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December/January 2011www.internationaltaxreview.com

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T H E L I N E S A R EB L U R R I N G

A scertaining a taxpayer’s motive forentering into tax mitigation transac-tions can be a key area of challenge,

and tax authorities are keen to see theadvice a taxpayer received before enteringinto the structure. However, in both theUK and the US, taxpayers may refuse todisclose to HM Revenue and Customs orto the IRS confidential tax advice providedto them by certain types of tax advisers.

The UK positionIn the UK, confidential tax advice given bya law firm is subject to a form of privilegecalled legal advice privilege (LAP). WhereLAP applies, the advice is protectedabsolutely from disclosure.

The Prudential, a UK financial servicesbusiness, assisted by one of the big fouraccountancy firms, have sought to persuadethe courts that LAP should also apply to taxadvice given by accountants and other non-legally qualified tax advisers. So far, theyhave failed before three courts (the special-ist tax tribunal, the High Court and, onOctober 13, the Court of Appeal).

A three-zero loss so far may not be asbad as it first seems for the accountancyprofession. Each court has been bound tofollow the Court of Appeal’s decision in1985 in Wilden Pump. Whilst the account-ants made arguments to try to distinguishWilden Pump, their best chance of successhas always been to overturn it. They canonly do that at the Supreme Court, theUK’s ultimate domestic appeal court.Consequently, the various stages of appealto date could be viewed as being meremechanics before the end game at theSupreme Court.

However, there is no guarantee that theSupreme Court will hear an appeal. TheCourt of Appeal decided emphatically that,even if it were not bound by Wilden Pump,it would have come to the same conclusion(and in this respect departed from the deci-sions of the lower courts). It noted that,once engaged, LAP applies without anybalancing exercise as to the rights andwrongs of disclosure in the particular cir-cumstances – in consequence, the scope ofLAP needs to be certain to protect the rulefrom abuse.

Lawyers have a single regulator and thescope of LAP as it stands is therefore cer-tain. Accountants, on the other hand, canchoose to be regulated by a number of dif-ferent professional bodies, if they chooseto be regulated at all. Moreover, other pro-fessionals also advise on the law and ajudicial extension for accountants wouldleave the scope of LAP entirely uncertain.Prescribing how the rule should beextended, if desirable at all, must be left toparliament.

This emphatic conclusion may beenough to dissuade the Supreme Court

from taking the case on, in which case theaccountants will be left to lobby for achange in the law.

For now, LAP applies only to advicegiven by lawyers. These are the keys fea-tures of LAP in the context of tax planning:• LAP applies to all confidential commu-

nications between lawyer and clientwithin the continuum of a legitimateinstruction to the lawyer to providelegal advice.

• For corporates, the term client is nar-rowly construed. Privileged communi-cations are just those between thelawyer and the officers or employees ofthe company who are tasked with seek-ing the advice. Internal communicationswith the wider business to gather thefacts on which the advice will be soughtare not covered.

• Internal communications discussing theadvice received will be privileged pro-vided the communications are on aconfidential and need to know basis.

• LAP belongs to the client and thelawyer must not waive it withoutinstructions. Waiver can be implied orexpressed. Waiver can also be on a lim-ited basis such as to a third party for aparticular purpose. Waiver cannot beselective and all documents relevant tothe issues in question must be disclosed.

• LAP is also lost if the confidentiality ofthe advice is lost, irrespective of theintention of the client. Care mustalways therefore be taken when sharingthe advice with external parties – itmust be on a strictly confidential andneed to know basis and under a clearstatement that LAP is not being waived.

• LAP applies where advice is given inthe name of a law firm, even if non-lawyers (such as accountants)employed by the firm have assisted inpreparing the advice. Conversely, noLAP applies if a lawyer working for anaccountancy firm (the lawyer in ques-tion would be non-practising in thesecircumstances) is involved in the givingof advice by that firm.

• At its broadest, legal advice is “adviceon what the client should sensibly andprudently do in the relevant legal con-text”. This extends to communicationsbetween lawyer and client where theclient is seeking advice on what filingposition a taxpayer can or should take,but probably not the mere transmis-sion of information to a lawyer in the(generally unlikely) event that thelawyer is completing the client’s taxreturn.

The US positionIn the US, the analogue to the LAP is theAttorney-Client Privilege (ACP). Theclassic formulation of the ACP is thatwhere legal advice of any kind is soughtfrom a professional legal adviser in hiscapacity as such (including in-housecounsel, assuming the communication isfor the purpose of obtaining legal advice),the communications relating to that pur-pose, made in confidence by the clientare at the client’s insistence permanentlyprotected from disclosure by the client orlegal adviser unless the protection is

www.internationaltaxreview.com | Client privilege

| 39December/January 2011

Jason Collins of McGrigors and Don Korb of Sullivan & Cromwell explain why tax authorities need to respectclient privilege and show how the US and UK handle confidential tax matters.

Why tax authorities need torespect client privilege

At its broadest, legaladvice is advice on

what the client shouldsensibly and prudentlydo in the relevant legal

context

waived. (See Upjohn Co v United States,449 US 383 (1981)).

The purpose of the ACP is to encour-age full and frank communicationbetween clients and attorneys. The privi-lege belongs to the client; therefore, theprivilege may be waived only by the client.The attorney cannot waive the privilegewithout the client’s consent.

The ACP applies only to confidentialcommunications. The privilege does notapply if:• the attorney is not rendering legal

advice. Business advice by an attorneyis not privileged;

• the purpose of the advice is to commita crime or fraud; or

• if the information is transmitted for thepurpose of preparing a tax return.In the US courts, there are two

approaches on this last point. One view isthat the preparation of a tax return is not alegal service. The other view is that thepreparation of a tax return is a legal serv-ice, but the information transmitted forpurposes of preparing a tax return (asopposed to information transmitted toobtain legal advice) is not privilegedbecause the information is intended to bedisclosed to the IRS since it appears on atax return filed with the IRS.

Accountants and other professionals whoare not attorneys who advise taxpayers canalso have their communications protectedby the ACP so long as they enter into aKovel arrangement with an attorney. InUnited States v Kovel, 296 F 2d 918 (2nd Cir1961), a law firm that engaged an account-ant on its own staff represented a taxpayerduring a grand jury investigation. To assistthe law firm in advising the taxpayer, thetaxpayer communicated information to thein-house accountant who, in turn, helpedexplain the client’s tax reporting to an attor-ney in the firm. In Kovel, the court held thatsince the law firm’s use of an accountant toassist it in understanding the conduct of theclient’s financial affairs fostered attorney-client communications, the ACP applied tothe accountant’s communications.

Since 1998, the US Internal RevenueCode has also provided a privilege forcommunications between a “federallyauthorised tax practitioner”and a taxpayer.However, such communications are pro-tected only to the extent the communica-tion would be considered a privilegedcommunication if it were between a tax-payer and an attorney.

A federally authorised tax practitioner isany individual who is authorised underFederal law to practice before the IRS. Thosepersons include attorneys, certified publicaccountants, enrolled agents, and enrolledactuaries. As with the ACP, this privilege has

not been extended to protect communica-tions between a tax practitioner and a clientsimply for the preparation of a tax return.

Since voluntary disclosure to a thirdparty is inconsistent with maintaining con-fidentiality, such a disclosure waives theACP. For example, in the recent Textroncase, (United States v Textron, Inc, 507 F Supp2d 138 (DRI 2007), rev’d 577 F 3d 21 (1st Cir2009) (en banc), cert denied, 2010 WL 2025198 (2010)), the privilege was waived by theclient when it provided information (in thatcase, its tax accrual workpapers) to its out-side auditors for the purpose of substantiat-ing its tax accrual reserve.

A voluntary disclosure waives the ACPnot only as to the specific communicationdisclosed, but also as to all other commu-nications relating to the same subject mat-ter (subject matter waiver). Some courtshave held that an inadvertent disclosurewaives the privilege. However, other courtshave been more lenient where an inadver-tent disclosure was not intentional andheld that it had not waived the privilege.

A client can also waive the ACP byimplication. This could happen where theclient testifies about portions of the attor-ney-client communication (implied waiv-

er), when the client places the attorney-client relationship directly at issue, orwhen the client asserts reliance on anattorney’s advice as an element of itsdefense such as to avoid penalties.

Extension of privilegeIt can be seen that privilege operates inbroadly the same way in the UK and US.The biggest difference is that, in the US,the lawmakers have extended the scope ofthe privilege to certain authorised non-lawyers. In the UK, Prudential is seeking topersuade the courts to extend the privilegebut without new legislation. A betting manwould probably say they will fail. It is alsodoubtful that parliament will have theappetite to change the law. The evidenceput forward by Prudential was that 90% ofUK tax advice is given by accountants, sothe absence of LAP does not appear to beharming the accountancy industry. WouldHMRC really want to put all that confi-dential tax advice out of their reach?Jason Collins (jason.collins@mcgrigors.com) is thehead of McGrigors’ tax disputes and investigationsteam and Donald Korb (korbd@sullcrom.com) is thehead of Sullivan & Cromwell’s tax controversypractice

Client privilege | www.internationaltaxreview.com

40 | December/January 2011

In the UK and US taxpayers can refuse to give information to the authorities