"Significant Purpose" of Tax Avoidance Trumps Document Privlege


The U.S. District Court for the Northern District of Illinois required Valero Energy Corp. to produce documents sought by the IRS, saying they were not protected by the tax practitioner privilege of IRC § 7525 because they concerned a tax shelter. In so holding, the court adopted a more expansive view of what constitutes “promotion” of a tax shelter than the one that figured in the U.S. v. Textron ruling now pending appeal in the First Circuit.

At issue in Valero were written communications between the oil refiner and its then-tax adviser, Arthur Andersen, in connection with Valero’s merger with Ultramar Diamond Shamrock Corp., a Canadian company. A series of transactions between Valero and its Canadian subsidiaries resulted in large foreign currency losses (claimed under sections 987 and 988) for Valero that produced $46 million in U.S. tax savings. The government claims in ongoing litigation that the losses were due to two circular cash flows undertaken expressly to create the tax loss.

After the court ruled in August 2007 that the work product privilege applied to some sought documents but not others, Valero supplied additional documents, some of them redacted, but withheld others, claiming they were confidential communications protected by the practitioner privilege (section 7525(a)(3)). The government moved to produce all the documents without redaction.

The court noted that under section 7525(b), the privilege does not apply to written communication “in connection with the promotion of the direct or indirect participation” of a corporation in a tax shelter as defined in section 6662(d)(2)(C)(ii). Valero alleges that the transaction in question was not a tax shelter, that it reflected “economic reality and other business purposes.” The court, however, held that the government need not establish that the transaction lacked economic reality or was driven primarily by tax avoidance concerns. Instead, under section 6662(d)(2)(C), avoidance or evasion of federal income tax need be only a significant purpose of the plan or arrangement. Since there was evidence, as the government claimed, of the losses being artificial circular transactions (some of which had a bank account open for only one day), the court held that tax avoidance was a significant purpose of the transactions.

Valero further argued that the word “promotion” refers only to the peddling of prepackaged tax shelters, as alluded to in Textron (100 AFTR2d 2007-5848, “Tax Matters: Work Product Stands Up to IRS Summons,” JofA, Nov. 07, page 80). The Valero court instead interpreted the word “promotion” more broadly, stating that it also applies to a person who assists in organizing a tax shelter. By advising Valero on a “step plan” that included the proposed Canadian refinancing transactions— a significant purpose of which was tax avoidance—the communications between Arthur Andersen and Valero were in promotion of a tax shelter, the court said.

n Valero Energy Corp. v. U.S., 102 AFTR2d 2008-5916

By Brian Elzweig, J.D., LL.M., assistant professor of business law, Texas A&M University–Corpus Christi.


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