Proposed IRS generally accepted auditing standards for the Coordinated Examination Program.

On February 3, 1994, Tax Executives Institute filed the following comments with the Internal Revenue Service on the IRS's draft Generally Accepted Auditing Standards for the Coordinated Examination Program. The IRS's draft proposes the adoption of standards in the following areas: Team Standards: (1) Professional Judgment, (2) Objectivity / Integrity, and (3) Training and Qualifications; Fieldwork Standards: (4) Planning, (5) Monitoring, (6) Examination Techniques, and (7) Issue Development; Documentation Standards: (8) Workpapers, (9) Reports, and (10) Post-Examination Techniques.

The Institutes's comments, which took the form of a letter from TEl President Ralph J. Weiland to Albert F. Gee, Executive Assistant to the Assistant Regional Commissioner (Examination), were developed following a review of the draft standards by the IRS Administrative Affairs Committee, whose chair is Robert D. Adams of the Halliburton Company. The following TEl members contributed to the Institute's comments: Joseph A. Cottonaro of Hershey Foods Corporation; Patrick J. Ellingsworth of Atlantic Richfield Company; Herbert L. Herman of Coltec Industries, Inc.; Sheldon A. Kimel of Brunswick Corporation; Louis J. Manetti of Bell & Howell Company; Patrick J. O'Brien of Sears Roebuck & Company; Charles W. Rau. of MCI Communications; Thomas B. Rogers of Apple Computer; G. Clark Van Bogart of Burlington Resources; and Harold N. Weber of General Motors Corporation. Anyone wishing to receive a copy of the draft standards to which the Institute| comments were directed should send a written request to TEl Headquarters.

On behalf of Tax Executives Institute, I am pleased to submit the following comments on the Internal Revenue Service's draft "Generally Accepted Auditing Standards for the Coordinated Examination Program." (The draft the Institute reviewed was dated September 30, 1993.) TEI appreciates the opportunity to review the draft standards, as well as the chance to meet on December 14, 1993, with you and other members of your task force. We regret the delay in submitting our comments, but the holidays and the press of other business made an earlier response impossible.

The Institute's comments were developed following a review of the draft standards by a large number of TEI members. Specifically, the draft standards were circulated to members of the Institute's IRS Administrative Affairs Committee and Executive Committee, as well as to other interested members of the Institute. The comments below represent a synthesis of the comments received. In addition, we have noted several typographical errors in the draft standards. Rather than detail those comments in this letter, we enclose a marked-up copy of the draft standards, on which we have marked our proposed changes.

General Comments

TEI is pleased that the Internal Revenue Service has undertaken to adopt uniform auditing standards for the Coordinated Examination Program. We believe the draft standards mark a very creditable step in the development process and are confident that the standards will contribute to more efficient and effective audits. We also believe, however, that the standards need to be crystallized in order to meaningfully affect actual examinations.

TEI has been a strong supporter of the IRS's recent changes to the CEP program, and has been especially excited by the steps the IRS has taken to involve the taxpayer in the CEP planning process. In our view, the key to more efficient CEP examinations is more frequent, more open, and more complete communication between the CEP team and the taxpayer. For this reason, we believe that the standards should emphasize the need for communication between the audit team and the taxpayer, both during the time the audit plan is prepared and during the examination itself. We appreciate that the task force wants to limit the total number of auditing standards, but nevertheless suggest that consideration be given to including a separate standard on communication (perhaps under "Fieldwork Standards"). In developing the Communication Standard, the task force could refer to planning, monitoring, issue development, and communicating during the actual conduct of field work. In addition, the Documentation Standards could be revised to address the sharing of information and documents between the taxpayer and CEP team members.

Moreover, we believe that the standards should reflect a recognition that, with staffing constraints on both taxpayers and the IRS, an examination can be completed promptly and efficiently only by establishing and following an agreed plan. For taxpayers, the same personnel may be responsible for the tax compliance, planning, audit, and appeals functions. Advance scheduling and knowledge of the timing and scope of information requests will greatly enhance tax department personnel's ability to serve all the tax functions and to provide timely responses to the CEP team. We recommend also that the IRS focus its requests on major or questionable areas. Delays and attendant problems can be minimized where the taxpayer is intimately involved in the planning process. The IRS, too, is more likely to be thorough and professional in its identification and analysis of possible tax adjustments if the CEP team has a clear conception of the schedule and scope of the audit, as well as clear auditing standards. Finally, detailed planning should enable both the IRS and the taxpayer to develop a greater variety of techniques for handling requests and issues expeditiously.

Professional Judgment

1. Professional judgment may be the most important quality of a good Case Manager or team member, and yet it is probably the hardest quality to describe in detail, to measure, to teach, and to instill. Nevertheless, we believe it would be helpful for teams members to be formally evaluated on their professional judgment as part of their regular performance reviews. (They might even be requested to evaluate themselves, since self-examination will likely make team members more sensitive to the need to exercise professional judgment.) Finally, we recommend that the Case Manager be expressly charged with causing the team to maintain a professional working relationship with the taxpayer.

2. The flush language of Paragraph 1 states that "[t]he team may decide against examination of a very large item because risk analysis indicates minimal tax potential," and Paragraph 1B states that "[s]ound professional judgment should be used in determining the scope, depth, procedures and methodology for the examination." TEI commends the task force for including these items in the draft standard. The Case Manager should exert leadership to prevent agents from pursuing areas that could have a minor effect on revenues (even if the agent's position were wholly sustained) but that may take considerable time and resources to develop. At the same time, TEI believes the auditing standards should explicitly confirm that the purpose of the CEP examination is to determine the taxpayer's correct taxable income, not to propose only adjustments in the government's favor. Such a statement would recognize that during the course of a CEP examination the IRS and the taxpayer often discover errors and omissions that decrease as well as increase taxable income.

3. A key to measuring and encouraging professional judgment is developing quantifiable standards in determining scope, depth, procedures, and methodology for examination. We believe that the IRS could usefully turn to the standards that apply in respect of an independent auditor's plan for a financial audit, including the "materiality" standard for financial statement purposes. "Materiality" is another way of saying "common sense." It must, in our view, be emphasized. For example, the audit plan might establish thresholds for the development of issues: one level for items that tend to reverse very quickly, and another level for adjustments that either do not reverse or that reverse over a very long period.

Objectivity and Integrity

1. TEI understands that the second standard is intended to focus on the necessity of team members not to come into the examination with any biases that will impair their professional judgment and their ability to faithfully pursue the IRS's mission (the determination of the correct tax liability). Thus, if an agent owns stock in the company, he or she might be biased one way, and if he or she has a product liability lawsuit pending against the company, he or she might be biased the other. The concept is easy to grasp, but we believe that the draft's use of the term "independence" is confusing. (It begs the question "independent from what?" From the taxpayer? From the agent's supervisors?) We believe "objectivity" is a better word and encourage the task force to use it. In addition, we wonder whether the term "external impairments," without more, is too vague to be helpful. For example, would the standard operate to impugn the objectivity or integrity of an agent who attends the same church as a member of the tax department staff?

2. We recommend that consideration be given to adding the following at the end of Paragraph 2A [which now reads "An adequately trained and proficient team must conscientiously combine all aspects of the examination process to complete a quality examination.]: "based on the merits of the issues and a thorough review of the applicable law and facts."

3. Paragraph 2B states that a "personal impairment" may include "[a]ny other relationship or preconceived idea which could affect objectivity? The relationship between the company's tax audit staff and the CEP team will obviously be affected by the personalities of the people on both sides of the relationship. Some taxpayers may be more aggressive in defending their returns or rebutting proposed adjustments than others, and CEP team members may react differently to how the taxpayer's personnel handle the audit. Where a personal relationship threatens to disrupt the audit (or undermine the objectivity of the CEP team)--for example, because a CEP team member "just doesn't like" a member of the taxpayer's audit staff the Case Manager should be encouraged to reassign the team member. In this regard, we believe it would be helpful for the Case Manager to meet regularly with the taxpayer's representatives to discuss how the taxpayer perceives the objectivity of the examination team. (This concept could be incorporated in Standard 5 (Monitoring).)

4. Paragraph 2B blends two points--conflicts of interest (including situations of partiality) and action procedures. We believe the two should be thoroughly, but separately, considered. We recommend that the standard not only discuss the need to examine conflicts/partiality regularly, but also provide guidance on how items are to be reported to IRS management and how management is expected to respond.

5. We recommend that a final sentence be added to Paragraph 2C [which now reads: "CEP examination teams should insure that knowledgeable third parties will not perceive a conflict of interest to exist. The appearance of a conflict of interest must be dealt with similar to dealing with an actual conflict of interest."]: "Actual conflicts of interest and the appearance of conflicts must be treated with like seriousness and dealt with in similar fashions."

Training and Qualifications

1. TEI supports the inclusion of a separate standard on training. We also welcome the reference in Paragraph 1A (relating to professional judgment) to an "adequately trained and proficient team." Training can only help team members develop the judgment necessary to conduct their examination in an efficient manner.

2. TEI agrees that it is important for members of the CEP team to receive adequate training in substantive tax law subjects, which of necessity involves the related skills of applying legal authorities to the facts and weighing the strengths and weaknesses of alternative positions and competing authorities. In addition, we believe the IRS should move toward requiring a minimum number of hours of training in accounting and financial reporting. Taxpayers too frequently are required to devote inordinate amounts of time to explaining relatively simple accounting and financial reporting consolidation subjects. Similarly, taxpayers are frequently frustrated because team members do not seem to have even a general understanding of the industry. To teach judgment and an awareness of financial reporting and business practices, the IRS could productively employ the case study approach (focusing on especially contentious audit situations).

3. In scheduling training for members of the CEP team, IRS management should take care not to so deplete the team that the examination comes to a halt. Not infrequently, the training of agents causes delays in completing the examination because only one training session is scheduled and all members of the team must attend or miss the training. This should be avoided.

4. We recommend that the following be substituted for Paragraph 3A:

CEP team members, individually as well as collectively, including the general members as well as the specialists, should possess a basic knowledge and good understanding of accounting principles and concepts and should have demonstrated an excellent ability to successfully apply the auditing

skills required for examination of large federal tax returns.

(Italicized words added.)

If the task force concludes that a general requirement that all team members possess a rudimentary understanding of accounting principles should not be included in the standards, then consideration should be given to requiring that accounting issues be the direct responsibility of the team coordinator.

Fieldwork Standards-- Generally

1. An overriding goal of the CEP program is currency. We recommend that pursuit of this goal be incorporated into the Fieldwork Standards.

2. The introductory language under the caption "Fieldwork Standards" states that "[t]he goals of the CEP examination are to examine sufficient competent information through interviews .... "Although we recognize the usefulness of interviews in certain circumstances, we believe that the CEP team should generally be cautioned that interviews of taxpayer personnel should be conducted only in extraordinary circumstances (since interviews disrupt taxpayer operations) or when volunteered by the taxpayer as the most expeditious means of communicating information or supporting a return position where paper documentation may not exist. Thus, alternatives to interviews should be pursued, such as the submission of written questions (which could, in return, be answered in writing). Indeed, the taxpayer's written comments will usually provide a better, more complete record than an agent's interview notes. In addition, an agent's insistence on interviewing company personnel may well lead the taxpayer to record the interview (to guard against errors and misinterpretation).

3. The references to "[i]dentify[ing] important areas of noncompliance with the Federal Tax Law" and "[a]ssur[ing] reasonable compliance with applicable sections of Federal Law" seem redundant. If both items are included, they should be distinguished.

4. TEI believes some reference should be made to various "nontraditional'' approaches to resolving issues. For example, the use of accelerated issue resolution (even in the absence of a formal AIR revenue procedure) should be considered by the CEP team.

Planning

1. TEI believes that there is a critical need to involve taxpayers in the examination planning process-- at all stages of the process. Thus, we applaud the statement in the flush language of Paragraph 4 that "[t]he CEP examination should be properly planned and include participation by the taxpayer .... "The level of communication must be substantial and continuous. For example, the taxpayer should have an opportunity to discuss special circumstances relating to the audit with the Case Manager, as well as any special needs the Case Manager foresees. To emphasize this point, we recommend that the first sentence of Paragraph 4A be revised to read, as follows:

The CEP examination should

be carefully planned for and

with the taxpayer. (Italicized

words added.)

2. Some TEI members who reviewed the draft standards expressed concern that the Planning Standard, while specifying variables in an audit, provides inadequate guidance on how they are to be taken into account in developing an effective audit plan. Although it would be impossible to describe all possibilities, a statement of procedures would likely prove helpful. Specifically, the standard could be revised to provide that the Case Manager should--

* Confer with the taxpayer's designated representatives;

* Write a plan that sets forth the time frame (including a scheduled completion date), specific sequence of audit subjects and techniques, their relative significance, and the responsibility of various persons (e.g., specialists, District Counsel);

* Have the plan reviewed by the Branch Chief;

* Discuss and review the plan with the taxpayer before the examination begins; and

* Review the plan from time to time during the examination and adjust it as necessary.

3. The standard should be clarified to provide expressly that the final audit plan is to be communicated to the taxpayer. (Taxpayers should not be required to ask for the plan.) This, coupled with the taxpayer's active involvement in

the development of the plan, will ensure that the taxpayer has ample opportunity to plan its resources for the examination. This is especially important in this era of corporate downsizing, and will benefit both the IRS and the taxpayer.

4. Paragraph 4A should be revised to provide that, in addition to reviewing the planning file (and involving the taxpayer), the Case Manager should review the post-audit critique from the previous examination cycle (as well as any relevant information from Appeals' disposition of previous cycles).

5. Specialists can play an important role in CEP examinations. The Case Manager, however, must exercise judgment in determining whether a specialist is needed. Moreover, if an initial decision to request a specialist proves to have been incorrect, the Case Manager should be encouraged to rescind the request. In other words, accountability should be built into the system to ensure that specialists do not spend unnecessary time requesting information and raising issues of dubious merit (simply to justify their presence on the CEP team).

6. CEP taxpayers are frequently frustrated by the interruption of the audit plan by vacations, training, the unavailability of specialists, and unusual circumstances. Requesting the taxpayer to extend the statute of limitations should not be viewed as an "easy" or proper response to inadequate planning.

Monitoring

1. We believe the standard should explicitly state that the Case Manager (or Team Coordinator) should hold regular (at least monthly) meetings with the taxpayer to discuss the progress of the examination. Indeed, the standard might promote the idea that monitoring should be the joint responsibility of the taxpayer and the CEP team; they should regularly discuss whether the examination is proceeding as planned and, if not, whether and what changes should be made to the plan. (Ideally, changes to the plan should be kept to a minimum, though changes should not be resisted where dictated by circumstances. ) These progress meetings might productively include team members (and members of the taxpayer's compliance staff), especially if problem areas have been identified in advance of the meeting.

2. The flush language of Paragraph 5 states that "[t]he progress of the examination should be carefully monitored and the plan modified when necessary." It would be helpful to explain that the modifications could well include abandoning certain issues or areas.

3. The last sentence of Paragraph 5B should be revised to read, as follows:

Significant plan modifications should be written, and should be provided to th e taxpayer.

Examination Techniques

1. Paragraph 6A should be expanded to provide that the CEP team should review the publicly available filings the taxpayer makes with other government agencies, as well as the financial statements prepared by independent auditors. Team members, however, should continue to request tax accrual workpapers only in accordance with the narrow standards prescribed in the Internal Revenue ManHal.

2. We believe that the second sentence in Paragraph 6A should be revised to read, as follows:

The nature, extent, and validity of the taxpayer's internal controls should be

assessed to determine only the examination techniques to be used but also the necessary scope of the examination.

3. We believe that the standard should be revised to encourage the CEP team to request a taxpayer presentation on, or description of, any significant (and possibly unique) financial or operational items concerning the taxpayer.

4. Paragraph 6B makes reference to conducting interviews of appropriate persons. As stated above (Comment i under "Fieldwork Standards-Generally"), we do not believe interviews are necessary in all cases (or even in most) and believe they can prove quite disruptive to the taxpayer's normal operations.

5. Paragraph 6B also addresses where the examination should be conducted, and does so in what we consider a very rigid fashion. It assumes, it seems to us, that the principal offices, location of accounting records, and location of tax personnel are always in the same place. Often, however, they are not. We recommend that language such as the following be substituted for the last sentence of Paragraph 6B:

The examination should be conducted in the most appropriate location, taking i nto account the location(s) of the taxpayer's principal offices, accounting records, and personnel familiar with the preparation of the tax return, as well as other rele - vant circumstances.

6. Paragraph 6C discusses the use of IDRs. We believe the standard should be revised to provide that the Case Manager or Team Coordinator should review all IDRs before they are issued (just as they are required to sign Notices of Proposed Adjustments). This is especially important where relatively inexperienced members are included in the team. The review would be aimed at ensuring that IDRs are specific rather than vague and not duplicative of prior IDRs. The standard should also recognize that, although information document requests may not take very much time to write, they often require the expenditure of much time and effort to answer. This recognition should lead the examination team to plan the issuance of IDRs with the taxpayer, so that requests that are likely to require a long time to answer (e.g., because the taxpayer must obtain records from remote (or even foreign) locations) should be issued earlier in the examination. (We also believe that the team should be encouraged not to "hold" IDRs, but rather to forward them to the taxpayer as they are developed.) Indeed, we believe there would be much merit in the Team Coordinator's discussing IDRs with the taxpayer before their issuance; such an approach could reduce or even eliminate ambiguous and unnecessary information requests.

7. Paragraph 6C states that "It]he team should request administrative assistance or utilize summons procedures when difficulties arise in securing information." We recommend that language such as the following be added at the end of the Paragraph:

However, reasonable efforts should be made to resolve such difficulties volunt arily with the taxpayer before pursuing such procedures. A summons should never be is- sued before the Case Manager or Team Coordinator discusses the problems with the taxpayer's representative.

8. Paragraph 6D states that "[s]upport examination [requests] should be made early" in the examination. The taxpayer should clearly be consulted before a final decision is made concerning support examinations, and the timing of any such examination should be coordinated with the taxpayer.

9. Paragraph 6E is somewhat garbled. We recommend that it be revised, as follows:

Requests for specialists and outside experts (including District Counsel) shou ld be considered early, whenver material issues, requiring the expertise and knowle dge of experts, are present. District Counsel assistance should be requested for is- sues having large tax impact, widespread industry application or difficult legal prob- lems.

We also believe that the standards (either under "Examination Techniques" or "Issue Development") should provide that taxpayers should be apprised when Counsel or specialists are consulted. (See Comment 1 under "Issue Development.") Finally, we believe that the Case Manager and Team Coordinator should be evaluated on how prudently they request (or decline to request) specialist (and Counsel) involvement.

10. Paragraph 6F refers to "audit technical guidelines applicable to various industries and issues." We are unsure, but believe this refers to extant IRS guidelines. If so, the standard should be clarified. We also believe that the standard should be beneficially revised to provide that taxpayer-specific examination techniques should be developed, discussed with the taxpayer (and modified if necessary), and passed on (with appropriate modifications) from cycle to cycle. These taxpayer-specific guidelines would take into account the taxpayer's business operations, accounting systems and procedures, and internal controls (as suggested in Paragraph 6A). (Such procedures are developed in respect of financial audits.)

Issue Development

1. Although Counsel's role in issue development is not discussed until Paragraph 7D and 7E of the standard, we discuss it first because of the sensitivity and importance of the issue. We recommend that the standard be revised to address more forthrightly the role of Counsel in the CEP examination. Taxpayers have been long concerned about the role of Counsel (including their ability to interact with Counsel personnel and to receive copies of any field service advice ("technical assistance") provided to the CEP team by either District Counsel or the Chief Counsel's Office). We recognize that we are advocating a policy change but believe the standard should state that taxpayers have the right to know when Counsel is involved in an examination and to discuss issues with Counsel.

2. Paragraph 7A states that "[i]ssues having minimal tax impact which are short term timing adjustments may not warrant extensive development." We recommend that the concept be expanded to specify that such issues should be abandoned once their immateriality has been demonstrated, even though time may have already been expended developing the issues.

3. In some cases, it will not be necessary to fully develop the facts in order to dispose of an issue because the law is clearly in the taxpayer's favor. For example, there may be issues that, even if the facts are construed against the taxpayer, should be resolved in the taxpayer's favor as a matter of law. In such a case, it would be unproductive for the CEP team to devote time and resources to developing the facts. Indeed, the (misguided) expenditure of time and resources might well lead the agent to pursue a highly questionable position in order to justify that expenditure of time and resources.

4. Paragraph 7B states that the Case Manager and specialist managers should be active in the resolution of issues. We agree, and believe that such involvement should not be deferred until after the issue has been developed; the timely involvement of the Case Manager and specialist manager could well lead to the early disposition of issues of dubious merit. We also believe that the standards should recognize that the involvement of the taxpayer in the development of issues should aid the early identification and resolution of issues.

5. Several TEI members who reviewed the draft standards expressed concern that the second sentence of Paragraph 7C could be construed to mean that the listed "nonlegal sources of information" are "authority" within the meaning of section 6662 of the Internal Revenue Code. The listed sources should be used only for background purposes (i.e., to identify possible issues), and should not be used (e.g., in Forms 5701) to justify proposed adjustments.

6. The standard should make it clear that the threatened assertion of penalties during the development stage of the examination is highly inappropriate. Penalties should not be used as a tool (weapon) to force taxpayer concessions, but rather should be asserted only where the facts warrant their imposition.

7. Finally, we believe the standard can be expanded to include the concept of issue evaluation and resolution. We recommend that consideration be given to explicitly identifying standards associated with weighing and evaluating legal authorities, the application of authorities to the facts uncovered during the examination, the identification of any additional facts needed for complete analysis, and the techniques for appropriate issue resolution.

Workpapers

1. We recommend that the standard be revised to incorporate the concept of contemporaneous review by the Team Coordinator (or, in appropriate cases, the Case Manager) of the examining agents' workpapers.

2. Several TEI members who reviewed the draft standards commented that the SAIN codes referred to in Paragraph 8A need to be revised and expanded to better describe the taxpayer's business operations.

3. We recommend that the last sentence in Paragraph 8B be revised to read, as follows:

Manual preparation of workpapers is preferred when it is more efficient.

4. We are unclear what is meant by the reference to "current year" in the second sentence of Paragraph 8C. The "real time" year even though it is not under audit? The last year for which a return was filed? Although we agree that there may be a benefit in using years subsequent to the years under examination as part of a compliance check, care should be exercised to ensure that the check does not inadvertently trigger the commencement of an audit of those years (e.g., for purposes of section 6662 or 7605(b)).

Reports

1. We recommend that the last sentence of Paragraph 9B be revised to read, as follows:

Reports should include the position of the taxpayer, except where the taxpayer does not provide this information to the team.

(Italicized words added; struckover words deleted.)

2. We believe that the reports of specialists should be timely received by the Case Manager and should not delay the timely issuance of the Revenue Agent's Report.

Post-Examination Activities

1. Paragraph 10B specifies that the CEP team is to prepare a written response (rebuttal) to the taxpayer's protest. We recommend that the standard set forth a time period within which the rebuttal is to be prepared; since CEP taxpayers are generally accorded 90 days to file their protest (the original 30 days plus an automatic 60-day extension), the rebuttal should be required to be submitted no later than 90 days after the protest is filed. (The examination should not be considered concluded until the rebuttal has been submitted.) We also recommend that the standard provide that a copy of the rebuttal should be provided to the taxpayer.

Conclusion

TEI appreciates the opportunity to provide its comments on the IRS's draft generally accepted auditing standards for the CEP program. If you should have any questions about our comments, please do not hesitate to call either Robert D. Adams of Halliburton Company, chair of the Institute's IRS Administrative Affairs Committee, at [phone], or Timothy J. McCormally of TEI's legal staff at [phone].