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A Practical Guide to Sarbanes-Oxley (Part II) This two-part article highlights substantive issues and compliance measures arising under the Sarbanes-Oxley Act of 2002. Part II focuses on the performance of nonaudit tax services for public audit clients, as well as provisions that can apply to any taxpayer or tax adviser.
George Goodman, Esq.
Authors note: The author would like to thank Jonathan P. Biller, Senior Tax Counsel, Alcon Laboratories, Inc., and Brian H. Marron, Director of Taxes, Harley-Davidson Motor Company, Inc., for their help with this article. 2003 George Goodman. All Rights Reserved. For more information about this article, contact Mr. Goodman at GRGoodman@foleylaw.com.
Executive Summary
Part I of this article, in the October 2003 issue, provided an overview of the Sarbanes-Oxley Act of 200222 (SOA), discussed substantive issues and tax compliance measures for public companies, and made recommendations. Part II, below, examines how the SOA restricts a public accounting firms performance of tax services for public audit clients. It also discusses how the reporting obligations of attorneys practicing before the Securities and Exchange Commission (SEC) may apply to a tax matter, addresses other provisions that can apply to any taxpayer or tax adviser and concludes with some recommendations.
Tax Services from Auditors Overview Under SOA Section 201, registered public accounting firms cannot perform certain specified nonaudit services (per se prohibited services) for their public audit clients, absent a specific order from the Public Company Accounting Oversight Board (PCAOB) permitting the rendition of such service. Other services may be performed only with the prior approval of the issuers audit committee. These restrictions do not apply to an accounting firms provision of nonaudit services to a nonpublic audit client, or to a public company that is not an audit client. The SEC has revised its regulations23 to clarify the meaning and scope of per se prohibited nonaudit services. Likewise, under the SOA, the PCAOB released Interim Professional Auditing Standards24essentially incorporating existing standards of the AICPA and the Independence Standards Board (ISB),25 some of which provide guidance as to when various types of nontax services would or would not impair auditor independence. Unfortunately, neither the SEC nor the PCAOB rules specifically address tax services, leaving some areas in which it is not clear whether the tax services fall within a per se prohibited category. However, the PCAOB is expected to determine and issue final independence standards, which may address tax services; the SEC could revisit the area as well. Both the auditor and the public audit client have responsibilities under the SOA as to the auditors performance of nonaudit services; each should ensure that it fulfills its respective duties.
Audit Tax Services The nonaudit service rules do not restrict an auditors provision of tax-related services as part of an audit of the public client. The restricted nonaudit services are: any professional services provided to an issuer by a registered public accounting firm, other than those provided to an issuer in connection with an audit or review of the financial statements.26 Reviews of tax accruals and providing tax services in connection with an audit should be deemed permissible audit (rather than nonaudit) services. Moreover, when an auditor is not providing tax advice on a proposed transaction or position, the auditors pre-audit review of the companys desired tax treatment, for the purpose of confirming the auditors likely views on later audit, should be deemed an audit service. Such tax-related audit work should be subsumed within the audit committees approval of an audit engagement (or perhaps covered by the de minimis exception27 in the event an aspect of such tax-related work is later deemed a nonaudit service). Thus, the nonaudit service rules should only apply to tax services to be rendered outside an audit.
Per Se Prohibited Services Tax services are not specifically listed as a per se prohibited nonaudit service; indeed, the SOA reflects Congresss intent that auditors be permitted to provide tax services to their public audit clients.28 Although the new SEC rules do not address tax services, the treatment of such services was debated and addressed in the preambles29 to the proposed and final rules. Based on these preambles, traditional tax compliance, planning and advice services should generally not be deemed per se prohibited services.30 Some tax services, however, may be per se prohibited legal, expert, appraisal or financial information system services. For example, representing an audit client in court (including Tax Court) would generally be a per se prohibited legal service.31 Serving as an expert witness in a tax proceeding or providing expert witness testimony on taxes in a nontax proceeding would generally be a prohibited expert service.32 One classification that seems unclear is representing an audit client before the Office of IRS Appeals. Such work does not require a law license, but arguably involves advocacy and, thus, may be a prohibited expert service. Other tax services can entail appraisals or valuations. According to the SEC,33 per se prohibitions on appraisal and valuation services do not prohibit an accounting firm from providing such services for non-financial reporting (e.g., transfer pricing studies, cost segregation studies, and other tax-only valuations) purposes. Presumably, this statement is based on the revised rules34 exception to the ban on appraisal and valuation services when it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit clients financial statements. However, this exception may not be available when a tax position based on an appraisal or valuation is subject to audit as a component of the tax provision. Finally, the Office of the Chief Accountant of the SEC answered some frequently asked questions on the SEC auditor independence rules.35 Question 18 states that an auditor may license or sell income tax return preparation software to an audit client, as long as audit committee preapproval is given. However, if the software performs functions in addition to return preparation, such other functions must be evaluated for their potential effect on independence. In particular, Question 19 states that the sale or licensing of software that would further determine, or generate information used in determining, the GAAP tax accrual and tax disclosures on the financial statements is prohibited as constituting the design and implementation of a financial information system.
Approval of Nonaudit Tax Services An auditor may provide a nonaudit tax service that does not fall within a per se prohibited service category to a public audit client, provided the clients audit committee first approves the service.36 This approval is done in accordance with SOA Section 202the general provision requiring audit committee pre-approval of all auditing and nonauditing services provided to the issuer by its auditor.37 At this point, no clear standards govern an audit committees decision about whether to approve retaining an auditor for a nonaudit tax service. Congress essentially left the question to audit committees (although the SEC or PCAOB could issue guidance as well):
This statement suggests that audit committees should create standards by which to evaluate potential tax service engagements. Relevant considerations may include:
Tax departments should be familiar with the types of tax services the company may want from an auditor and of the benefits and issues in retaining the auditor for those services. They should work closely with the audit committee in establishing the policies and standards for tax services the company may procure from its auditor and the procedures for doing so. In evaluating a proposed tax service, the audit committee should be informed of the specific nature of the proposed service and the potential problems or conflicts it trigger. Using its standards, the audit committee must specifically approve a particular tax service before it begins and should document its rationale for approving the engagement. One tax services guideline that many have endorsed is that an audit committee not approve services from the auditor that involve the sale or promotion of a tax shelter.39 On the other hand, the auditors review of a tax shelter marketed by another party, for the purpose of ascertaining how the auditor will treat the transaction on audit, should be an audit service, or in any event should be permissible. In addition, some companies have adopted rules barring auditors from providing tax or other services to senior management or audit committee members.40
Disclosure of Tax Services and Fees SOA Section 202 requires an issuer to disclose to investors its audit committees approval of nonaudit services that the auditor will perform. New SEC rules41 also require disclosure of the audit committees pre-approval policies and procedures. In addition, although SEC rules had already required proxy statement disclosure of professional fees paid to a principal independent accountant, the SEC has expanded those rules in response to the SOAs disclosure mandate. The new rules require disclosure of fees paid in each of the two most recent years, and in each of four categoriesaudit fees, audit-related fees, tax fees and all other fees. In addition, they require not just disclosure by entities that issue proxy statements, but by all entities filing Forms 10-K, 10-KSB, 20-F, 40-F and N-CSR, which includes smaller entities. The separate tax fees disclosure category is new. It does not include fees for tax services rendered in connection with an audit (such as review of the tax provision), which are included in audit fees; however, it is intended to capture all other services performed by the audit firms tax division professional staff (including tax compliance, planning and advice). Under tax fees, the company has to:
A tax department, accounting department and disclosure personnel should work together to ensure that (1) approval of nonaudit tax services is adequately disclosed, (2) fees for nonaudit tax services are properly reflected and disclosed as tax fees and (3) the services are adequately described.43
Attorney Reporting Obligations Generally Under SOA Section 307, the SEC promulgated new standards of professional conduct44 for attorneys representing issuers before the SEC. Their main thrust is to ensure that attorneys report a possible breach of laws up-the-ladder within the issuer client.45 Specifically, an attorney appearing and practicing before the [SEC] in the representation of an issuer, who becomes aware of evidence of a material violation of the securities laws, breach of a fiduciary duty or violation of similar laws, is required to report such evidence to the issuers chief legal officer or to both the chief legal officer and chief executive officer (CEO) and, failing receipt of an appropriate response, to the issuers audit committee or other board members. Alternatively, attorneys can report the matter to a qualified legal compliance committee of the board, if one exists.46 The rules also authorize an attorney to reveal confidential information to the SEC without the issuers consent under certain circumstances, such as to prevent a material violation of the securities laws likely to cause substantial financial injury to the issuers or investors. The rules apply to both in-house and outside attorneys.
Practicing before the SEC Whether these rules come into play in a tax matter, subjecting an attorney to reporting obligations, depends in part on whether he or she is appearing and practicing before the [SEC]. SEC rules define that phrase to mean transacting any business with the SEC, representing an issuer in connection with any SEC matter, providing advice on securities laws as to any documents to be filed or incorporated in a SEC filing, and giving advice on whether information, a statement, opinion or other writing is required to be filed with or incorporated in a SEC filing.47 Tax lawyers do not ordinarily give advice on securities laws; arguably, offering a tax opinion on or preparing a tax disclosure for a public transaction is distinct from the securities law aspects of that document, including the tax disclosure requirement. Nonetheless, the preamble to the final SEC rules suggests one is appearing and practicing before the [SEC] if one prepares a document knowing that it will be filed with or incorporated in an SEC filing.48 Thus, the SEC may view any advice incorporated in an SEC document as advice on securities laws. In any event, if a tax lawyer informs an attorney handling the securities law aspects of a tax problem, the latter attorney would clearly be subject to the reporting procedures.49
Material Violation The other prerequisite to a reporting obligation on a tax matter is evidence of a material violation of the securities law or a breach of fiduciary duty or similar violation. Evidence of a material violation is:50
Some situations may present relatively clear evidence of a material violation, such as a fraudulent tax disclosure section in an SEC document; others may be far less concrete. For example, whether an improper claim of tax benefits rises to that level would require consideration of how it is to be reflected in SEC documents, its materiality and other factors. Although the standard of a prudent and competent attorney is easily stated, it may be difficult to apply in practice. In sum, in-house and outside attorneys representing a public issuer who suspect a tax wrongdoing may be subject to the prescribed reporting procedures.
General Provisions The SOA contains some provisions that could apply to any taxpayerpublic or private, company or individualor any tax adviser.
CEO as Return Signer SOA Section 1001 states the sense of the Senate that any corporations Federal income tax return should be signed by its CEO. While the Senates version of the legislation enacted as the Jobs and Growth Tax Relief Reconciliation Act of 2003 would have amended Sec. 6062 to require the CEO to sign the corporate tax return, that provision did not pass.
Retaliation Penalties The SOA imposes stiff criminal penalties on malfeasance in connection with Federal matters and other official proceedings:
A department generally includes Treasury; an agency generally includes any U.S. department, commission, administration, authority, board or bureau. An official proceeding is a proceeding before (1) a Federal judge, magistrate, court or grand jury, including a U.S. Tax Court judge; (2) Congress; (3) a Federal government agency; or (4) an insurance regulatory official, agency or examiner.53 Federal tax audits and proceedings would seem to fall within the purview of these provisions; thus, those who improperly impede a Federal tax audit or proceeding face a stiff penalty. SOA Sec. 1107 imposes a fine and/or up to 10 years imprisonment on anyone who knowingly takes any action harmful to any person (including interference with his or her lawful employment or livelihood), with the intent to retaliate for providing truthful information as to the commission or possible commission of any Federal offense to a law enforcement officer.54 This could also come into play in connection with a Federal tax matter.
Conclusion Public company tax departments should participate in their companies efforts to comply with the SOAs mandates, discussed in Part I of this article in the October 2003 issue. The scope and effective date of the provisions are summarized in Exhibit 1. The new auditor independence standards will make auditors more independent of their public audit clients. Although auditors can still provide traditional tax compliance, planning and advice services, some tax services are prohibited, and the audit committee has to approve all tax services in advance. Tax departments and audit committees should work hand-in-hand to establish procedures and standards for securing pre-approval of tax services from the auditor, and to properly disclose tax fees and underlying services. Outside and in-house attorneys representing public companies may be required to report to the chief legal officer or board of directors evidence of a securities law or fiduciary duty violation stemming from a tax matter. Finally, the SOA imposes substantial criminal penalties for destroying or tampering with records or otherwise impeding a Federal tax audit or proceeding, and for retaliating against an informant who provides information about a possible Federal tax crime. |
