An Examination of Uncertain Tax Position Reserves Around the Purchase of Auditor Provided Tax Services

Abstract

Recent global audit failures combined with audit firms’ renewed focus on growing their consulting practices has increased regulatory attention on the impact of non-audit services on audit quality. In this study, we examine uncertain tax position reserves during the period prior to and immediately after a client purchases non-audit services for the first time from the auditor. We argue that audit firms could benefit from being overly skeptical of the tax planning of audit clients that do not purchase tax services because it increases the likelihood that the client will seek future tax advice from the auditor. Consistent with this argument, we find that companies report increases in tax reserves in the year before they begin purchasing auditor provided tax services (APTS). We also find that the tax reserve effects reverse after the client begins purchasing APTS. Consistent with incentives to sell APTS and inconsistent with a knowledge spillover effect, the increase and consequent decrease in tax reserves after purchasing APTS is driven by discretionary tax reserves and tax positions taken in prior periods. Furthermore, we find that this behavior reduces the accuracy of tax reserves implying a reduction in the quality of income tax information. Overall, the results are consistent with auditors influencing firms’ accounting for uncertain tax positions in a manner consistent with incentives to sell their own tax advisory services, which potentially impairs auditor independence and reduces accounting quality.

Keywords: Auditor independence, Non-audit services, auditor provided tax services, tax reserves, uncertain tax positions