PCAOB Rule 3522: Tax Services and Auditor Independence

The Public Company Accounting Oversight Board (PCAOB) was established under the Sarbanes-Oxley Act of 2002 to oversee the audits of public companies. A primary function of the PCAOB is to establish and enforce professional standards, including those related to auditor independence. PCAOB Rule 3522 is a specific regulation that addresses the provision of tax services by a registered public accounting firm to its audit clients. The rule aims to prevent conflicts of interest that could compromise an auditor’s objectivity and operates by setting clear boundaries on the types of tax services an auditor can provide.

The Audit Committee Pre-Approval Requirement

The core of the PCAOB’s rules on tax services is the requirement for pre-approval by the client’s audit committee. Before a registered accounting firm can provide any permissible tax service to an audit client, the engagement must be reviewed and approved by the audit committee. The accounting firm must provide the committee with sufficient information to make a reasoned judgment about the nature and scope of the proposed tax work. The committee is expected to consider whether the service could create a mutual or conflicting interest between the auditor and the company’s management.

The rules include a narrow de minimis exception under PCAOB Rule 3524. This applies to tax services not recognized as non-audit services at the time of the engagement, with a total fee of no more than five percent of the total revenues paid by the client to the firm during the fiscal year. These services must be promptly brought to the attention of the audit committee for approval before the completion of the audit. This provision is designed to accommodate minor, inadvertent oversights rather than serving as a standard operating procedure.

Prohibited Tax Services and Arrangements

PCAOB Rule 3522 explicitly prohibits accounting firms from providing certain types of tax services to their audit clients, which the audit committee cannot approve under any circumstances. One major category of banned services involves contingent fee arrangements. A contingent fee is a payment structure where the fee is dependent on achieving a specific outcome, such as a tax refund. Such arrangements are forbidden because they give the auditor a direct financial stake in the outcome of their advice, creating a conflict of interest.

The rule also forbids auditors from providing services related to confidential or aggressive tax position transactions. A confidential transaction is one where the advisor places limitations on the client’s ability to disclose the tax treatment or structure of the transaction. An “aggressive tax position” is a transaction where a significant purpose is tax avoidance, and the proposed tax treatment is not at least “more likely than not” to be upheld if challenged. This standard means there must be a greater than 50% likelihood of the position being sustained on its merits.

A restriction under PCAOB Rule 3523 prohibits an accounting firm from providing tax services to individuals who hold a Financial Reporting Oversight Role (FROR) at the audit client. This includes the executive in the role and their immediate family members. An FROR is a position with direct influence over the contents of the financial statements, and the prohibition extends to any individual who serves in an equivalent position. FROR positions include:

• Chief Executive Officer
• President
• Chief Financial Officer
• Chief Operating Officer
• General Counsel
• Chief Accounting Officer
• Controller
• Director of Internal Audit

Auditor Communication and Documentation

To facilitate the audit committee’s oversight role, the PCAOB mandates specific communication procedures for the accounting firm. Before the committee can pre-approve any tax service, the auditor must provide a detailed written description of the proposed engagement. This communication must outline the scope of the service, the proposed fee structure, and any related agreements. The firm is required to be transparent about all aspects of the engagement to allow for a thorough review.

The accounting firm must also discuss with the audit committee the potential effects of the proposed service on the firm’s independence. This involves a dialogue where the firm and the committee consider any threats that the engagement might pose to the auditor’s objectivity. The firm should be prepared to explain why the provision of the service is compatible with maintaining independence and address any concerns the committee might have.

Following the audit committee’s review and approval, the accounting firm has a responsibility to document the process. The firm must maintain records of its communications with the audit committee, including the written materials provided and the details of the independence discussion. This documentation serves as evidence that the required approval was obtained and that the potential impacts on auditor independence were properly considered.