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Notice 96-10: draft revenue procedure on the use of imaging systems to satisfy the requirements of section 6001 of the Internal Revenue Code.

On April 11, 1996, Tax Executives Institute submitted the following comments to the Internal Revenue Service concerning Notice 96-10, which requested comments on a proposed revenue procedure relating to the use of digital imaging to satisfy the recordkeeping requirements of the Internal Revenue Code. The Institute's comments were prepared under the aegis of TEI's IRS Administrative Affairs Committee, whose chair is Robert L. Ashby of Northern Telecom Inc. In light of the importance of the subject, Mr. Ashby appointed Lonnie F. Nicol of the Aluminum Company of America to serve as chair of a working group to develop the Institute's response to Notice 96-10. In addition to Messrs. Ashby and Nicol, the following members of the Institute contributed to the development of TEI's comments: Clifford G. Fuerst, Jr., of Federated Department Stories, Inc., John A. Gurovich of US West, Inc., Sheldon A. Kimel of Brunswick Corp., Louis J. Manetti and Edmund J. Caulfield of Bell & Howell, Thomas J. Oldfield of Eastman Kodak Company, and Thomas B. Rogers of Apple Computer, Inc.

On January 24, 1996, the Internal Revenue Service issued Notice 96-10 requesting comments on a burden reduction initiative to permit the use of imaging systems for the retention of books and records. Notice 96-10 -- which was reprinted in the February 12 issue of the Internal Revenue Bulletin (1996-7 I.R.B. 47) -- sets forth a revenue procedure on digital imaging that addresses one means of complying with the requirements of section 6001 of the Internal Revenue Code, relating to the books and records required to support the items shown on tax returns.

Tax Executives Institute (TEI) commends the IRS in moving forward with this important step to ease taxpayers' recordkeeping burdens by permitting them to take advantage of technological improvements in the records storage and management area. To that end, we encourage the IRS to prepare and release a revised version of Revenue Procedure 91-59, which sets forth the basic requirements that the IRS considers to be essential in cases where a taxpayer's records are maintained within an Automatic Data Processing (ADP) system. (TEI has previously submitted detailed recommendations with respect to Revenue Procedure 91-59, and we shall be pleased to provide additional copies of those recommendations upon request.) We also recommend that the revision anticipate to the extent possible the next generation of records technology, including the integration of database information with information stored on imaging systems (which is sometimes referred to as COLD -- computer output to laser disk -- technology).

TEI is pleased to submit the following comments on the proposed guidance and we look forward to working with the IRS in maximizing the benefits of technological improvements and minimizing administrative burdens on taxpayers.


TEI is the principal association of business tax executives in North America. The Institute's approximately 5,000 members represent more than 2,700 of the largest companies in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and the government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

TEI members are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed revenue procedure dealing with the retention of records using imaging systems.

General Comments

The stated goal of the proposed revenue procedure is to provide guidance to taxpayers on the use of imaging systems to maintain books and records. The draft procedure provides instruction on the operational capabilities of imaging systems and not the technical specifications for hardware and software.

Generally, TEI believes that the IRS's imaging system requirements should be no more onerous than the recordkeeping requirements for paper records. Indeed, digital imaging is merely an alternative system for storing records, and in our view taxpayers should not be subjected to significantly more burdensome requirements than those required for hard-copy records. We also believe that the particulars of a taxpayer's record storage system should be left to the taxpayer's discretion. Consequently, we applaud the inclusion of section 4.03 ("Recommended Practices"), which provides, as follows:

The implementation of record management practices is a business decision that is solely within the discretion of the taxpayer. Record management practices may include the labeling of documents, providing a secure storage environment, creating back-up copies, selecting an off-site storage location, retaining hard copies of illegible documents or documents that cannot be accurately or completely imaged or reproduced under the imaging system, and testing to confirm records integrity.

Throughout the draft procedure reference is made to "reasonable controls." We support this reasonable-control concept because it implies that taxpayers should exercise their judgment in setting standards for their systems and processes, rather than finding themselves hamstrung by one-size-fits-all pronouncements. We regret, however, that some of the draft's terms may be at once so expansive and ambiguous that the overall effect will be to detract from the procedure's promise. For example, section 4.01(3) provides that the taxpayers must retain written procedures that describe "in detail" the complete imaging system. We believe that the word "describe" is sufficient. Similarly, the draft procedure repeatedly refers to the need for written documentation, raising questions whether records produced on any system that is not supported by reams of written documentation will satisfy section 6001. In our mind's eye, taxpayers should be accorded great flexibility in how they maintain their records. Certainly, if a taxpayer is unable to document the underlying integrity and reliability of its imaging system, it is the taxpayer that must face the consequences. The procedure should not, however, impose artificial or arbitrary requirements.

The draft procedure seems to proceed from the expectation that records maintained on an imaging system will be instantaneously available to the IRS. Hence, section 4.01(4) states that the imaging system must be such that the taxpayer's books and records can be "automatically" identified and retrieved for viewing and printing. Taxpayers, however, wonder what is meant by the word "automatically," even on an illustrative basis. Moreover, section 4.02(1), relating to requirements of an indexing system, uses the term "rapid identification," but does not define it. Similarly, section 4.01(5) requires that images exhibit a "high degree" of legibility and readability, instead of simply stating that the records must be legible and readable (at least to the extent of the underlying paper records). And section 4.01(8) provides that the taxpayer must provide the IRS with the resources necessary for "promptly" locating, retrieving, reading, and reproducing on paper any imaged documents, but does not hint at what distinguishes "prompt" from "not prompt" action.

Unless the terms are tempered (either directly or through the inclusion of examples), taxpayers may well find themselves confronted with unbending requirements and threatened with unexpected penalties, since "rapid," "prompt," "automatic" and similar terms virtually invite differences of opinion between taxpayers and IRS examining agents. More fundamentally, we believe the IRS should confirm that the purpose of the imaging revenue procedure is to operate as much as a shield for taxpayers as it is to serve as a sword for the IRS. This is also why the procedure should accord with current business practices to the maximum extent possible, while being flexible enough to permit taxpayers to adapt those practices to avail themselves of further innovations as well as to the peculiarities of their own circumstances.

Stated differently, taxpayers should be given assurance that the procedure is not intended to trip them up but to liberate them to take advantage of new technology. Hence, if the taxpayer is able to produce (or reproduce) its books and records during an examination (and can satisfy the IRS concerning the underlying integrity of the records), then the taxpayer's failure to abide by every jot and tittle of the procedure should be immaterial. Since it is the results that are important, what goes on "behind the curtain" should be irrelevant as long as the taxpayer can produce the records. On the other hand, if the taxpayer is unable to produce requested records because of a system failure, whether the taxpayer conducted itself in accord with the procedure's requirements should be taken into account in determining what, if any, sanctions should be imposed on the taxpayer. Compliance with the revenue procedure should effectively immunize taxpayers from an inadequate records penalty, but the inverse should not necessarily be true.

Finally, we note that many of the potential problems addressed in these comments -- for example, those related to the need to remain flexible in order to take advantage of new technology as well as those related to the conversion of imaged documents when the taxpayer changes imaging systems -- will be ameliorated by the IRS's becoming more current in its audits. If an examination is being conducted within two or three years of a document's creation, it is less likely that problems will be encountered in retrieving either the original document or an imaged copy. Consequently, we strongly urge the IRS to press ahead on its various currency initiatives, since a byproduct of those efforts will be a lessening of any tension related to record retention or retrieval procedures.

Imaging System Requirements

* General Definition of an Imaging System. Section 4.01(1) of the draft procedure states that "[a]n imaging system for maintaining books and records for purposes of [sections] 6001 must create accurate and complete electronic images of hardcopy documents, and must index, store, preserve, retrieve, and reproduce imaged documents." The reference in the procedure to "hardcopy documents" places electronic documents completely outside the scope of the digital imaging rules. We recommend that the procedure be revised to read, as follows:

An imaging system for maintaining books and records for purposes of [sections] 6001 must create accurate and complete electronic images of hardcopy and electronically created documents, and must index, store, preserve, retrieve, and reproduce imaged documents.

* Reasonable Controls -- Level of Detail Required. Section 4.01(2)(a) of the draft procedure states that an imaging system must include "reasonable controls to ensure the integrity, accuracy, and reliability of the imaging system, including a record of where, when, by whom, and on what equipment the image was produced, including the hardware and software that was used." (Emphasis added.) TEI believes that the draft language is excessive, and that the IRS's interest can be protected by omitting the italicized language. We believe that a taxpayer's existing accounting procedures, including internal controls, should suffice as "reasonable controls" for ensuring integrity, accuracy, and reliability. A separate log or record of imaging is not necessary so long as the taxpayer has documented its internal controls and procedures in its imaging process.

* Reasonable Controls -- Example Involving Non-Erasable, Non-Rewritable Media. Section 4.01(2)(b) of the draft procedure provides that an imaging system must include "reasonable controls" to prevent the unauthorized creation of, addition to, alteration of, deletion of, or deterioration of any imaged document, and continues that an example of such a control could be "the use of non-erasable and non-rewritable media."

Although TEI appreciates the inclusion of the quoted language as an example that clarifies the scope of the term "reasonable controls," we are concerned about the implication that such a control should in fact routinely or always be imposed. Thus, although we believe that many companies either have or likely will adopt such a control, we are concerned because such a practice would drive up the cost, and hence drive down the efficiency, of imaging systems (especially as technology changes and other safeguards and controls are developed). Consequently, we urge the IRS to reiterate that no particular control will be considered necessary in all cases.

* Requirement of Regular Evaluations and Periodic Checks. Section 4.01(2)(c) of the draft procedure states that an imaging system must include an inspection and quality assurance program "evidenced by regular evaluations of the imaging system including periodic checks of imaged documents." We believe that the regular evaluation requirement should be clarified by the inclusion of an example that addresses the taxpayer's flexibility in defining how "periodic" its inspection of records must be, as well as the criteria that the taxpayer might consider using in performing the system evaluations.

* Requirement of Written Procedures. Section 4.01(3) of the draft procedure provides that, for each imaging system used, the taxpayer must establish and maintain written procedures that describe in detail the complete imaging system. TEI appreciates the IRS's desire to require detailed written documentation, and we are confident that written procedures will ordinarily be developed and maintained (especially by the large companies represented by the Institute's membership). At the same time, we wonder whether such a requirement is practical or necessary in all cases. To be sure, if the imaging system being referred to is a large, centrally controlled application, it will be supported by written procedures that are routinely updated and maintained. In many cases, however, the imaging system will be a small, specialized, departmental application, and the system while operationally unassailable may not be backed by faithfully updated written procedures. (To be candid, it may not always be possible for a taxpayer to identify or continually monitor all the imaging systems that are maintained in its corporate group.)

Accordingly, TEI recommends that the requirement for formal written procedures be limited to imaging systems containing a substantial volume of documents that are material to the determination of tax liability. Moreover, as previously noted, we believe that the term "in detail" should be eliminated from the procedure, and that consideration also be given to deleting the term "written" in order to afford taxpayers greater flexibility in maintaining their imaging systems.

* Requirement of Cross-Referencing. Section 4.01(4) of the draft procedure states that "the imaging system and the taxpayer's books and records must be cross referenced, so that all imaged documents that support an entry in the taxpayer's books and records can be automatically identified and retrieved for viewing and printing."

TEI recommends that the procedure clarify, at least by example, what is meant by the term "automatically identified and retrieved." If the term means that the imaging system must provide a seamless, direct path from the general ledger to the source documents, then this requirement is wholly unrealistic, in that it exceeds the capabilities of most accounting systems. For example, with large accounting systems, there are summary entries that "roll-up" from the source documents to the ultimate summary entries in the general ledger. In this case, the "audit path" from the general ledger to the source documents will not be "automatic" in that the imaging system will not "display" or reference all source documents for the activity in any given general ledger account. Indeed, there could be thousands of documents supporting the activity in just one general ledger account.

We recommend that the second sentence of this paragraph be revised to state that the imaging system and the taxpayer's books and records be referenced in a manner that provides an audit trail from the general ledger to the source documents and vice versa. Hence, while the taxpayer should have the ability to move from point A (e.g., an invoice recorded in the accounts payable system) to point B (e.g., a general ledger entry), that movement should not have to be automatic or instantaneous in order to satisfy the cross-referencing requirement of the revenue procedure.

* Requirement of High Degree of Legibility and Readability. Section 4.01(5) states that all images reproduced by the imaging system must exhibit "a high degree of legibility and readability." Obviously, the images reproduced by the imaging system can be no more legible or readable that the hardcopy documents that are scanned into the system. We recommend that this section be revised to acknowledge this and to delete the reference to "high degree" of legibility and readability; the definitions of the terms themselves should suffice.

* Ability to Retrieve and Reproduce Imaged Documents. Section 4.01(7) of the draft procedure states that the taxpayer must be able to retrieve and reproduce imaged documents at the time of an IRS examination and clarifies that reproduction includes the ability to print a legible and readable hardcopy of any imaged document. As previously stated, the legibility and readability of an imaged document is, in the first instance, a function of the legibility and readability of the underlying hardcopy document. Revising section 4.01(5) to reflect this should obviate any revision of section 4.01(7). We do recommend, however, that section 4.01(7) be modified to state that an imaging system will satisfy the retrieval-and-reproduction requirement as long as the imaged documents are provided within a reasonable period of time. (Just as paper records sometimes take days or weeks to locate and retrieve, imaged documents may well not be instantaneously available, since a taxpayer may have several imaging systems at various locations.)

* Requirement of Providing IRS with Resources. Section 4.01(8) of the draft procedure provides that the taxpayer must provide the IRS, at the time of the examination, with the resources necessary for "promptly" locating, retrieving, reading, and reproducing on paper any imaged document. The draft procedure provides that the term "resources" includes, for example, appropriate hardware and software, personnel, and documentation.

TEI submits that the provision on resources, which is modeled on a similar provision in Revenue Procedure 91-59, is extraordinarily and excessively broad. Section 7602 imposes a relevancy standard on the IRS's efforts to secure the taxpayer's books and records, and although the statutory standard is broad (and, concededly, pliable), it is not completely open-ended. In contrast, the draft procedure suggests that the IRS has the right to examine all imaged documents and, what is more, that the taxpayer must facilitate the IRS's efforts by, in effect, turning over the keys to the filing cabinet (or imaging system). Unrestricted access to the taxpayer's documents -- and at the taxpayer's expense -- is neither required by statute nor justifiable. Taxpayers clearly have the right to confine the IRS's access to relevant documents and to impose reasonable restrictions on the IRS's access to the imaging system, for example, when the taxpayer is using the system, when maintenance is being performed, or when the system is being updated.

This is a highly sensitive area to taxpayers. Although many, if not most, taxpayers are willing to facilitate the IRS's examination of their tax returns through the provision of computer resources, they do not share the IRS's expansive view of its authority under United States v. Davey, 543 F.2d 996 (2d Cir. 1976). Indeed, they -- and TEI -- read the court's decision in Davey as circumscribing the IRS's authority to transfer the cost and burden of providing computer resources to the taxpayer. The key, we submit, is balance -- in defining what must be made available to the IRS, when, and under what circumstances.

The language of section 4.01(8) should be tempered. Just as it is not practical (or justifiable) to require the taxpayer to turn over all paper records to the IRS during the course of an examination, it is not feasible to afford the agency access to all imaged document databases (i.e., there may be multiple databases for multinational companies). Therefore, we recommend that this provision be revised to state that the taxpayer is required to supply only those imaged documents requested during the course of an examination, and only those that have been identified as pertinent to the examination. Alternatively, the taxpayer should be permitted to supply hardcopy records in response to document requests made during the course of an examination. We also recommend that the word "promptly" be deleted from section 4.01(8), or be replaced by the phrase "within a reasonable period of time."

Beyond the question of the availability of imaged records, this section of the draft procedure broaches a new IRS methodology -- the legitimacy of which we question, first, as a general matter and, perhaps more relevant here, as it is woven into a revenue procedure concerning record maintenance procedures. We readily acknowledge that imaging technology (and the attendant indexing systems) will provide the IRS with a useful tool beyond what is available with paper records. We have significant doubts, however, about a provision that grants agents a license to engage in a fishing expedition in the taxpayer's ocean of records. Giving the IRS unfettered access to all documents outside the current information document request (IDR) system could well discourage taxpayers from taking full advantage of imaging technology. In the end, the IRS's ability to audit the taxpayer will correlatively suffer.

Through the IDR process, the IRS currently makes requests for specific documents (or for documents relating to specific subjects or transactions), and the taxpayer makes those records available. The same process should be followed whether the records at issue are the original hardcopy documents, stored on microfilm, microfiche, in an electronic format on the taxpayer's data-processing system, or stored on an imaging system. We reiterate, therefore, that taxpayers should not be required to turn over their entire imaging system to the IRS or, without limitation, to turn over hardware, software, personnel, etc., to the IRS. We urge the IRS to revise the procedure to reflect a more balanced view of the resources issue.

* Multiple Imaging Systems. Section 4.01(9) states that imaged documents that are contained in a system with respect to which the taxpayer ceases to maintain the hardware and software necessary to satisfy the conditions of the procedure "will be deemed destroyed by the taxpayer unless the existing imaged documents are converted to a format compatible with an imaging system that the taxpayer continues to maintain."

TEI recommends that this provision be modified to permit other alternatives to either (i) the maintenance of the old equipment or (ii) the conversion to a new imaging system. We believe that taxpayers should be allowed to use any alternative means as long as the taxpayer can produce the documents upon request. For example, one approach may be to convert the documents back to a hardcopy format. Another would be to contract with a service bureau or timesharing service to convert the old records on an as-needed basis, as long as the converted records are provided within a reasonable period of time after they are requested.

* Contractual Restrictions on IRS's Access to Records. Section 4.01(10) states that an imaging system must not be subject, in whole or in part, to any agreement (such as a contract or a license) that would limit or restrict the IRS's access to and use of the imaging system on the taxpayer's premises (or such other place where the imaging system is maintained), including personnel, hardware, software, files, indexes, and software documentation.

TEI recognizes the sensitivity of this area, and we appreciate that the matter is currently in litigation. Consequently, our initial reaction is to say that the enforceability of contracts with respect to the IRS's right to use these systems should be left to the courts and not even addressed in the procedure. (We note, moreover, that although the IRS's position was substantially vindicated in United States v. Norwest Corp, No. 4-94-MC-36 (D. Minn. Dec. 12, 1995), the court in that case did refuse to grant the IRS carte blanche in respect of the summonsed computer program.) Upon reflection, we believe that the issue is not whether restrictions exist in contracts or licenses, but whether those restrictions are enforceable. Clearly, a taxpayer cannot escape its obligations to maintain records by entering into an agreement with a third party to defeat the IRS's legitimate rights under section 7602. By the same token, the IRS cannot vitiate the legitimate and proprietary (and frequently copyrighted) rights of the third party by administrative fiat. At a minimum, the revenue procedure should limit the IRS's access to information that is necessary in determining the proper amount of tax.

* Requirements of an Indexing System. Section 4.02 of the procedure states that "an imaging system is a system that permits the rapid identification and retrieval for viewing or reproducing of relevant documents maintained in an imaging system." We question whether the use of the word "rapid" in the quoted sentence is necessary, and are concerned that, unless the word is deleted, taxpayers may be threatened with sanctions under the procedure on the ground that their indexing system is not "rapid" enough.

District Director Testing

Section 5 of the draft procedure provides that the District Director may periodically initiate tests of a taxpayer's imaging system, and that the tests will not constitute an "examination," "investigation," or "inspection" of the taxpayer's books and records within the meaning of section 7605(b), or a prior audit for purposes of section 530 of the Revenue Act of 1978, because the tests (or record evaluations) are not directly related to the determination of the tax liability of a taxpayer for a particular taxable period.

Although TEI appreciates the need for the IRS to confirm the integrity of the taxpayer's imaging system, we see no need for periodic testing of the imaging system outside the conduct of an examination. Periodic testing will be disruptive to businesses and an added cost to both the taxpayer and the government. We hence recommend that the District Director's right to initiate tests of a taxpayer's imaging system be circumscribed, especially in respect of taxpayers that are subject to continual audit as part of the IRS's Coordinated Examination Program. For example, any inspection should be coordinated through the Case Manager and Team Manager so it neither disrupts the conduct of the examination nor unduly burdens the taxpayer. Equally important, we believe the procedure should explicitly confirm that the District Director's review is to be limited to the taxpayer's imaging system and not extend to review of particular records for any purpose other than validating the recordkeeping system. Finally, we agree with the provision of the draft procedure that the District Director should inform the taxpayers of the results of any periodic tests. If any shortcomings are identified in the taxpayer's imaging system, the IRS should work with the taxpayer to resolve them in a satisfactory manner.


Section 8 of the draft procedure states that the District Director may issue a Notice of Inadequate Records if the taxpayer's books and records are available only as imaged documents and the taxpayer's imaging system fails to meet the requirements of the procedure. Section 6.02 of the procedure clarifies, however, that "even though a taxpayer's imaging system fails to meet the requirements of this revenue procedure, the penalties described in section 8 may not apply if the taxpayer maintains its original books and records, or maintains its books and records in micrographic form in conformity with Rev. Proc. 81-46, 1981-2 C.B. 621."

Although the IRS understandably wishes to retain the authority to impose penalties in appropriate cases, TEI submits that the agency should impose such penalties only as a last resort. Again, the key should be whether the IRS is able to secure access to the information necessary to verify the taxpayer's tax liability. Hence, we believe that section 6.02 of the procedure should be revised to clarify that penalties will not be imposed (not simply "may not" be imposed) where the taxpayer maintains its original books and records. (We wonder, however, why the taxpayer with a digital imaging system would ever retain the original documents.) Furthermore, section 8 should be modified to state that penalties will not be imposed where, even though the taxpayer may not have complied with all the requirements of the revenue procedure, the taxpayer is able to produce either the original document or a facsimile of the document.


Tax Executives Institute appreciates this opportunity to present its views on Notice 96-10 and the proposed revenue procedure on digital imaging. These comments were prepared under the aegis of the Institute's IRS Administrative Affairs Committee whose chair is Robert L. Ashby of Northern Telecom Inc. Any questions should be directed to Mr. Ashby at (615) 734-4621 or Timothy J. McCormally of TEI's professional staff at (202) 638-5601.
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Publication:Tax Executive
Date:May 1, 1996
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