by George G. Jones and Mark A. Luscombe
The Sarbanes-Oxley Act of 2002 imposed a number of restrictions on the non-auditing services that an auditor can perform while auditing a public company, and the Securities and Exchange Commission has recently approved regulations to guide auditing firms and public companies in complying with the requirements of the act.
How will these new regulations affect the tax practices of accountants and what impact, if any, will they have on the tax practices of accountants performing audits for non-publicly held companies?
The Sarbanes-Oxley Act of 2002, was enacted on July 30, 2002. A primary purpose of the legislation is to replace self-regulation of accountants and auditors by their own profession with public oversight. Section 201 of the Sarbanes-Oxley Act states that an auditor is prohibited from providing any non-audit service at the same time that the auditor is performing an audit of a public company.
The provision then goes on to list nine specific prohibited services: bookkeeping, financial information systems design and implementation, appraisal or valuation services, actuarial services, internal audit services, management or human resources functions, broker or investment services, legal and expert services, and any other service that the new Public Company Accounting Oversight Board determines, by regulation, is impermissible.
Tax services are not specifically mentioned. Tax services are, however, specifically mentioned in the following subsection requiring pre-approval for non-audit services: "A registered public accounting firm may engage in any non-audit service, including tax services, [other than the nine listed above] only if the activity is approved in advance by the audit committee of the issuer ... ."
What might constitute tax services was not specifically addressed.
The SEC issued proposed rules regarding auditor independence in December 2002. The proposed rules state that an accounting firm and the audit committee of the public company should consider, in deciding whether a particular tax service is prohibited, whether the tax service would constitute a legal service or an expert service, both of which are specifically prohibited.
In making this determination, consideration is to be given to the following basic principles: Auditors cannot audit their own work; auditors cannot perform management functions; and auditors cannot serve as an advocate for the audited company.
The SEC-proposed rules appeared to state that an auditor could also perform tax return preparation services but was prohibited from performing services involving tax shelters. All other tax services fell into the gray area to be evaluated based on the above criteria.
The SEC approved final rules on Jan. 22, 2003. While an official version of the final language had not been released at press time, indications from the SEC staff are that the rules will specifically prohibit very little in terms of tax services. In line with the statutory language of the Sarbanes-Oxley Act, whether the auditor can undertake particular tax services will be left to the decision of the audit committee.
Appearing to back off somewhat from the proposed regulations, tax shelter work by auditors will not be specifically prohibited. Instead, the audit committee is asked to look closely at transactions that have no real business purpose, as well as the auditing firm or a third party that presented it to the company. The audit committee is to ask whether an auditor can provide objective judgment in auditing such a transaction.
The SEC staff has indicated that the only specific prohibition in the final rules on tax services will be representation in the Tax Court. Accountants would appear to be able to provide tax services at the IRS administrative level by providing a factual account of work done or by researching tax issues for the company. The auditor should not, however, cross the line to become an advocate on the company’s behalf or accept retention by an attorney advocating on the company’s behalf.
The SEC apparently felt that they could not restrict tax services beyond the statutory language in the Sarbanes-Oxley Act, so the pressure will be on the audit committees to make the tough calls. Whether audit committees will tend to play it safe and generally separate audit services and tax services remains to be seen.
Accounting firms would appear to be free to promote tax services to their audit clients without conflict of interest concerns. Approval of the services by the audit committee would appear to provide protection to the accounting firm.
Non-publicly held audits
The Sarbanes-Oxley Act and SEC rules are directed at audits of publicly held companies. In a very real sense, however, these laws and regulations will now serve to define ethical standards for all auditors.
Many privately held companies are regularly audited for the benefit of majority and minority shareholders, as well as for potential lenders and others doing business with the companies. The standards for auditors providing tax services in the public arena are likely to become the standards with which auditors in the private arena are expected to comply.
A lender or minority shareholder relying on an audited financial statement will expect that the auditor certifying that statement was independent. Auditors of private firms will now generally look to the standards of the SEC and the Public Company Accounting Oversight Board, when it’s up and operating, to determine what it means to be independent.
Non-publicly held companies will frequently not have audit committees to evaluate and make a determination as it pertains to whether the auditor can appropriately provide a particular tax service. Therefore, even more so than in the public sector, the accountant will have to make the determination as to whether providing any particular tax service has a potentially adverse impact on auditor independence.
It appears as if the new public oversight of auditing practices will not result in many clear restrictions on the ability of accounting firms to provide both auditing and tax services.
With respect to public companies, the audit committees will be the arbiters of whether any particular tax service is permissible. Over time, consistent decisions by audit committees with respect to certain types of tax services may eventually create a more coherent body of guidance as to which tax services are permitted and which are prohibited.
Firms auditing private companies may eventually be able to look to this guidance to help them in deciding whether any particular tax service is appropriate. In the meantime, these accounting firms will probably be able to use the same professional standards that they have used in the past to determine whether any particular tax service might undermine their independence as an auditor.
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