Putting SEC Heat on Audit Firms and Corporate Tax Shelters: Responding to Tax Risk with Sunshine, Shame and Strict Liability
49 Pages Posted: 25 Nov 2003
In passing Sarbanes-Oxley, Congress missed an opportunity to address the impact on auditor independence and corporate governance of the tax services provided by auditors to reporting companies and their executives. Although the SEC's adopting release for auditor independence rules suggests that audit committees should not approve auditor tax services for transactions that lack a business purpose, the only non-audit tax service that the rules unambiguously prohibit is auditor representation of audit clients on tax issues in court proceedings.
This Article argues that the SEC's approach fails to respond adequately to the multidisciplinary expansion of audit firms. In particular, this Article contends that the inadequacy of audit committees' information about audit firms hinders their ability to perform key functions of selecting auditors and approving non-audit tax services. Similarly, directors likely have insufficient information about a reporting company's tax risks to permit effective monitoring of internal tax and accounting functions or company participation in potentially abusive tax transactions. Those information asymmetries also leave investors without tax risk information that would otherwise factor into investment decisions.
To address these problems, this Article urges the SEC to ban auditor provision of certain tax shelter services. These rules need not invent a separate, SEC-generated definition of problematic tax shelters. They can simply adopt by cross-reference the reporting categories for corporate tax shelters established in the IRS's recently finalized corporate tax shelter regulations. The Article also proposes two types of internal tax risk disclosure, also based on the IRS reporting categories, to enhance company directors' decisionmaking. The audit firm tax risk profile and reporting company tax risk profile would provide objective information to directors about audit firm and reporting company promotion of, and participation in, aggressive tax transactions. As an additional benefit, the profiles would counter the tendency of auditors to acquiesce in promoters' analysis of aggressive tax transactions. Finally, the Article proposes certain public disclosure based on these tax risk profiles, and a series of strict liability penalties to deter non-disclosure and ensure adequate review.
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