The SEC's auditor independence regulations: tax services under Sarbanes-Oxley.

• Author: Fuller, James P.

Editor's Note: As part of its continuing effort to keep members of Tax Executives Institute and other affected parties informed of the scope and implications of the auditor independence rules of the Sarbanes-Oxley Act, The Tax Executive is pleased to publish this article by James P. Fuller, David L. Forst, Barton W.S. Bassett, and Adam S. Halpern on the Securities and Exchange Commission's final regulations relating to how the provision of tax services are affected by the legislation's auditor independence rules. The views stated are those of the authors and not of Tax Executives Institute. Because it welcomes a robust discussion of the meaning and significance of Sarbanes-Oxley--articles appeared in both the September-October 2002 and November-December 2002 issues of the magazine--TEI invites the submission of questions, comments, rejoinders, and ripostes. Contributions should be sent to Editor, The Tax Executive, c/o Tax Executives Institute, 1200 G. Street, N.W., Suite 300, Washington, D.C. 20005-3814, or e-mailed to tmccormally@tei.org.

Introduction

This article analyzes the effect of the final regulations issued on January 22, 2003, by the Securities and Exchange Commission under the Sarbanes-Oxley Act (1) on the provision of tax services. Its intended audience is the Vice President-Tax or other chief tax officer of a publicly traded corporation. Designed to preserve the independence of a public company's auditor, these new regulations expressly prohibit the company's auditor from performing certain designated services, including certain tax services, and require the company's audit committee to pre-approve all services, including tax services, to be performed by the auditor.

Although seemingly straightforward at first glance, the regulations upon closer examination raise several important issues for the tax department. Tax planning services, tax advocacy services, expert services, and transfer pricing services all can raise issues of auditor independence under the new rules. As the person responsible for engaging tax advisers, the Vice President-Tax may want to consider carefully what auditor tax services he or she presents to the audit committee for approval. The content of such presentations also may be important. While the audit committee approval process offers the Vice President-Tax some assurance he or she is operating within the bounds of Sarbanes-Oxley, tax department personnel should keep in mind that the sufficiency and thoroughness of their disclosure to the audit committee will likely be reviewed carefully, especially if questions arise later.

Basic Principles

The final SEC regulations allow the company's independent auditor to perform a range of tax services for the company, while at the same time mandating limits on such services. The release accompanying the final regulations (the final release) (2) confirms that the audit firm may continue to provide tax services such as tax compliance, tax planning, and tax advice to audit clients, subject to audit committee pre-approval. (3) The final release also states, however, that audit committees and auditors should understand that providing certain tax services to audit clients could impair the auditor's independence in certain circumstances. (4) Clearly, the audit committee must exercise its pre-approval responsibility carefully, in a manner that preserves the auditor's continuing independence.

Congress and the SEC articulated three principles to be considered in evaluating whether non-audit services performed by the company's auditor would impair the auditor's independence. These principles are: (1) the auditor cannot audit its own work; (2) the auditor cannot function as a part of management; and (3) the auditor cannot serve in an advocacy role for the audit client. (5) A well-advised audit committee will consider these principles in deciding whether to approve the provision of a tax service by the company's auditor. (6) In particular, the principles that the auditor cannot serve in an advocacy role for the client and cannot audit its own work seem relevant to the audit committee's consideration of auditor tax services. For example, the final release states that the auditor may not represent an audit client in tax court. (7) It also suggests as a "best practice" that the auditor should not provide novel and debatable tax strategies for audit clients. (8)

Tax Planning Services

The new regulations contemplate that the auditor may provide tax planning services to its audit clients, if approved in advance by the audit committee. (9) In the final release, however, the SEC urged audit committees to consider carefully whether to engage the auditor for a transaction initially recommended by the auditor, the sole business purpose of which may be tax avoidance and the tax treatment of which may not be supported by law. (10) Assuming that the "sole business purpose" standard is to be taken literally, audit committees may face substantial difficulties in determining which transactions have a sole business purpose of tax avoidance and thus fall within the zone of increased scrutiny. (11) The question whether a transaction or arrangement has a non-tax business purpose has been the subject of numerous court cases (12) and can involve a highly subjective analysis. (13)

Audit committees may wish to be more conservative in approving auditor tax planning services. The SEC cited approvingly the conclusion reached by the Conference Board Commission on Public Trust and Private Enterprise that, as a "best practice," an auditor should not provide novel and debatable tax strategies and products that involve income tax shelters and extensive offshore partnerships or affiliates. (14) Members of the Conference Board...