by Ken Rankin
Washington - Major accounting firms may face painful new restrictions on their ability to offer lucrative tax services to audit clients under independence rules drafted by the Securities and Exchange Commission to implement the accounting reforms mandated by the Sarbanes-Oxley legislation.
Just how painful those restrictions will be for the industry’s bottom line may not be clear until a final version of the new rulemaking is issued, however. That’s supposed to happen by Jan. 26, 2003 - a deadline set by Congress to put hustle in the SEC’s process of implementing the new law.
But the rule proposal being circulated now for public comment contains so many unanswered questions that it may be difficult for the commission to meet that rigorous timetable.
Comments on the preliminary version from interested parties in and out of the accounting profession are expected to be extensive, and it is questionable whether the SEC’s short-handed staff will have time to digest, evaluate and incorporate complex recommendations from hundreds of competing interest groups in time to meet this month’s deadline.
The extensive SEC proposal, which was published in the Federal Register in mid-December, embraces three principles for auditor independence that the commission found to be underlying the Sarbanes-Oxley reform law.
"Those three broad principles are that an auditor cannot (1) audit his or her own work, (2) perform management functions, or (3) act as an advocate for the client," the commission said in the preamble to the proposed rule.
Beyond that, however, the version currently in circulation leaves unanswered scores of questions about which specific services auditors may perform for their clients without raising independence issues.
And nowhere are the stakes higher - or the outlook more cloudy - than in the offering of tax services by audit firms.
Although tax services were not included among the eight non-audit services specifically prohibited by Sarbanes-Oxley, the law empowers regulators to broaden that list by setting limitations on the provision of any other services by audit firms.
The SEC, however, elected to move gingerly in this area. After analyzing the "congressional intent" underlying the new audit reform law, commission staffers concluded that it "would appear to be that auditor independence is not impaired by an accountant providing traditional tax preparation services to an audit client or an affiliate of an audit client."
But while the proposed rules place no blanket roadblock to the offering of tax services to a firm’s audit clients, they do close accounting firms out of a number of important areas of tax practice.
Among other things, the rule would prohibit audit firms from representing their clients in tax court (though not necessarily in Internal Revenue Service administrative proceedings, where admission to the bar is not required). The SEC’s reasoning is that when "an accountant provides representation before a tax court, the accountant serves as an advocate for his or her client and the accountant’s independence would be impaired."
Additionally, the rule proposal would cut audit firms out of the lucrative business of formulating "tax strategies" or shelters for their audit clients. "The provision of these types of services may require the accountant to audit his or her own work, to become an advocate for the client’s position on novel tax issues, or to assume a management function," the commission explained.
The commission also is considering imposing restrictions on the ability of CPAs to provide tax opinions to their audit clients for use in business transactions with third parties.
"The tax opinion may be vital in the audit client’s efforts to induce the third party to enter into the transaction, particularly when the transaction is tax-driven," the SEC reasoned. "Under those circumstances, the auditor may be acting as an advocate for the audit client by actively promoting the client’s interests."
Tax attorneys, however, are likely to press the SEC to place even tighter restrictions on the ability of accountants to provide tax services - including an all-out ban on tax work for their audit and non-audit clients.
In seeking comment from accountants, lawyers and other interested parties, the SEC requested opinions on several specific issues, including suggestions for any other tax services that could raise independence concerns for auditors.
The commission also asked for comments on whether it is "meaningful to categorize tax services into permitted and disallowed activities," and whether the SEC should revisit its tentative position to lock auditors out of the tax shelter business.
