The behavior of external auditors and tax auditors: has it
changed over the years?
by
Jurjan van der Weide Master's Thesis Accountancy
University of Groningen, Faculty of Economics and Business
Student name: Jurjan van der Weide Student number: S2541556
E-mail: j.van.der.weide.5@student.rug.nl
Institution: Rijksuniversiteit Groningen Study: MSc Accountancy & Controlling
Phone: 06 - 27 11 67 45
Supervisor: Prof. Dr. I.I.J. Burgers
Date: 20 - 01 - 2020
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Abstract
The introduction of horizontal monitoring resulted in a situation of cooperative compliance between the Dutch tax authority and taxpayers. During their audit, the Dutch tax authority wants to rely on work performed by third parties and the internal controls of a firm. If this is sufficiently reliable, they can reduce their own audit activities. Based on the expectation gap theory, there are differences in expectations between external auditors and the society, which includes the Dutch tax authority. There are different views regarding materiality and tax risks. In this paper, the consequences of the differences in expectation of tax control on the behavior of the Dutch tax authority and external auditors will be examined. The aim is to investigate whether there are changes in behavior, and what the implications for this change in behavior is. The results show that the expectations of the Dutch tax authority lead to no change in the behavior of the external auditors. Therefore, the Dutch tax authority has to adjust their own behavior, and increase the audit activities performed.
Keywords: Materiality, expectation gap, change in behavior, external auditor, tax auditor.
List of abbreviations
AMPT = Audit Misstatement Posting Threshold
BCF = Business Control Framework
CAB = Controleaanpak Belastingdienst
DTA = Dutch Tax Authority
HM = Horizontal Monitoring
ISA = International Standards on Auditing
NV COS = Nadere voorschriften controle- en overige Standaarden OECD = Organization for Economic Cooperation and Development
SAD = Sum of Audit Differences
TCF = Tax Control Framework
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Table of content
Page
1. Introduction 5
1.1 The audit profession 5
1.2 Definitions of keywords 6
1.3 Horizontal Monitoring 7
1.4 Audit of tax versus tax audit: differences in materiality 8
1.5 Research question 9
2. Theoretical Framework and Literature Study 11
2.1Theory of inspired confidence & Expectation gap theory 11
2.1.1 The theory of inspired confidence 11
2.1.2 Porter's Audit Expectation-Performance gap 12
2.1.3 Majoor's Expectation gap 13
2.2 Terminology 15
2.2.1 Tax risks 15
2.2.1.1 Specific tax risk areas 15
2.2.1.2 General tax risk areas 16
2.2.2 Audit of tax 17
2.2.3 Tax audit 17
2.2.4 Horizontal Monitoring 20
2.2.5 Audit layer model 21
2.2.6 Tax Control Framework 22
3. Data and Methodology 25
3.1 Data collection 25
3.2 Data analysis 25
4. Results 28
4.1 Materiality 28
4.1.1 The Dutch tax authority's perspective 28
4.1.2 The external auditor's perspective 29
4.2 Tax risks 31
4.2.1 The Dutch tax authority's perspective 31
4.2.2 The external auditor's perspective 33
4.3 Tax Control Framework 35
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4.3.2 The external auditor's perspective 36
4.4 Behavioral changes 37
4.4.1 The Dutch tax authority's perspective 37
4.4.2 The external auditor's perspective 39
5. Conclusion & discussion 41
5.1 Conclusion 41
5.1.1 Materiality 41
5.1.2 Tax risks 41
5.1.3 Tax Control Framework 42
5.1.4 Behavioral changes 42
5.2 Discussion 44
5.2.1 Implications 44
5.2.2 Limitations and further research 44
References 46
Appendix A - Questions for the external auditor 49
Appendix B - Questions for the Dutch tax authority 51
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1. Introduction
1.1 The audit professionThe job of auditor was introduced around 1880, after the so-called Pincoffs affair. This affair is named after Lodewijk Pincoffs, a Dutchmen with a great eye for business and opportunities. At the age of 22, he and his cousin, Henry Kerdijk, started a business in textile dyeing, which immediately turned out to be a profitable business. After eight years, they wanted to expand their business, and decided to start doing business in Africa. After a few years, Pincoffs and Kerdijk had to attract new money, in order to keep the fleet in a good state. They borrowed money, which resulted in higher interests that had to be paid, for which they used new loans. Nobody seemed to notice that one debt covered the other. (Quadackers, 2015).
The business seemed to be prosper, but no profit was made in reality. The administration was a disaster. The true value of buildings and ships could not be determined. The amount of stocks was unclear. Profits shown in the books were in fact losses. These losses did not result in better behavior of Pincoffs and Kerdijk. In fact, the opposite happened, as they were
offering even more dividend to mislead the audience. New debts were used to pay older debts. In 1879, one of the commissioners of the company discovered that the firm was not as
profitable as the founders had said. The partners worried about the financial position of the firm. Pincoffs was no longer capable to hide the true position of the firm, and the
'Afrikaansche Handelsvereeniging' went bankrupt (Quadackers, 2015).
Although the need for external auditors had been there for a while, this affair can be seen as the straw that broke the camel's back. Around 1880 the audit profession was introduced. Ever since, the role of the auditor has been a topic for discussions and research. In recent years, there have been accounting scandals worldwide, such as Enron and Worldcom. These scandals were world-changing, as they resulted in new regulation. The Sarbanes-Oxley Act (SOX) was introduced in 2002 (Agrawal and Chadha, 2005). The main goal was to enhance corporate governance and thereby restore public confidence (Zhang, 2005). Society held auditors accountable for mistakes in audit reports. However, the question is whether this is justified. Do audit standards require auditors to make sure there are no mistakes whatsoever in the accounting numbers and figures?
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The first person who described differences between public expectations and the role of the auditor was Théodore Limperg. In the 1920s, he introduced the 'theory of inspired
confidence'. According to Limperg, confidence is the most important attribute in an audit. The theory highlights the social responsibility of an auditor. He is the one who has to examine whether there is no material misstatement nor fraud. According to Limperg, it is the auditor's obligation not to damage the inspired confidence of the audience. Vice versa, an auditor is not allowed to raise higher expectations then he is able to achieve by fulfilling his job. Limperg's theory was a framework for the further development of norms and values for auditors. Based on the theory of Limperg, other researchers introduced the expectation gap theory. Porter (1993) shows a gap in what society expects that auditors do and what the society perceives as the work of auditors. Majoor et al. (2015) describes different expectation gaps using the differences in what is agreed upfront, what the users/client needs, and what is delivered in the report. The quality of the audit is based on the expectations and whether these expectations meet reality. If reality does not meet the expectations, there is an expectation gap. The theory section will further elaborate on the theories of Limperg, Porter and Majoor. 1.2 Definitions of keywords
Some keywords used in this thesis are provided.
External Auditor - The natural person who works at or is connected to an audit firm, and
who is responsible for the examination of the statutory audit. (Wta, 2018)
Materiality - There are different terms, but for now information can be seen as material if
misstatements, including omissions, individually or together, could reasonably be expected to influence the economic decisions of users of the financial statements. Judgments regarding materiality are made taking into account the given circumstances, as well as the size and nature of the misstatement, or the combination of both. The materiality level will be set by the professional judgment of the auditor. (ISA 320/ NV COS 320)
Society - The person, people, organization(s) or groups of which the auditor expects they
will use the report. (HRA, 2018). In fact, this can be any interested party, so shareholders, but also internal and external stakeholders. The tax administration belongs to the external
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1.3 Horizontal monitoring
In 2005, horizontal monitoring (hereinafter: HM) was implemented in the Netherlands. The basis of HM lies within trust, mutual understanding and transparency between the taxpayer and the Dutch tax authority (hereinafter: DTA) (Veldhuizen, 2015). Before 2005, only vertical monitoring was in use. This is seen as the traditional method, where the DTA assesses the reliability of tax returns afterwards. This is done through questionnaires, control of the books and company visits. Companies thought that tax auditors worked from the perspective that companies tried everything to avoid taxes. Furthermore, the process was seen as inefficient and time wasting. Questionnaires could contain over 70 questions of events that happened years ago. The people who worked then, might have others jobs. In addition, questions were random, it looked like 'fishing expeditions' (Poolen, 2012). The implementation of horizontal monitoring focuses on mutual confidence, understanding and transparency. Relevant tax risks are suggested upfront by the company, so the tax auditor is able to give his opinion, and there are no surprises afterwards (Poolen, 2012).
Since the implementation of HM in the Netherlands, the DTA relies on the internal control systems of companies as well as on the work of auditors (Belastingdienst, 2008). This is advantageous for both parties. The DTA will receive information regarding tax strategies and management controls of companies upfront, and thus will have more tools to identify whether a company should be qualified as low-risk, medium-risk or high-risk taxpayer. In this way, the available resources can be used to monitor the high risk taxpayers. For companies, there is certainty regarding the tax positions upfront, and there are no surprises as the DTA provides their opinion regarding the suggested tax risks (Veldhuizen, 2015).
In order to get into a HM relation as a company, you need to have a solid functioning Tax Control Framework (hereinafter: TCF). The DTA wants to rely on activities that are already performed, and thus they need to analyze whether the TCF is functioning properly
(Belastingdienst, 2008). This can be shown in the audit layer model (figure 1), which is described in the Controleaanpak Belastingdienst (hereinafter: CAB)1. This model consists of layers, each representing a certain control. The higher the level of internal controls, or the better the quality of the external auditor, the more the DTA is able to rely on this. This results in bigger layers, and the DTA will be able to reduce its activities.
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Figure 1: Audit layer model2
1.4 Audit of tax versus tax audit: differences in materiality
The DTA wants to rely on activities performed by external auditors as well (Belastingdienst, 2013). However, the audit of the DTA differs from the audit of externals. The materiality and the reporting threshold for external auditors are often significantly higher than the materiality of the DTA (Wesdorp, 2015). While the DTA can have very low threshold, up to zero, it can be millions for external auditors. The reasons lie in the different scope, nature and extent of the audit(Engelmoer, 2015). The DTA wants to rely on the work of external auditors, but due to differences in materiality might not be able to reduce its activities if there is a significant difference. Another reason is tax positions might not be material for the external auditor, so he will not perform a lot of work on these positions, while the DTA needs this in order to execute his audit.
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1.5 Research question
Previous research mainly mentioned the existence of the expectation gap, but did not dig into the implications of the behavior of both the external auditor and the tax auditor. There are different views regarding materiality and tax risks, which can affect the behavior. Therefore, the main research question of this thesis is:
Do Dutch tax administrators' expectations of tax control performed by external auditors result in changes in behavior of external auditors and tax administrators?
In order to answer the central research question, the following sub-questions will contribute to get an understanding of the relevant theories and literature backgrounds. The sub-questions hold for both the audit of tax and the tax audit, and thus for both the external and tax auditors.
- How is materiality defined and determined? - What are the tax risks in an audit?
- What role does the TCF play in the audit, regarding taxes?
- Has there been a change in behavior regarding taxes in the audit for the external auditor or the tax auditor?
To answer the main question, I will first investigate the existing literature that focuses on the expectation gap as well as on how audits are executed by both external auditors and DTA, respectively by focusing on the audit frameworks that are used by external auditors and the DTA. I will conducted interviews with both external auditors as well as tax auditors, to gain insights in how materiality is determined. The DTA wants to rely on the work of external auditors, but there is a difference in materiality, which can result in too little assurance in the work of external auditors. During the interviews, I was able to see whether this affects behavior of either party. In addition, the determination of tax risks is included to investigate whether both parties recognize the same tax risks. There will be an elaboration on how external auditors and tax auditors use the TCF during the audit. The last sub-question focuses on the behavior and whether there has been a change in the last years. Based on these
answers, I will be able to answer the main research question and provide recommendations for improvements and further research.
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This thesis will contribute to existing literature by providing changes in the behavior of external auditors and tax auditors, due to the introduction of HM and the audit layer model in relation to materiality. Chapter 2 contains an overview of the previous conducted research focusing on the expectation gap, and the underlying theory, including tax risk areas, audit of tax, tax audit, HM, the audit layer model and the TCF. Chapter 3 describes the methodology and data collection. The results will be shown in chapter 4, including quotations from
interviews with external auditors and tax auditors. The answer to the central research question as well as to the sub-questions will be provided in chapter 5. Implications, limitations and suggestions for further research are also presented in this chapter.
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2. Theoretical Framework and Literature Study
Chapter two will provide the theoretical frameworks used in this thesis. Thereafter, the literature will be provided where relevant terminology is discussed.
2.1 Theory of inspired confidence and Expectation gap theory
This section will give a review of the theory of inspired confidence, developed by Limperg in 1932. Based on this theory, Porter (1993) and Majoor (2015) developed an expectation gap theory.
2.1.1 The theory of inspired confidence
The theory of inspired confidence was developed by Théodore Limperg Jr., at the end of the 1920s. The role of an auditor and the public is the central focus point. The auditor is the confidential adviser of the public audience, and the existence of the auditor is dependent on the confidence the public has in his work, as well as the confidence in his knowledge. According to Limperg, key in audits is confidence as well as independence of the auditor. In order to create confidence in their work, the auditor has to make sure that the amount of work that is performed matches the amount that is required. There may not be greater faith in the auditor than is justified by the amount of work and knowledge. The other way around, the job has to be done in a way that justifies the confidence that the audience has in the auditor. This is highlighted by Limperg (1932). He states that the auditor has a social responsibility to the public, and the public has a certain level of confidence in the work of the auditor. Because the auditor raises a certain level of confidence within the public, he has to match his activities, so that the work that he performs matches the expectations of the public. Second, the auditor has to make sure that the statements and announcements he makes, or the work he performs, do not raise higher confidence within the public than its activities justify. Both situations result in a difference between expectations and reality.
When reality does not meet up with the expectations, this can have two causes. First, the public may have excessive confidence in the work of an auditor, implying he can never live up to the expectations. Second, shortcomings in the work of the auditor, suggesting that the work performed is not sufficient to what is expected, and therefore resulting in a mismatch between expectations and the requirements. The distinction is important, as in the first cause the reason lies within the wrong expectations of the public, while in respect of the second
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cause, the auditor should blame himself. In both cases, the result of these mismatches is an expectation gap between the public and the auditor.
2.1.2 Porter's Audit Expectation-Performance gap
In 1993, Porter developed a framework to show the mismatch between expectations and reality, which he called the audit expectation-performance gap. It consists of a performance gap and a reasonableness gap, shown in figure 2.
Figure 2: Expectation gap by Porter 3
The difference in what society expects from the performances of auditors and what society can expect from the auditors, the reasonable duties, is called the performance gap. The
performance gap can be decomposed into a deficient performance gap and deficient standards gap. The deficient performance gap is the difference in what the law and regulation says that an auditor is obligated to do versus what the auditor actually does. If there is a gap, an auditor is not performing his job well. The deficient standards gap results from the difference in what is the reasonably expected duties of the auditor, but not present in laws and regulation. While the external auditor has no obligation to fulfill certain tasks, society expects him to do so. The reasonableness gap is the gap between expectations of society versus what can reasonably be
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Source: Hassink, H. F., Bollen, L. H., Meuwissen, R. H., & de Vries, M. J. (2009). Corporate fraud and the audit expectations gap: A study among business managers. Journal of international accounting, auditing and taxation, 18(2), 85-100.
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expected from an auditor. Society can have unreasonably high expectations from the work of auditors (Limperg, 1932), which might lead to a higher gap.
2.1.3 Majoor's expectation gap (2015)
Limperg's theory of inspired confidence mainly focuses on the requirements that an auditor has to fulfill according to society. Inspired confidence is based on the expectations of society regarding the quality of the work of the auditor. This quality is determined by whether or not the work matches the expectations of the society and the users. When expectations do not match reality, there is an expectation gap (Majoor et al., 2015).
Figure 3: Expectation gap by Majoor (2015)4
Figure 3 shows three circles, that all stand for a different aspect. The top circle A, "Agreed" shows what has been agreed, between the society or users of the statements and the auditors. The bottom left circle N, "Needs", stands for the needs of users and clients. The bottom right circle D, "Delivered", stands for what is actually delivered by the auditor. These three circles result in seven different segments (Majoor et al., 2015).
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Majoor, G. C. M., van Kollenburg, J. C. E., & van Asselt, E. (2015). Grondslagen van auditing & assurance. Noordhoff Uitgevers. p. 16. Translated into English by author.
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Segment 1: What has been agreed beforehand is similar to what belongs to the needs of
society as well as to what is delivered by the auditor. There is no gap between the expectations, and thus no cause for a gap, it contains real quality.
Segment 2: The auditor may deliver services that also fulfill the needs of the client, but were
not agreed upon. Though the service fulfills a need of the user, it might result in an
expectation gap due to lack of communication. The client did not expect the extra service of the auditor, and might be disappointed as he did not know the auditor would deliver additional work in advance.
Segment 3: Agreements between client and auditor upon the work, belonging to the needs of
the client. However, the auditor did not fulfill this agreement. The client experiences this as part of the expectation gap, and sees this as a failure from the auditor. This is also known as the performance gap.
Segment 4: If the accountant agreed and delivered appointments that do not belong to the
needs of the client, the client might have the feeling that he pays for something he does not need, so an increase in costs while getting nothing in return.
Segment 5: Agreements that do not belong to the needs of the client and are not delivered.
Like segment three, the client can see this as failure from the auditor, and is part of the performance gap. However, the client might see this as less urgent, as the failure is outside of his own needs, and thus not seen as crucial.
Segment 6: The client may have certain needs which are not accepted by the auditor when
making agreements. The auditor does not want to or is not able to accept the wishes of the client, for example due to a lack of knowledge or a lack of independency at the auditor. When the auditor is not able to convince the client that he cannot or will not be able to deliver the needs of the client, it can result in an expectation gap. There will only be an expectation gap if there is a lack of communication or misunderstanding between the client and the auditor.
Segment 7: Aligns somewhat with segment four, as it includes the delivered services that do
not contribute to the demand of the client, and are not agreed upon. Majoor refers to both segments as economic expectation gaps, as the client might feel that he has to pay for services that he did not ask for, and that do not contribute to his needs. These segments can be labeled as the aspiring part of the expectation gap, as the client is confronted with the undesired aspirations of the auditor.
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This section discusses relevant terminology. First the tax risk areas will be discussed. Later on, the audit of tax, the tax audit, HM, the audit layer model and the TCF will be discussed. Literature on materiality will be examined within audit of tax and tax audit.
2.2.1 Tax risks
There is not a universal definition of tax risks. Arlinghaus (1998) describes it as the likelihood that tax outcome differs from what is expected, due to a variety of reasons, for example, the judicial process, changes in the law, changes in business assumptions, an
increased intensity of audits, and uncertainty in the interpretation of the law. There are two tax risk areas, the specific risk areas and the general risk areas (PricewaterhouseCoopers, 2004; Wunder, 2009), containing a total of seven different risks.
2.2.1.1 Specific tax risk areas
Transactional risk
All transactions carry a certain level of risk. These risks and exposures that are associated with the transactions, are shown in the transactional risk. This risk increases as the
transactions become more unusual or less routine. For the routine transactions, there can be well-designed procedures, which cannot be created for non-routine transactions. Examples of such non-routine transactions are the acquisitions or disposals of businesses, reorganizations, or significant restructuring projects. These will generally imply a greater transactional risk as compared to every day transactions such as selling products and services.
Operational risk
The operational risk focuses on the risks of applying the tax laws, regulations and decisions to the routine every day business operations of a company. Every type of operation will carry a different level of tax risk. One of the main examples is transfer pricing issues. According to a survey of EY (2018), rate transfer pricing in the top two of risks. Other examples are new business ventures or new operating structures.
Compliance risk
Each company has certain obligations when it comes down to tax compliance. The risk that is accompanied with meeting these obligations is called the compliance risk. It relates to the preparation, completion and review of an organization's tax returns. Examples are risks that
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are present in a company's systems, processes and procedures by preparing and submitting the tax returns.
Financial accounting risk
An example of this risk comes from changes in systems and policies. The introduction of Section 404 of SOX led to public companies having to include an assessment of the internal controls over their financial reporting. Good internal controls result in lower risks, while worse internal controls result in high risk and a low degree of certainty.
2.2.1.2 Generic tax risk areas
Portfolio risk
This is the overall aggregate level of risk, when looking at the first three specific risk areas. It is an interaction of the transactional, operational and compliance risk, which is relevant for organizations that are involved in a number of transactions. When looking at these risks separately, they may be below threshold, but when combined, they might exceed this
threshold and become unacceptable. Portfolio risk can be calculated by looking at the impact and the probability of these risks happening.
Management risk
The management risk mainly focuses on the risk of not properly managing the risks mentioned above. The number of tax risk managers is increasing, as organizations
acknowledge the importance of managing risks. If the issues regarding tax risk management are "under-managed", organizations might be unexpectedly surprised or even miss
opportunities. Examples are changes in personnel, or new resources.
Reputational risk
This risk focuses on the impact that the actions of an organization has on their reputation. The reputation influences business interests. Companies do not want to be associated with
negativity, otherwise this can hurt their reputation. If a company does not pay its fair share, or the perception of the outside world is that the company does not do it, then it might hurt the reputation and the overall business.
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2.2.2 Audit of tax
In order to perform the audit, an external auditor uses a risk-based approach. The objective is to lower the risk to an acceptably low level. To develop a strategy that goes along with this approach, the external auditor has to identify and assess risks in a firm. The purpose of an audit performed by an external auditor is to provide the user of the financial statement with a sufficient degree of confidence, that what is presented is free from material misstatements (Wesdorp, 2015). If there are no material misstatements discovered by the auditor, he is able to provide an unqualified opinion. If misstatements are found, they should be lower than the materiality level, both individual and aggregate, in order to get to an unqualified opinion (Wesdorp, 2015). Whether misstatements are material or not is determined using the definition of materiality (ISA 200.6; section 1.2)
Materiality for the audit of tax is set during the first phase of an audit, the planning and risk identification phase. The overall materiality, or planning materiality, is set for the total audit. A materiality for separate items is referred to as the performance materiality, and is a
percentage of the overall materiality. There is also a threshold called the SAD, the sum of audit differences. Misstatements below this threshold are reported to management, but are so small and trivial, they do not have to be adjusted. (Wesdorp, 2015).
2.2.3 Tax audit
The CAB is written by the DTA, and describes the way in which the tax auditors should work (Belastingdienst, 2013). The strategic goal of the DTA is compliance, defined as the willingness of taxpayers, either businesses or individuals, to fulfill their tax obligations by reporting relevant facts correctly, on time and in full (Hornstra, 2011). In order to obtain compliance, the DTA uses a risk management based approach (figure 4). Voluntary
compliance is stimulated as much as possible. The risk assessment is based on both subjective and objective information.
18 Figure 4: Risk Management Process 5
The DTA has to make sure that a tax return is sufficient, in order to execute their supervisory role. To get this confirmation, the CAB describes two criteria when assessing information:
- Control information must be sufficient. There has to be enough information, both qualitative and quantitative, to make a judgment on the declaration. A tax auditor has to do the exact amount of work to make this judgment, nothing more and nothing less. - This control information is not only derived from the work of a tax auditor, he is also allowed to use the work of third parties, for example, the external auditor. This is shown in the transaction model below and the audit layer model, which will be discussed in section 2.2.5.
The transaction model (figure 5) says that every transaction from the 'real world' needs to be recorded. These transactions can also be online, through the internet and web-shops. All these transactions result in source data, which can result in helpful information. This information is subject to both internal control and external control.
5
Hornstra, J., (2011). The Netherlands. In: Khwaja, M. S., Awasthi, R., & Loeprick, J. (Eds.). (2011). Risk-Based Tax Audits: Approaches and Country Experiences. The World Bank, p.85
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Figure 5: Transaction model6
Taxpayers are responsible for providing information to the DTA, as well as being obligated to keep a sufficiently clear administration. Being for providing information on time is a requirement laid down in Article 47 of the Dutch General Tax Act. The taxpayer has to provide information to the inspector when he is asked to. This can be any sort of information, as long as the inspector feels it is relevant. The requirement of keeping a sufficiently clear administration is laid down in Article 52 of the Dutch General Tax Act. Taxpayers must keep a clear administration, and have to keep information sufficiently available of the last seven years. This should result in sufficient audit information for the DTA. The second option to receive information is through the work of third parties.
The materiality of the DTA is determined during the preplanning phase. It is the maximum amount of undiscovered misstatements that may remain in the statements after our audit, while our judgment is that the tax return is 'sufficient'. This is the quantitative materiality. The qualitative materiality is a found misstatement, focusing on the nature of the misstatement. If there is a (severe) culpable misstatement, it does not matter if it is material or not, it will always block the unqualified opinion. The DTA sets the materiality based on the size of an organization. As the size of an organization increases, the materiality will increase. To get the same materiality for equal-sized companies, the DTA created a materiality table based on turnover (table 1).
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Table 1
Materiality table of the DTA7
Size of the company (in Dutch revenue)
Materiality - 300.000 Revenue x 5% 300.000 - 500.000 15.000 500.000 - 1.000.000 30.000 1.000.000 - 2.200.000 60.000 2.200.000 - 4.400.000 120.000 4.400.000 - 8.800.000 180.000 8.800.000 - 17.500.000 300.000 17.500.000 - 35.000.000 600.000 35.000.000 - 70.000.000 900.000 70.000.000 - 140.000.000 1.500.000 140.000.000 - 3.000.000 2.2.4 Horizontal Monitoring
The DTA implemented HM in 2005, after being blamed for inefficient tax assessments and audits, large backlogs and 'fishing expeditions' (Poolen, 2012). The exploration of HM started in June 2004, as the State Secretary for Finance wrote a letter to the Dutch parliament with the suggestion of introducing a new way of monitoring next to vertical monitoring (State
Secretary for Finance, 2004). In 2005, the concept of HM was introduced by the State Secretary for Finance, in a letter to the Dutch parliament (State Secretary for Finance, 2005). HM is defined as a form of social non-governmental control, aiming for the improvement of product and service quality within certain professional groups or industries (Veldhuizen, 2015). The idea is working on the basis of trust and co-operative compliance to fight aggressive tax planning. It was called the 'enhanced relationship' approach. The OECD also stimulated the development of these relationships (OECD, 2008; Belastingdienst, 2013). In 2013 the framework was renamed the 'cooperative compliance' approach, where disclosure and transparency are crucial concepts (OECD, 2013). The DTA wants to stimulate voluntary compliance, they use the risk management based approach, where HM fits right in (Hornstra, 2011).
The goals of HM are to improve compliance, improve the service level for business, to work in real time, reduce the administrative burden and to provide certainty in advance
7 Belastingdienst (2013) Controleaanpak Belastingdienst (CAB), de CAB en zijn modellen toegepast in toezicht,
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(Veldhuizen, 2015). There are advantages for both parties, and thus companies are willing to enter a HM agreement. One of the conditions to apply for HM is to show that you are 'in control', where a TCF is required (Hoyng & van der Reijden, 2009). The implementation of a TCF is explained in section 2.2.6. For companies the main advantage is the certainty
regarding their tax positions, as they can discuss items beforehand. For the DTA, there is more disclosure and transparency regarding taxpayers. They are able to identify the low-risk taxpayers, and the high-risk taxpayers. This helps the DTA to use the available resources for monitoring high-risk taxpayers. It also helps the DTA to rely on the internal controls of a company, including the TCF.
2.2.5 Audit layer model
HM resulted in a situation of trust and compliance, where the DTA wants to use information of third parties as well as the internal controls of companies. In this way, they can reduce their own activities, which is illustrated in figure1. The audit layer model consists of several layers, each describing a certain control. The size of each layer differs for every organization, as the quality of internal and external controls differ. The better the functioning of the
internal/external controls, the bigger the layers.
The model starts with identifying the primary processes of a company. The first layer is internal control. Every entrepreneur needs reliable information in order to run the business, and so they should have taken internal control measures to guarantee the quality of
information (Engelmoer, 2015). The model shows that external auditors can contribute to the reduction of audit activities by the DTA. If they perform more work, which the DTA can support, the external layer will be bigger, and so the tax audit layer will be smaller, which implies a reduction in activities for the DTA.
For the DTA to rely on a TCF, it needs to be functioning properly, and thus be monitored. This is the responsibility of the company (Belastingdienst, 2013). However, the DTA should also conduct real-time testing in order to assure the TCF is functioning properly (OECD, 2013). In order to rely on the work of external auditors, the tax auditor needs to assess the quality of the work (Belastingdienst, 2013). The measures of internal control can be referred to as the Business Control Framework (hereinafter: BCF), where the measures of internal control designed and implemented for taxes are a significant part of the TCF (Engelmoer, 2015). A TCF can help the DTA to support on the internal controls of an organization, but it can also help the external auditor. The effects of a properly functioning TCF and sufficient work of the external auditor is shown in figure 7.
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Figure 7: Audit layer model in horizontal monitoring8
This situation has an additional layer, compared to figure 1. This layer represents the TCF, and covers partly the external control layer and the tax audit layer, implying that a TCF can both be beneficial for external auditors as for tax auditors. The model also shows the main purpose of HM. If tax auditors are able to rely on the quality of internal controls and additional external controls, the DTA can reduce its own activities.
2.2.6 Tax Control Framework
In order to comply with the rules of Article 47 and 52 of the Dutch General Tax Act, a TCF is very helpful for companies and taxpayers. According to the DTA, a TCF is an internal control instrument that focuses specifically on business's tax processes, which are not necessarily restricted to the tax department. The TCF is an integral part of a company's
Business or Internal Control Framework. Tax refers to all elements of control that are relevant to tax, whereby the term 'tax' covers all types of tax (Belastingdienst, 2008). The DTA is able to reduce activities when a company implemented a TCF, and all relevant events and
consequences are implemented correctly (OECD, 2016). The OECD (2016) published TCF
8 Belastingdienst (2013) Controleaanpak Belastingdienst (CAB), de CAB en zijn modellen toegepast in toezicht,
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principles, which are referred to as building blocks. These building blocks help companies to implement a sufficiently working TCF.
Tax Strategy Established
The framework starts with describing the tax strategy and objectives of the company. In this description an operational roadmap, the objectives and measures of the business, how the organization, tax department and objectives are steered and a statement that the business complies with the law should be present. The tax strategy should encompass a tone at the top, stating the risk appetite of the company. The risk appetite is the types of risk that a firm is willing to assume (Board, 2013). Transparency and compliance are crucial for the DTA, and should be implemented in the tax strategy, and are thus a subject of a TCF.
Applied Comprehensively
A TCF should be comprehensive. All transactions within a company can affect the tax position, and thus the TCF needs to cover all areas. It is important to cover all the taxes in the company, as this increases certainty and the usefulness of cooperative compliance. The TCF should reflect the tax strategy objectives of the business and whether the processes deliver the goals (OECD, 2016).
Responsibility Assigned
The tax strategy and TCF should be developed by the senior management or the board. They are responsible for the design, implementation and effectiveness of the TCF. This means that the people how execute this, need to have sufficient knowledge, experience and skills in order to make this effective. The responsibility for the functioning of the TCF lies within the company, and is the main responsibility of the tax department (OECD, 2016).
Governance Documented
The business and tax strategy should be aligned with the tax governance of the business. Poor governance can result in high risks, such as non-compliance. Transactions and events should be compared to expected norms and potential risks, so they can be managed. There should be ongoing discussions about the internal control risks. The governance process should describe and define for example the tax responsibilities, accountability and the monitoring and mitigating of tax risks and testing of the TCF.
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Testing Performed
Monitoring and testing is the responsibility of the company, but the DTA should conduct real-time testing to assure the TCF is functioning properly (OECD, 2013). When there are changes in for example the business strategy, the board, the tax department or tax legislation, there should be maintenance regarding the TCF. It should also be subject of regular
monitoring, testing and maintenance, in order to comply with the existing laws, and to make sure there are no errors present.
Assurance Provided
In order to provide the desired assurance, the previously mentioned five building blocks should be present. The tax risks are subject to proper control, so outputs can be relied upon. This can be done by implementing the previously mentioned five building blocks. This results in a reasonable assurance that tax risks are not bigger than the risk appetite. The TCF is then able to identify, mitigate and/or eliminate the additional risks (Bakker & Kloosterhof, 2010).
According to Bakker and Kloosterhof (2010), the TCF is mainly facilitating for external auditors. A properly functioning TCF means that the internal controls are able to detect tax risks, and mitigate it, and so the auditor is able to rely on the controls for his own audit. This implies that he can reduce the amount of work as there is reasonable assurance regarding the presence of tax risks (Meiboom, 2019). In addition, the impact of the processes controlled in a TCF can be seen as too insignificant to lead to material misstatements, and thus not being in control cannot lead to material misstatements.
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3. Data and Methodology
This section will explain how the data used in this thesis is collected. Thereafter, a analysis of the data will be presented.
3.1 Data Collection
To answer the main research question and the sub-questions, both literature review and empirical research were conducted. The literature review is reported on in chapter two. It improves the understanding of Limperg's (1932) inspired confidence theory and the expectation gap theory of both Porter (1993) and Majoor (2015). The way in which both external and tax auditors work has been explained as well. This information was extracted from reports that are publicly available, in respect of both external auditors and of the DTA. For the external auditors, the information was extracted through previous literature and the International Standards on Auditing (ISA). These are also available in Dutch, the Nadere Voorschriften Controle- en Overige Standaarden (NV COS). For the DTA several different reports and guides, among which the CAB, describe the tax audit.
To gain more in-depth knowledge of the actual processes, as well as to understand the behavior of both external auditors and tax auditors, interviews were conducted. Qualitative research makes it possible to test current theory and create new theory (Eisenhardt &
Graebner, 2007). The interviews were conducted two-on-one9, semi-structured, because they are able to deliver richer data, the possibility to gain in-depth understanding increases, and the social interaction in an interview increases the motivation to respond with more extensive answers. (Smith, 2015). Semi-structured interviews are also more suited for the exploration of perceptions and opinions of interviewees when it comes down to more complex and sensitive issues, plus the fact that the data retrieved can be clarified in the conversation (Barriball and While, 1994).
3.2 Data analysis
The set of questions for the external auditors can be found in Appendix A, and the set of questions for the auditor of the DTA can be found in Appendix B. To make sure the set of questions is correct, a test interview was conducted. Both sets consist of around 20 open questions, which were asked in Dutch, as this is the native language of both the interviewers
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A fellow student's subject, whose research question is "What is the difference in perception of material tax risks between external auditors and auditors of the Dutch tax administration regarding audits of large
enterprises?", and this study lie are related. After consultation with the supervisor, permission was granted to conduct the interviews together.
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as the interviewee. Thus a potential language barrier was overcome. Before the interviews started, all interviewees were informed on confidentiality and anonymity, and agreed to sign a consent form afterwards. An empty consent form can be found in Appendix C. All
interviewees agreed on the interviews being recorded, which also resulted in conversations being more open, and more interaction as the interviewers could freely speak and listen, instead of taking notes. After the interviews, the transcripts were written in Dutch, and were sent to the interviewees to make sure that what was said, was valid. The interviewees got the chance to add additional information, make comments on things they expressed, and adjust sentences that were not intended the way it was written in the transcript. Quotations used in the study have been translated in English, which might result in a loss of information.
The external auditors who were selected for the interviews all work at one of the Big four companies. The external auditors had different clients in different industries, both in the public and private sector. Examples of such industries are automotive companies, financial services, construction companies, healthcare institutions and real-estate companies. It is assumed this difference will not influence the results of this study as tax risks apply to all industries, and all taxpayers can enter a HM agreement. To not include all different sized firms, the focus of this study is on large enterprises. For the DTA, interviews were conducted with certified auditors, who work in the large enterprise segment. Some had been working in other segments of the tax authority, which can result in broader answers and knowledge. Table 2 contains information on the function and perspective of the interviewee as well as the date and duration of the interviews.
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TABLE 2 Interview Information
Function Perspective Duration Date
Audit Manager External Auditor 0.53 03-12-2019
Auditor DTA DTA 1.46 12-12-2019
Auditor DTA DTA 1.16 12-12-2019
Audit Manager External Auditor 0.51 13-12-2019
Audit Trainee External Auditor 0.28 13-12-2019
Audit Partner External Auditor 1.13 17-12-2019
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4. Results
This section discusses the results of the interviews. Based on the sub-questions, there are five topics that will be discussed. Each topic includes the view of the tax auditor and the external auditor. The topics will focus on materiality, tax risks, the TCF, the behavioral changes.
4.1 Materiality
4.1.1. The Dutch tax authority's perspective
According to the theory, the DTA determines materiality by using the table (table 2) in the publicly available CAB (Belastingdienst, 2013). The table shows a standard materiality of three million for enterprises with revenues of over 140 million. To see how this works in practice, the interviews focused on the terms of materiality as well as the determination of materiality levels.
["We use quantitative and qualitative materiality. The quantitative materiality is derived through the materiality table in the CAB. This gives us a percentage to use on a benchmark, usually revenue of a company." - Auditor DTA]
[" Large enterprises usually fall into the largest category. If revenues exceed 140 million euro's, we take three million as a standard materiality level for these companies." - Auditor DTA]
Qualitative materiality focuses on the nature of the misstatement. It does not matter if the amount found is material, it should always be corrected. The misstatements are seen as culpable, and they will always block an unqualified opinion. This is confirmed in the interviews.
["Qualitative materiality focuses on the nature of the misstatements. When fraudulent activities arise, we will use qualitative materiality, to see what has happened at the company." - Auditor DTA]
["When we see higher internal risks, risks that might lead to fraud, we will intensify our investigation, zoom in on the risk areas, and use qualitative materiality. The focus is on
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the client, whether he is non-compliant with laws. The misstatement does not have to be material regarding quantitative materiality." - Auditor DTA]
The materiality of the DTA is usually lower than materiality of external auditors (Wesdorp, 2015). This difference can be significant, as percentages can vary quite heavily. Reasons provided in theory suggest a difference in nature and scope. The DTA provided the following reasons.
["We apply materiality to the accuracy of the financial statements. The external auditor uses materiality for the overall statements, while we purely focus on the accuracy of the items. There is also a difference in scope, as our focus is more risk-oriented." - Auditor DTA]
["Our job focuses on securing the regularity and legal equality of tax revenues, which arises from our public function. Tax money belongs to all of us. We do not want
misstatements, our correction threshold is around 250 euro's. Another reason can be that we want to prevent any discussion that we executed too little audit activities." - Auditor DTA]
According to the DTA, there is a difference in materiality because they use a different scope, accept a lower amount of misstatements in the audit, and the role is different. They represent the population of the Netherlands. Tax money belongs to all of us, and thus taxes should be collected correctly and accurate.
4.1.2 The external auditor's perspective
The determination of materiality for external auditors is described in NV COS 320. This is a description of the process, as materiality is determined by professional judgment of the
external auditor. There are no standard percentages for materiality. However, during the interviews, there does seem to be a standard pattern along the external auditors.
["We start with an overall materiality, a percentage of a benchmark, for example total assets, total costs, or revenues. The performance materiality will be 75% if there are no particularities, otherwise it can drop to 50%. " - Audit Partner]
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["High-risk factor include a first-year client, but also findings by the tax authority in the audit of last year. Another reason can be an insufficient internal control." - Audit Trainee]
The theory also mentioned a reporting threshold. Misstatements below this threshold do not have to be corrected (Wesdorp, 2015). During interviews, this was called the Audit
Misstatement Posting Threshold (hereinafter: AMPT).
["We use the AMPT as reporting threshold. Misstatements smaller than the AMPT will not be corrected, misstatements larger than the AMPT will always be reported to
management, and they have to correct it." - Audit Trainee]
[ The reporting threshold is set at 5%, everything below this 5% is so small/trivial, it will not impact the financial statements. Everything above the 5% threshold will always be put on a list, and we request the client to adjust it." - Audit Partner]
Normally, the external auditors only use one materiality for all items. There is a possibility to use other levels of materiality (NV COS 320), but not all external auditors use this
possibility.
[We use only one way to calculate materiality, though the standards provide the opportunity to work with specific levels of materiality for certain posts." - Audit Manager]
["The famous example of using more than one materiality is liquid assets. They should be connected accurately to the bank statements, so you will use a low materiality level for these items." - Audit Partner]
According to the external auditors, the differences in materiality levels of the DTA compared to themselves has several reasons.
["Our audits are for a very large group of stakeholders, while the tax authority only has the "Kingdom of the Netherlands" as stakeholder. The DTA has more time to focus on specific items, while we have the statutory obligation to have an audited financial statements within twelve months after closing the financial year." - Audit Manager]
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["Tax items are relatively small, and thus most of the time not material. From a societal perspective, the DTA does not want the risk of large misstatements, so they use lower materiality levels." - Audit Manager]
According to the external auditors, the reason for differences in materiality is because they have different stakeholders, they use a different scope, and they have a different role
compared to the DTA. The DTA has a responsibility towards the population of the Netherlands, while the external auditors have a responsibility to the users of the financial statements. In addition, the external auditors have a time limit, which implies that a higher materiality must be used to provide reasonable assurance in the given time frame. If more assurance should be provided, the materiality should be lower, and there are more activities that have to be performed by the external auditor. The question is whether this is possible in the given time frame. The difference with the DTA is that they have more time and are able to zoom in on riskier items.
4.2 Tax risks
4.2.1 The Dutch tax authority's perspective
The risk assessment of the DTA starts in the preplanning phase. To assess these risks, there are certain key matters they will take a look at, including tax risks. There is not a standard list of tax risks, but the assessment is done based on the professional judgment of the tax auditor.
["Determining the tax risks is based on professional judgment. We do not use a specific list of tax risks. The major risk for the tax authority is an incorrect tax return, either inaccurate or incomplete." Auditor DTA]
The tax auditor will need information to apply his judgment. The DTA has several
techniques to get this information, such as conversations before the start of the audit, looking at looking at earlier audits. In practice, there are more ways to get this information, and make an assessment of the tax risks.
["For example, we use tax returns and the tone at the top and culture within a company. We have conversations with the company and the external auditors. Through horizontal monitoring and a TCF, a company is able to suggest tax risks and discuss them in advance." - Auditor DTA]
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["Internal and tax controls play a crucial part in determining material tax risks. We reduce our work if there is positive pre-information. This also implies that you need to have an opinion regarding the internal controls of a company. " - Auditor DTA]
There is no standard list of tax risks used, but there are certain risks that occur more than others. For the DTA, the largest risk is the risk of an incorrect tax return. This risk can come from a variety of different other tax risks. According to the tax auditors, the most common tax risks are within transfer pricing policies and tax latencies.
["In my opinion, the main tax risk is the transfer pricing. We have multiple teams with specialists that focus on this topic." - Auditor DTA]
["The main tax risks for large enterprises are tax latencies. The influence of different countries makes it more complex, you need to get the right information connected to the right latency." Auditor DTA]
["Transaction risks and process risks can mainly be controlled through the internal controls and a TCF. We do focus on incidental transactions. As they are incidental, they will probably not be controlled through the internal controls, and so they need more attention. Examples are acquisitions or restructuring costs." - Auditor DTA]
The material tax risks mentioned in the theory section analyzed the risks more from the perspective of the external auditor. The transfer pricing risk fall within the operational risks and the tax latencies within the compliance risks (PricewaterhouseCooper, 2004). As the DTA wants to rely on the internal controls of a company, the transaction and process risks are quite small. During the interviews, there were other important risks, that are not mentioned in theory.
["Two of the main risks are 'shift risk' and 'leakage risk'. Shift risk includes ,for example, the shifting of depreciation to other years. A leakage risk can be a wrongfully deducted item, that when accepted by the DTA cannot be corrected." - Auditor DTA]
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The DTA uses risk assessment and professional judgment to detect the material tax risks. The biggest risk for the DTA remains the risk of an incorrect tax return, which combines all risks previously mentioned. This might also result in the difference in materiality, as they want this risk to be minimized, and thus apply a lower materiality level.
4.2.2 The external auditor's perspective
The initial risk assessment starts before a client is accepted. This focuses on several factors, the general risks in the audit (NV COS 315). The tax risks are also included.
["Risks are assessed during the client acceptance phase. The industry of the company will be analyzed, what is the view of the audience towards the company, in what businesses is the company active? Are there any reputational risks present?" - Audit Partner]
["Certain companies and certain countries are known for higher tax risks, higher risk of corruption and higher risk of fraud. Directly from the start, it is one of the factors we take into consideration." - Audit Partner]
During the risk assessment, the tax risks will be analyzed as well. The external auditors do not have a standard list, but use their professional judgment. There are certain situations with higher risks, such as companies operating worldwide. Different tax rules must be applied in different countries, which can lead to an increase in risk. You have to make sure that the correct laws are applied. The complexity of taxes is another reason which can increase risks. For high tax complex situations, the external auditors will ask the tax specialists, as they do have the knowledge regarding these complexities, and the external auditors not always possess this knowledge.
["We will ask tax specialists if we see a company that is operating in several countries, as we do not possess the knowledge, and it can be a complex situation. The tax specialists do have the knowledge, and they are able to see whether the transfer pricing policy used is acceptable for the DTA." - Audit Trainee]
["The tax positions have a higher risk because it is a complex item. That might be a reason to zoom in on tax positions, using a lower materiality level. For example, when there
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are temporary differences or deductible losses, you should see whether the correct rules are applied." - Audit Manager]
The theory section described several tax risks. In practice, there is not a standard list. There are certain risks that occur more often, and were mentioned in several interviews. These risks are discussed below.
["The biggest tax risks are compliance risk and reputation risk. A company must comply with laws and regulations, including tax law. This includes tax latencies, as it takes estimations of the external auditors, and opinions can vary. This can be complex. Reputation risk can come from different tax morals across countries. As a multinational, you will always run the risk that something goes fiscally wrong at one of the hundreds of daughter companies, who you will not be able to monitor intensively, and so it can backfire at the company. The presence of tax specialists, a compliance department or an internal audit department reduces tax risk for us. " - Audit Partner
["There is a change compared to previous years, the opinion of society is taken into account. This affects mainly the reputation risk. Tax constructions advised a couple of years ago, are nowadays seen as unethical." - Audit Manager]
["Transfer pricing in international operations gets attention. This is mainly the operational risk." - Audit Manager]
["Transfer pricing policies can increase tax risks. Being too aggressive, being too careful, or not having enough knowledge of taxes increases risk as well. Another risk is non-compliance with laws and regulations. " - Audit Trainee]
Risks regarding transfer pricing policies are mentioned several times, as well as reputation
risk. External auditors have become more aware of the influence of reputation. They pay more attention to these risks. Besides that, compliance with laws and regulations has an influence as well, especially for large companies operating worldwide. In different countries, there are different tax regimes. Not complying to the law can influence the reputation as well, for both the clients as for the audit companies. This is thus a follow-up risk, as compliance problems can lead to reputational damage.
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4.3 Tax Control Framework
4.3.1 The Dutch tax authority's perspective
The DTA uses the audit layer model for every audit. The starting point is to look at the internal control layer. Thereafter, the work of the external auditor is examined, which can increase the assurance regarding the tax position. This was shown in figure 7. In order to get insights in a company, the auditor has several options.
["In the preplanning phase, the audit layer model is always used. We have to take note of the internal control as well as the activities performed by the external auditor. This is done through risk-assessment, introductory conversations, looking at critical company processes, and by identifying key risks. Another option is to use audit file inspection, analyze the findings of the external auditor, and check the substantive tests he performed." Auditor DTA]
The DTA wants to rely on and support the activities of the external auditors. If the internal and external layers are bigger, the tax auditor is able to reduce more of his activities. Another framework that can help reduce the amount of activities performed by the tax auditor is a solid working TCF. For HM, the DTA requires a TCF. A TCF also increases the ability to rely on the internal controls of a firm, as the building blocks of the TCF explained (OECD, 2016). A reduction in the work of the DTA is justifiable when it is working properly (Belastingdienst, 2013)
["At large enterprises, we cannot work without internal control, and so you will need a TCF. It has value for companies, as tax returns can be dealt with quicker, and there will be less surprises as tax risks have already been discussed upfront. If a company shows that he is 'in control', they will get less supervision. There will always be some supervision though, as we have to monitor whether a company is still in control." - Auditor DTA]
["In a TCF, several key risks have been identified. Through internal controls and a TCF, the company wants to reduce or mitigate those risks. In order to do this, there need to be certain internal control and tax control measures." Auditor DTA]
The interviews show that a tax auditor is able to reduce his own activities when there is a properly functioning TCF. The TCF has identified tax risks, and through internal controls it is able to reduce or mitigate them. This can reduce the audit activities performed by the DTA.
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["After identifying the internal controls, the systems around a company, and the work performed by the external auditor, we determine our rest risk. This risk shows us were our focus should be, based on the information gained earlier." Auditor DTA]
["I need to have an opinion regarding the revenue recognition, the external auditor already executed a marginal analysis. I can use this analyses, I do not have to execute a second analysis by myself." Auditor DTA]
After identifying the layers of the audit model, the audit activities for the DTA that remain are visible. If activities are performed by the external auditor, with the same scope, the DTA is able to rely on these activities. The interviews show that the theory in the CAB is also used in practice. The example of the marginal analysis also holds for other activities, such as sample testing, ratio analysis and so on. The DTA does need to bear in mind that materiality can be significantly higher. If this is the case, they have to do additional work in order for the tests to be reliable.
["We always analyze the materiality of the external auditor. If there are too little activities performed by the external auditor, or the materiality is significantly higher, we cannot rely on his work." - Auditor DTA]
The interviews show that the DTA always uses the audit layer model to see whether they
can reduce their audit activities. A TCF is used as guidance to see whether and how the internal controls work. The work of external auditors is used, but only when performed with the same scope, otherwise additional activities have to be performed.
4.3.2 The external auditor's perspective
A TCF can also reduce the risk for external auditors, as the internal controls help to mitigate certain tax risks (Bakker & Kloosterhof, 2010). The company is responsible for implementing and monitoring a TCF. Meiboom (2019) showed that the control over the processes in a TCF is too small, so it could not lead to a material impact. This was also the view during the interviews, as the external auditors explained they did not perform a lot of work regarding the TCF.
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["We do not use it. The TCF operates on a detailed level and an operational level. Because of this detailed level, a TCF is not material, the processes and risks are below our threshold, and so it cannot lead to material misstatements. We do check whether the requirements of horizontal monitoring are met, and we do read the TCF to see whether something useful is found for the audit. " - Audit Manager]
["The TCF has to be set up and monitored by the organization, I do not use it." - Audit Trainee]
["Does a company have a TCF? Do they have a tax department who monitors the TCF? If yes, it will lower the tax risks of the company. Asset managers are more and more looking at the fiscal integrity of the companies they invested in, and also looking at the TCFs of companies, whether they are searching for the borders of the law, so we do use a TCF when it is present. . " - Audit Partner]
The responsibility for monitoring a TCF is for the company. The external auditors do not
assess whether it is functioning properly, as this responsibility lies within the company (OECD, 2016). It can reduce the tax risks, but it is not used in the risk assessment. When a TCF is present, some external auditors do take a look at it to see whether there are additional tax risks or helpful information and internal controls.
4.4 Behavioral changes
4.4.1 The Dutch tax authority's perspective
The expectation gap states that the audience expects more compared to what the external auditor delivers (Porter, 1993). The DTA is also part of the audience. To see whether this expectation gap has lead to a change in their behavior, we asked the tax auditors to reflect on the behavior of the external auditors and on their own behavior.
Since the introduction of HM, there is more openness and between companies and the DTA. This also affected the relation between the external auditors and the DTA. The CAB is
publicly available, so everyone knows what the audit method of the DTA is. There seems to be a change in the relationship between external and tax auditors.
