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United States v. Microsoft Ruling Limits Privilege with Accountants

By: Samantha Levokove, Linda Galler and William L. Bricker Jr.

A federal district court judge [1] has ordered Microsoft to comply with IRS summonses issued in connection with a transfer pricing audit. Judge Ricardo S. Martinez ruled that communications received by Microsoft from KPMG pertaining to transactions related to cost-sharing agreements were not protected by the Section 7525 tax practitioner privilege.[2]

KPMG had presented Microsoft with several options for restructuring its Puerto Rico operations; central to these options was the use of a cost sharing arrangement. Microsoft was interested and retained KPMG to provide tax consulting services. When the IRS sought detailed information and documents regarding the tax advice and planning provided by KPMG, Microsoft declined to provide it, citing the Section 7525 tax practitioner privilege and setting off protracted court proceedings to enforce the IRS summonses. Section 7525 provides a limited privilege to communications between a taxpayer and an accountant (such as KPMG) to the extent they would be privileged if made between a taxpayer and an attorney and for the purpose of obtaining tax advice. The court ruled in favor of the IRS, holding that the KPMG documents were related to promotion of a tax shelter and therefore were not privileged.

The opinion adopts an expansive construction of the statutory exception to Section 7525 protection for communications in connection with the “promotion” of a “tax shelter.” Because the cost sharing arrangements had a “significant purpose” of avoiding or evading federal income tax, the court ruled that they were tax shelters. And because the plans for the transactions originated with KPMG, not Microsoft, the court concluded that KPMG had promoted them. The court was particularly vexed that tax savings, not business or customer-related concerns, appear to have driven Microsoft’s decision-making process.

In a narrower sense, the opinion can be read as calling into question the availability of any privilege for communications with accounting firms in the context of transfer pricing planning. Moving forward, taxpayers should assume that the IRS will be entitled to view all communications between a taxpayer and its accounting firm(s) (including but not limited to emails, memos, and texts) in any transfer pricing audit.


[1] United States v. Microsoft Corp., No. C15-102RS (W.D. Wash. Jan. 17, 2020) (copy of opinion enclosed). The Court of Appeals reached a consistent result in Valero Energy Corp. v. United States, 569 F.3d 626 (7th Cir. 2009)

[2] The judge also concluded that communications from KPMG were not entitled to protection as work product prepared in anticipation of litigation.

“Section” references are to the Internal Revenue Code of 1986, as amended.

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