The IRS Win In Textron "Troubles" Schering-Plough's Lawyers -- But Why, Exactly?

An article in the overnight online Wall Street Journal, generally laying out the concerns of various large companies in the wake of the Textron tax case outcome (on an appeal, en banc) -- gave me a moment to reflect. Reflect on "what else" might be at stake -- in the minds of some of these other companies' executives. Consider this, from the WSJ:

. . . .Thomas Sabatino, general counsel of Schering-Plough, worries the court's decision could make in-house lawyers wary of providing complete assessments of any potential future litigation, information that is used to calculate how much money companies set aside for legal issues. "The fear factor for corporate counsel is that. . . the ruling would say any analysis done by lawyers to ensure the accuracy of financial statements can be exposed," he says. "That makes it much more difficult for lawyers to continue to protect their client."

Some tax experts say the concern is misplaced. Corporate lawyers are "trying to expand the work-product doctrine far beyond its original intent," says Dennis Ventry, a law professor at the University of California, Davis, whose analysis of the Textron case was cited by the court in its opinion. "The IRS operates with significant information deficiencies," he says, "and some companies bury things into a large tax return and try to obscure what they're doing. . . ."

Judge Michael Boudin, writing for the majority on the court, said: "Textron apparently thinks it is 'unfair' for the government to have access to its spreadsheets, but tax collection is not a game. Underpaying taxes threatens the essential public interest in revenue collection. . . ."

Okay -- we are all for candid self-assessments, Mr. Sabatino. Really. We all are.

I simply must ask: Isn't it at least possible that Schering-Plough's lawyers are less concerned about frank, and candid, self-assessments, generally -- and more concerned about some (or all) of this?

From the Schering-Plough 2008 SEC Form 10-K:

. . . .Schering-Plough maintains its intent to indefinitely reinvest earnings of its international subsidiaries. Schering-Plough has not provided deferred taxes on approximately $7.5 billion of undistributed foreign earnings as of December 31, 2008. Determining the tax liability that would arise if these earnings were remitted is not practicable. That liability would depend on a number of factors, including the amount of the earnings distributed and whether the U.S. operations were generating taxable profits or losses. . . .

Net income/(loss) in 2008 and 2007 include the amortization of fair values of certain assets acquired as part of the OBS acquisition. Net loss in 2007 includes a charge for acquired in-process research and development of $3.8 billion in connection with the acquisition of OBS. . . .

Schering-Plough’s unrecognized tax benefits result primarily from the varying application of statutes, regulations and interpretations and include exposures on intercompany terms of cross border arrangements and utilization of cash held by foreign subsidiaries (investment in U.S. property) as well as Schering-Plough’s tax matters litigation. . . . At December 31, 2008 and 2007, the total amount of unrecognized tax benefits was $994 million and $859 million, respectively, which includes tax liabilities as well as reductions to deferred tax assets carrying a full valuation allowance. At December 31, 2008 and 2007, approximately $596 million and $535 million, respectively, of total unrecognized tax benefits, if recognized, would affect the effective tax rate. Management believes it is reasonably possible that total unrecognized tax benefits could decrease over the next twelve-month period up to approximately $625 million. This would be primarily attributable to a decision in the tax matter currently being litigated in Newark District Court for which a decision has not yet been rendered, possible final resolution of Schering-Plough’s 1997 through 2002 examination by the IRS and appeals and possible resolutions of various other matters. . . .

Schering-Plough had been considering the filing of refund claims based on court decisions involving the claim of right doctrine. Two courts of appeal decisions, clarifying the law in this area made it clear that Schering-Plough would not prevail on these claims. The amount of unrecognized tax benefits has been reduced accordingly and had no impact on the net loss in 2007. . . .

Net consolidated income tax payments, exclusive of payments related to the tax examinations and litigation discussed below, during 2008, 2007 and 2006 were $444 million, $389 million and $234 million, respectively.

During the second quarter of 2007, the IRS completed its examination of Schering-Plough’s 1997-2002 federal income tax returns. Schering-Plough is seeking resolution of an issue raised during this examination through the IRS administrative appeals process. In July 2007, Schering-Plough made a payment of $98 million to the IRS pertaining to the 1997-2002 examination. Schering-Plough remains open with the IRS for the 1997 through 2008 tax years. During 2008, the IRS commenced its examination of the 2003 — 2006 federal income tax returns. This examination is expected to be completed in 2010. For most of its other significant tax jurisdictions (both U.S. state and foreign), Schering-Plough’s income tax returns are open for examination for the period 2000 through 2008.

In October 2001, IRS auditors asserted that two interest rate swaps that Schering-Plough entered into with an unrelated party should be recharacterized as loans from affiliated companies, resulting in additional tax liability for the 1991 and 1992 tax years. In September 2004, Schering-Plough made payments to the IRS in the amount of $194 million for income tax and $279 million for interest. Schering-Plough filed refund claims for the tax and interest with the IRS in December 2004. Following the IRS’s denial of Schering-Plough’s claims for a refund, Schering-Plough filed suit in May 2005 in the U.S. District Court for the District of New Jersey for refund of the full amount of the tax and interest. This refund litigation has been tried in Newark District court and a decision has not yet been rendered. . . .

Gee -- those ($7.5 billion; $3.8 billion) are some rather large numbers. Huge, even by the outsized New Merck-ian standards. I think it likely that candid self-assessments (especially SEC financial-statement related ones) are safe, so long as they reflect a strong desire to comply with -- as opposed to evade -- the law. I think documents which would suggest the taxpayer had no colorable argument, but was trying to conceal that fact, should likely not be "work product" -- as there is no "unfetterd right" of counsel, to aid in the commission of any fraud. That is, to knowingly make plans specifically designed to intentionally -- and unlawfully -- evade paying taxes -- i.e., to violate the federal criminal statutes.

[We'll likely get back to looking at highly-concentrated European Animal Health market segments, tomorrow -- like multivalent clostridia/pasteurella vaccines in Italy and the U.K.; like multivalent cat vaccines in the U.K.; and like monovalent multispecies rabies vaccines in the U.K., Greece and Finland. Yeh -- like those.]