Auditor Independence: Separation Anxiety

Many tax services may be ''inappropriate'' work for auditors to perform for their audit clients, says the SEC.

Tax services looked to be about the only function auditors could safely perform for their audit clients under the Sarbanes-Oxley Act of 2002. But new rules from the Securities and Exchange Commission, along with impending changes in the accounting industry, could well force companies to split up the work among different firms.

Rather than ban specific tax services, though, the SEC is laying down guidelines for work it would consider inappropriate for auditors to perform. Projects that would require auditors to audit their own work, act as advocates for clients, or take on a management role for clients would be banned by the proposal. The rules were scheduled to be finalized in late January.

At the very least, those principles imply that auditors will be excluded from structuring clients’ tax shelters, representing audit clients in tax court, and giving tax opinions in potential merger situations. And in the absence of clear lines, “I think companies will not use their auditors for tax services,” says Timothy McCormally, executive director of the Tax Executives Institute. “Given the criticism they could face, they’ll think it’s not something they want to roll the dice on.” Newly nominated SEC chairman William Donaldson has yet to weigh in on the issue, but given the pressure to restore investor confidence, he is unlikely to water it down.

The SEC has stressed that it is not trying to prohibit auditors from doing basic tax preparation work, provided the arrangement has been approved by a company’s audit committee. But industry experts say it will be hard for audit firms to retain their tax partners for those tasks alone. “You don’t make a lot of money doing the tax-compliance work that would be allowed,” says Allan D. Koltin, president and CEO of the Practice Development Institute, an accounting consultancy in Chicago.

At press time, no major companies had announced they would split audit and tax as a result of the proposal. In fact, Cisco Systems Inc., which paid PricewaterhouseCoopers LLP $2.3 million in audit fees and $14 million for tax services in 2002, has already balked at the notion in response to a shareholder proposal.

However, OneSource Information Services Inc., which uses PwC as its auditor, parceled out its tax work to Ernst & Young about a year ago. “It’s worked out well,” says CFO Roy Landon. The move helped OneSource lower its effective tax rate from 40 percent to 37 percent.

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