M E M O R A N D U M
May 1, 2009
TO: Distribution
FROM: Burt, Staples & Maner LLP
RE: IRS Suggests Use of Internal Audit Departments to Control Costs of QI
External Audits
The IRS recently proposed that a U.S. office of an accounting firm
must participate in the external audit of a Qualified Intermediary
(“QI”). The proposal set off an uproar in both the QI community
and among accounting firms because of the significantly higher costs
that would result, both from duplication of efforts in the audit and the
increased risk to the accounting firms. In response to such
concerns, the IRS has been informally suggesting that the best solution
might be for QIs to opt for the alternative of using their internal
audit departments to audit the QIs’ compliance with the QI Agreement.
QIs should carefully consider the pros and cons of this alternative
since it has both advantages and potential pitfalls.
THE
PROPOSED CHANGE: Accounting firm personnel based in the QI’s
country typically perform the QI external audit, which itself is not a
true “audit” but an “agreed-upon procedure” (“AUP”) check. While
some international accounting firms will assign U.S. personnel to review
the results before they are submitted to the IRS, most do not. In
Announcement 2008-98, the IRS proposed that QI external auditors be
required to associate with a U.S. auditor that accepts joint and several
liability for the conduct of the audit and cosigns the audit report.
The IRS presumably felt that inclusion of such U.S. oversight might
increase the rigor of the “audit” to uncover indicia of fraud or misuse
of the QI Agreement. The QI community has expressed strong
concern that the proposed requirement would add significantly to the
costs of the audits, and questioned the morphing of an AUP check into
one more akin to a financial statement audit.
THE IRS
SUGGESTION: IRS officials have been informally suggesting that the
“solution” to the above concerns might be for QIs to adopt the “external
audit waiver” option set forth in section 10.01.6 of the External Audit
Guidelines (Rev. Proc. 2002-55). They have further
suggested that having the QI conduct “self-audits” on an ongoing basis
may be a desirable change. Under section 10.01.6, a QI can apply
to the IRS for a waiver of an external audit for an audit year if the QI
has maintained a substantial and independent internal audit staff that
has conducted a review of the QI’s compliance with the QI Agreement each
year for the three years preceding the audit year (“three-year
requirement”). The QI must submit to the IRS its request for such
a waiver before June 30 of the year following the year to be audited.
If the waiver is granted, the QI’s internal audit department conducts
the AUP check and provides the results to the IRS. Alternatively,
the QI can seek special IRS clearance to conduct a proposed program of
tests, checks, and other audit procedures of its own design.
Special clearance of a QI’s self-designed internal audit review program
must be handled through a written application and will likely involve
one or more pre-submission conferences.
For QIs whose internal
auditors have not historically been auditing its QI compliance, the
three-year requirement could preclude a QI from obtaining immediately a
waiver of its external audit. However, the QI could consider
informally approaching the IRS for a waiver of this requirement, or
modifying its current internal audit program to cover QI compliance so
that an external audit waiver can be sought in the future.
PROS:
The obvious advantage to a QI could be significant cost savings.
Such savings could be even more pronounced if a QI is willing to
“tailor” its audit to its particular circumstances and such audit is
approved by the IRS, as provided in section 10.01.6. Finally, a QI
with an internal audit team continuously checking its compliance might
be able to catch any problems early on and prevent them from evolving
into more serious compliance issues with the IRS - no small
consideration given the challenging conditions for QIs that have
developed of late.
CONS: While a QI would clearly
eliminate costs associated with external audit firms, it will bear the
cost of training its internal audit personnel to conduct its own audit
and the additional costs of the audit itself, which may be on a
continuous basis. In addition, a QI considering a “tailored” audit
should take into account the time and cost of having its plan approved
by the IRS. A QI should also consider any additional risk
associated with moving the audit responsibility from the external
auditor to its internal audit staff, although such risk could be
mitigated by engaging an external expert to oversee its efforts.
Finally, it should be noted that even if an external audit waiver is
granted, the IRS will likely reserve the right to request an external
audit at a later date.
RECOMMENDATIONS: We urge QIs to
carefully consider the pros and cons of the internal audit alternative,
particularly if the IRS finalizes its proposal. As discussed
above, this alternative could produce cost savings, although perhaps not
as great as the IRS presumes. We would be happy to assist any QI
in evaluating its options and discussing an external audit waiver with
the IRS if desired.