly gain access to that information. If they can, the implementation of FIN 48 essentially "lifts the veil" on a company’s tax strategies, planning and positions, making it much more difficult to protect tax sensitive material.
4.2 New Zealand entities are also likely soon to be required to make revealing disclosures in their financial statements about their uncertain tax positions. If so, similar concerns will arise here. I set out below a number of ways New Zealand taxpayers could be affected by such disclosure requirements.
IRD access to taxpayer work papers and opinions documenting their uncertain tax positions
4.3 The extent of legitimate concern for New Zealand entities somewhat depends on the breadth of the New Zealand Commissioner of Inland Revenue’s (“CIR”) powers to obtain tax analysis documentation from taxpayers. The CIR has wide powers to access taxpayer premises directly to inspect information held there , and to request, remove and copy taxpayer information . There is also generally nothing to stop the CIR seeking information from multiple sources, including sources other than the affected taxpayer. That may include work papers and advice held by an entity’s auditors, accountants or other advisers.
4.4 Specifically, the CIR has statutory authority to demand information where it considers such information is necessary or relevant for any purpose relating to the administration or enforcement of the Inland Revenue Acts . A range of remedies are available to the CIR if such demands are not complied with .
4.5 The disclosure of a tax valuation allowance in an entity’s financial statements would provide direct guidance to the IRD as to the extent of an entity’s uncertain tax positions. Enquiries could then be made as to what those uncertainties relate to by approaching taxpayers directly for supporting documentation. If the CIR is able to obtain an inventory of a taxpayer’s uncertain tax positions that would understandably provide fertile ground for further investigation. The CIR regularly performs both targeted and random audits of a taxpayer’s affairs. Targeted audits may well be directed by disclosures made in an entity’s financial statements regarding uncertain tax positions. Access by the CIR to accounting work papers has been the subject of concern and administrative sensitivity for some years . The CIR’s powers have been limited to some extent by the enactment of a limited right of non-disclosure for accounting tax advice , but these matters are likely to be revisited in the light of the proposed changes to accounting standards.
4.6 Once a tax position is questioned by the IRD, New Zealand has a detailed taxation disputes resolution process that both the CIR and taxpayer must comply with . The process is designed to encourage full and frank communication between parties and the resolution of issues without the need for litigation. In particular, it aims to ensure that all the relevant evidence, facts and legal arguments are canvassed before a case proceeds to a court or hearing authority. The process has been criticised as being unwieldy and expensive, and as “burning off” taxpayers before they have a chance to litigate tax matters .
4.7 The process requires a series of steps specified in legislation, the main elements of which are:
a) A notice of proposed adjustment (“NOPA”) - this is a notice that either the CIR or taxpayer issues to the other advising that an adjustment is sought in relation to the taxpayer's assessment, the Commissioner's assessment or any other disputable decision.
b) A notice of response (“NOR”) - this must be issued by the recipient of a NOPA if they disagree with it.
c) A disclosure notice and statement of position (“SOP”) - the issue of a disclosure notice by the Commissioner triggers the issue of a SOP. Each SOP must provide an outline of the facts, evidence, issues and propositions of law with sufficient details to support the position taken. The parties are then limited to the facts, evidence, issues and propositions of law included in their SOP if the case proceeds to court .
4.8 It is likely that the CIR will be able to issue more NOPAs in the future which challenge taxpayer assessments based on what could essentially be the taxpayer’s own opinions as to uncertain tax positions, as expressed in documentation required by IAS 12. Conversely, where a taxpayer challenges an assessment made by the CIR, the CIR is likely to enquire into the taxpayer’s own documentation to see if the opinions expressed within it support the taxpayer’s challenge . If those documents have to be produced, it is likely to be difficult for a taxpayer to argue differently from the opinions expressed in their own documentation. Accordingly, taxpayers may be restricted for practical purposes in the disputes process to opinions and positions taken in such documents. Such a situation may make it much harder for taxpayers to achieve favourable settlements with the IRD by arguing the strength of their legal position.
4.9 Furthermore, IRD access to such documentation will have significant implications for the imposition of shortfall penalties . Documentation may well recognise interest and penalties the entity would be liable for if a tax position is not sustained. If a tax position is considered to have a less than 50% chance of being sustained, that is likely to be an invitation to the CIR to impose a penalty.
4.10 Shortfall penalties, based on tax shortfalls, are graded. The amount of the penalty increases progressively in accordance with the seriousness of the taxpayer’s default. It would be much easier for the IRD to establish that such penalties apply where it has access to specific information as to a taxpayer’s perceptions of the accuracy of a tax position taken.
4.11 For example, a penalty for an “unacceptable tax position” applies when a tax shortfall arises because a tax position is not “about as likely as not” to be correct. A lesser standard may be easily determined from a taxpayer’s own calculations of probability. It may also be easier to determine whether a taxpayer has not taken reasonable care, been grossly careless, has taken an abusive tax position, or is guilty of evasion through the availability of their own documentation. All these possibilities involve other shortfall penalties that are available to the CIR.
5. WHAT PROTECTIONS FROM DISCLOSURE OF INFORMATION TO THE CIR EXIST IN NEW ZEALAND?
5.1 New Zealand taxpayers will need to be vigilant in protecting their tax sensitive information should New Zealand accounting disclosure requirements become more consistent with those of FIN 48. As discussed above, the CIR has wide powers to require access to taxpayer records and it is difficult to withhold requested information. What follows is a review of the protections from disclosure of tax sensitive material that currently exist in New Zealand. To differing degrees, such protections include IRD policy statements and administrative limits, judicial review of the exercise of investigating powers, and statutory and common law privileges.
Policy Statements as to IRD standard practice
5.2 Policy statements released by the CIR indicate that he will exercise restraint in requiring access to work papers and advice prepared by an entity’s auditors and accountants. While such statements do not bind the CIR and have no force in law, they represent an indication as to likely IRD common practice. It is to be noted, however, that these statements pre-date the possible change in accounting standards and the opportunity offered by that may be too good for the CIR to resist.
Access to advice and work papers prepared by accountants
5.3 The CIR released a policy statement in 1993 regarding access to advice and other work papers prepared by accountants . The statement provides that, while maintaining the objective of efficiently administering the various Inland Revenue Acts, the IRD will not seek to interfere unnecessarily with the accountant/client relationship. It further provides that it is not appropriate for a departmental investigator to carry out a wide-ranging inquiry on accountants' advice work papers in the hope that something useful may emerge. That statement acknowledges that accountants and their clients must feel free to communicate honestly and openly for a professional relationship to exist. The statement gave accountants a degree of administrative protection, but did not grant any legislative privilege from disclosure. The CIR feels less bound by this statement since the enactment of a statutory non-disclosure right for accountants’ tax advice, discussed further below .
Access to advice and work papers prepared by auditors
5.4 The IRD had also earlier released a policy statement in relation to audit work papers in 1991. The statement makes clear that the CIR considers he has wide statutory powers of access to audit work papers that override the confidentiality of an auditor's operating method. However, the statement provides that requests for access to audit work papers will arise only in the course of enquiries conducted by the Investigations Unit of the IRD or by a specialist inspector¸ and will not be a routine part of investigations. Accordingly, requests for access to audit work papers will only be made in exceptional circumstances and in the first instance the information will be requested from the taxpayer. An auditor may also seek professional advice before complying with requests, to determine if particular documents on an audit file are subject to legal professional privilege. Further, when an auditor holds both audit work papers and other work papers on a common file, the auditor is not expected to make available the audit work paper content of the file unless a request is made specifically for such work papers in the manner described above.
5.5 These policy statements provide some indication as to the way the IRD could be expected to conduct itself in relation to legitimate requests for documentation and provide some re-assurance that the IRD will not seek to interfere unnecessarily with the accountant/client relationship. It is heartening for taxpayers that they suggest the CIR considers that it is not appropriate for a departmental investigator to carry out a wide-ranging inquiry on accountants' advice work papers in the hope that something useful may emerge. However, such statements do not provide a strong re-assurance to taxpayers because legally the CIR has wide powers to request anything he considers “necessary and relevant”. There is no prohibition on “fishing expeditions” and the Courts have made it clear that if the CIR considers he must depart from standard practice statements, he may do so . There is no legitimate expectation that he will necessarily apply the statements if he is required to act otherwise.
Judicial Review and legislative care and management provisions
5.6 There is an overriding requirement under administrative law that all public powers must be exercised in good faith. Historically, judicial review has been used by taxpayers to challenge the Commissioner's administration of the tax legislation leading to an assessment. It can be used to address such things as procedural error, unlawfulness, bad faith and abuse of power. For example, it has been asserted by taxpayers that the CIR may be breaching legislative care and management provisions when he does not follow policy statements such as those mentioned above. Such provisions recognise that the Commissioner is responsible for carrying out his role in a manner that fosters the integrity and effective functioning of the tax system.
5.7 However, judicial review of the CIR’s decision making processes and other avenues of challenge which seek to argue that the CIR has breached his responsibilities under the care and management legislative provisions have been progressively narrowed by case law. Judicial review now appears to only be available in exceptional circumstances such as conscious mal-administration on the part of an IRD officer .
5.8 Accordingly it will be very difficult to challenge information requests that are perceived to be unfair, an abuse of power or made in bad faith through judicial review proceedings. However, this may be an option in a case of conscious maladministration on the part of the CIR.
Statutory Privilege and Non-Disclosure Rights
5.9 The main limitation on the CIR’s information-gathering powers is a statutory regime for legal privilege and non-disclosure of accountants’ tax advice. Therefore, maintaining privilege or non-disclosure rights over documentation is likely to be the most effective way to avoid disclosure. New Zealand statutory privileges include legal professional privilege and so-called tax advice non-disclosure (“TAND”) rights.
Legal Professional Privilege
5.10 The common law doctrine of legal professional privilege (sometimes called legal advice privilege) is largely embodied in the New Zealand tax legislation. Under section 20 of the Tax Administration Act 1994 (“TAA”) any confidential communication passing between legal practitioners, or a legal practitioner and a client, is privileged from disclosure. Accordingly, any document covered by this privilege is outside the scope of an IRD information request, and indeed the privilege extends beyond the investigation stage to discovery in litigation. The privilege is conferred more generally under the Evidence Act 2006.
5.11 Subject to certain exceptions, any information or book or document is privileged from disclosure under section 20 if:
a) it is a confidential communication (oral or written) passing between:
i) a legal practitioner in his or her professional capacity and another legal practitioner in such capacity, or
ii) a legal practitioner in his or her professional capacity and a client; and
b) it is made or brought into existence for the purpose of obtaining or giving legal advice or assistance; and
c) it is not made or brought into existence for the purpose of committing or furthering the commission of some illegal or wrongful act.
5.12 Accordingly, taxpayers may claim legal professional privilege over legal advice obtained regarding their uncertain tax positions and withhold such advice from the CIR. However, legal professional privilege only goes so far. It protects communications between lawyer and client but does not apply to communications between a lawyer and third parties unless they are agents of the lawyer’s client or they enjoy a common interest privilege. Otherwise, common law litigation privilege (the equivalent of the US work product doctrine) and the terms of the Evidence Act 2006 may apply. Therefore, audit work papers commenting on tax advice and legal opinions pertaining to an entity’s uncertain tax positions may not fall under this privilege unless carefully deployed. Furthermore, disclosure of legal opinions and advice to accountants and auditors may waive privilege in such documents. In the Australian case Barnes v FC of T the Full Federal Court commented that:
"To attract privilege...it is necessary to show that the copy was created for the dominant purpose of seeking legal advice or assistance. The consequence of this may be that an original document which is not created for the dominant purpose of seeking legal advice and assistance, and thus was not privileged, may become privileged if a copy of it is created for that purpose. On the other hand, for example, where a document is privileged, but a copy of it is created for the purpose of commercial negotiation, this may result in the copy not being privileged."
5.13 I also note that if documents are merely lodged with a lawyer for safe custody, they are not privileged from disclosure . However, in some cases a copy of an unprivileged document sent to counsel as a communication in itself may attract privilege .
5.14 Importantly, however, New Zealand Courts have recognised that a person may release a document in which privilege is asserted for a limited purpose, without necessarily waiving the privilege entirely. Thus in Russell McVeagh v Auckland District Law Society , the Judicial Committee of the Privy Council upheld arrangements between a law firm and the Law Society for certain privileged documents to be disclosed only for limited purposes in the context of investigations being undertaken by the Society. The disclosure did not amount to a wholesale waiver of privilege.
5.15 TAND rights provide protection from disclosure for documents containing tax advice given by accountants. Specifically, a book or document is eligible to be a tax advice document if any of the following criteria are satisfied:
a) it is created for the main purpose of instructing a tax advisor to act for a person by giving advice to the person about the operation and effect of tax laws;
b) it is created by a tax advisor or, if the tax advisor is in public practice, an employee of the tax advisor's firm, for the main purpose of recording research and analysis that is performed for the main purpose of enabling the tax advisor to give advice about the operation and effect of tax laws, or
c) it is created by a tax advisor or, if the tax advisor is in public practice, an employee of the tax advisor's firm, for the main purpose of giving tax advice or recording advice given about the operation and effect of tax laws.
5.16 Accordingly, tax opinions and advice given by a company’s accountants will also be privileged from disclosure to the CIR. However, TAND rights for accountants’ tax advice do not extend to financial statements, work papers, numerical calculations compiled for the purpose of calculating a taxpayer's tax liability, or any other documents created by a tax advisor for main purposes other than giving a client advice on the operation and effect of tax laws. For that same reason, TAND rights do not extend to the advice of auditors. In performing the audit and recording their conclusions, auditors are not acting as tax advisers, but are expressing an opinion about the financial statements of an entity as a whole. That means audit work papers and tax accrual work papers are unlikely to be covered by the TAND regime, although specialist tax advice obtained for the purpose of permitting auditors to reach conclusions on applicable accounting issues may be protected from disclosure .
Common law privileges
5.17 Litigation privilege is available at New Zealand common law and under the Evidence Act 2006 and may provide some further protection for tax accrual information held by third parties. It reaches more widely than legal professional privilege and applies to:
a) communications between a legal professional advisor and a third party if made for the purpose of pending or contemplated litigation; and
b) communications between a client and third party, where such communications are made with a view to obtaining information to be submitted to a legal professional advisor for the purpose of pending or contemplated litigation.
5.18 I note that while section 20 of the TAA does not provide for litigation privilege, the courts have tacitly accepted that litigation privilege still applies in New Zealand in a tax context.
5.19 To claim litigation privilege, work must have been carried out with the dominant purpose of conducting or advising on actual or reasonably anticipated litigation . Privilege cannot be claimed for documents prepared before that time. It is uncertain whether documentation prepared by taxpayers in order to comply with accounting standards would be regarded as having been prepared for the dominant purpose of advising on reasonably anticipated litigation in New Zealand.
5.20 In Dinsdale v C of IR the New Zealand Court of Appeal held that if litigation is but one of two or more equally important purposes, it is not the dominant purpose. That case arose as a result of a request by the IRD under section 17 of the TAA for interview notes prepared by accountants in the course of an audit of a bank. The taxpayer’s application for a declaration that audit documents requested by the CIR were protected by legal professional and litigation privilege was dismissed by the court. It is notable that the attendance of a solicitor at the interviews was held to be at best indicative of an equal, rather than a dominant, purpose of the interviewing process.
5.21 In Glenharrow Limited v CIR a taxpayer succeeded in obtaining access to expert reports given to the IRD for the purpose of it preparing its notices under the statutory tax disputes process. The IRD argued that litigation privilege applied because the case was almost inevitably headed for Court over alleged tax avoidance. But the Court of Appeal concluded that the main purpose of the reports was to inform the CIR in the context of the disputes process, which is designed to avoid litigation.
5.22 It is a question of fact what the dominant purpose is in each case, but these cases suggest that New Zealand courts may not be willing to find that documentation prepared for the primary purpose of complying with an accounting standard is protected by litigation privilege. Such an approach would be consistent with the recent decision on appeal in US v Textron Inc . However, I note there are calls for that decision to be reviewed by the Supreme Court due to its significant repercussions for taxpayers.
5.23 In that judgment, released on 13 August 2009, the United States Court of Appeals for the First Circuit, sitting en banc, ruled that tax accrual work papers are not protected from production by the attorney work product doctrine (the equivalent of common law litigation privilege) when requested by an IRS administrative summons. The court ruled that dual purpose documents are not protected unless they are prepared for use in litigation. Since it was undisputed that the tax accrual work papers were prepared in the first instance to establish and support the tax reserve figures for the audited financial statements, they were found not to have been prepared for use in litigation, notwithstanding that they were prepared in response to the prospect of litigation.
5.24 The case provides a telling example of how accounting disclosures might be utilised by revenue authorities. IRS agents suspected a Textron subsidiary had invested in transactions determined to be tax shelters, and subsequently issued an administrative summons seeking all of the company’s relevant work papers. Textron’s tax accrual work papers included a spreadsheet listing each questionable item that might be the subject of possible dispute by the IRS, the dollar amount subject to dispute, and the estimated chance of success by the IRS on that item. The papers also included numerous back up materials, including documents written by Textron’s in-house counsel reflecting their opinion as to which items should go on the spreadsheet and the risk of litigation percentage that should apply to each item.
5.25 If litigation privilege is given a similar narrow scope in New Zealand, we might see similar behaviour from the IRD, should comparable accounting disclosures and documentation shortly be required.
5.26 It is clear that the most effective means of restricting IRD access to IAS 12 documentation is likely to be reliance on TAND rights, legal professional privilege or litigation privilege. The degree of legal protection provided to audit and accountant work papers will largely depend on the way litigation or “work product” privilege is construed and applied in New Zealand. It remains to be seen whether New Zealand courts will follow or be influenced by US v Textron Inc. Existing New Zealand authority tends to suggest that litigation privilege will be narrowly applied.
6. WHAT STEPS CAN BE TAKEN TO BRING DOCUMENTATION WITHIN ALL OR ANY OF THE PROTECTIONS?
6.1 Should proposed changes to IAS 12 go ahead, protecting work papers that document uncertain tax positions will become of utmost importance to New Zealand entities required to comply with the standard. Whilst some protections from disclosure exist as discussed above, it is likely the CIR will be entitled to gain access to much of the documentation prepared by taxpayers in order to account for their uncertain tax positions unless defensive strategies are adopted. What follows is a discussion of simple measures that may be taken by taxpayers to enhance the protection of sensitive tax documentation in a New Zealand context. They are likely to be similar to the measures taken by companies required to comply with FIN 48 and U.S. GAAP.
6.2 Suggested strategies include:
a) The taxpayer should engage legal counsel to provide the final advice on doubtful tax positions.
b) Legal counsel should engage accounting assistance from the taxpayer’s accountants to assist in the analysis and qualification of doubtful tax positions.
c) Release of legal communications or TAND communications to auditors or other advisers should be under strict terms which assert confidentiality for all other purposes and enjoin the auditors or other advisers from compromising that retained privilege.
c) Documents relating to doubtful tax positions should be separated from other less sensitive material and managed in terms of access and use.
Involvement of legal counsel as primary adviser
6.3 Legal professional privilege is stronger and less limited than TAND rights. It ought to ensure that communications to and from a legal adviser (including those through an agent of the client such as an accountant) are treated as confidential and protected from disclosure. The terms on which the lawyer is engaged will be important in determining the scope of the brief, what communications will reasonably fall within the professional relationship, the requirement for confidentiality and the areas of legal advice and assistance that are required. Importantly, legal professional privilege covers tax contextual information, such as must be disclosed under TAND rights, so it is important that facts are communicated by or on behalf of the client to counsel so that they are protected from disclosure.
Engagement of the accountant
6.4 Outside litigation privilege there is no automatic protection for communications by a third party to a lawyer for the purpose of allowing the lawyer to provide legal advice or assistance. There are risks in relying on litigation privilege in the context of advice on doubtful tax positions, for the reasons already canvassed. Two approaches need, therefore, to be borne in mind. The first is to position the accounting adviser as the agent of the client in providing information to counsel. This arguably brings such information within the express terms of the statutory legal privilege. The second is to ensure that, even if the agency argument fails, the information given by the accountant (admittedly shorn of tax contextual information) falls within the client’s TAND rights.
Limited release to auditors and other advisers
6.5 The terms on which advice given by counsel about doubtful tax positions is released to other professional advisers must be very clear and limited. Ideally one would avoid a release at all and some US advisers advocate face to face meetings and verbal summaries being given to auditors. That may not be acceptable to the auditors and in my view it ought to be possible to develop terms of disclosure which reflect the following:
a) The essential confidentiality of the material.
b) The reasons prompting the disclosure and the use to which the material is to be put in that context.
c) The creation of a relationship of confidentiality between the discloser and recipient of the information.
d) The fact that the disclosure is not intended by the taxpayer to be a general waiver (or indeed any waiver at all) of privilege.
e) The acceptance by the recipient, the auditor, that disclosure is made for a limited purpose and that both the taxpayer and the auditor expect that any request to either for disclosure will be resisted on the basis of the taxpayer’s privilege.
Storage and separation of documentation
6.6 To emphasise that documentation is confidential and privileged, each document should be clearly marked as such. Further, language which explicitly stipulates the sole purpose of the document (and that any attachment or enclosure is provided in connection with seeking or providing legal advice) should be used within it. For example, if an email or letter is sent with the intention of obtaining legal advice, the request for advice should be included in the letter or email, even if a verbal request for that advice will also be made.
6.7 Furthermore, work papers documenting uncertain tax positions should be segregated into separate file folders depending upon whether the materials are protected by legal professional privilege or litigation privilege. For example, separate files should be created for the following documentation:
a) The inventory of each tax position that may be subject to a tax dispute.
b) The probability percentage figures and the dollar amounts of the tax reserves for each tax issue.
c) The legal analysis of each disputed tax issue listed, including strategies for each dispute, the strength and weakness of the taxpayer's position and the legal advice from the taxpayer's advisers.
6.8 Companies should then ensure that such information is stored separately and securely and a record is kept of those accessing the information. All persons to whom the documents are disclosed should agree to maintain the confidentiality of the documents and not to include the documents in any other document.
6.9 By segregating tax accrual work papers and documentation into separate files, a company can at least control and track information protected by litigation privilege, tax advice privilege or legal professional privilege and avoid inadvertently handing over such documentation to the IRD, or a third party from whom the IRD could then request the information.
6.10 It remains to be seen whether company directors will take a more conservative approach to tax risk management and income tax planning as a result of increased reporting requirements.
6.11 One approach may be to apply for a binding ruling as to an uncertain tax position . The decision as to whether it is desirable or worthwhile to apply for a binding ruling will vary according to each taxpayer's circumstances. From a practical point of view taxpayers will also have to weigh up other factors, such as the likelihood that the ruling will be favourable and the potential implications of an unfavourable ruling being obtained, and the timeframe within which the ruling would need to be obtained in order to be useful. At present the rulings regime is notoriously slow and it is often difficult to obtain a ruling with anything like a timely response. Added to that there is reluctance on the part of the IRD to rule on potentially contentious matters. Its willingness and ability to do so is sometimes confounded by the need to ensure that the Solicitor General, the Crown’s chief law officer, agrees with the ruling.
7.1 While FIN 48 does not apply in New Zealand, it is highly likely that similar requirements soon will. If so, New Zealand taxpayers will be faced with similar disclosure requirements to those of companies required to comply with U.S. GAAP. Limited protections from disclosure are available in New Zealand under both statute and common law. However, unless careful steps are taken to have them apply, the protections are unlikely to prevent most tax accrual information from being disclosed to the IRD on request. That is especially so for documents held and created by auditors and accountants. In relation to these, much still depends on the way litigation privilege is construed and applied in New Zealand.
7.2 Case law suggests it will be interpreted narrowly, meaning tax accrual work papers produced to comply with an accounting standard are unlikely to be protected simply because they deal with a potentially contentious tax issue. That is concerning considering the type of information that could be required under IAS 12, as proposed, and the breadth of the IRD’s power to access that information. Something more will be required to bring tax analysis of doubtful tax positions within the scope of privilege and TAND rights. That is likely to pose a significant challenge to lawyers and accountants who will have to arrange their respective professional roles and relationships in the best interests of their mutual clients.
(c) G D Clews 2009
The assistance of S L Buckley in preparing this paper is acknowledged