"Audit" vs. "non-audit" tax services under Sarbanes-Oxley.

• Author: Durst, Michael C.

Introduction

Previous articles in The Tax Executive have addressed portions of the Sarbanes-Oxley Act of special interest to corporate tax executives. Among the topics covered are provisions requiring audit committees to pre-approve non audit services to be performed by a company's auditing firm, as well as less frequently discussed, but at least as important, provisions aimed at preventing misrepresentations in financial statements. (1) This article addresses an additional aspect of the environment--the increased role of tax specialists in the financial audit process itself.

Anecdotal evidence abounds that the Sarbanes-Oxley Act, coupled with the high level of publicity that has attended some large-scale corporate tax controversies, has increased the scrutiny accounting firms are giving to companies' income tax positions in connection with the companies' financial audits. This increased scrutiny has led to greater participation in financial audits by tax specialists within the accounting firms, who often perform their increased audit responsibilities in tandem with their longstanding roles in tax compliance, planning, and representation in examinations. The greater involvement of tax specialists in financial audits should advance the investor-protection goals of Sarbanes-Oxley. (2)

Significantly, the Sarbanes-Oxley Act placed important limitations, mainly in the form of audit committee pre-approval requirements, on the provision of audit and non-audit tax services by members of auditing firms. (3) In addition, the fees paid annually for "non-audit" services must be disclosed, and the fees for non-audit "tax services" must be identified specifically. Inevitably, tax executives, working with their CFOs and audit committees, will need to develop sensible ways to distinguish between these categories. Neither the statute nor the SEC regulations provide much guidance on how audit committees should differentiate between these categories of services, but rather generally leave the question to audit committees' discretion. This article strives to help fill the vacuum, enabling tax executives and audit committees to identify the salient issues when they arise and to deal with them thoughtfully and carefully.

Difficulty of Distinguishing Between Audit and Non-Audit Tax Services

Despite the importance of distinguishing between audit and non-audit tax services, it will often be very difficult to draw a clear line between (1) tax advice provided in connection with an audit and (2) tax advice properly regarded as planning or consulting advice beyond the scope of the audit. The challenge is heightened by companies' not wanting to wait until the financial audit is formally underway in order to confirm whether the auditors agree to the proposed accounting treatment of a particular tax position. Instead, companies are understandably seeking real-time advice from the auditing firm, at the time a particular tax position is contemplated, on whether the proposed treatment ultimately will be acceptable to the auditing firm.

In view of the significant judgment required in evaluating tax reporting positions, as well as the complexity of many tax issues, tax specialists at the auditing firm who are asked whether a proposed position will be acceptable will frequently (and understand ably) opine that a fully professional response involves more than a bare "yes" or "no." In such circumstances, it may be difficult if not impossible to determine confidently where the "audit" activities of the auditing firm's tax specialists end and "tax planning" services, above and beyond the auditing function, begin.

The stakes involved in answering this question wrongly can be considerable. If services that the company and its auditing firm initially classify as "audit" services are in retrospect deemed to constitute tax planning services, then the company can be found to have failed in its pre-approval obligations under Sarbanes-Oxley, as well as to have misreported the level of its fees for non-audit tax services. Both the company and the auditing firm, therefore, will want to exercise care to make the necessary distinctions in an appropriate manner. (4)

Procedurally, a company's audit committee faces a two-step inquiry under Sarbanes-Oxley when the activities of an auditing firm's tax specialists approach the hazy line separating audit services from non-audit tax advice. The first question is whether the tax advice should be considered to fall within the audit or non-audit category. Second, if the audit committee determines that services should be placed within the...