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Feature

Stuart E. Seigel
Chairman and CEO
Seigel & Associates LLC

Are You Prepared to Release Hitherto Undisclosed Information?

Tax reserves, FIN 48, and corporate governance … and the potential for “soft spots” to be newly opened to the SEC and other regulatory bodies, institutional investors, stock analysts, and corporate gadflies.

By Stuart E. Seigel

Board members are paying more attention than ever before to the issue of tax reserves — attention that is now intensifying as public companies prepare their 2007 financial statements for publication and SEC filing with annual reports.

The reason is FIN 48, prescribed by the Financial Accounting Standards Board, which not only mandates new procedures for consistent application in determining the amount of tax reserves commencing in 2007, but also requires, for the first time, separate disclosure of such reserves in financial statements.

Complying with FIN 48 involves new risks and liabilities for the corporation, the board, and the audit committee. And the disclosure requirements of FIN 48 mean that these parties must be newly ready to explain and defend the resulting tax positions taken.

New Mandate
It is now mandated that companies publicly disclose the level of their tax reserves as well as information concerning additions, deletions, and prospective changes. This hitherto undisclosed information will be readily available to the SEC and other regulatory bodies, and to institutional investors, stock analysts, and corporate gadflies looking for “soft-spots.”

Sarbanes-Oxley requires CEOs and CFOs to personally sign and attest to the correctness of financial statements, including these new disclosures. It heightens the exposure and level of risk for audit committees and boards as well. Corporate management and board members are being called upon to understand, explain, and, in some cases, to defend not only the results, but the process and oversight used to comply with the strictures of FIN 48.

Increasingly, companies are looking for independent sources of assistance in dealing with tax reserve issues to help ensure that tax reserves will withstand scrutiny.

Sensitive Judgments
The complexities of the tax code are little understood outside of a company’s tax department, where individuals make a career of deciphering its intricacies. And, while the efficacy of the amounts reserved for potential future tax liabilities is the critical goal, determining tax reserves is heavily infused with sensitive judgments.

Board members must be comfortable with these judgments in an environment of elevated interest and inquiry and heightened potential for risks of noncompliance — such as restatements, investigations, litigation, penalties, or worse. Savvy board members are looking for ways to gain more comfort with the tax reserve results, as well as with the soundness of the procedures used to derive those reserves.

Adding to the complexity, companies can no longer simply rely on traditional sources of assurance for tax reserve issues.

The reason is that in nearly all cases, those that determined or passed judgment on the tax reserve most likely had a hand in originating or executing tax strategies for the company, or are engaged in similar work for other companies.

This often makes it difficult for them to step back far enough from the issues to provide a truly objective and appropriate valuation of the reserves — be it an outside auditor that also performs tax work for the company, an outside tax advisor, or even an in-house tax department because, in all these cases, advising on the tax reserve determinations essentially is “auditing” what could be their own recommended and implemented tax strategies, or similar strategies they may have implemented or recommended to other clients.

An Emerging Best Practice
Hiring a truly independent outside advisor for tax reserve issues is emerging as a corporate governance best practice. The reason is that tax reserves withstand examination best if those that played a role in their determination are truly independent. That achieves the goal of eliminating the reality or perception of bias.

Concerns are dispelled if the advisory firm, because it offers no services other than those relating to the determination of tax reserves and required collateral disclosures, neither receives nor can seek to receive additional fees for other services provided to the client.

Board members can prepare themselves to face these issues by keeping the following thoughts in mind:

The risks of non-compliance are higher than ever — and companies are starting to recognize this.
Disclosure means that questions will follow. Board members are working to understand the dynamics of tax reserves and their implications in order to prepare for the increased attention they are receiving.
The best plan to deflate potential questions is to ensure not just the quality, but also the independence of the decision-making process.

Companies can avoid potential risks and pitfalls through the meaningful and thoughtful participation by corporate boards in the implementation of tax reserve processes and procedures that conform to the best corporate practices.

Stuart E. Seigel is a former Chief Counsel of the Internal Revenue Service and Chairman and CEO of Seigel & Associates LLC, tax reserve advisors. He can be contacted at stuart@seigel-llc.com.