Voluntary Disclosure Agreements and Auditor Independence
Cook, John K., Brown, Kevin F., Lightle, Susan S., The CPA Journal
Crafling a Policy that Fits the Process
The demand for CPA firms* tax services related to voluntary disclosure agreements (VDA) with state governments has grown dramatically since the promulgation of FASB Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes, which has led to demand for comprehensive nexus studies to determine the existence and extent of state tax exposure. VDA services typically entail a CPA firm facilitating an agreement between a state and the taxpayer (who often remains anonymous until the agreement is finalized) to determine a tax liability in states where income tax returns have not been filed previously. As with any nonattest service provided to an attest client, auditor independence must be considered prior to offering to provide the VDA services. In the past, some CPA firms may have adopted policies prohibiting them from providing VDA services to attest clients based on an assumption that such services would inherently entail negotiation, hence advocacy, thereby impairing the firm's independence.
On the contrary, the authors argue that the automatic or quasi-automatic nature of the VDA process in many states actually removes advocacy from the process. Hence, VDA services may not impair independence. Due to important differences in VDA processes from state to state, however, firms should not adopt a blanket approach (i.e., concluding that VDA services always impair or never impair independence) but, rather, evaluate the process for each specific jurisdiction in question.
An Analytic Approach
The important benefits of most, if not all, voluntary disclosure agreement programs are the limitation of periods for which the taxpayer will be liable for unpaid tax (i.e., the look-back period) and the limitation or elimination of otherwise applicable penalties (e.g.. failure-to-file and failure-to-pay penalties). Both are significant potential benefits of a VDA for taxpayers. Taxpayers who have failed to file returns in a particular jurisdiction typically have no protection, because most statute of limitations periods do not commence until the taxpayer files a return. Thus, nonfilers often have potential liability for all previous years. At the same time, penalties can be a significant component of a taxpayer's potential liability in a particular state. The ability to eliminate or limit potential liability, both temporally and quantitatively, is a significant inducement to participate in a VDA process.
At the same time, taxpayers often lack the ability or inclination to enter into a disclosure agreement on their own. They often turn to their CPA for professional assistance in securing the benefits of such an agreement. If the CPA firm providing tax advice also provides attest services to the client, the firm must consider the implications of the contemplated VDA services on its independence. In determining whether the provision of VDA services would impair independence, however, an acrossthe-board rule is problematic. A blanket approach is untenable, primarily because taxing jurisdictions offer or impose a variety of VDA processes. Each state's VDA process must be analyzed to determine whether a firm's provision of VDA services to an attest client would constitute a prohibited nonaudit service under the Sarbanes-Oxley Act, violate any or all of the act's three basic principles, or would otherwise impair the firm's independence with respect to AICPA ethics rules. This determination depends on the discretion, if any, exercised by the state tax authority in administering the VDA process. Thus, VDA process can be usefully divided into two classes: 1) discretionary and 2) automatic or nondiscretionary.
Discretionary processes. VDA processes fali'mg into the discretionary class are those in which the taxing authority is expected or required to make one or more determinations of qualification for participation in the VDA process. These determinations are often subjective or. …