It’s not unusual for public companies to have the same firm perform their external audits and prepare their tax returns. But does this practice raise auditor independence issues?
Some people feel that it could create conflicts of interest or impair auditor independence. For such reasons, the European Union will soon prohibit public interest entity auditors from preparing their clients’ tax returns and providing a variety of other tax services.
On the other hand, research suggests companies whose auditors prepare their tax returns tend to take less aggressive tax positions. And surveys have found many investors prefer to have a company’s auditor do its taxes.
To some degree, then, beyond following all tax reporting and audit guidelines for your locale, the decision comes down to your firm’s preferences.
The Sarbanes-Oxley Act of 2002 prohibited certain services and relationships that it deemed to impair auditor independence. These include:
- Financial information systems design and implementation
- Appraisal and valuation services
- Actuarial services
- Internal audit services
Notably absent from the list: tax services.
As a rule, auditor-provided tax services don’t raise independence issues if the company’s audit committee approves the arrangement. But that doesn’t mean the arrangements are always permissible.
Understanding potential conflicts of interest
Even though tax services aren’t prohibited, they may violate SEC auditor independence rules if they create a conflict of interest. A potential conflict of interest could occur when:
- An auditor-developed tax strategy results in sanctions against the company or some other legal liability.
- An auditor is tasked with auditing their own work or serves as an audit client’s advocate, thereby impairing their independence per SEC rules.
Additionally, the Public Company Accounting Oversight Board (PCAOB) prohibits auditors from providing tax services under certain circumstances. These include occasions when:
- The auditor receives a commission or contingent fee for such services
- The auditor advises the company regarding certain confidential or “aggressive” tax transactions
- The auditor provides tax services to someone in a financial oversight role with the company
What are the benefits of using the same tax and audit provider?
Despite these potential issues, there may be advantages to having your auditor do your taxes.
According to a study published in The Journal of the American Taxation Association, many investors believe the benefits of auditor-provided tax services — including enhanced financial reporting as a result of “knowledge spillover” — outweigh potential threats to auditor independence.
Another notable finding is that auditor-prepared tax returns tend to contain fewer aggressive tax positions. According to a study published in The Accounting Review, corporate tax returns prepared by external auditors claim approximately 30% fewer questionable tax benefits than returns prepared in-house or by non-auditors.
The authors believe auditors are more familiar with certain risks — including financial reporting restatement and reputation risks — than other types of tax preparers. As a result, auditors tend to avoid knowingly taking questionable tax positions.
Review your arrangements
Auditors in the U.S. aren’t strictly banned from providing tax services to audit clients, and having the same firm provide both services does offer certain advantages. Still, it’s critical for audit committees to review these arrangements carefully to assess their potential impact on auditor independence and ensure compliance with SEC and PCAOB rules.
How Wipfli can help
Whether you’re looking for audit reporting assistance or tax filing guidance — or both — Wipfli’s team of tax and auditing specialists can help. Contact us today to learn more.
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