By Raj Kushwaha, EVP Products and Services, Velosant, LP
The United States' Sarbanes-Oxley Act (U.S. Public Company Accounting Reform and Investor Protection Act) of 2002 marks the most significant reform in US public financial reporting of recent times. Designed to restore public confidence in the management of public companies following the outcry over Enron, WorldCom and others, Sarbanes-Oxley has impacted directly on the responsibilities and liabilities of Corporate Executives, Board of Directors, Audit Committees, Auditors and Analysts. In this article we explore the implications of Sarbanes-Oxley for corporate tax departments, and suggest that the Act places new and important responsibilities on the shoulders of those responsible for tax compliance within public companies.
The financial impact of poor tax calculation and compliance processes should be self-evident. Each individual sales and purchasing transaction requires sales/use/VAT tax determinations. On the sales side, poor practice may result in payment delays with knock-on implications for cash flow as well as customer relationship implications. On the procurement side, weakness in vendor tax analysis may also result in payment delays, supply chain blockages and adverse credit ratings.
So for all companies, sales/use/VAT tax calculations impact many business processes. And these issues are particularly sensitive for companies that are deemed high risk because their organisational structure is designed to gain competitive advantage from capitalizing on or avoiding specific tax collection duties and rules.
Sarbanes-Oxley impacts on the work of corporate tax departments in two distinct spheres. First, the legislation changes the relationship between external auditors and the company's Audit Committee. Secondly, the Act requires corporate tax departments to fulfill new and specific responsibilities.
A new relationship
In respect of Tax Services, Sarbanes-Oxley highlights the potential dangers of the same firm undertaking both auditing and tax services for a company by altering the relationship between external auditors and a company's Audit Committee. Whilst not prohibiting auditors from undertaking tax services, Sarbanes-Oxley introduces a new requirement for such services to be approved or âpre-approved' by a company's audit committee, imposing new responsibilities on both the corporate tax department and the audit committee.
Under SEC Final Rules, auditors are permitted to undertake a variety of tax services. These include:
- Tax-only valuations (transfer pricing studies, cost segregation studies, etc.)
- Tax compliance, including preparation of:- Original and amended returns,
- Claims for refund, and
- Tax payment planning services
- Tax advice, including- Assistance with tax audits and appeals,
- Tax advice related to mergers and acquisitions,
- Employee benefit plans, and
- Requests for rulings or technical advice from taxing authorities
- Tax planning
The appointment and retention of auditors is a question for a company's audit committee. Where auditors also provide tax services to the company, SEC Final Rules stipulate that the audit committee should scrutinize:
- Transactions initially recommended by the firm's accountant,
- Transactions for which the sole business purpose is tax avoidance, and
- The tax treatment of which may not be supported by the US Internal Revenue Code and related regulations
This three-part test (all three tests must be met in order for the auditors to fail audit committee scrutiny) is equally applicable to local, state, federal and foreign taxes.
Supporting the Audit Committee
Corporate tax departments can perform a very useful function in assisting the audit committee to fulfill its Sarbanes-Oxley responsibilities with regard to tax services. Certainly it is advisable that the VP of Tax or Tax Director should obtain a copy of the company's auditing policy and understand its provisions, as well as the process for seeking approval if services are not pre-approved.
It is important to remember that historically, audit committees have not been involved in approving tax services and they may not have the knowledge or background to properly evaluate the qualifications of the audit firm to provide a particular tax service. This can be a handicap and may have the unintended consequence that an audit committee may refuse to approve a project simply because it is being offered by the company's auditor. Clearly, this may not be in the best interests of the company. The tax department should offer to provide the audit committee with information to assist them in making an informed decision although, of course, an audit committee is under no obligation to accept the advice.
In building and sustaining a relationship with the company's audit committee, the tax department should seek to educate and inform the audit committee in its responsibilities. This includes providing an estimate of the tax benefit to the company of a specific project and why the auditor is best placed to undertake the work. In relation to tax planning projects, the tax department should make the audit committee aware that planning projects should be scrutinized with regard to whether there is a business purpose other than tax avoidance, and whether the tax treatment is supported in the tax law and regulations. Both of these tests must fail in order for the transaction to fail audit committee scrutiny. If a non-tax business purpose is the motivation, then the department should provide an explanation of the business purpose.
Section 404 of the Sarbanes-Oxley Act requires that in 2004 both company management and Auditors will be asked to express an opinion on whether management's assertion about the effectiveness on internal control over financial reporting is fairly stated in conformity with an established internal control framework. Specifically, that an annual report is issued by the company's management regarding the effectiveness of the company's internal controls and procedures for financial reporting, and an attestation by the company's auditors as to the accuracy of management's assessment.
Section 404 has a substantial impact upon tax departments. In particular:
- Taxes, including those traditionally reported âabove the line' such as sales, use and VAT, comma may be considered a material element in the financial statements.
- Tax policies, processes and controls, including those with regard to reporting and tax compliance, must be auditable and subject to senior management and external auditor scrutiny.
Many companies have some way to go before their tax department processes are sufficiently well documented that external auditors can reach an unqualified opinion under Section 404 of the Act. However, companies should consider the wider benefits of undertaking the substantial work required to comply with Section 404. Benefits include the adoption of improved tax practices and control, improved integration with other functions and improved visibility for the tax function and its valuable contribution to sound financial practice and reporting within the company.
Whenever tax is significant to the company, the processes and controls impacting the determination and disclosure of the tax must be considered and should be documented and evaluated in a manner consistent with other significant business processes. These principles, always sensible practice, are now legal requirements for corporate tax departments in the execution of their responsibilities with regard to compliance with Sarbanes-Oxley.
Raj Kushwaha, EVP Products and Services, Velosant, LP
As head of Products and Services for Velosant, Kushwaha has overall responsibility for Product and services development and delivery.
He brings more than 10 years of proven experience in information technology, entrepreneurship and general management to Velosant. Kushwaha has a wealth of experience in shaping secure and flexible technology architecture as well as formulating overall strategy for online commerce, specifically in business-to-business.
Formed in June 2003, Velosant provides a broad set of financial supply chain solutions to mid- and large-sized enterprises worldwide. Solutions from Velosant enable buyers and their vendors to streamline the complexity of invoicing, payment and taxation; realize cost savings through the elimination of paper and manual practices; and enhance trading partner communications.
Velosant's Taxware product suite offers leading global commercial tax compliance services. The Taxware products simplify the tax calculation and compliance process with solutions for sales and use taxes, exemption processing, automated returns, e-commerce transactions, taxing jurisdiction assignment, and value-added tax (VAT) for businesses worldwide.