In October 2010, we made reference to Section 989G(b) of the Dodd-Frank Act. This section required the SEC to conduct a study to determine how the commission could reduce the burden of complying with Section 404(b) of the Sarbanes-Oxley Act for companies whose market capitalization is between $75 million and $250 million, while maintaining investor protections for such companies (see ). Section 989G(b) also required the study to consider whether reducing the compliance burden — or even a complete exemption from Section 404(b) compliance — would encourage such companies to list on exchanges in the United States in their initial public offerings. This study was to address only the auditor attestation requirement with respect to an issuer‘s internal control over financial reporting. It did not address management‘s continued responsibility for reporting on the effectiveness of internal controls over financial reporting (“ICFR”) pursuant to Section 404(a).
The research discussed in the study, which was completed this past April, primarily focuses on findings related to accelerated filers. The study confirmed what the SEC believed to be true: that investors generally view the auditor’s attestation on ICFR to be beneficial; and that financial reporting is more reliable when the auditor is involved with ICFR assessments. Interestingly enough, the findings also put to rest the perception that companies may choose to list overseas or delist from U.S. exchanges as a result of the onerous requirements of and costs associated with SOX compliance. The study concluded that “there is not conclusive evidence linking the requirements of Section 404(b) to listing decisions of the studied range of issuers.” Predictably, and to the dismay of many hopeful accelerated filers, the study’s two principal recommendations did not include a complete exemption from the requirements of Section 404(b) for accelerated filers, but encouraged activities that have the potential to further improve both the effectiveness and efficiency of Section 404(b) implementation.
Tax-Related Material Weaknesses in 2011
Upon perusing some of the tax-related material weaknesses disclosed after the 2010 year-end and first-quarter 2011 filing seasons, we are sticking with last October’s theme. The harsh reality remains that despite the existence of SOX rules for many years, tax-related material weaknesses are alive and kicking in 2011. As a result, it’s worth rehashing what continue to be the prominent culprits that can result in material weaknesses, as well as some best practices for successfully navigating these risks.
Below is a representative sample disclosure of a tax-related material weakness taken from a year-end 2010 10-K filing:
“The principal factors contributing to the material weakness were: 1) inadequate staffing and technical expertise within the company related to taxes, 2) ineffective review and approval practices relating to taxes, 3) inadequate processes to effectively reconcile income tax accounts and 4) inadequate controls over the preparation of the quarterly tax provision.”
Not surprisingly, personnel, staffing and oversight issues continue to be among the most prevalent culprits when a material weakness label is placed on a company’s tax-related internal controls. In some cases, these weaknesses resulted from inadequate resources in the corporate tax department — for example, insufficient personnel or a lack of specific expertise, such as experience with ASC 740 or international tax issues. Additionally, inadequate oversight or a lack of understanding by management of complex tax calculations prepared by the tax department caused material weaknesses in many cases. This type of weakness was also reported in cases where the tax function was outsourced, with inadequate oversight of the third-party tax consultant or a lack of understanding of the calculations prepared by the third-party tax consultant. Furthermore, for corporations with complex structures or with overseas operations, lack of proper oversight in tax reporting by domestic and foreign subsidiaries often resulted in a material weakness.
Best Practices – What Is Working?
So what kinds of things are companies doing to beef up their tax controls?
- Improving tax accounting technical quality
- reevaluating quarterly close processes with a focus on discrete events
- building and maintaining entity-level tax-basis balance sheets
- formalizing review procedures
- putting procedures in place to detect legislative and judicial tax law changes and any business changes (globally) that might impact taxes
- continuing to develop technical tax and ASC 740 skills of tax department personnel
- Improving communications and efficiency
- reassessing and standardizing tax reporting packages
- clearly defining roles and responsibilities for tax department personnel
- documenting processes and key controls with a program of independent testing by the internal audit function
- aligning responsibilities and maintaining open communication between the tax function, finance and business units
- understanding and using IT controls over tax data sources
- developing U.S. and global tax-return compliance tracking and retention policies and procedures
- implementing tax provision software (see )
- Using tax technology
Alvarez & Marsal Taxand Says:
Historically, the tax function of a company has not always received the attention it is due when compared with other areas of a business. But with the steady flow of material weaknesses in tax being reported by SEC registrants as well as increased scrutiny by taxing authorities and the investor community, a company’s tax affairs have quickly become a staple on the board’s monthly meeting agenda. Unfortunately, the road to recovery from material weakness can be a long one. Although you might be confident that your company’s internal controls over income tax accounting are adequate, we encourage you to use the examples cited above in committing to the continued assessment and enhancement of your internal control processes and procedures, especially in situations where complex tax planning has been undertaken at your company.
Managing Director, New York
Stephanie DeYoung, Senior Director, contributed to this article
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