After over three years of discussion, a provisional agreement on EU audit reform was reached on 18 December 2013 between the EC, the European Parliament and EU member states. This was approved by the Parliament on 3 April and has now been ratified by the Council of Ministers, paving the way for a new regulation and directive to enter into force in the next few months. There is a transitional phase and, although there are exceptions, in general the full impact of the rules will not apply until 2016. The rules are complex and there is limited guidance, but the potential impact is considered below.
The rules will only apply to EU public interest entities (PIEs). The definition of a PIE is the same as under the EU Accounting Directive (article 2(1) of 2013/34/EU) and includes: EU entities (and entities of EEA countries bound by EU legislation) which have transferable securities (equity or debt) admitted to trading on a ‘regulated market’; ‘credit institutions’ (banks); and ‘insurance undertakings’.
There is limited guidance at present and the impact is not always clear. For example, PIEs are defined on an entity by entity basis, not at group level, but the rules can impact EU and non-EU subsidiaries of the PIE and EU formed parents. Member states can individually designate as PIEs other undertakings that are of significant public relevance; for example, because of the nature of their business or their size.
It is estimated that there are roughly 300,000 companies in the EU that require a statutory audit and, of these, 30,000 are PIEs.
The key element of the legislation that has attracted most press attention is that of mandatory audit firm rotation, which is not explored here. Much less attention has been given to the impact for audit firms and their clients on the provision of non-audit services (NAS), including tax services. Permitted NAS must be capped at 70% of average fees paid in the last three consecutive years for the statutory audit and audit committee approval must be obtained. However, prohibited NAS include:
(Member states have the option of permitting the first four of the service categories listed above, subject to conditions around materiality in the accounts, additional communication with the audit committee and compliance with underlying independence principles.)
There are no special ‘grandfathering’ rules for existing projects when the new laws come into effect during 2016.
Undoubtedly, a patchwork of rules will develop across Europe, and the ‘materiality’ exemption will be open to interpretation. One area of difficulty is transfer pricing, where work can conceivably be considered to be tax compliance, tax advisory and, potentially, even as playing a part in management or decision making.
In practice, regardless of the patchwork of law, audit committees of European and global groups are likely to adopt group policies widely restricting NAS. This will have a significant impact on the market for tax compliance and advisory services, notably in the financial sector.
Historically, many corporates have used their auditors for tax compliance and advisory services, given their existing relationship and their understanding of the business; and some tax advisers may have relied exclusively on ‘referrals’ to maintain their business. What is clear is that those days are gone and many longstanding relationships will come to an end.
But what about the impact for the buyers of tax services? Steve Hoy, head of tax at The Phoenix Group PLC, says:
‘In my career, I have seen an ever increasing focus on auditor independence, the last major change being the Sarbanes-Oxley Act of 2002 introduced by the SEC. However, these rules will have a far wider impact. For example, tax compliance was not previously seen as a risk area and is now in scope. Synergies from information gathering will be lost and this may impact the cost of services.
‘It will take firms time to understand the rules and to develop systems to manage the risk of non-compliance. It will also take audit committees time to understand the patchwork of legislation and to develop appropriate policies. I envisage confusion and time delays, which will not be welcome when there is a need to act quickly to appoint an adviser, for example, for an imminent transaction.
‘I recognise the good intentions, but I am not convinced the rules will always have a positive impact on competition and they will create a raft of new problems. For example, in practice audit committees may apply NAS restrictions in the tendering phase of an audit; I envisage situations where effectively there is no choice but to use a particular service provider and, in extreme situations, this could even lead to exclusion from the market.
‘The rules are undoubtedly a game changer and I will have to work harder at extending my adviser network, but this is not necessarily straightforward for some specialist insurance tax issues!’
PIEs and accounting firms are entering into a turbulent phase for the provision of NAS. It is clear that:
