The General Accountability Office and the Internal Revenue Service have added their own muscle to a Public Company Accounting Oversight Board proposal that would restrict the ability of accountants to provide tax services to audit clients.

In December, the PCAOB signaled its intent to prohibit auditors from offering tax services to audit clients on a contingent-fee basis, and bar them from providing any tax services to corporate officers who are "in a reporting oversight role of an audit client."

The proposal would prohibit firms 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.

In addition, the proposal expanded on current Securities and Exchange Commission rules to require that an auditor seeking audit committee pre-approval of tax services give the committee certain information, discuss with the committee the services' potential effects on firm independence, and document the discussion.

Now the GAO has released a study showing that, over a multi-year period, tax shelters provided by accounting firms or external auditors potentially siphoned off $129 billion in revenue from U.S. coffers.

According to the GAO, some 207 Fortune 500 companies purchased shelters from their auditor or from accounting firms, resulting in a potential revenue loss of $56.6 billion. About 44 percent of this was related to tax years 1998 through 2003.

Meanwhile, the IRS announced a settlement initiative for executives and companies that participated in an abusive tax avoidance transaction involving the transfer of stock options or restricted stock to family-controlled entities.

Under this scheme, executives delayed paying income tax on stock options for up to 30 years, and also evaded related employment taxes. The executives, often facilitated by their corporate employers, transferred stock options to family-controlled partnerships and other related entities typically created for the sole purpose of receiving the options and avoiding taxes on compensation income normally taxed to the executive. The tax objective was to defer for up to 30 years the taxes on the compensation, and the plan resulted, in many cases, in the corporation deferring a legitimate deduction for the same compensation.

"These transactions raise questions not only about compliance with the tax laws, but also, in some instances, about corporate governance and auditor independence," said IRS Commissioner Mark W. Everson. "These deals were done for the personal benefit of executives, often at the expense of shareholders."

Corporate executives who engaged in these transactions will have until May 23, 2005, to accept an IRS settlement offer to resolve their tax issues. The offer also extends to corporations that issued the options to executives and directors as part of their compensation.

Under the terms of the settlement, participating executives must report 100 percent of the compensation and must pay interest and a 10 percent penalty, one-half of the maximum 20 percent applicable penalty. Corporations and executives must also pay appropriate employment taxes. The parties will be allowed to deduct out-of-pocket transaction costs, typically promoter and professional fees. Corporations will be allowed a deduction for the compensation expense reported by the executive.

Securities and Exchange Commission Chairman William Donaldson praised the IRS move. "I commend the IRS for resolving this matter," he said. "It is important that leaders in our capital markets avoid inappropriate conflicts of interest such as those described in the IRS's executive stock option initiative."

"The settlement initiative applies to stock options issued before July 2003," observed Laurie Asch, senior tax analyst at New York-based RIA. "It's kind of an outgrowth of Enron, but it's an issue that has been of concern to the IRS historically. It's a very active area - they've issued new rules on golden parachutes and incentive stock options, and with the Jobs Act last year there will be a lot more to come. It's a general crackdown on deferred compensation."

A concerted crackdown?

Some observers noted a connection between the timing of the GAO report, the IRS settlement initiative and the PCAOB proposal.

"I do find it curious," said a tax attorney whose firm represents some of the companies in the GAO report. "There's a lot going on in the shelter area, and it appears they're trying to scare people away from testing the law, rather than prosecuting them after the fact."

"There's a methodological problem in there," he added. "Just because a transaction is listed doesn't mean it is actually abusive. In fact, the IRS has gone out of its way in saying that, yet the GAO report treats it that way - they have used listed transactions as a proxy for abusive transactions."

The GAO report matched data disclosed to or discovered by the IRS on tax shelter acquisitions and promoters of the tax shelters to information from Standard & Poor's on the auditors, top officers and directors of the April 2003 Fortune 500.

The GAO admitted that its results might be imprecise. "For example," it said in the report, "The IRS's data may not include all tax shelters, because some taxpayers may not have disclosed all abusive or other reportable transactions to the IRS, and the IRS likely has not identified all such transactions on its own. On the other hand, the data might also include some tax shelters that could be later determined nonabusive and did include some items that needed to be reported to the IRS, but unexpectedly turned out to be non-abusive."

In the meantime, the PCAOB proposal has generated wide- spread public interest, with over 800 comments submitted to the board.

"The PCAOB proposed ethics and independence rules are principles-based, premised on the goal of building and maintaining investor confidence in the public company audit system," said Jeffrey Frishman, the national partner-in-charge of tax quality assurance for Chicago-based Grant Thornton.

"We support a principles-based approach for setting standards regarding auditor independence," he continued. "The fact that approximately 800 public comments were submitted in response to the proposed rules is terrific - it seems to reflect a broad commitment to embrace the efforts of PCAOB."

"One challenge underscored by the public comments," he noted, "is structuring standards that capture the PCAOB's independence concerns without being overbroad. This could result in unintentionally restricting a company's ability to obtain necessary advice in the ordinary course of business operations on appropriate, non-abusive business and tax planning matters."

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