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Regulations issued by the US Securities and Exchange Commission (SEC) on 28 January governing auditor independence will have a major impact on tax advisers, both inside and outside the US.
The regulations were issued under the Sarbanes-Oxley Act, which was enacted in response to the accounting scandals surrounding Enron and other companies. Sarbanes-Oxley applies only to entities with securities listed on a US exchange, or in other limited circumstances where the SEC has jurisdiction. While this may constitute a relatively small number of non-US companies compared with the total number of listed companies worldwide, the impact of the auditor independence rules on non-US tax advisers should not be underestimated. Accounting firms outside the US are subject to the Sarbanes-Oxley auditor independence rules by virtue of performing audits subject to SEC jurisdiction.
Sarbanes-Oxley's independence rules do not limit the types of services that accounting firms may offer in the market generally; they are merely a qualification test for firms that wish to undertake the statutorily regulated role of a public company's independent auditor. Unless three tests are met, an accounting firm does not meet the definition of an independent auditor under the SEC's rules. Sarbanes-Oxley prevents accounting firms from acting as an "independent auditor" where their independence is impaired by non-audit services. This is not a 'lawyer versus accountant' issue, with lawyers attempting to snatch lucrative tax work away from the accounting firms - Sarbanes-Oxley benefits lawyers only to the extent that they get to compete on a level playing field with accounting firms.
Sarbanes-Oxley divides non-audit services into two categories: those that impair independence per se, and those that might impair independence. An auditor can perform any service not on the per se list, including tax services, provided the company's audit committee pre-approves the service and such service does not impair the auditor's independence. Unfortunately, the SEC has not provided audit committees with guidance regarding how to evaluate whether particular tax services impair an auditor's independence.
The final regulations were initially viewed as a victory for accounting firms, but this may be a premature judgement. This is because the rules represent a major problem for audit committees. This can only be understood in the context of the proposed rules released by the SEC last December. The proposed rules raised some troubling questions for auditors - specifically, they indicated that audit committees should be mindful of certain core principles that determine whether an auditor lacks independence, such as an accounting firm auditing its own work or acting as an advocate for the client. The proposed rules offered the example of impaired independence arising from "the formulation of tax strategies (eg tax shelters) designed to minimize a company's tax obligations". The proposed rules also questioned whether an auditor should provide third-party tax opinions for its audit clients.
The final auditor independence regulations do not mention any of the troubling questions raised in the proposed regulations, which is why they are considered a victory for the accounting profession. The final rules essentially state that it is possible for an auditor to provide tax compliance, planning and other advice without impairing its independence. However, the final rules also cite, without explicit endorsement, the Commission on Public Trust and Private Enterprise's report, which concluded as a "best practice" that auditors should not provide tax advice concerning "novel and debatable" tax strategies and products. Although there are many interpretations of this seemingly conflicting advice, the best appears to be simply that audit committees are on their own in deciding whether a particular tax service impairs their auditor's independence.
All of this leaves audit committees with an unenviable task if their auditors are also their normal tax advisers. Audit committees will now become the battleground on which auditors seek approval to sell tax products and otherwise provide sophisticated tax planning advice to the company. On the one hand, audit committees may need to contend with long-term and trusted accounting firm tax advisers, who for obvious reasons will attempt to preserve their position; on the other, audit committees must thoughtfully consider whether hiring the auditor for a particular tax engagement potentially prejudices their independence.
It is important to remember that the audit committee's choice of tax adviser is not a referendum on whether the auditor's tax accountants will provide good tax advice. Instead, the audit committee must make a decision about whether it believes the audit side of the accountancy firm will have its independence impaired if the company uses the tax side of the firm for a particular tax service or product. This concern is particularly important where value or other premium fees are being charged for the tax advice or product, or where the auditor is selling a "pre-packaged" tax shelter, the effect of which its audit arm will have to determine.
Sarbanes-Oxley makes the audit committee responsible for selecting, compensating and supervising the company's auditor. The audit committee is actually responsible for the auditor's independence, and by default for the appearance of auditor independence, which can be just as important.
The spectre of Enron and other major accounting scandals will obviously enter into the equation of whether to utilise auditors for tax planning and products. Audit committees need to conclude that auditor independence is not impaired and should seriously consider how the choice of the auditor will be described in the press if the tax benefits prove illusory and the reserve is inadequate. Audit committees should ask this second question even if their company is not subject to Sarbanes-Oxley. Thus, Sarbanes-Oxley will likely have an impact on the market for tax advice far greater than its legal scope.
So where does this leave tax advisers, both lawyers and accountants?
The Sarbanes-Oxley auditor independence rules provide a minimum standard, and many companies will look to exceed the minimum in order to avoid the appearance of impropriety. It appears that many listed companies, even those not subject to Sarbanes-Oxley, are limiting the amount of auditor-provided non-audit services in order to ensure auditor independence. Many corporate boards are demanding second opinions, often from law firms, before considering accounting firm-proposed tax planning or products. Further, some boards are considering using only a non-auditor in particularly sensitive transactions where auditor independence is paramount.
Accounting firms also benefit under Sarbanes-Oxley. They are not per se excluded from a broad range of lucrative tax work. In fact, Sarbanes-Oxley provides an additional chance for accounting firms to pitch tax services to non-audit clients. Therefore, Sarbanes-Oxley offers opportunities for both tax lawyers and accountants.
John Taylor is a US-qualified senior tax associate at Allen & Overy's London office
|Tax advice under the Sarbanes-Oxley Act|
Accountants cannot audit a company if their non-audit services impair independence.