Robert T. Bossart
34 South Lewis Place
Rockville Centre, New York 11570
January 2, 2003
The Securities and Exchange Commission
Office of Investor Education and Assistance
450 Fifth Street, NW
Washington, D.C. 20549
To The Commission:
As an international tax partner who retired from Arthur Andersen over a year before the Enron debacle, and based on the standards set forth by Congress in enacting the Sarbanes-Oxley Act of 2002, I believe that there are only five "tax services" that an auditor should be able to provide to an SEC registrant without losing its independence:
- Preparing the corporate income tax returns from the company's audited books and records after reflecting all audit adjustments;
- Preparing the corporate ERISA (or non-US ERISA equivalent) tax returns from the company's audited ERISA (or non-U.S. ERISA equivalent) books and records after reflecting all audit adjustments;
- Reviewing the company's income or ERISA tax returns prepared by the company so long as the review is sufficient to require the auditor to sign the tax return as a "Preparer" under the U.S. Federal income tax rules;
- Responding to tax return examination questions about how the auditor prepared the tax return under examination; and
- Responding to an audit client's tax questions only on factual matters for which only one answer exists, e. g., on what form does the U.S.-based registrant file its U.S. Federal tax return?
This assumes that the SEC continues to view the auditor's review of a registrant's tax accruals reflected in the financial statements as part of audit services, a view with which I concur.
Strictly limiting an auditor's tax services to these five areas is the only way to meet the goals, objectives, and principles stated by Congress and reiterated by the SEC in issuing its proposed rules. First and foremost, it is difficult if not impossible to restore investor confidence without absolute independence of auditors from their registrant clients. To achieve this goal, it is just as important to create independence rules that are easy to understand and apply by auditors, registrants, the SEC, and investors alike. Therefore, "bright line" rules are imperative. Each of the five tax services above meets that test.
Once the relationship goes beyond pure tax compliance into any area where multiple answers or "gray areas for interpretation" might exist, relationships can and most likely will begin to blur, making enforcement more difficult and eroding investor confidence. There is absolutely no need to risk such complications where a significant number of alternative providers of tax services exist in the marketplace, including different CPA firms (from the registrant's auditor), law firms, and possibly other tax specialists. Likewise, any registrant's one-time transitional cost to a new tax advisor is less than the investing public's losses since Enron and the potential for future losses without investor confidence in the absolute independence of auditors.
Likewise, only the five tax services above meet the three key Congressional and SEC principles regarding auditor independence in performing non-audit services for clients. They are that the auditor cannot (1) audit its own work, (2) perform management functions, OR (3) act as an advocate for the client. Any action which violates even one of these principles fatally impairs the auditor's independence.
It is difficult if not impossible to think of a situation involving tax planning that does not violate one or more of these three principles. Any issue for which more than one answer may exist puts the tax advisor into the position of becoming an advocate for the client. It also can generate having one outcome reported in the tax return ("tax return position"), but a higher amount of tax reserves created than required by the tax return position in order to reflect the possible additional taxes which the registrant may have to pay if the tax authorities successfully challenge that reporting ("tax reserve position"). Under such circumstances, the auditor then must audit its own work because opining on the adequacy of the tax provision and tax reserves reflected in the registrant's financial statements is a requirement of any financial statement audit. If the issue is large enough, such as a global tax minimization study, the tax advisor's involvement in the registrant's affairs may even rise to the level of performing management functions. Thus, any tax planning issue for which more than one answer or implication exists fatally impairs an auditor's independence by violating at least one if not more of the three key principles.
For example, consider transfer pricing. Transfer pricing is a tax planning issue that represents the prices at which a group of related parties in different tax jurisdictions that have different tax rates transfer goods, intangibles, services, and capital among members of the group. Aggressive transfer pricing positions can have an immediate as well as long-term impact on a company's financial statements as long as the tax rates between the two jurisdictions involved are different. (This is why the unsupported comment in section 3 that transfer pricing studies are acceptable for auditors to perform because they are used for non-financial reporting is totally incorrect - just as the related comment about cost segregation studies is incorrect because of tax credit reasons in some jurisdictions.)
Related parties are required to make such transfers at prices as if the members were dealing with unrelated parties. However, a "price list" (of acceptable interest rates) exists only for capital transfers to and from the United States. No equivalent acceptable price list exists for goods, intangibles or services in the United States or probably any other jurisdiction. As a result, creating and maintaining an international or domestic transfer pricing policy requires considerable judgment as well as objective facts and functional analysis. Likewise, transfer pricing is the largest area of tax return examination disputes between companies and tax authorities worldwide. Therefore, many companies report their incomes using for their tax return position what they believe are acceptable transfer prices, supported by expert economic analyses as required in the United States. Many of these same companies then establish a tax reserve position based on expert economic analysis and provide additional taxes to their tax reserves in case the tax return amounts are successfully disputed by the Federal, state or provincial, or local tax authorities.
Given these circumstances, having the auditor use its tax and economic professionals to perform the transfer pricing analysis directly violates the prohibition against performing expert services. It also requires the auditor to audit its own work to determine whether the reserves the registrant establishes are adequate to meet the potential additional tax liability requirements during some future tax examination dispute over the amounts reported in the return. If the tax authorities do dispute the reported amount, then the auditor becomes the registrant's advocate during the tax dispute by arguing why the reported amounts should be accepted by the tax authorities. If the tax authorities are successful for an amount higher than that originally reserved, the auditor bears some responsibility for the negative impact on the subsequent year financial statements since it was the auditor and its economics expert which helped the registrant establish the original transfer pricing tax reserve position and then signed off on it as being adequate but not excessive under the accounting rules. This is exactly the lack of independence that Congress intended to eliminate.
This same argument applies to any other form of tax planning by the auditor. The need for tax return and tax reserve positions that tax planning generates puts the auditor in the position of auditing its own work, probably acting as an advocate for its client when the tax authorities examine the tax return, and possibly involve it in management functions if the scope of the project is large enough. Where violating only one of the three principles can fatally impair an auditor's independence, most if not all tax planning violate at least two if not all three of these principles. That is why only the five tax services originally mentioned above satisfy the goals, objectives, and principles of Congress and the SEC. Consistent with Congressional intent and the Sarbanes-Oxley Act of 202 itself, the five tax services enumerated are simple to understand, easy to implement as well as to enforce, and capable of enhancing investor confidence in the independence of auditors. In today's environment, that is exactly what is needed.
Thank you for considering these comments. I would look forward to answering
any questions that you may have.
Very truly yours,
Robert T. Bossart