Experts: PCAOB restraints on tax services not enough

The Public Company Accounting Oversight Board's plan to place new restrictions on the ability of accountants to offer tax services to their audit clients doesn't go far enough to restore investor confidence in financial reporting, critics of the accounting profession warned.

In recent comments to the board expressing concern over new tax service restrictions proposed late last year, several tax experts urged the oversight body to place auditors on an even shorter leash.

In order to "help restore investor confidence in the independence of auditors and the integrity of their audits, the PCAOB should adopt a rule which prohibits audit firms from providing any tax services which are unrelated to the audit," New York City tax attorney Robert Chira told the board.

"I believe the board has clear and ample legal authority to prohibit such non-audit related tax services," he said, commenting on the PCOAB proposal. "I further believe the board should exercise leadership in this area to persuade the Securities and Exchange Commission to the position that an audit firm should perform audits and not commingle that function with the performance of unrelated tax services."

Meanwhile, Harvard Law professor Bernard Wolfman called for an even more far-reaching set of limitations on the sale of tax services by accountants.

Arguing that the PCAOB's proposed rule does not go far enough to ensure the independence of auditors, he maintained that "the auditor of a public company should not be permitted to render tax services to any company, whether the company is an audit client of the auditor or not."

The only exception under Wolfman's plan would be for "routine compliance work and tax return preparation."

In contrast, the new rule proposed by the PCAOB in December would allow accountants to continue providing general tax services to audit clients, but prohibit them from marketing tax strategies that involve "an aggressive interpretation of applicable tax laws and regulations," or result in a tax avoidance maneuver that is a listed or confidential transaction under Treasury regulations.

The proposal also calls for outlawing the use of contingent fees for tax services to audit clients, and would bar audit firms from providing any tax services to corporate officers who are "in a reporting oversight role of an audit client."

The PCAOB wrestled with the idea of a far more restrictive policy toward tax services by auditors, but ultimately concluded that such an approach would be unnecessarily burdensome for accountants and their clients.

In defending the PCAOB's decision to stop short of an all-out prohibition against the sale of tax services to audit clients, board member Daniel L. Goelzer said, "Auditors have traditionally performed these kinds of services for their audit clients, and this kind of assistance is particularly important to small and medium-sized businesses that lack the resources to maintain extensive in-house tax expertise."

For his part, however, tax attorney Chira argued that allowing auditors to perform tax services unrelated to the audit may create significant conflicts of interest that undermine auditor independence.

"For example, if an audit firm receives $5 million for tax services from its audit client concerning reorganization plans (i.e. mergers, acquisitions, divestitures) contemporaneously with performing an audit of the client's financial statements, for which it is paid $2 million, investors, creditors and other third parties who rely upon the financial statements may perceive that the audit firm lacks the objectivity and independence to challenge management's financial statement assertions, since to do so may affect the client's retention of the auditors for similar tax services in the future," he said.

Chira told PCAOB officials, "The $5 million fee for tax services may distort the mental attitude, objectivity and independence required to perform the audit of the financial statements."

In addition to expanding on the proposed new restrictions on tax services by auditors, Chira also suggested that the board press Congress to enact new federal legislation "that would require audit firms to separate themselves legally from other parts of their firm that perform tax services and other non-audit services."

Under this approach, "all auditors would be in one firm and all other personnel (tax advisors, management consultants, etc.) in another, with the management and profits of each firm separate," he explained.

Not all of the comments trickling in to PCAOB were critical of the board's proposal for regulating the tax services offered by auditors.

For example, former Financial Accounting Standards Board chair Dennis R. Beresford described the PCAOB's approach as "an appropriate balance between permission (with audit committee approval) for accounting firms to provide specified tax services, while prohibiting those services that could create an actual or perceived independence problem."

Beresford, now the Ernst & Young Executive Professor of Accounting at the University of Georgia's J.M. Tull School of Accounting, noted that "there are good business reasons to use a company's auditors to perform certain other services based on their knowledge of the company and other factors."

Corporate "audit committees should be allowed to exercise professional judgment and approve non-audit services to be performed where there are business reasons to do so and the services in question would not undermine auditor independence," he said.