21.2.03 Notice u/s 161/205 of the Income Tax Ordinance, 2001 issued to Corporation for tax year 2013-14

Enquiry:

This query is related to ABC Corporation on which FBR had some observations related to code of ethics compliance for tax year 2013-14.

Background:

ABC Corporation is established in China as a state-owned hydropower project contractor during the 1950s. It has dynamic network including regional divisions and offices in Asia, Africa, Oceania, South America and Europe, supervising 113 overseas branches / representative offices in 84 countries. In Asia, their head office is located in Islamabad. ABC Corporation Limited is listed as a registered taxpayer.

Extract of FBR observation on audit firm of Corporation, M/s XYZ & Company, Chartered Accountants, is reproduced below:

“…..It is further pertinent to mention that not only your firm, M/s XYZ & Company, Chartered Accountants, prepared the Financial Statements and Audited Accounts of the company, in fact they are also the engaging partner of the concerned company which shows either professional incompetence of the firm or deliberate attempt aiming at misleading the undersigned.
It has also been observed that preparation of financial statements and conducting of audit by the same firm and simultaneously representing the taxpayer being tax attorney before the Inland Revenue Authorities is not only morally wrong but also against the professional ethics and the best international practice in vogue all across the world. In Pakistan, after realizing the same, SECP has changed this practice for public listed companies.”

Opinion:

The relevant Committee of the Institute (the Committee) has considered the matter and would like to inform you that in 1990 the Institute adopted the International Federation of Accountants’ (IFAC) Code of Ethics for Professional Accountants for the first time with some amendments so that the services provided by its members should be in accordance with the internationally accepted norms and principles. Since then the Institute is following IFAC’S Code. In April 2015, the International Ethics Standards Board for Accountants (IESBA) of IFAC issued a revised Code of Ethics for Professional Accountants, clarifying requirements for all professional accountants and significantly strengthening the independence requirements of auditors in providing their services, which was adopted by the Institute subject to some changes as per local regulatory requirements.

The Committee would like to refer the following paragraphs of ICAP Code of Ethics (the Code) issued in 2008, as the query relates to tax year 2013-14:

290.159 The potential threats to independence will most frequently arise when a non-assurance service is provided to a financial statement audit client. ……. Threats to independence, however, may also arise when a firm provides a non-assurance service related to the subject matter information, of a non- financial statement audit assurance engagement. In such cases, consideration should be given to the significance of the firm’s involvement with the subject matter information, of the engagement, whether any self-review threats are created and whether any threats to independence could be reduced to an acceptable level by application of safeguards, or whether the engagement should be declined. ……..

290.164 The provision of certain non-assurance services to financial statement audit clients may create threats to independence so significant that no safeguard could eliminate the threat or reduce it to an acceptable level. However, the provision of such services to a related entity, division or discrete financial statement item of such clients may be permissible when any threats to the firm’s independence have been reduced to an acceptable level by arrangements for that related entity, division or discrete financial statement item to be audited by another firm or when another firm reperforms the non-assurance service to the extent necessary to enable it to take responsibility for that service.

290.165 Assisting a financial statement audit client in matters such as preparing accounting records or financial statements may create a self-review threat when the financial statements are subsequently audited by the firm.

290.166 It is the responsibility of financial statement audit client management to ensure that accounting records are kept and financial statements are prepared, although they may request the firm to provide assistance. If firm, or network firm, personnel providing such assistance make management decisions, the self-review threat created could not be reduced to an acceptable level by any safeguards. Consequently, personnel should not make such decisions. Examples of such managerial decisions include:

• Determining or changing journal entries, or the classifications for accounts or transaction or other accounting records without obtaining the approval of the financial statement audit client;
• Authorizing or approving transactions; and
• Preparing source documents or originating data (including decisions on valuation assumptions), or making changes to such documents or data.

In addition to above, please refer the safeguards provided in the paragraph 290.162 of the Code when non-assurance services are provided to assurance clients.

Financial Statements Audit Clients that are Not Listed Entities

290.169 The firm, or a network firm, may provide a financial statement audit client that is not a listed entity with accounting and bookkeeping services, including payroll services, of a routine or mechanical nature, provided any self-review threat created is reduced to an acceptable level.

Examples of such services include:
• Recording transactions for which the audit client has determined or approved the appropriate account classification;
• Posting coded transactions to the audit client’s general ledger;
• Preparing financial statements based on information in the trial balance; and
• Posting the audit client approved entries to the trial balance.

The significance of any threat created should be evaluated and, if the threat is other than clearly insignificant, safeguards should be considered and applied as necessary to reduce the threat to an acceptable level. Such safeguards might include:

• Making arrangements so such services are not performed by a member of the assurance team;
• Implementing policies and procedures to prohibit the individual providing such services from making any managerial decisions on behalf of the audit client;
• Requiring the source data for the accounting entries to be originated by the audit client;
• Requiring the underlying assumptions to be originated and approved by the audit client; or
• Obtaining audit client approval for any proposed journal entries or other changes affecting the financial statements.

In the light of above, the Code allows unlisted company’s auditor to prepare financial statements and also to perform audit, provided safeguards are in place.

With regard to providing tax related advisory services, the Committee would also like to draw your attention to para 290.176 of the Code:

290.176 The firm may be asked to provide taxation services to a financial statement audit client. Taxation services comprise a broad range of services, including compliance, planning, provision of formal taxation opinions and assistance in the resolution of tax disputes. Such assignments are generally not seen to create threats to independence.

The Committee is of the opinion that the external auditor may engage in tax advisory services. However, certain tax services may also pose a threat in the form of self-review and/or advocacy for which the auditor needs to take care of by applying the necessary safeguards.

In addition to above, the Committee would also like you to refer section 290.175-290.188 pertaining to the taxation services of the revised ICAP Code of Ethics 2015 which is effective for audits of financial statements for periods beginning on or after July 01, 2015. In section 290.179-290.180, the revised Code distinguishes between the requirements for listed and unlisted clients, otherwise it allows external auditor to perform varied taxation services that are mentioned in the Code.

The full copy of the ICAP Code of Ethics can be accessed at:

http://www.icap.net.pk/wp-content/uploads/2013/12/Code-of-Ethics-2008.pdf

http://www.icap.net.pk/wp-content/uploads/2013/12/ICAP-revised-Code-of-Ethics-2015.pdf

(May 09, 2016)