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Accountability of Financial Officers for reporting system controls

 

Legislation will be introduced in Finance Bill 2009 (expected on 30 April 2009) to ensure that accounting systems in operation within large UK tax paying groups are adequate for the purposes of accurate tax reporting (ie tax returns and supporting computations).

The measure

Senior accounting officers (likely to be the Finance Director) of such companies will be required to:

  • take reasonable steps to establish and monitor accounting systems within their companies that are adequate for the purposes of accurate tax reporting;
  • certify annually to HMRC that the accounting systems in operation are adequate for the purposes of accurate tax reporting; or
  • specify the nature of any inadequacies and confirm that those inadequacies have been notified to the company auditors.

A penalty chargeable directly on the Senior Accounting Officer will be introduced for a failure to meet the obligations. This could be up to £5,000. This will be in addition to penalties imposed on the company, although the precise operation of these penalties has not been explained in any detail.

It is expected that the certification provided by the senior accounting officer will be similar to that required of SEC registrants under the US 2002 Sarbanes-Oxley Act - ie that management have established and are maintaining an adequate internal control structure and procedures for tax reporting. The critical test will therefore not be whether the tax return contains any inaccuracies, but whether sufficient controls were in place to enable accurate tax reporting.

Who will be affected?

The proposition is that this measure would apply to large companies, large groups of companies (effectively companies other than those defined as 'small' and 'medium sized' in the Companies Act 2006), and their senior accounting officers.

This would mean companies that satisfy at least 2 out of the following 3 criteria:

  • Turnover, more than £22.8 million
  • Balance sheet total, more than £11.4 million
  • Employees, more than 250.

When?

These obligations will apply only to returns due to be made for accounting reference periods beginning on or after the date that Finance Bill 2009 receives Royal Assent which is expected by 21 July 2009. However, there may be transitional arrangements included in the Finance Bill.
 

Our view

We are surprised to see the introduction of this proposal as it has not been the subject of any consultation and it appears inconsistent with recent communications from HMRC regarding their approach to assessing the quality of taxpayers' systems as part of the risk-based approach.

Our fundamental concern is that it appears to impose a significant new compliance burden on businesses, as well as presenting a potential personal exposure for the Senior Accounting Officer, while at the same time remaining silent on the hurdle of what is 'adequate' in this context.

We are uncertain as to the existing capability of HMRC to assess the adequacy of accounting systems in this context, particularly for corporate taxes where HMRC has only very recently begun to formulate its expectations for the purposes of the risk-based approach and penalty regime. Even in the context of indirect taxes, where an evaluation of systems has formed a central part of the assessment process for a number of years, this is likely to present a resourcing challenge

It is also questionable how relevant the Sarbanes-Oxley ('SOX') experience should be here as the US legislation was developed specifically in relation to financial reporting and so arguably does not extend to the tax return preparation process. Reference is made by HMRC to 'certain corporate tax governance controls... to produce accurate tax computations' which appears to extend beyond the scope of SOX. It is possible that this could even extend to requirements for general ledger codes to be further categorised for tax than is currently done by the majority of large companies. SOX also focuses on group reporting whereas tax returns are prepared from entity financial statements which may be prepared under a different set of accounting standards (UK GAAP in the majority of cases). It is likely that there will be consultation with large companies on how this would work in practice.

SOX also operates under the concept of materiality as it is a financial reporting requirement. There is currently no similar concept of materiality in tax return preparation. As a consequence of importing a SOX-based approach, HMRC may now therefore be introducing the concept of materiality into their assessment of a tax return although it is not clear whether this would be equivalent to auditing materiality or whether a new concept of tax materiality will have to be introduced.

HMRC are expecting that this measure will raise an additional £140 million of exchequer receipts over 4 years from around 60,000 companies. We believe that the impact is likely to be closer to neutral given that many companies do not currently have sufficiently high data quality to support tax deductions. These new requirements may lead to further deductions becoming available from the improvement in data quality.

HMRC do not view these measures as imposing any significant additional burden on companies where 'adequate accounting systems' are already in place. However, we would expect the reality (in line with the US experience) to be that considerable additional work will need to be undertaken in relation to documentation of processes, assessment and benchmarking of risks and the adequacy of controls and the implementation of remediation plans as well as potential changes to the set up of accounting systems including general ledger code set up. There may also be an impact on the division of roles and responsibilities for tax within business where currently the signatory of the tax return is more likely to be the Head of Tax than the Senior Accounting Officer.

The personal responsibility aspect of these measures is very surprising and will no doubt be unwelcome to those concerned. As it is not expected that the operation of the controls will be required to be externally audited, the 'self reporting' of inadequacies puts an additional responsibility on the company and it is likely that there will be significant additional internal procedures and documentation required in order to report the Senior Accounting Officer's certification.

Overall we believe this will have wide reaching implications for companies and individuals which will need considerable focus over the coming months.