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Auditor independence and tax practitioners.


* THE SEC's NEW AUDITOR INDEPENDENCE RULES could have a significant effect on some tax practitioners. The SEC includes tax among the non-audit services CPA firms provide.

* AS PROPOSED, THE SEC RULES PUT IN DOUBT whether an auditor can do anything other than review the tax provision in the financial statements or prepare the client's tax returns without further disclosure or impaired independence. The AICPA tax division suggested impairment be determined circumstantially rather than on the basis of a particular service relationship.

* THE FINAL RULES TAKE A MORE MODERATE stance on audit firms providing tax-related services to audit clients. They recognize the important role CPAs play in representing clients in tax matters but provide no guidance on the specific types of tax advocacy that would not impair independence.

* CPAs WILL NEED ADDITIONAL GUIDANCE to implement the final rules. It's unclear, for example, whether lobbying for tax law changes or representing an audit client before state and local government tax authorities will impair independence. And it's still unclear whether CPAs can represent audit clients before the U.S. Tax Court.

* THE SEC ISSUED PRELIMINARY GUIDANCE in January 2001. Among the issues it resolved was that CPAs can prepare tax studies, such as those related to minimizing state income taxes, sales tax distributions, transfer pricing and Lifo conformity, without impairing independence.

The SEC rules may affect all segments of the profession.

Much has been written and many have speculated about the impact the new SEC auditor independence rules (effective February 5, 2001) will have on CPA firms that provide services such as consulting to their SEC audit clients. However, few observers have considered the impact rule 2-01 of regulation X will have on tax practice, which the SEC includes among the other non-audit services CPA firms provide.

Although the work of the Independence Standards Board is ongoing, there are differences between its approach and the one the SEC took. With many voices discussing standards, all CPAs should be concerned with each step in the evolution of these independence standards and the impact they will have on non-audit services. Accordingly, this article discusses both the changes that are found in the final SEC release as well as the key tax provisions in the original proposal that were dropped (for now) or modified.


The SEC was motivated to replace the existing independence rules to "protect the reliability and integrity of the financial statements of public companies." It felt significant structural changes in the accounting profession, including reorganizations and consolidations as well as demographic changes in society, necessitated revising the rules (last amended in 1983) to keep them "relevant, effective and fair."

The new rules focus on three areas that might impair independence, provide some limited exceptions and require most public companies to disclose in the annual proxy statement information about auditor independence. The major factors that might impair independence are

* Investments by auditors and their families in audit clients.

* Employment relationships between auditors or their families and audit clients.

There is a chance a national independence standard could emerge for all CPAs, not just those with SEC clients.

* Non-audit services including tax that auditors provide to audit clients.

The rule creates a safe harbor for otherwise proscribed activity if a (]PA firm has a satisfactory quality control system designed to ensure compliance. The disclosure requirements focus on the nature and magnitude of the otherwise allowable non-audit services auditors provide to audit clients.


Broad-based professional service firms that do more than review a client's tax accrual for audit purposes will want to understand the potential and actual impact of the proposed and final rules on all other tax-related services.

All CPAs who have attestation responsibilities should be aware of unresolved issues. Why all CPAs, not just those who have audit clients regulated by the SEC? There are several reasons. The independence controversy received considerable attention from the public, the press, the AICPA and Congress. There is a national movement toward standardized licensing and reciprocity requirements. Since state boards of accountancy need to regulate the profession within their borders, there is a real possibility that a national independence standard might emerge for all CPAs, not just those with SEC practice responsibilities.


The SEC issued its new independence rules on November 21, 2000, following a three-month comment period. The commission received almost 3,000 letters and conducted 35 hours of oral hearings with testimony from almost 100 CPAs, investor representatives, CEOs, CFOs, academics and other interested parties.

As originally proposed in June 2000 ( proposed/34-42994.htm), the SEC rules would have had a significant impact on tax-related services audit firms provide to audit clients. The proposal's general principles of independence said that when the auditor acted as an advocate for the audit client, independence would be impaired. The proposal further prohibited audit firms from providing audit clients with specific services. Those with the most impact on tax practice included appraisal or valuation, actuarial, human resource, legal and expert services, whether provided in the context of a tax compliance or consulting engagement.

Companies would have been required to disclose in their proxy statements virtually all fees they paid to their auditors for non-audit services. The proposal created an exception for "tax-related services" but did not define this term and in fact used a narrower term, "traditional tax preparation services," in a context that implied the latter was the preferred interpretation. In other words, the original SEC draft cast doubt on whether the auditor could do anything other than review the tax provision in the financial statements or prepare the client's tax returns without either further disclosure or impaired independence. The proposal also would have banned "value-added" and advocacy fees for audit clients. The SEC asked for comments on whether providing tax opinions to audit clients would impair an auditor's independence.

AICPA response. The AICPA tax executive committee formed a working group to study and comment on the tax aspects of the SEC proposal. Given the nature of client representation engagements before the IRS and other government agencies, the "advocacy" language was especially problematic for the working group. It noted the SEC's inconsistency in excluding "tax-related services" and yet emphasizing that the exclusion applied only to "traditional tax preparation services." In speaking about tax opinions, commentators said the legal system would temper any temptation toward real or apparent bias a CPA rendering such an opinion might have. The comments suggested that any impairment of independence be determined circumstantially, rather than based on the existence of a particular service relationship.


The final rules ( take a more moderate stance on audit firms providing tax-related services to audit clients. The SEC retained but moved the language regarding CPA advocacy on the client's behalf. As originally proposed, the existence of advocacy was a conclusive impairment of independence. In the final rules, however, the SEC moved the advocacy language to a preliminary note and designate, d it as one of four principles to consider in making independence determinations. (The others are whether the relationship or service creates a mutual or conflicting interest between the auditor and the audit client; places the auditor in the position of auditing his or her own work; or results in the auditor's acting as the audit client's management or employee.) Although these changes recognize the important role CPAs play in representing clients in tax matters, they provide no guidance on the specific types of tax advocacy that would not impair independence.

While the final rule retains restrictions on providing appraisal and valuation services, the SEC added specific exceptions for valuations conducted as part of tax planning or tax compliance services and for analyses of actuarial considerations in federal income tax planning [rule 2-01(c) (4)(iii)(3) & (iv)(3)]. The final rule also modifies the original SEC proposal regarding human resource services by clarifying the accountants' role in providing tax advice incident to structuring compensation packages [rule 2-01 (c) (4) (vii)].

The SEC removed the prohibition against providing expert services and the ban on value-added billings, both of which could have had a severe impact on tax practice. In its explanation of the final rule, the SEC said it chose not to adopt the expert service rule to avoid the implication that a CPA firm could not defend work done for audit clients before bodies such as the IRS and the SEC. It did not address providing tax opinions to audit clients. The ex pert discussion section of the final rules implies that the expert opinion the SEC contemplates would take place in a judicial or regulatory proceeding, not as part of an offering statement. Presumably the SEC will determine whether rendering an expert opinion on tax consequences compromises independence on a case-by-case basis using the four basic principles.

On the contingent fee issue, the SEC chose to follow the AICPA position--which allows such fees in certain tax matters--and eliminated the value-added language. However, the explanation specifically cites a situation involving an analysis of the client's expenditures to determine qualification for tax credits. Depending on the billing agreement, this engagement could result in a supposed value-added fee being recharacterized as a contingent fee and thus prohibited.


The CPA profession will need additional SEC guidance to fully implement the final rules. In the advocacy area, what types of engagements will not impair independence? For example, will lobbying to change tax laws, representation before state and local government tax authorities or being part of a negotiating team in a new plant site selection engagement be allowed? In appraisal and valuation services, the SEC explanation says it does not consider purchase price allocations (required under IRC section 1060 for tax purposes) to be an allowable exception. This appears to prohibit a CPA firm from advising a client on implementing--for financial statement purposes--an allocation it prepared as an allowable service under the tax planning and compliance appraisal exception [rule 2-01 (c) (4)(iii)(3)].

Regarding actuarial services, rule 2-01 (c) (4) (iv) (B) (3) says there will be no impairment if the CPA "analyzes actuarial considerations and alternatives in federal income tax planning" (emphasis added). This leaves open the issue of similar analyses in other federal, state and international tax engagements not involving income taxes.

The final rules retain the prohibition against providing legal services to audit clients when the person providing the service must be admitted to practice before the courts of a U.S. jurisdiction [rule 2-01(c)(4)((ix)]. Since non-attorneys may be admitted to practice before the U.S. Tax Court and represent clients, this rule seems to contradict the positive statement in the explanation that the restriction on non-audit services is not intended to preclude defending work performed in various jurisdictions.


On January 16, 2001 the SEC issued--in question and answer format--preliminary guidance on interpreting rule 2-01 ( htm). Question i clarifies that a company must disclose as audit fees only tax service fees related to auditing the income tax accrual in schedule 14A. It need not list other tax fees as audit fees, but must list them in the "all other fees" category.

Question 15 addresses the legal services issue, explaining that not only services requiring appearance in court are prohibited but all services requiring admission to practice before the courts of a U.S. jurisdiction. While this explanation still does not address the Tax Court issue, it would seem traditional litigation support engagements such as helping develop a tax case--where the CPA's work becomes part of the attorney's work product--should not cause an independence problem.

Question 16 addresses the prohibition in rule 2-01 (c) (4)(i) preventing auditors from providing bookkeeping services for audit clients. Some tax studies, such as those related to minimizing state income taxes, sales tax distributions, transfer pricing and Lifo conformity, should not cause independence problems if the audit firm performs them for a client. The answer to this question clarifies that an independence problem arises when the audit firm "participates with management in operational decisions" Helping management frame questions, develop alternatives and provide information about alternatives should not be construed as participating in operational decisions. Situations where clients outsource payroll functions, including reporting to federal, state and local tax authorities, may be more problematic. Is the CPA engaged in "preparing or originating source data" within rule 2-01 (c)(4)(i) when providing such services?


It seems clear the SEC heard and reacted positively to many of the public comments on the proposed rule, including those from the AICPA. But the issue is by no means settled. As the SEC seeks future comments regarding interpretations and guidance, and as local jurisdictions take up the issue of independence standards, affected tax practitioners need to respond promptly with comments and questions so the standard is implemented with as much clarity as possible and takes their professional needs into account.

Chairman's Statement: SEC Open Meeting Rules Governing Auditor Independence

* "As we grapple with the profound changes sweeping our markets, safeguarding the public trust--above all else--must serve as our enduring mandate and collective goal."

* "I continue to respect the power of our markets and firmly believe that this private sector response today, motivated by commission guidance, represents a constructive foundation for a new partnership, committed to the primacy of full and fair and accurate disclosure on behalf of America's investors."

* "The rule identifies certain non-audit services that, if provided to an audit client, would impair independence. I believe the scope of these prohibitions is targeted, sensible and, in many cases, consistent with the current restrictions on the profession's and the SEC's books."

Source: Excerpts from Arthur Levitt's remarks on November 15. 2000,

TOM PURCELL, CPA, PhD, is assistant professor of accounting and professor of law at Creighton University in Omaha, Nebraska. He is a member of the AICPA tax executive committee. His e-mail address is DAVID LIFSON, CPA, is a partner with Hays & Co. in New York City. He is a member and immediate past chair of the tax executive committee. His e-mail address is
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Title Annotation:SEC auditor independence rules
Author:Lifson, David
Publication:Journal of Accountancy
Geographic Code:1USA
Date:Jun 1, 2001
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