The recent decision by the Financial Accounting Standards Board not to defer the effective date of FASB Interpretation No. 48, despite appeals from companies and industry groups to postpone its implementation, spotlights the radical changes in approach required of financial-statement preparers, auditors and tax advisors.FIN 48, Accounting for Uncertainty in Income Taxes, is effective for fiscal years beginning after Dec. 15, 2006. It establishes a "more-likely-than-not" threshold for the reporting of uncertain tax positions on financial statements. Under the rule, an uncertain tax position may not be recognized unless it is more likely than not that it will be sustained on its technical merits, and there is a more than 50 percent likelihood that it would be sustained if it were challenged and considered by the highest court in the particular jurisdiction.

"FIN 48 applies to public and nonpublic entities as well," observed Mark Wells, executive editor of Thomson PPC. "The whole disclosure side is causing concern on everybody's part. Any taxpaying corporate client now has to consider FIN 48."

"FIN 48 applies to every company that has GAAP accounting," explained Tom Ochsenschlager, vice president of taxation for the American Institute of CPAs. "If a company borrows money, the bank will ask for GAAP financial statements."

"The world for corporate managers is about to change," said Stuart E. Seigel, former chief counsel to the Internal Revenue Service.

Seigel, president of New York-based Seigel & Associates LLC, believes that the intersection of corporate governance and tax practice has become an issue of concern. "It has been a longstanding practice for accounting firms to provide an array of tax services to their clients, including tax advice and strategy, as well as assistance in tax compliance," he said. "This is regarded as a good practice because it is generally accepted that the auditing firm that provides tax services helps in ensuring the quality of an audit. Moreover, using one firm tends to be more effective and efficient than using two firms."

"Before 2001, they just did it," he continued, "but in 2001 the Securities and Exchange Commission issued regs prohibiting audit firms from providing eight specific non-audit services to their public company clients. Other non-audit services could only be done if the auditing firm received approval from the audit committee of the company's board of directors."

But combining the roles of auditor and tax advisor has the potential to undermine the perception that the auditor is independent of the client, according to Seigel. "The issue of tax reserves is central to the question of independence," he said.

"Until FIN 48, tax reserves had not been disclosed in financial statements," he said. "For public companies, for the first time, these will have to be separately disclosed, and on an annual basis they will have to show additions and deletions from tax reserves."

"Companies are required by principles of accounting to maintain such reserves, and for good reason," he said. "From an accounting standpoint, a true reflection of the company's income for a given year should include not just its current taxes, but the potential amount that it may eventually have to pay, if that is greater. Unlike most other expenses, you don't know at the end of the year what your ultimate liability will be. The final resolution may not happen for several years."

Although Sarbanes-Oxley permits companies to use the same firm for both audit and tax work, Seigel believes that FIN 48, requiring much deeper disclosure on tax reserves, will pressure audit committees to play it safe by employing two accounting firms instead of one.


In terms of auditor independence, there's a problem whether or not the same firm provides both audit and tax services, according to Seigel.

"Auditing procedures require auditors to pass judgment on the tax reserve, but if the same firm gave tax advice, it can be accused of auditing its own work," he said. "If they are looking at issues that they had a hand in developing, they can be viewed as an advocate of the client. Both of these are indicative of non-independence."

But splitting up the work between two firms results in a loss of efficiency and puts tension into the board room, since the board has to make the decision to keep one firm or hire two. Moreover, FIN 48 not only requires companies to reveal the amount of their tax reserves, but additions and subtractions from the reserves must also be disclosed.

"If the firm that provided the tax advice has a hand in the determination or review of the tax reserve, the bias remains," Seigel continued. "It will not have the same level of acceptance unless there is a separate level of independent opinion. Even though the audit firm is not the same as the tax firm, it's starting out with a tax reserve established by a firm that gives tax advice."

The solution is to have an independent firm assess the reliability of the tax reserve, said Seigel. "An independent expert opinion gives the company a separate level of reliability," he said. "The objectivity of the opinion cannot be questioned, and the company can continue to have one firm do the audit and tax work because management now has an independent expert opinion that attests to the propriety of the tax reserve."

"This is being done in a number of cases," said the AICPA's Ochsenschlager. "The average corporation has to be pretty large to justify an in-house tax department, so a lot of firms are outsourcing this task - getting another firm to make the tax judgment on liability on the balance sheet and tax figures on the income statement."

"The company hires a third party to do the provisions review," he explained. "This is in addition to the audit firm and the firm that does the tax compliance work."

Whichever way the corporation decides to handle it, it is a process that is likely to grow in scale and significance, according to Seigel.

"In my view, FIN 48 is just the first step in the reform of financial reporting of tax liabilities and practices," he said. "It is the beginning of a trend that will continue as the demand for greater disclosure and transparency accumulates. Trying to determine the real effective tax rate of a corporation, particularly one with multiple entities or foreign operations, is a virtual impossibility for most investors and analysts. I think we will see companies required to disclose more details of their tax profile as time goes on."

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