VIA E-MAIL DELIVERY TO RULE-COMMENTS@SEC.GOV
United States Securities and Exchange Commission
Re: 17 CFR Parts 210, 240, 249 and 274
Ladies and Gentlemen:
On behalf of Tax Executives Institute, I am pleased to submit the following comments on Proposed Rule RIN 3235-A173, "Strengthening the Commission's Requirements Regarding Auditor Independence" (the "Proposed Rules"), published in the Federal Register for December 13, 2002,1 related to the Sarbanes-Oxley Act of 2002 (the "Act").2 As the preeminent association of business tax professionals, TEI has a significant interest in maintaining the integrity and vitality of America's self-assessment tax system and the financial reporting system of which the provision for taxes, at the Federal level and the state and local levels in the United States, and for foreign levies as well, is a material part. The Act was passed to address concerns that our members share with the investing public. TEI supports the general purposes of the Act, but urges the Commission to clarify the application of the rules with respect to rendering tax services.
Stated simply, registrants must be able to obtain these tax services under rules of sufficient clarity of application so that the relatively simple decision of selecting a vendor for the respective service does not itself carry unreasonable burdens or penalties for foot faults. Absent such clarification, qualified vendors for particular services will be effectively disqualified simply out of caution, and both taxpayers and service providers - the marketplace (including the investing public) - will be disserved.
Tax Executives Institute was established in 1944 to serve the professional needs of business tax professionals. Today, the Institute has 53 chapters in the United States, Canada, and Europe. Our more than 5,300 members are accountants, attorneys, and other business professionals who work for 2,800 of the leading companies in North America and Europe. As a professional organization, the Institute is firmly dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. The Institute is committed to maintaining a system that works - one that builds upon the principle of voluntary compliance and is consistent with sound tax policy, one that taxpayers can comply with, and one in which the IRS can effectively perform its functions without unduly burdening taxpayers. We also support efforts to ensure that companies fairly present their financial condition in financial statements and related documents filed with the SEC.
These goals can only be achieved through our members' adherence to the highest standards of professional competence and integrity. To ensure compliance with the law, TEI's Standards of Conduct exhort the members to "present the facts required in tax returns and all the facts pertinent to the resolution of questions at issue with representatives of the government imposing the tax." As important, the members "recognize an obligation to make an affirmative contribution to the sound administration of the laws, and to the adoption of sound legislation, by cooperation and consultation with the persons charged with those functions, having due regard for the interests of society, as well as the interests of the company and its employees." In short, TEI members agree that a balance must be struck between public duty and private right.
TEI members are responsible for conducting the tax affairs of their companies and ensuring their compliance with the tax laws. TEI members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily basis. Most of the companies represented by our members are subjected to scrutiny by the U.S. Internal Revenue Service and by various other agencies in the United States and foreign jurisdictions on a continual basis.
As a professional association of in-house tax executives, TEI offers a different perspective on these issues from other organizations. The Institute does not represent the professional advisors (be they attorneys or accountants) who render these tax services. Rather, TEI's members work directly for the corporations that routinely enter into business transactions that require an analysis of their tax benefits and burdens. These companies have professional staffs dedicated to ensuringcompliance with the law while minimizing their tax liability. To accomplish this objective, TEI members engage the services of professional tax advisers, including those rendered by their companies' independent auditors. We, along with the government and the investing public, have the most at stake in trying to craft a financial reporting system that fairly presents the results of operations and is as administrable and efficient as possible.
Some of the controversy surrounding the adoption of the Act, as well as the Proposed Rules, relates to the potential effects of the legislation's auditor independence rules upon audit firms and other professional firms rendering professional tax services in conjunction with or ancillary to audit services to registrants. TEI members are the consumers of such services, and their interests involve not only the concerns to which the Proposed Rules are directly aimed, but also the ability to obtain various necessary tax services of the highest quality in an efficient and cost-effective manner. These services3 are not generic but in fact vary widely in their character - their fundamental nature, their relationship to the tax provision that is part of the financial statements, their relationship to U.S. federal law, and even whether they are related to levies or impositions of the United States, or to its political subdivisions, or to a foreign government.
Structure of the Proposed Rules
Section 201 of the Act provides in pertinent part:
(a) Prohibited activities. Section 10A of the Securities Exchange Act of 1934 (15 U.S.C. 78j-l) is amended by adding at the end the following:
"(g) Prohibited Activities - Except as provided in subsection (h), it shall be unlawful for a registered public accounting firm (and any associated person of that firm, to the extent determined appropriate by the Commission) that performs for any issuer any audit required by this title or the rules of the Commission under this title or, beginning 180 days after the date of commencement of the operations of the Public Company Accounting Oversight Board established under section 101 of the Sarbanes-Oxley Act of 2002 (in this section referred to as the `Board'), the rules of the Board, to provide to that issuer, contemporaneously with the audit, any non-audit service, including -
"(1) bookkeeping or other services related to the accounting records or financial statements of the audit client;
"(2) financial information systems design and implementation;
"(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports;
"(4) actuarial services;
"(5) internal audit outsourcing services;
"(6) management functions or human resources;
"(7) broker or dealer, investment adviser, or investment banking services;
"(8) legal services and expert services unrelated to the audit; and
"(9) any other service that the Board determines, by regulation, is impermissible.
"(h) Preapproval Required for Non-audit Services - A registered public accounting firm may engage in any non-audit service, including tax services, that is not described in any of paragraphs (1) through (9) of subsection (g) for an audit client, only if the activity is approved in advance by the audit committee of the issuer, in accordance with subsection (I).
"(b) Exemption Authority. - The Board may, on a case by case basis, exempt any person, issuer, public accounting firm, or transaction from the prohibition on the provision of services under section 10A(g) of the Securities Exchange Act of 1934 (as added by this section), to the extent that such exemption is necessary or appropriate in the public interest and is consistent with the protection of investors, and subject to review by the Commission in the same manner as for rules of the Board under section 107." (Emphasis added.)
Thus, in seeking to strengthen auditor independence, the Act provides in new subsection (g) that certain categories of non-audit activities, by their inherent nature, presumptively compromise auditor independence, either in actuality or in appearance, and thus may not be offered by a registered public accounting firm, except as provided in subsection (h). In new subsection (h), the Act provides that a registered public accounting firm may engage in any non-audit service, including tax services, if it is not described in any of paragraphs (1) through (9) of subsection (g) for an audit client, as long as the service is approved in advance. Lastly, in section 201(b) of the Act, the Board is granted authority, on a case-by-case basis, to exempt a transaction, issuer, or firm from the prohibitions of subsection (g) if in the public interest and consistent with the protection of investors.
There is circularity in the application of subsections (g) and (h) of section 201, the consequence of which is confusion and major ambiguity. While Congress intended to make changes in current law, it intended to infuse the operation of the rules with some flexibility depending on the facts of each case. Thus, there remains an important question whether the provisions of the Act, taken together, hold that non-audit "tax services" (despite their mention in subsection (h)) are not as a category wholly within subsection (h), but rather must be evaluated to determine if they are within the types of services that are prohibited outright by subsection (g) or, alternatively, whethertax services are permitted under the procedures of subsection (h) without reference to subsection (g). The Proposed Rules are not clear on the factors that registrants (through their audit committees) should utilize when making such determinations, and hence provide precious little clarity about the discharge of the duties imposed by the Act on the board of directors, audit committee, and executives of the company.
The legislative history of the Act provides in relevant part:
"The intention of this provision is to draw a clear line around a limited list of non-audit services that accounting firms may not provide to public company audit clients because their doing so creates a fundamental conflict of interest of the accounting firms. The list is based on simple principles. An accounting firm, in order to be independent of its audit client, should not audit its own work, which would be involved in providing bookkeeping services, financial information systems design, appraisal or valuation services, actuarial services, and internal audit outsourcing services to an audit client. The accounting firm should not function as part of management or as an employee of the audit client, which would be required if the accounting firm provides human resources services such as recruiting, hiring, and designing compensation packages for the officers, directors, and managers of an audit client. The accounting firm should not act as an advocate of the audit client, which would be involved in providing legal and expert services to an audit client in legal, administrative, or regulatory proceedings, or serving as a broker-dealer, investment adviser, or investment banker to an audit client, which places the auditor in the role of promoting a client's stock or other interests....The legislation requires that audit services, as well as non-audit services other than those proscribed by the bill, must be pre-approved by the audit committee of the public company's board of directors. The Committee heard testimony on the role that the audit committee of a public company should play in connection with the engagement of an auditor to provide audit and non-audit services contemporaneously....After studying this issue, the Committee believes the protection of investors warrants a requirement that a public company's audit committee approve in advance the services that the auditor will provide to such company (if those services are not explicitly prohibited under the bill). Accordingly, the bill requires the audit committee of a public company to pre-approve all of the services, both audit and non-audit, provided to that company by a registered public accounting firm. The bill does not require an issuer's audit committee to pre-approve non-audit services provided by an accounting firm that is not auditing the issuer. 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." S. Rep. No. 107-205 [Public Company Accounting Reform and Investor Protection Act of 2002], reprinted in Hardesty, Corporate Governance andAccounting Under The Sarbanes-Oxley Act of 2002, at ¶ 5003 (Warren Gorham & Lamont, 2002) (the "Senate Report").
TEI submits that giving meaningful and practical scope to these rules must be a fundamental purpose of the Proposed Rules.
The term "tax services" encompasses many different types of activities performed by public accounting firms, law firms, various types of appraisal and evaluation firms, and lobbying and governmental relations specialists. As described in the ABA-AICPA 1981 Statement, legal services and accounting services are often inextricably intertwined in the field of federal income taxation.4 Larger public accounting firms have expanded their practices in recent decades, and their multidisciplinary practices now offer a wide variety of bundled services offered by various departments, offices, and personnel, sometimes spread across many jurisdictions. In many cases, the availability of these services from the audit firm represents a convenience to companies, but in some cases their availability may be critical or even necessary because of the absence of viable or cost-efficient alternatives.
For example, in some foreign jurisdictions it may be difficult or even impossible for multinational companies to obtain consulting services on the taxes of that jurisdiction from consultants who are able to understand their application to multinational companies and who do not work for a large public accounting firm. To be sure, the company may be able to obtain the foreign tax services from a public accounting firm that is not its auditor, but even if the services were available from competing public accounting firms, their incremental cost (in terms of both money and learning or training time to become familiar with the company's business) may be prohibitive.5
Tax services may be generally grouped in certain subcategories:6
(1) Return preparation and compliance. Most registrants (including those by whom our members are employed) have in-house compliance personnel who perform much or most ofthe tax compliance function. Others may employ outside professionals to perform such functions. Thus, public accounting firms and other consultants are often employed to render services in conjunction with these functions. For example, firms may offer data accumulation or processing functions,7 or other more routine, less technical services. Or they may be asked to analyze such data with an eye to whether transactions can be reported in alternative ways under complex provisions of law to minimize the taxes to be paid.8,9 These analyses and studies may be quite complex and may require the application of substantial technical resources. Other issues may also be referred to outside consultants for resolution by technical experts, either because the taxpayer may not have technical expertise within its organization, because the taxpayer wishes to confirm that its own personnel have reached an appropriate resolution, or just because of the volume of the work to be performed and the availability of suitable internal resources.
(2) Accrual of taxes for purposes of the provision for taxes in the financial statements. Tax department personnel of the public accounting firm may assist audit department personnel of the firm and the company accounting and tax personnel with respect to the necessary accruals of taxes that are part of the financial statement presentation of the results of operations. These tax accruals relate to the tax return positions taken on various issues, and are in many cases material to the financial position of the company. Review of the accruals may be a critical part of the audit process.10 Review of the accruals and underlying transactions also may reveal issues that give rise to further consultation with the company on possible changes to the tax returns or may affect planning for future transactions.
(3) Tax planning and advice. Public accounting firms and other tax consultants often provide advice on prospective operations or activities. Public accounting firms may also suggest alternative tax plans or tax minimization strategies to companies where they believe that the particular strategy may be beneficial. These activities may involve an analysis of many factors applicable to the circumstances, including whether certain provisions of U.S. or foreign law may apply, which corporate or other legal structures should be employed, and how the resulting transactions should be reported in all those jurisdictions. Designing a particular structure may result in a request by the company for assistance in obtaining an advance ruling from the relevant tax authorities that the anticipated structures will be respected if the transactions are consummated.11 Obtaining the requested rulings may involve analysis and the submission of a technical request for ruling, meetings with personnel of the respective tax authorities, and in some cases administrative proceedings.
(4) Valuation and Transfer Pricing Services. Either in conjunction with tax advice and planning services, or as a stand-alone service, public accounting firms often engage in valuation studies12 or analyses that are employed in the context of determining an appropriate transfer price for the sales of goods or the sale or license of intangible assets, including appropriate royalty rates.
(5) Tax Controversy and Litigation Services. As in the context of return preparation and compliance functions, many companies turn to outside experts, including public accounting firms, for assistance in matters arising from the examination of their returns by various tax authorities. In the early stages of an examination, much of the activity of company personnel and outside consultants involve responses to inquiries (including requests for documents that in some cases involve the organization and production of voluminous responses). In later stages, if adjustments to the returns are proposed, a full range of services may be necessary to sustain the taxpayer's position on the tax return or report that may include preparation of memoranda, administrative protests and briefs, supporting studies and analyses, and meetings with tax officials and administrative appeals. Ultimately, proposed adjustments may result in formal litigation with the tax authority. As adjustments are proposed, the company may be prompted to take a different position in a previously filed return as well. In that situation, a claim for refund may be possible, which in turn may lead to additional services of a similar nature.
(6) Lobbying before regulatory agencies and legislative bodies. In addition to complying with existing law, taxpayers are often concerned with modifying the tax law treatment of particular transactions in the future (or even in the past) or in deflecting or discouraging changes in the tax law treatment of various items as such changes may be suggested by others, including interpretative regulations issued by tax authorities, or statutory law as enacted by Congress, the states, or foreign jurisdictions.
As stated at the outset, TEI supports the basic purposes and general approach of the Act and the Proposed Rules. In clarifying and promulgating the rules, the Commission should consider the following:
Tax services are not a generic, one-size-fits-all type of activity. The term "tax services" encompasses a wide variety of services, each of which may carry its own implications depending upon the specific circumstances. At the same time, Congress seemingly intended that a different sort of analysis would govern, as evidenced by the specific inclusion of the term "tax services" in subsection (h). Commentators have forcefully urged conflicting constructions of these provisions and their intent.
The final rules must directly solve this conundrum. More fundamentally, they should be capable of clear application. Registrants (their boards of directors, their audit committees, and their executive officers) and service providers alike have an interest in rules that may be readily understood and confidently applied. If the rules are ambiguous - and therefore confusing - prudence will often (if not always) dictate that the company not ask the auditor to render the service, which may be cost-inefficient and counter-productive. TEI believes that the "tax marketplace" is best served by according registrants the broadest array of choices (of advisers) consistent with the purposes and provisions of the Act. Regrettably, an unintended consequence of the Proposed Rules may be to narrow the range of choices, not because of explicit policy decisions but rather because of less than optimal drafting. Thus, the Proposed Rules in some cases seemingly treat tax services as if they were generic in character; in some cases suggest that the three-factor test described in the legislative history13 should be used, or at least may be relevant; and in other cases seem to say that registrants may make their own approach without giving them the comfort of a "safe-harbor." The Proposed Rules apply conflicting principles to these determinations.
A determination that all tax services are within the purview of the rules of subsection (h) will provide registrants with the greatest potential range of services from an audit firm provider and, inmany cases, at the lowest cost given the firm's likely familiarity with the company. If, however, it is determined that the rules require particular tax service to be measured against the prohibitions of subsection (g), TEI believes it appropriate to address the concerns in the following manner:
(1) Particular tax services would be examined on a service-by-service basis.
(2) The rules of subsection (g) of section 201 of the Act should be applied to each such service to be provided. Specifically, the audit committee would consider the application of factors identified in the Proposed Rules:
(a) An accounting firm, in order to be independent of its audit client, should not audit its own work.
(b) The accounting firm should not function as part of management or as an employee of the audit client.
(c) The accounting firm should not act as an advocate of the audit client, which would involve providing legal and expert services to an audit client in legal, administrative, or regulatory proceedings, or serving as a broker-dealer, investment adviser, or investment banker to an audit client.
(3) In determining whether services are prohibited by subsection (g), an analysis should be made whether the effect of the service will result in a change in the company's tax accrual or its financial condition that is material when considered on a cumulative basis under principles similar to those already existing under generally accepted auditing standards. This determination may include a consideration of either or both transaction amounts and professional fees. If the service is not material, the service should be permitted.
Whichever approach to tax services is chosen by the Commission, the prescribed approval procedure under subsection (h) of section 201 of the Act should allow for blanket approvals for a particular audit period of specific services that may occur on more than one occasion (that otherwise meet the requirements of the preceding recommendations if so determined). An audit committee and the executive staffs should not have to pre-approve every single occurrence of a particular service (e.g., informal tax advice on unrelated issues in multiple phone calls).
The rules as finally adopted should provide that reasonable compliance with these procedures in the best judgment of the audit committee and the Board of Directors should be legally sufficient to discharge the members of the Board and the executive staff of the company of their responsibilities under these provisions of the Act.
We appreciate the opportunity to comment on the Proposed Rules. We would be willing to meet with staff of the Commission or the Public Company Accounting Oversight Board to further explain our views.
Any questions about the Institute's views should be directed to Fred F. Murray, the Institute's General Counsel and Director of Tax Affairs at 202.638.5601, or firstname.lastname@example.org.
Tax Executives Institute, Inc.