Do Tax Services Impair Auditors' Independence?

As Enron’s tax shelters come into the public eye, the media have begun to focus new attention on an old question, “Do tax services impair auditors’ independence?”

Some Tax Experts Say “Yes"

A sampling of press accounts shows some informed sources would reply in the affirmative, particularly when it comes to auditing tax shelters:

  • “If you are auditing your own creations, it is very difficult to criticize them,” says Robert Willens, a Lehman Brothers tax expert who disapproves of the accounting profession’s recent move into selling aggressive tax shelters. (“Accounting in Crisis: One Plus One Makes What?,” Fortune, January 7, 2002.)
  • “They’re aggressively marketing…corporate tax shelters,” says Robert McIntyre of Citizens for Tax Justice, a research and advocacy group funded by unions, referring to the nation’s largest accounting firms. “They work them from every angle. They tell companies to do it. They argue with the IRS that these ought to be allowed. And they lobby the Congress to try to make them legal.” (“Accountants’ Tax Services Draw Fire,” Washington Post, February 7, 2002.)
  • “There obviously is a potential conflict in that, if the accounting firm has given tax advice, it would be hard for the same accounting firm to take a different position,” in its audit opinion, said tax lawyer Richard M. Lipton, who chairs the American Bar Association’s tax section. (“Accountants’ Tax Services Draw Fire,” Washington Post, February 7, 2002.)

What's A Tax Shelter?

Perhaps the most widely quoted definition of a tax shelter is a quip by Yale Law Professor Michael Graetz: “A deal done by very smart people that, absent tax considerations, would be very stupid.” (“IRS Setbacks in Court Rekindle Debate About Need for Tax-Shelter Legislation,” Wall Street Journal, January 7, 2002.)

Experts say it’s so hard to set bright line tests for what is and isn’t a tax shelter that it’s almost like setting accounting standards: It takes four years to set the rule and four minutes for someone to find a way around it. In recent court cases, the government has won several major corporate tax-shelter battles, including cases involving Colgate-Palmolive, Winn-Dixie Stores, and AlliedSignal which combined with Honeywell International in 1999. But the Internal Revenue Service (IRS) has also lost cases.

Currently, the IRS is trying a tax amnesty program. It is offering to waive penalties for companies that come forward by April 23rd and voluntarily disclose their use of questionable tax shelters -- and the name of the tax shelter promoter. (IRS Announcement 2002-2)

What's It Worth To Accounting Firms?

Evidence suggests that promoting tax shelters and lobbying for them are important business activities for accounting firms and can provide a big slice of their total annual revenues.

  • Promoting tax shelters. Accounting firms figure prominently among the promoters of corporate tax shelters. In December 2001, the IRS sent 28 soft letters on listed transactions to 22 different corporate shelter promoters, according to Larry Langdon, commissioner of the IRS’s Large and Mid-Size Business Division. The promoters included seven accounting firms. And, make no mistake about it, promoting tax shelters is a lucrative business. The Washington Post quotes Mr. Lipton as saying one large accounting firm was recently offering a tax shelter strategy for a $20 million fee.
  • Lobbying for tax shelters. Accounting firms also play a major role in the closely-related business of tax lobbying. Firms that do tax lobbying are required to file reports with Congress under the Lobbying Disclosure Act of 1995. The reports for 1999 and later are available online from the Senate Office of Public Records at http://sopr.senate.gov. An analysis of the data by Tax Notes Today found PricewaterhouseCoopers, (PwC) was the largest tax lobbying firm in the year 2000. PwC earned approximately $9.5 million that year for tax lobbying. Washington Council Ernst & Young earned $6 million, but it got a late start since it only came into being as a result of a merger in the spring of 2000.

The key to accounting firm success in tax lobbying, according to Tax Notes Today, is to employ former chiefs of staff of the Joint Committee on Taxation. Over the years, PwC has employed three: Bobby Shapiro, Mark McConaghy, and Kenneth Kies who joined the firm in 1998. A steady stream of talented tax committee staffers followed these leaders to PwC, earning PwC the moniker “Joint Committee West.” When a firm has tax experts with credentials like these leading the way, some might speculate that it would take an unusually bold audit partner indeed to challenge the validity of a major client’s tax provisions and liabilities.

Still, accounting firms maintain that nothing has changed. “Accounting firms have been providing tax services to clients for a hundred years,” PwC spokesman Steven G. Silber reportedly told the Post. “There is no conflict with the audit.”

-Rosemary Schlank

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