Independence Rules and Tax Services
Presenter:
Wendy Hambleton
BDO USA, LLP
Importance of Independence
•An auditor’s impartiality is the indispensable quality that
inspires confidence in the dependability of his or her services,
and therefore the reliability of the financial statements.
•Independence is both in fact and appearance.
•If not independent financial statements are not considered
audited.
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What Organizations Set Independence Standards?
American Institute of Certified Public Accountants
(AICPA)
Public Company Accounting Oversight Board (PCAOB)
Securities and Exchange Commission (SEC)
Department of Labor (DOL)
Government Accounting Office (GAO)
International Federation of Accountants (IFAC)
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When do which Standards Apply
Private companies – AICPA, DOL, GAO, IFAC
Public companies – SEC, PCAOB, DOL, GAO, IFAC
For public companies independence includes all
periods in an IPO.
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AICPA Rules
Under AICPA Rules the following would be prohibited:
(a) assume the role of a client employee or management;
(b) conduct the operations of the client entity,
(c) consummate transactions,
(d) have custody of the client’s assets or
(e) exercise authority on behalf of the client.
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AICPA Independence Rules Pertaining to Tax
Accounting Services (Non-attest Services)
AICPA independence rules are applicable to all audits of privately held
entities including business acquired by an issuer that are filed with the
SEC per Rule 3-05. AICPA rules permit the auditor to perform tax
accounting services for the audit client provided:
•All management decisions and functions must be performed by the client
•An individual (preferably senior management) who possesses the suitable
skill, knowledge or experience to oversee and understand the concepts of
the tax accounting work is designated by the client
•The client must accept responsibility for the results of the tax accounting
work performed by the auditor
•Auditor must document in writing (engagement letter) understanding
with the client of the above responsibilities
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Example Wording in Engagement Letter
In order for us to remain independent, professional standards require us to
maintain certain respective roles and relationships with you with respect to the
non-attest services described above. Prior to performing such services in
conjunction with our audit, management must acknowledge its acceptance of
certain responsibilities.
We will not perform management functions or make management decisions on
behalf of your Company. However, we will provide advice and recommendations
to assist management of the Company in performing its functions and fulfilling its
responsibilities.
The Company agrees to perform the following functions in connection with our
performance of the (non-attest services):
Make all management decisions and perform all management functions with
respect to the (specify non-attest services) provided by us.
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Sample Engagement Letter - continued
Assign (name of the Company’s representative with the suitable skill, knowledge,
and/or experience) to oversee the (specify the non-attest services) and evaluate
the adequacy and results of the services.
Accept responsibility for the results of (specify non-attest services).
Establish and maintain internal controls over (the specified non-attest services).
The services are limited to those outlined above. We, in our professional
judgment, reserve the right to refuse to perform any procedure or take any action
that could be construed as making management decisions or performing
management functions. The Company must make all decisions with regard to our
recommendations. By signing this Agreement, you acknowledge your acceptance
of these responsibilities.
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AICPA Permitted Services
Under the AICPA rules, independence would not be considered to be
impaired if the auditor:
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Records transactions for which client’s management has determined and
approved the appropriate account classification;
Posts coded transactions to the client’s general ledger;
Prepares financial statements based on information in the trial balance;
Posts client-approved entries to a client’s trial balance;
Proposes standard, adjusting, or correcting journal entries or other changes
affecting the financial statements to the client; provided the client reviews the
entries and the auditor is satisfied that management understands the impact of
the proposed entries on the financial statements.
Calculate the tax accrual; or
Prepare the tax footnote disclosure
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AICPA Prohibited Services
Examples of some prohibited services under AICPA rules:
•Accepting responsibility to authorize payment of client funds
(electronically or otherwise), except as specifically provided for with
respect to electronic payroll tax payments;
•Accepting responsibility to sign or cosign client checks, even if only in
emergency situations;
•Maintaining a client’s bank account or otherwise have custody of a
client’s funds or make credit or banking decisions for the client;
•Signing payroll tax returns on behalf of client management; or
•Approving vendor invoices for payment.
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Overview of SEC Independence Rules-Basic
Concepts
• Registered public accounting firm are required to comply with Rules
that are applicable to all issuers and their affiliates (subsidiaries)
• If auditee is contemplating an IPO in the United States then auditor
must follow SEC independence rules for all years audited and included
in the registration statement
• SEC independence rules do not apply to audits of financial statements
of business acquired by the issuer that are filed with the SEC (Rule 3-05
financial statements)
• SEC views all member firms of a global accounting network as one Firm
• Non-audit services—three principles
• All audit and permissible non-audit services need to be pre-approved by
the issuer’s audit committee
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SEC Independence Principles Regarding Non-Audit
Services
•
SEC has three basic principles that the auditors of issuers
should use to evaluate whether the non-audit service such
as preparing a tax accrual will impair the auditor’s
independence with respect to the issuer:
1. An auditor cannot audit his/her own work.
2. An auditor cannot function as part of management
3. An auditor cannot act as an advocate for his/her
own audit client
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An Introduction of BDO
Non-Audit Services Prohibited by the SEC
• Bookkeeping or other services related to accounting
records or financial statements (generally applies to all tax
accounting services)
• Other prohibited non-audit services include financial
information systems design and implementation (i.e., tax
automation system work); appraisal and valuation;
actuarial; internal audit outsourcing; management
functions; human resources; legal; investment
bank/broker-dealer; and expert services
• There are no exceptions to this rule (ie, immateriality of
the subsidiary is not an exception)
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An Introduction of BDO
Prohibited Tax Accounting/Bookkeeping Service
Examples
•Maintaining or preparing the issuer’s accounting records
•Calculating the tax accrual
•Preparation of the tax footnote to the financial statements
•Providing the accounting firm’s tax calculation templates to
the issuer
•Converting foreign GAAP financial statement to US GAAP or
IFRS
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Permissible Non-Audit Services Related to Tax
Accounting
Permissible non-audit services related to tax accounting can be provided by the
auditor provided these services have been pre-approved by the issuer’s audit
committee:
•Transfer pricing
•Cost segregation studies and other tax-only valuation work
•Tax compliance services
•Tax planning and research
•Review of tax automation software installed by another service provider
•Consulting, reviewing, and commenting on the application of ASC 740 GAAP
requirements
•Calculating tax depreciation for the Form 1120 after the issuer has filed the
related year’s Form 10-K with the SEC
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Prohibited Bookkeeping/Tax Services Example
•ABC Accounting Firm’s Iceland affiliate is engaged by the local subsidiary of a
large publicly held USA corporation to determine and prepare the subsidiary’s US
GAAP tax accrual. The parent USA corporation is a publicly held audit client of
ABC Accounting Firm USA. The Iceland subsidiary is immaterial to the client’s
consolidated financial statements and the ABC Member Firm that performs the tax
accrual service does not perform any audit or statutory audit work for this client.
However, the tax accrual determination and calculation is considered under SEC
independence rules to be a prohibited bookkeeping service impairing
independence since this work will be subject to audit and is a management
function. As a result, tax accounting service was ceased immediately and ABC USA
issued a written independence communication to the client’s audit committee
informing them of this independence impairment.
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ASC 740-10 (SEC-FIN 48) Independence GuidanceProhibitions
• ASC 740-10 assistance provided by the auditor may result in a
prohibited bookkeeping service and the following services are
prohibited:
1) Drafting the implementation plan for the issuer
2) Drafting the ASC 740-10 required disclosures for the issuer
3) Providing advice, recommendations, findings or observations that
result in providing an issuer’s accounting staff a “roadmap” to
follow
4) Indentifying uncertain tax positions or otherwise performing a
management function
5) Preparing disclosures or assisting in the measurement of tax
positions or cumulative adjustments
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An Introduction of BDO
ASC 740-10 (FIN 48) Independence GuidancePermissible Services
• ASC 740-10 assistance provided by the auditor that are permissible
under the SEC independence rules include:
1) Review and provide comments to the issuer’s list of uncertain tax
positions
2) Consult on areas of exposure and/or applicable statues of limitations
3) Suggest additional items for the issuer to evaluate as uncertain tax
positions based on the auditor’s knowledge of the issuer
4) Provide technical advice, such as tax opinions on matters that are
not precluded by the PCOAB rules pertaining to confidential
transactions including transfer pricing and Nexus studies
5) Provide a reaction to drafts of disclosures prepared by the issuer or
its outside tax advisor
6) Make suggestions regarding tax planning or the management of tax
examinations
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An Introduction of BDO
SEC Independence Rule: Pre-Approval of Non-Audit
Services
• SEC independence rules require that the issuer’s audit committee preapprove all permissible tax services/non-audit services as well as all
audit and other assurance services
• Rule applies to issuer, its subsidiaries and its affiliates
• Non-audit services not pre-approved by the issuer’s audit committee
will impair the auditor’s independence
• PCAOB Independence rules reinforces existing SEC audit committee
pre-approval rules
• Registered public accounting firms must describe in writing to the
issuer’s audit committee the nature and scope of all tax services
• Required to discuss with audit committee the effects of all tax
services on accounting firm’s independence
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Pre-Approval
The SEC rules include a limited waiver (de minimis exception) of the preapproval requirement. The waiver is available only for permissible nonattest services. It is not available for: (1) audit services or (2) prohibited
non-attest services.
The following conditions have to be met in order to obtain the waiver:
• The aggregate amount of services is less than 5% of fees paid to the
Firm;
• The services were not recognized at the time the Firm was engaged to
perform the work; and
• The services are promptly brought to the audit committee’s attention
and approved prior to the completion of the audit.
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Audit Committee Pre-Approval Not Obtained –
Example
During the completion stage of an audit of a U.S. publicly held company, the
engagement partner discovered that a variety of tax services had been completed
by the registered public firm’s international affiliated firms without the required
pre-approved by the issuer’s audit committee. Furthermore, the pre-approval
requirements mandated by the PCAOB were also not met. Therefore, the
engagement partner needed to inform the client’s audit committee by the
required written communication mandated by PCAOB Independence rules that the
accounting firm’s independence had been impaired.
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Custody of Client's Assets
Activities involving custody of client’s assets are considered
“other services” related to accounting records of financial
statements that are prohibited by the SEC such as:
1) Receiving or forwarding the client’s mail
2) Maintaining corporate records, such as minutes
3) Remitting the client’s funds (whether electronically or
mailing) to a governmental taxing authorities
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An Introduction of BDO
PCAOB – Tax Services for Persons in Financial
Reporting Oversight Roles
• An auditor is not independent if the auditor provides tax
services to a member of management (and their immediate
family members) in financial reporting oversight role
(FROR) at the audit client or material subsidiary
• “Material” subsidiary is defined as 5% of parent’s
consolidated assets, revenues, or pre-tax income
• Excludes a client’s independent board members
• Tax services can be provided to persons in FROR for the
portion of the audit period that precedes the professional
engagement period
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An Introduction of BDO
PCAOB – Tax Services for Persons in Financial
Reporting Oversight Roles
• For new listed clients, tax services may be provided for
persons in a FROR during the year, but prior to being
auditor of the company and tax services must cease upon
appointment as auditor
• For existing non-listed clients, tax services may be
provided to persons in a FROR during the year, but only
prior to filing an IPO (or other corporate events such as
reverse mergers) where audit services become subject to
PCAOB standards
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Gifts, Privileges, and Entertainment
AICPA ethics Ruling No. 113 is applicable to all clients – audit
clients as well as non-audit clients (i.e., tax and consulting
clients) objectivity would not be considered to be impaired if
a Firm partner or professional staff offers or accepts gifts or
entertainment to or from a client (including an individual in a
key position with the client or an individual owning 10
percent or more of the client’s outstanding equity securities
or other ownership interests), provided that the gift is
reasonable in the circumstances.
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Reasonable in the Circumstances
Relevant facts and circumstances that should be considered include:
The nature of the gift or entertainment
The occasion giving rise to the gift or entertainment
The cost or value of the gift or entertainment
The nature, frequency, and value of other gifts or entertainment offered or
accepted
Whether the entertainment was associated with the active conduct of business
either directly before, during, or after the entertainment
Whether other clients participated in the entertainment; and
The individuals from the client and audit firm professional personnel who
participated in the entertainment.
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Example
A grateful client gives partner two tickets to the Super Bowl. The tickets are
considered a gift to the partner (since the client would not be accompanying the
partner). Since the value of the tickets is substantial, the gift is not reasonable in
the circumstances. Therefore, the partner must gracefully decline the gift of
Super Bowl tickets from the tax client, in order not to violate Rule 102 – Integrity
and Objectivity of the AICPA Code of Professional Conduct. If the client
accompanies the partner to the Super Bowl, this sporting event will then be
considered entertainment, as long as client business was conducted before,
during, or after the game. The partner should use his or her professional judgment
to determine whether the entertainment (sporting event) was reasonable in the
circumstances.
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Questions?
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