RSM Resources

For years, public companies with complicated tax issues could simply turn to their outside audit firm for assistance. But following the passage of the Sarbanes-Oxley Act of 2002 (SOX), that choice could land companies in choppy regulatory waters.

SOX, and new Securities and Exchange Commission and Public Company Accounting Oversight Board rules that followed, prohibit auditors of most publicly held companies from reviewing their own work. These auditors also can’t perform management functions or prepare source data for financial statements.

So who can you turn to for help in calculating your company’s "tax provision" — an estimate of current and deferred tax assets and liabilities as required by Financial Accounting Standard 109 (FAS109) — if you don’t have that expertise on staff?

"This is a real headache for both management and the auditing community, because they’re arriving at this problem at about the same time," says Chuck Landes, vice president of professional standards for the American Institute of Certified Public Accountants (AICPA) in Washington, D.C. "For that reason, a lot of midsized public companies are now having to look for a second consulting partner to figure out the right answers on their tax provisions."

While SOX specifically prohibits audit firms from also providing several non-audit functions — such as bookkeeping, appraisal or valuation services, broker-dealer services, or decision-making as an officer,manager or director of a company — for the same company, the restrictions on tax services are not as clear-cut.

For example, the audit committee of a public company may "preapprove" permissible non-audit services, including certain forms of tax work. But the new regulations don’t precisely define where acceptable tax-related services — such as compliance, planning or advice — may overlap with the prohibited non-audit activities. Given that wide latitude for interpretation, many audit committees have simply chosen to reject non-audit services from their primary external audit firm.

Clearly, public companies face the most difficult challenges in managing the audit and tax separation issue. But that doesn’t mean private firms should overlook the issue. Increasingly, privately held companies are adopting SOX safeguards because they make good business sense.

Since audits in most private companies typically have a limited number of uses, mainly with lenders and insurance providers, Landes says financial managers may benefit from talking one-on-one with your lender and insurance company to see if they’d like to see a clearer division between your company’s audit and tax functions.

While separating tax and audit functions is clearly not appropriate for all private businesses, there are situations where it makes sense. Companies seeking investment from venture capitalists or developing a long-term strategy to go public would be wise to separate their tax and audit functions to avoid any hint of impropriety. And businesses in which the accounting firm handles not only audit and corporate tax, but also personal tax and financial planning for key executives, may want to consider how that arrangement may look to third parties such as lenders and insurers.

"In that case, a banker considering a business loan may have a right to be concerned about the audit and tax partnership," Landes says. "The consultant may be so personally close to the situation that they might not be totally objective when it comes to a review of the financial statements."

If your company is making choices about how to separate its audit and tax preparation functions, experts suggest the following steps:

For a private company, do a cost/benefit analysis. Experts say the main advantage to using a separate provider for tax services is the assurance of auditor independence. But private firms with existing audit and tax relationships in a single firm should carefully weigh the independence issue against the loss of institutional history.

"A good test for a private company executive is to ask, "If I were in a public firm, could my outside auditor do this tax work for me?’" Landes says. "If the answer is no, I’d need to consider the additional cost of hiring a second firm against the improved perception that my company is financially well-run."

Seek out recommendations. Not all accounting and CPA firms have the same level of expertise in tax and FAS 109-related matters. Professionals suggest that finance leaders contact peer companies in a given industry, or members of trade associations who have expertise in financial management for referrals.

Prepare detailed interview questions. Once you select a list of consulting firms to approach,use the same questions in each screening interview. Be prepared to ask about aconsultant’s FAS 109 qualifications and its work with similar companies. If your business has international operations, make sure to determine if the prospective consultant has experience preparing or reviewing foreign tax provisions. At the end of an interview, request references from current or recent client engagements.

Get competitive bids. Because an increasing number of companies are turning away from traditional audit partners in favor of third-party tax service providers, the cost of audit services is expected to rise to help make up the difference. On the other hand, the marketplace for tax services is becoming more competitive. Professionals suggest using the screening and interview process to cut the list to two or three finalists, each of whom should be given the opportunity to respond to a clearly defined request for proposal.

Use an outside firm to backstop internal staff. If you choose to add staff to handle your company’s tax concerns, consider retaining a third-party consultant experienced in FAS 109 issues to help ensure a smooth transition. This step may be especially helpful if your company has unique or unusual tax circumstances, such as foreign operations or recent business acquisitions that may affect how the tax provision is calculated. You can always call on this third party to review your company’s work.

Through these tips, your company can make better decisions about how to handle its critical audit and tax preparation issues and remain in compliance with SOX.