Tax Internal Controls in an Era of Transparency and Disclosure: S0X404, ASC 740, and PCAOB may seem easily managed but pose significant risks if not closely monitored.

Author:Bennecke, John P.
Position:Sarbanes-Oxley Act of 2002, Public Company Accounting Oversight Board

To meet the demands of the Public Company Accounting Oversight Board, audit firms continue to increase activity related to internal controls. So, what's the big deal? Let's look at some numbers:

* tax accounting was the second leading cause of 2016 financial restatements;

* in 2016, ninety-eight percent of financial restatements were tax related;

* an average of thirty-six hours was spent on each key control (including design, documentation, and testing); and

* almost sixty percent of reported tax material weaknesses were attributed to insufficient tax accounting expertise, insufficient review, and lack of general procedures.

Those numbers aren't a total surprise. For over a decade, multinational and domestic companies alike have faced the burden of complying with everchanging and evolving rules and guidelines for tax internal controls that have left confusion, frustration, and restatements in their wake.

Most recently, we have wrestled with uncertainty in the current U.S. tax environment, including its impact on global organizations and global jurisdictions. As of the passage of the Tax Cuts and Jobs Act, or TCJA (2017), we all began 2018 trying to navigate a bumpy landscape that offers more questions than answers. A rocky road is not new for tax professionals, for whom change seems to be the status quo, but the TCJA added risk to an already risky terrain.

This article discusses relevant areas that may help you improve your tax internal control environment. To do so, I think it's important to first revisit the past.

A History Lesson

In direct response to a few well-documented and now current accounting case studies, we are left with an environment that has been forever changed by the Public Company Accounting Reform and Investor Protection Act of 2002. You may know this as simply "the Act" or "Sarbanes-Oxley" ("SOX"). For some of you, the Act may be academic. For others, it plays a near-daily role in your practice. For me, SOX was the impetus behind my being forever transformed from a practicing tax professional into a part-time auditor at one of the Big Four (or, at the time, Big Five) firms.

Section 404 of the Sarbanes-Oxley Act

When the Act was enacted in 2002, it was the most significant accounting and financial legislation issued in nearly a decade. Although the Act contains several sections, I will delve into Section 404, on management assessment of internal controls. This section aims to provide certainty and security for those who make investment decisions based on issued financial statements. It is relevant to readers of those statements, analysts and investors in capital markets, and the public at large.

When the Act was enacted, public companies now had to implement Section 404 within their tax environments and throughout their companies' financial processes. The first year presented companies, and all of us working within and with those companies, many challenges and significant additional costs associated with implementing SOX. Now, sixteen years later, many of us are still undecided as to whether SOX and Section 404 in particular have succeeded as intended.

In the early days of Section 404, not only were companies and their staff heavily involved in designing and implementing the internal controls environment, but so were the Big Four and many mid-tier firms. These accounting firms provided significant services in this area. In retrospect, this seems a bit ironic, given the behavior of certain audit firms and several well-publicized failures that led to the creation of the Act in the first place. The emphasis on auditor independence was, and continues to be, a significant feature of SOX. Even today, there are still concerns about how independent audit firms are from the clients they serve and what lines are blurred or ignored. We will explore this area in more detail, but for now it is worth considering your own tax...

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