U.S. v. Coopers & Lybrand

• Decision Date: 15 February 1977
• Docket Number: No. 76-1066,76-1066
• Citation: 550 F.2d 615
• Parties: 77-1 USTC P 9216 UNITED STATES of America and John G. Shea, Special Agent, Internal Revenue Service, Petitioners-Appellants, v. COOPERS & LYBRAND et al., Respondents-Appellees, and Johns-Manville Corporation, Respondent in Intervention-Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 615

550 F.2d 615

77-1 USTC P 9216

UNITED STATES of America and John G. Shea, Special Agent Internal Revenue Service, Petitioners-Appellants, v. COOPERS & LYBRAND et al., Respondents-Appellees and Johns-Manville Corporation, Respondent in Intervention-Appellee.

No. 76-1066.

United States Court of Appeals Tenth Circuit.

Submitted Nov. 15, 1976.

Decided Feb. 15, 1977.

Carleton D. Powell, Atty., Tax Div., Dept. of Justice, Washington, D. C. (Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, and Crombie J. D. Garrett, Attys., Tax Div., Dept. of Justice, Washington, D. C., on the brief, James L. Treece, U. S. Atty., Denver, Colo., of counsel), for petitioners-appellants.

William E. Murane, Denver, Colo. (Ben E. Chidlaw and Paul T. Ruttam, Denver, Colo., on the brief), of Holland and Hart, for respondents-appellees.

James E. Bye, Denver, Colo. (Peter H. Holme, Jr., Charles J. Kall and C. Garold Sims, Denver, Colo., on the brief), of Holme, Roberts & Owen, Denver, Colo., for respondent in intervention-appellee.

Before BARRETT and DOYLE, Circuit Judges, and CHILSON, ^* District Judge.

BARRETT, Circuit Judge.

Petitioners-appellants, ¹ United States of America and John G. Shea (Shea), Special Agent, Internal Revenue Service (IRS), appeal the denial of enforcement of an IRS summons issued pursuant to 26 U.S.C.A. § 7602, ² in relation to IRS examination and audit of Johns-Manville, Inc. (J-M) corporate federal income tax returns for the years 1971 and 1972.

J-M, respondent in intervention-appellee, is a major national corporation having subsidiaries and affiliates throughout the United States and abroad. The IRS has audited every federal income tax return of J-M since 1913 and does so on a continuing basis.

Coopers and Lybrand (C&L) is a national firm of certified public accountants employed by J-M who examined and reported on the consolidated statements of J-M for the years 1971 and 1972. It functioned solely in an auditing capacity and did not participate in the actual preparation and filing of J-M's federal tax returns.

During the latter part of 1974 the IRS issued a summons pursuant to § 7602 directing C&L to testify and produce its books and records relative to its examination and audit of J-M. C&L responded and produced voluminous workpapers and documents but declined to disclose its audit program or the tax pool analysis file.

The audit program is a master plan prepared by C&L, specifically tailored for auditing J-M. Included within the audit program is a listing of procedures to be followed by C&L personnel in auditing J-M records with a "check off" method of confirming that such procedures were followed, together with suggestions for future modifications of the plan. The tax pool analysis file prepared by J-M personnel contains its estimates of J-M's contingent liabilities for future income tax periods. It is utilized by J-M in preparing financial statements in compliance with Securities and Exchange Commission's (SEC) requirements and it is also utilized by C&L in verifying that J-M's financial statements have been prepared in accordance with generally accepted accounting principles. It is uncontested that neither the audit program nor the tax pool analysis file were utilized in the preparation of the 1971 and 1972 tax returns.

After C&L refused to produce the audit program and tax pool analysis file, IRS filed its petition for judicial enforcement of the summonses pursuant to 26 U.S.C.A. §§ 7402(b) and 7604(a). A show cause order was issued and a full evidentiary hearing followed. During the hearing Shea testified that the tax pool analysis file might be relevant as a source of possible inconsistent positions or improper figures and that the audit program would bear on J-M's intent and "would assist us in determining whether or not to pursue a particular area." C&L resisted production of its audit program. C&L, joined by J-M, resisted production of the tax pool analysis file. They argued that the information sought was not relevant, that the information was already available to IRS from documents then in its possession, and that strong policy reasons relative to an auditor-client relationship weighed heavily against production.

In denying enforcement of the summonses, the court found that J-M's cooperation with the IRS in relation to the investigation was extensive and that tax fraud had not been charged. The court found and/or concluded, inter alia Initially, we conclude that the Service has failed to make the requisite showing that the Audit Program is relevant to the tax investigation pursuant to which it is sought. The evidence establishes to our satisfaction that Coopers and Lybrand has no responsibility for the preparation or review of J-M's income tax returns. J-M's returns are prepared internally by J-M's tax personnel. As a consequence, we conclude that the Audit Program was not prepared in conjunction with or connected in any manner to the preparation or filing of J-M's 1971 and 1972 income tax returns.

We find from the evidence presented that the Audit Program does not contain any factual data regarding any corporate transactions of J-M; rather it consists solely of a listing of procedures to be followed by C&L personnel throughout the United States in examining books and records of J-M, documentation of the extent to which such proceedings were followed, and suggestions for the future modification of such procedures.

The Audit program was prepared prior to C&L's 1971 and 1972 audits of J-M. During the course of the 1971 and 1972 audits, the only information recorded in the Audit Program was (1) confirmation by C&L personnel that the Audit Program procedures were complied with or (2) explanations of why the procedures were inapplicable in certain instances, and (3) modifications of the Audit Program.

We next approach the issue of production of the Tax Pool Analysis file and related papers. . . .

In the instant case, the IRS has not challenged respondents' argument that the tax pool does not contain records of transactions. The evidence is clear that the Tax Pool was not prepared in connection with the preparation and filing of J-M's tax returns. The IRS here does not seek records of corporate transactions or the data which are customarily maintained in support of company transactions, instead it seeks private thoughts and theories of the taxpayer.

Consolidated financial statements are prepared annually by Johns-Manville for inclusion in reports to stockholders and certain mandatory filings with the Securities and Exchange Commission. Coopers and Lybrand examines and reports on these consolidated financial statements (and utilizes the tax pool analysis file to that end).

. . . The uncontradicted evidence establishes to our satisfaction that the Tax Pool Analysis file and related papers were not issued or compiled in connection with the preparation or filing of J-M's income tax returns. Coopers & Lybrand has no responsibility in regard to determining or reporting on J-M's tax liability. The limited purpose for which the Tax Pool was created by J-M and communicated to C&L was unrelated and distinct from J-M's tax liability or the preparation of J-M's tax returns.

IRS does not contest or challenge the court's findings that C&L had no responsibility for the preparation or review of J-M's income tax returns; that the returns were prepared by J-M personnel; that the audit program does not contain any factual data regarding any corporate transactions of J-M; that the tax pool was not prepared in connection with the preparation and filing of J-M's tax returns; and that the tax pool analysis file was created by J-M for its usage in preparing annual consolidated financial statements and utilized by C&L in verifying that the financial statements were properly reported in accordance with generally accepted auditing procedures. These findings are therefore accepted as true and controlling for purposes of this appeal. Valdez v. Black, 446 F.2d 1071 (10th Cir. 1971), cert. denied, 405 U.S. 963, 92 S.Ct. 1167, 31 L.Ed.2d 238 (1972).

On appeal IRS contends the district court (1) "erred in refusing to order enforcement of IRS summonses for the production of an independent accounting firm's tax pool analysis file, containing memoranda of conversations with taxpayer's employees and the employees' memoranda, maintained by the firm for the purpose of auditing taxpayer's financial statements", and (2) erred in "refusing to order enforcement of Internal Revenue Service summonses for production of an independent accounting firm's audit program prepared and maintained by the firm for the purpose of auditing taxpayer's financial statements."

It is significant, we believe, that the IRS's delineation of the issues on appeal reemphasize that neither the tax pool analysis file nor the audit program were utilized by J-M in the preparation of federal income tax returns; that the tax pool analysis file was utilized solely for auditing J-M's financial statements; and that the audit program's usage was similarly limited. Noteworthy, too, is the fact that all of the work papers involved in the audit program for the years 1971 and 1972 have been turned over to the IRS. Also, J-M and C&L have repeatedly made their personnel available, prior to and during trial, to the IRS to respond to any questions that the Service may have. Even so, the IRS has elected not to question the employees of either company.

I.

Notwithstanding its concession that the tax pool analysis file was developed by J-M and utilized by J-M and C&L solely for the purpose of preparing annual consolidated financial statements for inclusion in reports to stockholders and for certain mandatory filings with the SEC, IRS contends that the file comes within a § 7602 summons because it might show tax fraud, because it might show substantial tax liability, and because it would be relevant to show and establish the state of mind of employees...