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Financial Reporting and the Law

In a recent Section 21(a) Report, the SEC explained that—although tax services and other non-audit services provided by an auditor may be permissible—the way they are provided may adversely affect the auditor’s independence. For example, if an auditor loans a non-manager employee to an audit client to assist with the preparation of tax returns or other tax compliance work, the auditor would be considered to lack independence. The SEC’s January 24 report notes that Rule 2-01 of Regulation S-X prohibits an auditor from both “being” and “acting” as an employee of an audit client, even if the non-audit service is permissible.

Based on the SEC’s report, audit committees must do the following when evaluating whether to approve a permissible non-audit service, including a tax service:

  • Scrutinize both the nature of the proposed service as well as the manner in which that service will be delivered. In no event can an auditor’s personnel act as an employee of the audit client.
  • Make sure that the auditor would not do something indirectly (acting as an employee) that the auditor cannot do directly (being an employee).
  • Make sure that the service would not suggest that the auditor is acting as an employee of the audit client. The degree of control that the audit client exercises over the auditor’s personnel is a key inquiry in this regard.

The Section 21(a) Report notes that tax services are still permissible because, unlike “loaned staff arrangements, typical tax services engagements do not involve the audit firm providing personnel to the audit client, but rather involve the audit firm performing services for the audit client.” In addition, in a typical tax service, the work is conducted by audit firm personnel and supervised by the audit firm’s managers, who have complete responsibility for the quality of the work.