A practical guide to Sarbanes-Oxley, part II.

• Author: George, Goodman
• Position: Part 2

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.

Part I of this article, in the October 2003 issue, provided an overview of the Sarbanes-Oxley Act of 2002 (22) (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 firm's performance tax services for public audit clients. It a discuss how the reporting obligations or of attorneys practicing before Securities and Exchange Commission (SEC) may apply to a tax matter, addresses other provisions that can apply to 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 issuer's audit committee. These restrictions do not apply to an accounting firm's 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 regulations (23) to clarify the meaning and scope of per se prohibited nonaudit services. Likewise, under the SOA, the PCAOB released Interim Professional Auditing Standards (24)--essentially incorporating existing standards of the AICPA and the In-dependence 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 SeA as to the auditor's performance of nonaudit services; each should ensure that it fulfills its respective duties.

Audit Tax Services

The nonaudit service rules do not restrict an auditor's 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 auditor's pre-audit review of the company's desired tax treatment, for the purpose of confirming the auditor's likely views on later audit, should be deemed an audit service. Such tax related audit work should be subsumed within the audit committee's approval of an audit engagement (or perhaps covered by the de minimis exception (27) 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 Congress's 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 preambles (29) 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 involve advocacy and, thus, may be a prohibited expert service.

Other tax services can entail appraisals or valuations. According u 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 rule's (34) exception to the ban on appraisal and valuation service when "it is reasonable to conclude that the results of these services wit not be subject to audit procedure during an audit of" the audit client! financial statements." However, this exception may not he available whet 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 or 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 client's audit committee first approves the service. (36) This approval is done in accordance with SOA Section 202--the general provision requiring audit committee preapproval of all auditing and nonauditing services provided to the issuer by its auditor. (37) At this point, no clear standards govern an audit committee's 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):

The bill does not require the audit committee to make a particular finding in order to pre-approve an activity. The members of the audit committee shall vote consistent with the standards they determine to be appropriate in light of their fiduciary responsibilities and such other considerations they deem to be relevant. (38)

This statement suggests that audit committees should create standards by which to evaluate potential tax service engagements. Relevant considerations may include:

* The three auditor independence principles (i.e., the extent to which the auditor may end up auditing its own work, undertaking a management function or serving as an advocate);

* The fees to be paid for the service, both absolutely and in relation to the total fees for audit and nonaudit services paid to the auditor;

* The extent to which having the auditor perform the service could compromise its objectivity and independence on audit;

* How far in the future the tax service engagement is to commence and the length of time it is expected to continue;

* The specificity with which the service is described;

* The practicability and cost of procuring...