Challenges of Transparency in Corporate Tax Departments, The

CPA Journal, The, Oct 2007 by Cowan, Mark J, English, Tom

Third, the IRS is clearly willing to take taxpayers to court in support of its workpaper requests, at least in the tax shelter arena. United States v. Textron, Inc. is currently pending in the U.S. District Court for Rhode Island. In this case, the IRS has accused Textron of engaging in several listed transactions and is therefore seeking all of Textron's tax accrual workpapers. The outcome of this case may help define the parameters of the IRS's power in this area, clarify whether any sort of work product privilege can apply in the tax accrual area, and shed further light on the how the IRS is implementing its workpaper policy. (For more on Textron, see Christopher M. Netram, "Summons Enforcement Action Filed for Tax Accrual Workpapers," Tax Notes Today, May 2, 2006.)

To minimize the risk of IRS access, experts traditionally advised corporate tax departments to provide independent auditors only with summary information about their tax exposures (e.g., Thomas F. Carlucci, et al, "The Perfect Storm Gathers," The Tax Executive, November-December 2005). The hope was that if the auditor was not provided significant detail, then confidentiality could be maintained, Arthur Young would not apply, and the work-product and attorney-client privileges would therefore be more likely to apply. Auditors' reduced documentation practices in the 1990s, previously discussed, aided in this strategy. This approach is no longer feasible under FIN 48.

The AICPA professional audit standards instruct financial statement auditors to consider lack of documentation access or existence when forming an opinion on the financial statements. In general, client-imposed limitations on access to material information will result in significant report modifications, including the potential for a disclaimer of opinion (AU 508.24). These standards apply to all audits (both public and private) because AU 508 was adopted by the PCAOB as part if its interim standards. As noted above, auditors have more exposure in light of FIN 48 and will likely not settle for mere summary schedules in support of the client's FIN 48 assertions.

More Disclosure, More Risks

The recent PCAOB and ASB documentation standards and FIN 48 should result in more accurate financial reporting, more useful information to auditors and investors, and better management of tax risks. At the same time, these new rules create compliance headaches for already overburdened corporate tax departments. Tax departments should consider using the experience of their internal audit departments to deal with this issue. The internal audit function is uniquely situated to provide assistance in this area because it involves internal control, tax, documentation, and audit standard expertise.

A more troubling problem, and one less easy to address, is that the new rules result in tax accrual workpapers that can provide the IRS with precise directions to the company's tax exposures. While the IRS has historically restrained itself, it has been more aggressive recently in requesting tax accrual workpapers. With so much detail now required, the IRS may be tempted to be even more expansive in its scope.