Auditor-provided Tax Services Research Articles

Did the PCAOB's Restrictions on Auditors' Tax Services Improve Audit Quality?

ABSTRACTIn 2005–2006, the PCAOB imposed restrictions on auditors' tax services in order to strengthen auditor independence and improve audit quality. The restrictions resulted in a significant drop in auditor-provided tax services (APTS). To test the impact on audit quality, I partition the sample into a treatment group (companies whose APTS purchases dropped significantly when the restrictions were introduced) and a control group (companies whose APTS purchases were relatively unaffected) and I measure audit quality using the incidence of accounting misstatements, tax-related misstatements, and auditors' going-concern opinions. Using a difference-in-differences design, I find no change in audit quality for the treatment group relative to the control group after the restrictions are imposed.

The Economic Consequences of Tax Service Provider Sanctions: Evidence from KPMG's Deferred Prosecution Agreement

ABSTRACTThis study investigates the effect of KPMG's Deferred Prosecution Agreement (DPA) on the accounting firm's ability to sell auditor-provided tax services (APTS) and its clients' tax avoidance. We document that following the DPA, clients were more likely to discontinue or reduce purchasing APTS from KPMG relative to the other Big 4 accounting firms. However, we do not find any evidence of a change in tax avoidance among KPMG clients continuing to purchase APTS following the DPA relative to other Big 4 clients. Broadly, our findings highlight how elevated reporting standards and external monitoring impose significant negative economic consequences on the service providers subject to these sanctions. At the same time, it appears clients do not suffer any observable tax costs by continuing to engage a sanctioned tax service provider.

Auditor-provided tax services and long-term tax avoidance

Purpose– The purpose of this paper is to determine the association between auditor-provided tax services (APTS) and long-term corporate tax rates.Design/methodology/approach– The paper uses empirical data and multivariate regression models to explore the relationship between a firm’s use of APTS and their long-term effective tax rate.Findings– An economically and statistically significant long-term negative relationship was found between firm levels of APTS and taxes paid. Further, a portion of this benefit is lost for some firms when returning to their auditor for tax services even after a short break.Originality/value– This paper contributes to the debate regarding the value of APTS by providing evidence of the apparent long-term negative consequences to firms who reduce their reliance on APTS, perhaps even through the engagement of separate accounting firms for their audit and tax functions, although these consequences may be mitigated upon return with a significant increase in APTS. However, this is the first study, to our knowledge, to explore, in a long-term setting, the consequences of a firm’s return to their auditors for a non-audit service previously reduced or terminated. Additionally, further incremental contributions are made to other studies that look at APTS and tax avoidance by studying the long-term relationship which allows firms to consider the cumulative cost/benefit relationship between independence and knowledge spillover.

Tax Internal Control Quality: The Role of Auditor-Provided Tax Services

We propose that auditor-provided tax services (tax NAS) improve internal control quality by accelerating audit firm awareness of transactions material to the financial statements. Using data from 2004 to 2012, we find robust evidence that companies purchasing tax NAS are significantly less likely to disclose a material weakness and that this result is not due to auditor independence impairment. A one standard-deviation increase in tax NAS is associated with approximately a 13 percent decrease in the rate of material weaknesses relative to the base rate. These results are robust to tests addressing endogeneity concerns. Additional cross-sectional analyses reveal expected increased effects of tax NAS on internal control quality (1) after significant operational changes that require changes to the internal control structure, and (2) earlier in the relationship with the financial statement audit firm, when there are fewer established lines of communication between the audit team and client. This paper contributes to the knowledge spillover literature by identifying a mechanism through which tax NAS improve overall financial reporting quality.

Auditor-provided tax services and stock price crash risk

This paper examines whether auditor-provided tax services affect stock price crash risk: an important consideration for stock investors. Provision of tax services by incumbent auditors could accentuate or attenuate crash risk depending on whether such services give rise to knowledge spillover or impair auditor independence. The study investigates two channels through which tax services might affect crash risk: earnings management in tax expenses and tax avoidance. Also examined is whether the association between tax services and crash risk is moderated by the particular business strategy that organizations pursue. A two-stage model is used to control for the potential endogeneity inherent in the selection of auditors for tax services. Empirical findings reveal that auditor-provided tax services attenuate crash risk by constraining both earnings management in tax expenses and tax avoidance. Further evidence shows that auditor-provided tax services reduce crash risk for firms following innovator business strategies. Taken together, empirical findings reported in this study support knowledge spillover benefits, that is, insights gained from tax services can enhance audit effectiveness.

The Role of Auditors, Non-Auditors, and Internal Tax Departments in Corporate Tax Aggressiveness

ABSTRACTUsing confidential data from the Internal Revenue Service on who signs a corporation's tax return, we investigate whether the party primarily responsible for the tax compliance function of the firm—the auditor, an external non-auditor, or the internal tax department—is related to the corporation's tax aggressiveness. We report three key findings: (1) firms preparing their own tax returns or hiring a non-auditor claim more aggressive tax positions than firms using their auditor as the tax preparer; (2) auditor-provided tax services are related to tax aggressiveness even after considering tax preparer identity, which supports and extends prior research using tax fees as a proxy for tax planning; and (3) Big 4 tax preparers, in particular, are linked to less tax aggressiveness when they are the auditor than when they are not the auditor. Our findings help policymakers and researchers better understand an important feature of tax compliance intermediaries; particularly, how the dual role via audits is related to observable corporate tax outcomes.

Do auditor-provided tax services improve the relation between tax-related internal control and book-tax differences?

This study investigates whether companies purchasing tax services from auditors can improve the relation between tax-related internal controls and book-tax differences. We employ permanent book-tax differences as a proxy of tax avoidance and temporary book-tax differences as a proxy of earnings management via pre-tax accruals. Our findings show that companies with a higher probability of reporting a material weakness regarding tax-related internal controls have larger permanent and temporary differences (i.e. a higher degree of tax avoidance and earnings management activities); however, companies purchasing auditor-provided tax services can mitigate the positive relation between tax-related internal control weaknesses and permanent differences in the post-SOX period, but no effect on temporary differences.

Tax Account Misstatements and the PCAOB's Restrictions on Auditorss Tax Services

In 2005-2006, the PCAOB imposed restrictions on auditors’ tax services in order to strengthen auditor independence and improve audit quality. The restrictions resulted in a significant drop in auditor-provided tax services (APTS). To test the impact on audit quality, I partition the sample into a treatment group (companies whose APTS purchases dropped significantly when the restrictions were introduced) and a control group (companies whose APTS purchases were relatively unaffected) and I measure audit quality using the incidence of accounting misstatements, tax-related misstatements, and auditors’ going-concern opinions. Using a difference-in-differences design, I find no change in audit quality for the treatment group relative to the control group after the restrictions are imposed.

The Relation Between Auditor-Provided Tax Service Fees and Audit Fees After the Sarbanes–Oxley Act

The Sarbanes–Oxley Act of 2002 (SOX) permits the provision of tax services by auditors and restricts other major non-audit services previously provided by auditors for their audit clients. This article examines the relation between auditor-provided tax fees and audit fees after SOX. The results, using a tax fee model and an audit fee model with a larger set of non-overlapping independent variables in both models, show a positive relationship between tax and audit fees, after controlling for factors that could drive both fees. An additional test shows that firms that employ (do not employ) their incumbent auditors also for tax service are likely to pay higher (lower) audit fees than in the case when they only (also) employ their auditors for audit service. The results of other tests are also consistent with the suggestion that auditors cross-sell their non-audit services to their audit clients.

Internal Control Quality: The Role of Auditor-Provided Tax Services

ABSTRACTWe propose that auditor-provided tax services (tax NAS) improve internal control quality by accelerating audit firm awareness of transactions material to the financial statements. Using data from 2004 to 2012, we find robust evidence that companies purchasing tax NAS are significantly less likely to disclose a material weakness and that this result is not due to auditor independence impairment. A one-standard-deviation increase in tax NAS is associated with approximately a 13 percent decrease in the rate of material weaknesses relative to the base rate. These results are robust to tests addressing endogeneity concerns. Additional cross-sectional analyses reveal expected increased effects of tax NAS on internal control quality (1) after significant operational changes that require changes to the internal control structure, and (2) earlier in the relationship with the financial statement audit firm, when there are fewer established lines of communication between the audit team and client. This paper contributes to the knowledge spillover literature by identifying a mechanism through which tax NAS improve overall financial reporting quality.

Auditor-Provided Tax Services and Earnings Management in Tax Expense

Regulators do not prohibit auditors from providing tax services to their audit clients, provided that these services are preapproved by audit committees. I examine whether the association between auditor-provided tax services and earnings management in tax expense varies with audit committee effectiveness. I develop a composite proxy for audit committee effectiveness by combining six audit committee characteristics. I find that auditor-provided tax services are less positively associated with earnings management in tax expense as audit committee effectiveness increases. My findings suggest that the knowledge spillover effect of auditor-provided tax services is more likely to dominate the independence impairment effect when auditor-provided tax services are preapproved by more effective audit committees.

Auditor-Provided Tax Services and Earnings Management Through the Tax Accounts

Auditor-Provided Tax Services and Earnings Management Through the Tax Accounts

Auditor-Provided Tax Services and Stock Price Crash Risk

Auditor-Provided Tax Services and Stock Price Crash Risk

The Impact of Auditor-Provided Tax Services on Tax Accrual Quality

The Impact of Auditor-Provided Tax Services on Tax Accrual Quality

Audit committee financial expertise, corporate governance, and the voluntary switch from auditor-provided to non-auditor-provided tax services

A prime objective of the SOX is to safeguard auditor independence. We investigate the relation between audit committee quality, corporate governance, and audit committees' decision to switch from permissible auditor-provided tax services. We find that firms with more independent boards, audit committees with greater accounting financial expertise, higher stock ownership by directors and institutions, that separate the CEO and Chairman of the board positions, and with higher tax to audit fee ratios are more likely to switch to a non-auditor provider. Further, we document that firms are more likely to switch prior to issuing equity. We find no evidence that broad financial expertise on audit committees is related to the switch decision, suggesting that the SEC's initial narrow definition of expertise is more consistent with the objective of the SOX. Overall, our results suggest that accounting financial expertise and strong corporate governance contribute to enhanced audit committee monitoring of auditor independence.

Does Corporate Tax Aggressiveness Influence Audit Pricing?

We evaluate whether, and under what circumstances, corporate tax aggressiveness influences audit pricing. Using a compound measure of two long-run effective tax rates, we find that tax aggressive firms pay higher fees for external audit services after controlling for factors related to earnings management. The fee premium increases with management’s uncertainty about the sustainability of tax positions if audited by tax authorities (i.e., disclosed tax reserves). Further, the provision of auditor-provided tax services may create knowledge spillovers that alleviate the fee premium for tax aggressiveness, unless tax uncertainty is high. Finally, an accounting firm’s industry expertise in auditing is associated with higher audit fees independent of tax aggressiveness, whereas industry expertise in taxation leads to a fee premium only for tax aggressive clients. Overall, the evidence implies firms’ aggressive tax behavior, tax services provider, and auditor-expertise interact to influence the pricing of audit engagements.

Do Auditor-Provided Tax Services Impair Independence or Generate Knowledge Spillover? Evidence from Assessing Tax Accrual Quality

This paper tests whether auditor-provided tax services (APTS) affect estimation error in income tax expense. A decrease (increase) in tax expense estimation error is consistent with knowledge spillover (reduced professional skepticism) from one accounting firm providing both audit and tax services. We find that estimation error in the tax account is nearly 10 percent greater for firms that purchase a material amount of APTS, consistent with reduced professional skepticism. These results are robust to a variety of methods to address endogeneity concerns. We examine two alternative explanations for reduced professional skepticism and find evidence consistent with in-group identification, not economic bonding. In-group identification is a cognitive bias that leads one to establish a higher threshold for questioning work performed by people from one’s group relative to work performed by outsiders. In an APTS setting, in-group identification leads auditors to view tax work performed by professionals from their accounting firm with less skepticism than tax work performed by professionals outside their firm. Our findings provide new evidence of how APTS affects income tax expense estimation error and informs recent US and EU legislative initiatives that question whether APTS should continue to be permitted.

DISCUSSION OF Do Auditor-Provided Tax Services Enhance or Impair the Value Relevance of Earnings?

K rishnan, Visvanathan, and Yu (2013) (hereafter, KVY) fill a relevant gap in the burgeoning auditor-provided tax services (ATS) literature by examining investor perception of the costs and benefits of ATS. Prior and contemporaneous studies have investigated the influence of ATS on tax avoidance, financial statement quality, and creditor perception, but a study of the influence of ATS on value relevance was missing from the literature until now. KVY provide evidence that the value relevance of earnings is positively associated with the ratio of tax fees to total fees paid to auditors.

Auditor-Provided Tax Services and Earnings Management in Tax Expense: The Importance of Audit Committees

Regulators do not prohibit auditors from providing tax services to their audit clients, provided these services are preapproved by audit committees. I examine whether the association between auditor-provided tax services and earnings management in tax expense varies with audit committee effectiveness. I develop a composite proxy for audit committee effectiveness by combining six audit committee characteristics. I find that auditor-provided tax services are less positively associated with earnings management in tax expense as audit committee effectiveness increases. My findings suggest that the knowledge spillover effect of auditor-provided tax services is more likely to dominate the independence impairment effect when auditor-provided tax services are preapproved by more effective audit committees.

Do Auditor-Provided Tax Services Enhance or Impair the Value Relevance of Earnings?

ABSTRACT:Recently, some firms have decoupled their audit and tax service providers in an effort to improve the perceived credibility of their financial statements. Many firms, however, continue to rely on their current auditor for tax services. Therefore, we examine whether investors assign a lower valuation to firms that continue to use their auditor for tax services. We find that the value-relevance of earnings is increasing in the ratio of tax fees over total fees paid to the auditor. Further, for a sample of firms that switched to other providers of tax services, we find that the value-relevance of earnings is lower in the year of the switch. These findings support the notion that on average, investors perceive the benefits of auditor-provided tax services; i.e., enhanced financial reporting quality due to knowledge spillover to be greater than the costs of auditor-provided tax services; i.e., threat to auditor independence. Our findings have important implications for audit committee chairs, managers, and regulators.