Perceptions of material tax risks of external auditors and
auditors of the Dutch tax administration: Should the law
and regulations concerning materiality be adjusted?
__________________________________________________________________________________Master thesis Accountancy
University of Groningen, Faculty of Economics and Business
January 20, 2020
MARIT VAN DER POL
Student number: S3841995
Hoofdweg 12
9305 TE Roderesch
Tel.: +31 (0) 6 34463858
E-mail: m.a.van.der.pol@student.rug.nl
Supervisor: Prof. Dr. I.J.J. Burgers
ABSTRACT
The Dutch tax administration (hereafter: DTA) relies in its audits on the work of external auditors. Based on which information it can use, the DTA decides whether or not to reduce its audit activities. Because of this reliance the aim of this research is to determine whether there is a difference in perception of material tax risks between external auditors and auditors of the DTA regarding audits of large enterprises. As the legitimacy of their operations arises from law and regulations, the implications of such a difference for current law and regulations concerning materiality are identified. Interviews have been conducted with both auditor groups to gain their perception of material tax risks and the suitability of law and regulations regarding materiality. The results show that there is indeed a difference in perception of material tax risks, although this does not lead to an audit expectation gap, as auditors of the DTA take note of the materiality threshold used by the external auditors and the tax risks they identified. External auditors should be encouraged to use an additional lower materiality threshold on tax positions in the situation of high tax risk, which is incorporated in the current auditing standards. The materiality threshold of external auditors is generally higher than those of the DTA in audits of very large enterprises. The DTA should add additional thresholds to the materiality table causing its materiality threshold to be closer to the materiality of external auditors. Due to this the DTA is better able to rely on the work of external auditors, which results in less audit activities it has to perform by itself. This benefits society as more audits can be performed.
TABLE OF CONTENTS
LIST OF ABBREVIATIONS ... 4
1. INTRODUCTION ... 5
1.1 Scope of this study ... 6
1.2 Scientific contribution ... 7
1.3 Thesis outline ... 8
2. THEORETICAL BACKGROUND ... 9
2.1 Theories ... 9
2.1.1 Audit expectation gap theory ... 9
2.1.2 Legitimacy theory ... 9
2.2 Types of tax risks ... 10
2.3 The audit process and materiality ... 12
2.3.1 Audit of tax and materiality ... 12
2.3.2 Tax audit and materiality ... 14
2.3.3 Comparison audit of tax and tax audit regarding materiality ... 17
3. METHODOLOGY ... 18
3.1 Research design ... 18
3.2 Data collection and analysis ... 18
4. RESULTS INTERVIEWS ... 20
4.1 Audit of tax and materiality ... 20
4.2 Tax audit and materiality ... 20
4.3 Comparison audit of tax and tax audit regarding materiality ... 21
4.4 Material tax risks ... 22
4.4.1 External auditors ... 22
4.4.2 Auditors of the Dutch tax administration ... 22
4.5 Suitability of law and regulations regarding materiality and tax ... 23
4.5.1 External auditors ... 23
4.5.2 Auditors of the Dutch tax administration ... 23
5. CONCLUSION AND DISCUSSION ... 25
REFERENCES ... 29
APPENDIX 1: INTERVIEWGUIDES ... 33
LIST OF ABBREVIATIONS
AO/IC Administrative Organization and Internal Control CAB Controleaanpak Belastingdienst
DTA Dutch tax administration ERM Enterprise Risk Management
ISA International Standards on Auditing
NBA Koninklijke Nederlandse Beroepsorganisatie van Accountants NV COS Nadere Voorschriften Controle- en Overige Standaarden OECD Organization for Economic Co-operation and Development SAD Summary of Audit Differences
SME Small- and Medium-sized Enterprises TCF Tax Control Framework
TLM Tax Layer Model VAT Value-Added Tax
1. INTRODUCTION
Companies are, due to legal requirements or voluntarily, subject to audits by audit firms. By performing an audit engagement external auditors are able to give reasonable assurance to the society whether the financial statements present a true and fair view of the company’s
financial position and performance (Eimers, 2008). Companies can also be subject to audits by the Dutch tax administration (hereafter: DTA). In the audit process the DTA tries to detect cases of non-compliance (The World Bank, 2011). In these audits the DTA focuses on
whether a tax return is acceptable, which means that it is compliant with law and regulations and is free of material errors (Vos, & De Jong, 2015).
Based on NV COS 315 external auditors need to identify material risks to determine their audit activities for an audit engagement (NBA, 2019). The DTA determines risks in the planning phase of its audits and also applies a materiality threshold (Belastingdienst, n.d.). Materiality, in short, is a measure for external auditors to determine when deviations in the financial statements have influence on economic decisions of the users of that information (NEMACC, 2018). The materiality threshold is, among other things, important during the planning process of an audit (Messier, Martinov-Bennie, & Eilifsen, 2005) and is a very important audit judgement since the degree of auditor effort on an audit engagement is based on it (Blokdijk, Drieenhuizen, Simunic, & Stein, 2003).
In this research two groups of auditors are distinguished: external auditors and auditors of the DTA. With external auditors is meant auditors that work for an audit firm. It is important to identify what both groups of auditors perceive as material tax risks as how the DTA performs its audits relying partly on the work of the external auditor. For this the DTA uses the Tax Layer Model (TLM). This is a risk analysis model, to define which audit activities it has to perform (Belastingdienst, n.d.), taken into account information it may use in its audits which has been collected by the taxpayer itself, or by its tax advisor, and by its external auditor (Belastingdienst, n.d.; Vos, & De Jong, 2015). Based on which information it can use, the DTA decides whether or not to reduce its audit activities.
For the DTA it is important to know if its perception of material tax risks matches with that of external auditors, or where it possibly differs. Tax risk, in short, can be defined as the
likelihood that tax outcome differs from what is expected, due to a variety of reasons
(Arlinghaus, 1998). Tax risks are important in the identification of whether tax positions are material or not. Based on NV COS 320 external auditors have the possibility to use additional materiality thresholds in a situation of specific risks (NBA, 2018), among which tax risks. As the materiality threshold for tax audits by tax authorities often differs from the materiality threshold used by external auditors (Wesdorp, 2015) this has an influence on what both groups perceive as material tax positions. When external auditors use different criteria on material tax risks than those expected by the DTA, the auditors of the DTA rely in their audit activities on erroneous information. Due to this the DTA can possibly make wrong decisions about which auditing activities it will perform. In such case the detection of non-compliance is not performed well. This research aims to identify whether there is a difference between what external auditors perceive as material tax risks and what auditors of the DTA perceive as material tax risks. In case of a difference there could be an audit expectation gap between the external auditor’s performance and the DTA’s expectations of the external auditor’s
performance, specifically regarding material tax risks.
In case the perceptions of material tax risks deviate between auditors of the DTA and external auditors this research has also the aim to identify whether law and regulations
regarding materiality should be adapted. The way auditors of the DTA and external auditors have to determine their materiality threshold is indicated by law and regulations. This means that the legitimacy of their operations arises from law and regulations. The question is whether the law and regulations regarding materiality should be adapted to better meet the expectations of society. Through interviews with auditors of the DTA and external auditors, insights into their perception of material tax risks and the suitability of current law and regulations regarding materiality is gained.
1.1 Scope of this study
To limit the scope of this study I will focus on large enterprises. The choice for large
enterprises is made because large enterprises disclose to a greater extent on risks than small- and medium-sized enterprises (SME). Dutch medium-sized and large enterprises are required to describe significant risks and uncertainties to which the company is exposed in the
management report according to Art. 391 of book 2 of the Dutch Civil Code (Deloitte, 2018). This disclosure is also called the risk paragraph. Regarding risk disclosure the Dutch
Accounting Standards Board (DASB) has some additions to the legal requirements of 2:391 BW 2. Medium-sized, large and public enterprises are in line with DAS 400.110c required to extent the risk paragraph since 2015. They have to describe their risk appetite, the impact of the risks and how they are going to address them (EY, 2015). Further, Dutch public
enterprises, which are large enterprises, should also comply to the Dutch Corporate Governance Code (Deloitte, 2018). Compliance with the Code means that enterprises are required to comply, or explain how and why they depart from the principles and best practices of the Code. Regarding risks, enterprises should explain in the management report which risks the company is facing, provide a description of how they will face those risks and of the company’s risk appetite. (Monitoring Committee Corporate Governance Code, 2016; PWC, 2014). Also, research found a positive relation between company size and risk disclosure (Linsley, & Shrives, 2006). The main idea behind this is that larger enterprises share more information because they have more stakeholders to whom they are accountable. In addition to a higher amount of disclosure, large enterprises also engage more in risk management activities. Company size is positively related to the implementation of Enterprise Risk Management (ERM) activities (Beasley, Clune, & Hermanson, 2005; Hoyt, & Liebenberg, 2009). This can be explained because larger enterprises have a greater need for an effective ERM and have also more resources to implement an ERM (Beasley et al., 2005). The greater extent of disclosure on risks by large enterprises and the fact that they engage more in risk management activities makes large enterprises an appropriate segment to focus this research on. Due to this, interviews have only been conducted with auditors of the large enterprise department of the DTA and external auditors of Big 4 audit firms.
The research question the study intents to answer is the following:
“Do perceptions of material tax risks deviate between external auditors and auditors of the Dutch tax administration regarding audits of large enterprises and if so, what implications
does such deviation have for current law and regulations concerning materiality” In order to answer the research question the following sub questions are composed: 1. What are tax risks?
This sub question provides knowledge on what tax risks are. Also, different types of tax risks will be explained.
2. How do external auditors use the materiality concept in their audits?
The second sub question provides an answer on how external auditors use materiality in their audits. I will explain how external auditors perform an audit of tax and what the materiality concept is used for during an audit. Further, I will describe how external auditors determine the general materiality threshold.
3. How do auditors of the Dutch tax administration use the materiality concept in their audits?
The third sub question provides an answer on how the DTA uses materiality in its audits. I will explain how a tax audit is performed and what the influence of the Tax Layer Model is on its audits. I will also explain how it uses Tax Control Frameworks in its audits.
4. What do external auditors and auditors of the Dutch tax administration perceive as material tax risks in audits of large enterprises?
The fourth sub question provides an answer on what external auditors and auditors of the DTA perceive as material tax risks in their audits of large enterprises. Due to this, differences in perception can be identified.
5. What do external auditors and auditors of the Dutch tax administration think of the suitability of law and regulations regarding materiality and tax?
This last sub question will provide an answer on what both types of auditors think of the suitability of law and regulations regarding the determination of the materiality threshold and the audit of tax positions. Based on this can be determined whether law and regulations regarding materiality should be adapted.
1.2 Scientific contribution
To my best knowledge thus far, no research has been conducted on the subject of material tax risks. However, materiality in general got quite some attention of researchers. A substantial body of research has been done on this topic (Messier et al., 2005). Many studies focused on the effect of the lack of clear standardized guidelines for the materiality threshold for
auditors’ judgement (Blokdijk et al., 2003; DeZoort, Holt, & Stanley, 2019; NEMACC, 2018; Severus, & Steller, 2010). NEMACC researched what materiality means for and how it is used by Dutch external accountants. They found that these accountants perceived the
definition of materiality and how to use this in audits as abstract. DeZoort et al. (2019) found that it remains challenging for external auditors to implement the concept of materiality in practice, due to its complex and subjective nature. According to Severus and Steller (2010) standardization of the guidelines would lead to a more uniform judgement of materiality between external auditors. The vagueness around the materiality threshold has not only effect on external auditors. Regulators and researchers have long struggled with an efficient and effective implementation of audit materiality (DeZoort et al., 2019). Further, it can also lead to tension between the external auditor and his client regarding the materiality amount
(Patterson, & Smith, 2003). Also, Houghton, Jubb and Kend (2011) found that the concept of materiality is not well understood by the users of audited financial reports. They argue that there is a need for explanation and disclosure about materiality in layman’s terms, because a failure to fully understand materiality exacerbates the audit expectation gap.
Quite some research has been done on factors that influence the materiality threshold. Researchers are very consistent on the importance of professional judgement in establishing the materiality threshold (Acito, Burks, & Johnson, 2009; Blokdijk et al., 2003; Martinov, & Roebuck, 1998; Messier et al., 2005; Severus, & Steller, 2010). The fact that external auditors take into account the financial information needs of users of the financial statements in this
judgement has been mentioned as well (Martinov, & Roebuck, 1998). Further, the materiality threshold is influenced by other factors than professional judgement and the financial
information needs of users. For example, Blokdijk et al. (2003) found that the overall materiality value used by Dutch external auditors increases with the quality of the client’s control environment and decreases with the complexity of the client. He also found that Big 5 firms use a lower amount than non-Big 5 firms, which is consistent with a higher audit quality level of Big 5 firms. Researchers are inconclusive on the level of consistency about the used benchmarks to determine the materiality threshold. Research of Eilifsen and Messier (2015) showed that there is a high level of consistency across the eight largest US audit firms in how they determine overall materiality. There would be significant agreement on the used
benchmarks (e.g. total assets and income before taxes) and the percentages applied to
determine the materiality. On the other hand, Martinov and Roebuck (1998) show diversity in how the six largest Australian audit firms set the materiality level. Research by Messier et al. (2005) shows major audit firms have a variable approach in determining materiality, by using different benchmarks.
According to Wesdorp (2015) the materiality amounts for tax audits by tax authorities often differs from the materiality threshold used by external auditors due to differences in scope, nature and extent of the audit. Another difference is that in a tax audit normally all detected and known misstatements above the materiality threshold are to be corrected, even though the misstatements are not material.
This study contributes to the literature by providing new information regarding the subject of material tax risks. Upon to my best knowledge no research has been done regarding material tax risks. This research aims to fill the gap in the literature by providing new information on what auditors of the DTA and external auditors perceive as material tax risks and how they determine the materiality threshold. This adds to the literature on the audit expectation gap as it provides knowledge on whether there is an expectation gap or not, regarding material tax risks. It also provides knowledge on the suitability of law and regulations regarding
materiality in case of a perceived difference in material tax risks between auditors of the DTA and external auditors. This research contributes also to the profession because it may help them in understanding a difference in determination of material tax risks which can give tax authorities new insights for enhancing their audit activities, when they rely on the information of external auditors.
1.3 Thesis outline
This thesis is structured as follows. In chapter 2 the theoretical background of this study is elaborated. Thereafter, chapter 3 the describes the methodology of the study regarding data collection and data analysis. Subsequently, chapter 4 presents the results of the interviews. Finally, chapter 5 concludes the research and theoretical and practical implications are discussed. Also, limitations of the research and recommendations for future research are given.
2. THEORETICAL BACKGROUND
2.1 Theories
In this study two theories are used. This study is based on the audit expectation gap theory. The legitimacy theory is applied in understanding the role of law and regulations regarding materiality and the legitimacy of the operations of both auditor groups. Hereafter both theories and their applicability on the study are explained.
2.1.1 Audit expectation gap theory
According to the audit expectation gap auditors and the society hold different beliefs about the responsibilities and duties of external auditors (Koh, & Woo, 1998). There is a gap between auditor’s performance, as perceived by society, and society’s expectations of auditors (Porter, 1993). This can further be subdivided in a reasonableness gap and a
performance gap. The reasonableness gap is the gap between what society expects of auditors and what reasonably can be expected of them. A performance gap is a gap between what society expects of auditors and what society perceives they achieve (Porter, 1993). The society holds for example different beliefs on the responsibilities of auditors to detect and disclose on irregularities and illegal activities, on the level of assurance an audit provides and regarding auditor’s independence (Koh, & Woo, 1998). Research identified several ways to narrow the expectation gap. Examples are: providing an expanded audit report, education of society on the nature and limitations of an audit, (Koh, & Woo, 1998) and providing
disclosure of the materiality threshold (Houghton et al., 2011).
This study takes the audit expectation gap as a starting point. In this study the audit
expectation gap can be applied on the relation between the DTA and external auditors. The DTA can be seen as the party which has expectations about the perception of the material tax risks of external auditors. This is important due to the reliance of the DTA on the work of external auditors, which has consequences for the amount of audit activities performed by the DTA. When external auditors use different criteria on material tax risks than those expected by the DTA, the auditors of the DTA can make wrong decisions concerning their audit activities relying on the information of external auditors. So, in that case there is a gap between the external auditor’s performance and the DTA’s expectations of the external
auditor’s performance, specifically regarding material tax risks. This study is going to identify whether there is a difference in perception of material tax risks between the two types of auditors and if so, whether there is a gap.
2.1.2 Legitimacy theory
The legitimacy theory is increasingly being used in accounting research (Smith, 2017). According to this theory an organization is part of a broader social system (Deegan, 2006). The theory suggests that there is a kind of ‘social contract’ between an organization and society. Society has expectations regarding the operations of an organization. According to the theory, an organization should try to ensure that their operations fall within the
expectations of society and so, not breach the social contract (An, Davey, & Eggleton, 2011). Organizations exist to the extent that society considers they are legitimate. Basically, society grants an organization the state of legitimacy (Deegan, 2006). When there is no
correspondence between how an organization acts and how society perceives the organization should act this is called a ‘legitimacy gap’ (Deegan, 2006). The existence of a legitimacy gap threatens the legitimacy of an organization and as a result can have implications for the survival of an organization (An et al., 2011). This can lead for example to clients refusing to buy products or services of a company (Deegan, 2006).
In this study there exists a social contract between society and the DTA and between society and external auditors regarding how both auditor groups perform their work. The DTA as well as external auditors have to ensure that their operations fall within the expectations of society. Breaches of the social contract needs to be prevented. Earlier breaches had
consequences for the DTA as well for external auditors. The DTA breached their social contract in a derailed fraud hunt for childcare allowances, which led to reputation damage and even to resignation of the State Secretary for Finance (RTL Nieuws, 2019). External auditors their reputation was damaged after several scandals (Trouw, 2019). Both examples show the urge for the DTA and external auditors to ensure that their operations fall within the
expectations of society.
The materiality threshold is important in these social contracts, because it has an influence on how both the DTA and external auditors perform their work. As it has an influence on the degree of auditor effort on an audit engagement and it determines which audit activities they are going to perform (Blokdijk et al., 2003). However, the materiality threshold for tax audits by tax authorities often differs from the materiality threshold used by external auditors (Wesdorp, 2015). The way auditors of the DTA and external auditors have to determine their materiality threshold is indicated by law and regulations. This means that the legitimacy of their operations arises from law and regulations. This study is going to identify whether law and regulations regarding materiality should be adapted to better meet the expectations of society when the perceptions of material tax risks deviate between auditors of the DTA and external auditors.
2.2 Types of tax risks
Some of the uncertainties, or risks, in the activities and decisions of organizations are tax related (Drake, Lusch, & Stekelberg, 2019). Arlinghaus (1998) defines tax risk as the likelihood that tax outcome differs from what is expected, due to a variety of reasons. Companies may not adequately understand tax risk due to its technical and complicated nature (Neubig, & Sangha, 2004). PwC (2004) divides tax risks in the following seven areas: transactional risk, operational risk, compliance risk, financial accounting risk, portfolio risk, management risk, and reputational risk. The seven areas are divided in specific risk areas and more generic risk areas, which are more about managing the specific risks. The seven areas (PwC, 2004) are explained further below.
Specific risk areas: ¨ Transactional risk
These are risks associated with specific transactions which organizations conduct. Generally, the more unusual a transaction, the higher the risk. So, the level of risk depends on the level of routine in these transactions. Examples are transactions concerning acquisition or disposal of (a part of) a business, reorganizations and financing transactions. Other important factors are for example failure of
documentation and implementation of a transaction, and the degree of involvement of the tax function in transactions.
¨ Operational risk
Operational risk refers to the risk regarding applying regulations, tax laws and decisions about the everyday business operations, which are routine to an
organization. The level of risk depends on the type of operations. Also, risk is higher when the tax function of a company is less close to the business operations. A very important operational risk is transfer pricing.
¨ Compliance risk
These are risks regarding meeting tax compliance obligations of organizations. Such occur in the preparation, the completion, as well as review of tax returns of
organizations. The integrity of accounting systems and information where tax
information is extracted from is important in this for example. Further, the effectivity of tax authorities and changes of legislation are also of influence. Frequent changes in legislation increase tax risk, because there is a higher probability on making mistakes when changes are not timely noticed (Shtiller et al., 2016). Also, difficult tax
legislation makes it difficult for companies to manage tax risks and so, to be compliant (Van der Enden, De Groot, & Van der Stroom, 2010).
¨ Financial accounting risk
This risk is about the uncertainty in financial reporting and tax figures. The effectivity of internal controls has an impact on this. Changes in accounting policies and
accounting systems are also of influence. It not only relates to tax figures in financial accounts, but also to tax figures in cash flow planning, and forecasting for example. Generic risk areas:
¨ Portfolio risk
Portfolio risk is about the overall risk level of transactional risk, operational risk, and compliance risk together. The risk of a particular transaction may be acceptable, but the three risks combined together may be higher than acceptable.
¨ Management risk
This is the risk of not properly managing the other tax risks. The level of risk depends on the tax risk management policy of a company and can for example also be
influenced by employees with tax knowledge leaving the company. ¨ Reputational risk
Reputational risk is about the impact on an organization which arises after questionable actions became public. Negative media attention and tax authority investigations can have a disadvantageous impact on the business. An example is how companies are perceived by society when having an aggressive tax planning becomes public.
A risk that can be added to the seven areas of PwC is the legislative risk. ¨ Legislative risk
This risk can occur due to potential changes in the current law that might erode the value of past and current tax positions (Neubig, & Sangha, 2004).
Corporate income tax risks can also be subdivided in technical risks and process risks (Van der Enden, & Van der Stroom, 2015).
¨ Technical risk
This tax risk comes from the potential uncertainty in the interpretation of tax law (Neubig, & Sangha, 2004). Examples are: the incorrect implementation of a tax ruling by a company, non-compliance with tax law and regulations caused by unawareness of changes or a wrong interpretation of these tax laws and regulations and the incorrect treatment of interest expenses which could result in tax adjustments and penalties (Van der Enden, & Van der Stroom, 2015).
¨ Process risk
These risks relate to processes, systems and people and are less dependent on tax law and regulations than technical risks. Examples are: errors in tax calculations which leads to incorrect tax positions, not in time filing of tax returns which can result in a penalty and an incorrect tax return due to incorrect or incomplete input data (Van der Enden, & Van der Stroom, 2015).
Value-added tax (VAT), customs duties, corporate income tax and wage tax are the taxes that bring the most common tax risks in the Netherlands (Van der Enden et al., 2010). Transfer pricing, which is linked to corporate income tax, is regarded as one of the biggest tax risks (Borkowski, & Gaffney, 2012; EY, 2017; Plesner Rossing, 2013; Wunder, 2009). This is due to the increased level of scrutiny that transfer pricing activities of companies have been under from multiple stakeholders (EY, 2017). Further, indirect taxes, e.g. VAT on the value added to goods and services, is perceived as second highest risk by companies (EY, 2017). Tax authorities on the other hand rank indirect taxes as highest risk and transfer pricing as second highest risk (EY, 2018).
2.3 The audit process and materiality
In this section first the audit of tax and the concept of materiality is explained. Hereafter, it is elaborated how materiality is applied in the tax audit. Also, horizontal monitoring, TLM and TCF are addressed. Finally, this section concludes with a comparison of the audit of tax and tax audit regarding materiality.
2.3.1 Audit of tax and materiality
External auditors perform their audits in line with requirements of the Dutch standards on auditing ‘Nadere Voorschriften Controle- en Overige Standaarden’ (NV COS) issued by the NBA, which is the professional body for Dutch accountants. External auditors need to comply to the NV COS and can only deviate in special circumstances (NBA, 2018). The standards of NV COS are derived from the International Standards on Auditing (ISA). NV COS 320 prescribes that misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements (NBA, 2018). So, materiality is a measure for external auditors to determine when deviations in the financial statements have influence on economic decisions of users of that information (NEMACC, 2018).
According to NV COS 200 the goal of an auditor during an audit is to get a reasonable degree of certainty about whether the financial statements are free of a material deviation which is the result of fraud or faults, to enable the auditor to express an opinion on whether the financial statements have been prepared in all material aspects (NBA, 2018). An absolute level of assurance is not possible because external auditors cannot audit every transaction due to efficiency considerations (Eimers, 2008). An audit needs to be conducted in a reasonable time period and at reasonable cost (Wesdorp, 2015). This is the reason why external auditors use a materiality threshold as it is a very important audit judgement since the degree of auditor effort on an audit engagement is based on it (Blokdijk et al., 2003).
On the basis of NV COS 320 materiality is used in an audit for the following purposes (NBA, 2018):
- Identification and assessment of risks of material misstatement;
- Determination of the nature, timing and extent of further audit procedures;
- Evaluation of the effect of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.
As can be seen from what purposes materiality is used for, the external auditor uses the materiality concept in the planning phase and in performing and evaluating the audit (Wesdorp, 2015). So, it is used throughout the whole audit process. Overall materiality is determined at the overall level, which is the materiality level for financial statements as a whole. Performance materiality is set at the individual account level and so is lower than the overall materiality. It is used to reduce the probability that the aggregate of uncorrected and undetected misstatements exceeds the overall materiality to an appropriately low level (Wesdorp, 2015). Also, a summary of audit differences (SAD) amount is determined. The audit differences under this threshold are considered as being clearly trivial. The differences above this threshold are reported to the management of the company and those charged with governance (Wesdorp, 2015).
In NV COS 320 also the possibility to use an additional materiality threshold is mentioned. In the specific circumstances for when one or more particular classes of
transactions, account balances, or disclosures for which misstatements of lesser amounts than the overall materiality could reasonably be expected to influence the economic decisions of users taken on the basis of financial statements, the auditor shall also determine a lower materiality threshold (NBA, 2018).
According to NV COS 320 auditors should determine the height of materiality using
professional judgement and take into consideration the financial information needs of users of the financial statements in context of the company and its environment (NBA, 2018).
Auditors should consider an appropriate benchmark, which is a measurement basis, and the appropriate percentage to apply to the benchmark (Wesdorp, 2015). NV COS 320 mentions that benchmarks that can be appropriate are among others: profit before tax, revenue, equity, gross profit, total expenses, total assets and intrinsic value. Which one the auditor should choose depends on the circumstances of the entity (NBA, 2018).An auditor considers for example that for a profit driven company with a very low profit before tax revenue might be a more appropriate benchmark than profit before tax. According to NV COS 315 the
determination of the chosen benchmark and the applied percentages is a matter of
professional judgement. Dependent on the circumstances the applied percentage could be higher or lower (NBA, 2018). As is shown the regulations on the height of the materiality threshold by NV COS is not very strict and asks indeed a large amount of professional judgement of an auditor. This is in line with prior research showing a lack of clear standardized guidelines for the height of the materiality threshold (Blokdijk et al., 2003; DeZoort et al., 2019; NEMACC, 2018; Severus, & Steller, 2010).
After determination of the materiality threshold, the external auditor determines which accounts are significant based upon its size and/or that has a risk of material statement in it. Significant risks have a higher magnitude of potential misstatement and a higher likelihood of occurrence. Also for insignificant accounts, which are account balances less than the
performance materiality, the external auditor assesses whether the account is susceptible to material misstatements. Based on these significant and insignificant accounts and disclosures the external auditor determines his audit strategy (Wesdorp, 2015).
In their audits external auditors take into account the tax positions in the financial statements which they audit. Auditing the tax positions by external auditors is also called audit of tax. The general overall materiality and performance materiality are also used to determine whether there is a risk of material misstatement in the tax positions (Wesdorp, 2015).
2.3.2 Tax audit and materiality
The auditors of the DTA perform tax audits. In these audits the DTA focuses on whether atax return is acceptable, which means that it is compliant with law and regulations and is free of material errors (Vos, & De Jong, 2015). The DTA strives to ensure that the amount of tax payable that does not come in is as small as possible (Belastingdienst, 2017). Tax audits can focus on several tax returns, such as VAT and corporate income tax. Tax audits are just like audits of tax based on a risk analysis (Engelmoer, 2015). The DTA also starts in the planning phase with a determination of the risks (Vos, & De Jong, 2015).
Hereafter is elaborated what the DTA regards as materiality and how they determine this. Also, horizontal monitoring and the TLM are explained, because these concepts are important to understand why the DTA relies on the work of external auditors. Finally, the TCF is
addressed, because the TCF can be used to determine material tax risks. Materiality
Just as for external auditors, it is from a cost perspective for the DTA also not possible to audit each and every transaction (Belastingdienst, 2008). It also uses the materiality threshold to determine the amount of work. The DTA defines materiality as the total amount of faults in the population what regardless of the exercised supervision maximally may remain
undiscovered. This is called quantitative materiality (Belastingdienst, n.d.). So, it is important that the total amount of (potential) faults in the tax return does not exceed the materiality level (NEMACC, 2018). The DTA determines the materiality for an audit on the basis of the
company size, measured by its revenue. The bigger the size of the company and its revenue, the higher the materiality level. In Table 2.1 the materiality levels are shown (Belastingdienst, n.d.).
Revenue company (€) 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
Table 2.1: Materiality table of the DTA (Belastingdienst, n.d., p. 24)
As the table shows the highest materiality threshold used is 3 million. The DTA can deviate from the table in some exceptions. For example, when they have a special materiality table for specific audits or when the audit is only focused on one tax resource like payroll taxes. The materiality level is, in addition to the demanded reliability and the amount of faults allowed in the sample, used to determine the sample size for audits (Belastingdienst, n.d.). The DTA also uses the definition of qualitative materiality. This is focused on the significance and nature of a fault. Regardless of the financial impact, when these kinds of faults occur a tax return cannot be accepted (Belastingdienst, n.d.; NEMACC, 2018). For example, in the case of fraud. In principle, all detected faults, regardless of the materiality level, need to be corrected despite their financial impact (NEMACC, 2018).
Horizontal monitoring
Since 2005 in the Netherlands a voluntary tax compliance system is used which is called ‘horizontal monitoring’. Horizontal monitoring is applied in audits of SMEs and large
enterprises (Belastingdienst, 2016). This horizontal monitoring approach is perceived as very sophisticated (The World Bank, 2011). Horizontal monitoring is based on the assumption that a tax return is prepared correctly. For that, agreements are made with the taxpayer and/or his tax advisor (Belastingdienst, 2010). These agreements are recorded in a covenant between the DTA and the taxpayer for large enterprises (Belastingdienst 2013) and between the DTA and the tax advisor of SMEs (Belastingdienst, 2016). Due to horizontal monitoring the taxpayer informs the tax authority about tax relevant situations, like uncertain tax positions. Also, discussions can take place about the interpretation of tax laws. These situations are discussed up-front, which results in agreement on how to deal with this by the taxpayer and prevents conflicts with the tax authority (Veldhuizen, 2015). So, the essence of horizontal monitoring is that beforehand is ensured that the tax return is compliant, instead of only looking in hindsight whether this is the case or not (Belastingdienst, 2010). The DTA now has the possibility to rely on the work of the taxpayer and his tax advisor.
Tay Layer Model
An important aspect in the horizontal monitoring audit approach is that the DTA regards it as not necessary to collect all the evidence by itself. It wants to use as much information as possible that is already collected by third-parties. These third-parties are the taxpayer itself, his tax advisor and his external auditor. This is because the DTA does not want to perform auditing activities which are already sufficiently performed by those parties (Belastingdienst, n.d.). This concept is represented by the TLM. The TLM visually represents the use of information already collected by third-parties. So, by use of the TLM audit activities can be reduced (Belastingdienst, n.b.). This is done to reduce workload and costs. As the DTA is increasingly relying on the control information of the taxpayer and external auditors this leads to a substantial cost reduction for the government (Vos, & De Jong, 2015). The visual
representation of the TLM is shown in Figure 2.1.
The TLM consists of several layers. The layers are different for every organization, which has the result that the extent to which can be relied on the information is different for every organization (BD, n.d). The inner circle shows the business operations of the taxpayer. The first layer represents the internal control of the company. This is based on the perception that the taxpayer takes measures to assure reliable information, because it is in his own interest that the quality of the information that comes from his business operations is reliable (Vos, & De Jong, 2015). External audit is seen as the second layer. This represents the information of external auditors about the tax positions in the annual account and about the administrative organization and internal control (AO/IC) of a company (Engelmoer, 2015). The DTA could ask to review (parts of) the audit dossier. Based on this the DTA auditors determine how much substantive procedures they still have to perform (Belastingdienst, 2013). The last layer shows the tax audit of the DTA. The tax audit part on the right side of the figure shows the audit activities which the auditors of the DTA perform in reliance on the work of the third-parties. Tax audit on the left side of the figure represents the audit activities that are left to perform whereby the DTA does not rely on information of others.
When the DTA relies in a tax audit on information of third parties this information is generally only reviewed. This review focuses on the scope and quality of the activities performed. External auditors are obligated to cooperate with an audit dossier review upon request of the DTA. On the basis of Art. 53 juncto 47 AWR third parties, so also external auditors, are obligated to provide information that is important for taxation to the DTA. External auditors are on the basis of Art 20 Lid 1 Wta obligated to secrecy regarding
information about their client obtained at an audit. However, on the basis of Art. 20 Lid 2 Wta they can deviate from this and provide confidential information to third parties when required (NBA, 2010). The NBA issued in 2010 guidance 1113 with the course of action in the case of reviewing the audit dossier of external auditors by the DTA, taking into account the
mentioned relevant laws and regulations (NBA, 2010). Tax Control Framework and materiality
By assessing and testing a TCF a tax authority obtains assurance about the reliability of the tax returnand the accompanying disclosure of material tax risks (OECD, 2016). So, the DTA can use an effectively working TCF to determine the material tax risks of a company in a tax audit. That is why a taxpayer needs to draft a TCF when he wants to take part in horizontal monitoring (Van der Enden et al., 2010). According to Hoyng, Kloosterhof and Macpherson (2010) a TCF is “a system to identify, mitigate, control and report tax risks”. A TCF is part of a business control framework and is different for every company. With a properly designed and effectively operating TCF a company is able to control its tax risks (Van der Enden, & De Groot, 2015). A TCF is effective, when the company is in control of its tax affairs and
provides transparent disclosure on its tax risks (OECD, 2016). The effectiveness of a TCF is important for the DTA, for the extent to which the DTA is able to rely on the internal control of the taxpayer, which is represented in the TLM. It determines the intensity of the
supervision of the DTA (Van der Enden, & De Groot, 2015). According to the OECD (2016) the extent of tax audits can be reduced significantly when a company’s TCF is effective. The DTA gives no specific guidance on how a TCF should precisely look like, because in its opinion it is not its role to prescribe how companies should conduct their business. (Van der Enden et al., 2010; Van der Enden, & De Groot, 2015). Three models are mentioned by the DTA where a TCF can be based on: the Levers of control model of Simons, the Internal control framework of COSO and COSO ERM (Belastingdienst, 2008).
In 2016 the OECD published guidance for companies on how to design and operate their TCFs. This is not prescriptive. According to the OECD a TCF contains the following six essential building blocks or principles (OECD, 2016):
¨ Tax strategy established: It is important that a tax strategy is established and is clearly documented. This should at least encompass the company’s risk appetite, tax risk strategy and the tone at the top which reflects the board’s risk appetite.
¨ Applied comprehensively: The TCF needs to be able to comprise all the company’s activities, because all transactions in a company affect the tax positions. Ideally the TCF should be embedded in the day-to-day operations. Routine transactions as well as non-routine transactions should be covered. ¨ Responsibility assigned: The company’s board is accountable for the design,
implementation and the effectiveness of a TCF and the development of the tax strategy. The responsibility and the role of the company’s tax department, which is the execution of the tax strategy, should also be recognized. ¨ Governance documented: A system of rules and reporting is needed that
ensures that transactions and events are compared with the expected norms and ensures managing of non-compliance risks. This should be documented and assessed periodically on effectiveness.
¨ Testing performed: There should be regular testing on compliance with the policies and processes which are part of the TCF to assure that the TCF is functioning well.
¨ Assurance provided: This is about the capability of a TCF to provide
assurance to stakeholders including the tax authority. It should give assurance that tax risks are properly controlled and that can be relied upon the tax return. These TCF principles are consistent with COSO (OECD, 2016). Basically, the principle ‘assurance provided’ is the result of properly managing the other five principles. When they are properly managed assurance can be provided.
2.3.3 Comparison audit of tax and tax audit regarding materiality
There are more differences than similarities between the two audit types. General similarities are that both audits are based on a risk approach and both have the objective to determine whether the tax law has been applied correctly. Hereafter three main differences are given. First, regarding materiality the overall materiality and performance materiality thresholds for audits of tax regarding income tax positions are often significantly higher than in tax audits. This is due to differences in scope, nature and extent of the audits. Some tax authorities, like the DTA, use no or very low thresholds (Wesdorp, 2015). Second, in contrast to the not very specific guidelines regarding the determination of materiality for external auditors, the DTA has a specified calculation to determine the materiality threshold (NEMACC, 2018). Finally, in principle all detected misstatements above a certain amount are to be corrected after a tax audit, even when the misstatements are not material. Due to this the materiality amount of the DTA is only important in the planning phase and not in performing the audit, which is
different from an audit by external auditors for whom materiality is important during the whole audit process (NEMACC, 2018).
In the next chapter the design of this research is explained. Also, is shown how the data collection and analysis have been performed.
3. METHODOLOGY
3.1 Research design
A research design can be seen as a blueprint for the collection and analysis of data. The research methodology of this study is a qualitative research, because the research question can be answered by collecting insights and opinions about the subject (Verhoeven, 2011), rather than by collecting quantitative data. Qualitative studies are based on qualitative information like words, sentences and narratives (Blumberg Cooper, & Schindler, 2014), resulting in a focus on meaning rather than on numbers (Smith, 2017).
Qualitative data can be collected in a case study (Smith, 2017). Case study research is ‘an empirical inquiry that investigates a contemporary phenomenon within its real-life context’ (Yin, 1989: 23). The research method in this research is a multiple case study, whereby several cases are investigated. In a multiple case study differences between and within cases can be explored (Yin, 2003). In this research there are two units of analysis: auditors of the DTA and Dutch external auditors.
3.2 Data collection and analysis
To answer the research question and sub questions data has been collected by means of literature review, inspection of documents and interviews. The first sub question regarding what tax risks are is answered by conducting a literature review. The second and third sub question about how both groups use the materiality concept in their audits is answered by means of literature review and inspection of documents. Regarding external auditors special consideration has been devoted to the regulations regarding the materiality threshold of the Dutch auditing standards NV COS. For the third sub question several documents of the DTA have been inspected, of which the ‘Controleaanpak Belastingdienst’ (CAB) is especially important. The last two sub questions about the perceptions of material tax risks and the suitability of law and regulations regarding materiality of both groups, are answered by means of interviews.
The interviews have been conducted with participants of both groups: external auditors and auditors of the DTA, to gain the perspective of both groups. In total seven interviews were conducted, four with external auditors and three with auditors of the DTA. This sample size was chosen due to the limited time scope and because new interviews would not generate new information anymore. The data collection is than saturated (Guest, Bunch, & Johnson, 2006). Specifications of the interviews are shown in Table 3.1.
Participant Function Experience Duration interview
External auditors
1 Audit Manager 9 years in audit practice 54 min 2 Audit Manager 11.5 years in audit practice;
University lecturer
51 min 3 Audit Trainee 3 years in audit practice;
University lecturer
29 min 4 Audit Partner 12 years in audit practice;
University lecturer
73 min Auditors DTA
5 Auditor DTA 34 years at DTA 104 min
6 Auditor DTA 22 years at DTA 76 min
7 Auditor DTA 18 years at DTA 59 min
The interviews have been conducted with experienced professionals in order to assure the collection of higher quality data. Furthermore, the interviews with external auditors have only been conducted with chartered accountants working at audit firms belonging to the Big 4. External auditors of three of the four Big 4 audit firms have been interviewed. According to research audit quality is dependent on audit firm size and generally audits of large (Big 4) audit firms are deemed of higher quality (DeAngelo, 1981; Francis, 2004). The interviews with auditors of the DTA have only been conducted with auditors working for the large enterprises department due to the specification of the study directed at large enterprises. Two different interview guides have been composed to gain specified information from both groups. The interview questions have been based on the information obtained out of the literature review and the inspection of documents. The interviews have been conducted in a semi-structured manner. This means that a researcher prepares questions in advance, but also asks additional questions which arise in the course of the interview (Smith, 2017). The
interview guides can be found in Appendix 1. During the composition of the interview guides an interview training has been followed were a test-interview has been conducted. Some interview questions were tested and it helped to practice with the interview technique to be able to obtain sufficient and appropriate data. The interviews have been conducted in Dutch to mitigate the effect of a potential language barrier. Beforehand matters of anonymity and confidentiality were discussed with the participants. All participants were asked to sign a consent form. An unsigned version of the consent form can be found in Appendix 2. The interviews were recorded after permission was asked to the participant. In contrast to solely taking notes during the interview, this will lead to more reliable data collection. Afterwards the recordings were manually turned into a transcript. Transcripts were written in Dutch and the used quotes were translated in English afterwards. This translation could possibly lead to a loss of essence due to interpretation and perception of the researcher. After transcription the transcripts were send to the participants for approval. This was done in a short time period after the interview was conducted, to ensure that the participant had the interview fresh in mind. In case of feedback transcripts were adjusted. The transcripts have been anonymized. The quotations presented in chapter 4 have been extracted from the transcripts.
The transcripts were analyzed by means of coding. Valid and consistent coding is very important for the reliability of the data analysis. With coding, the data is organized by
interpretation of the content and making connections between different pieces of information (Smith, 2017), by assigning numbers or other symbols to the interview answers (Blumberg et al., 2014). This was done to identify patterns from the transcripts, to be able to draw
conclusions from the data. The coding system was formed by linking the information to the sub questions. This have been done manually.
In the next chapter the results of the interviews relevant for answering the research question are shown.
4. RESULTS INTERVIEWS
4.1 Audit of tax and materiality
This section gives the results for the second sub question: ‘How do external auditors use the materiality concept in their audits?’
The external auditors were asked which different materiality thresholds they use in the audit. In accordance with the theory section they all use the three materiality thresholds: overall materiality, performance materiality and the SAD. However, all the different audit firms use slightly different terms for them. Further, the interviewees were asked how they determine materiality in audits for large enterprises. Their approach was in accordance with the
standards. They use different benchmarks dependent on what is important for the users of the financial statements, whereby the profit measures are used most often. The applied percentage for overall materiality is dependent on the risk profile of the client and the company type. For performance materiality internal factors like the quality of the internal control are important. In this professional judgement is considered very important.
One of the external auditors explains the application of materiality in an audit as follows: [“Every position in the financial statements above the performance materiality is automatically in scope. It is just the assessment whether it is higher or lower. When it is lower we don’t do anything with it and when it is higher it is in scope” – Audit Manager]
When asked whether the external auditors use multiple materiality thresholds in an audit, one of the external auditors mentioned the possibility to use an additional materiality threshold:
[“We determine the main materiality and then sometimes we use an additional materiality threshold for certain accounts and for certain disclosures… So, suppose you have an overall materiality of 10 million and a performance materiality of 7.5 million and you want to audit a specific post with an overall materiality of 1 million and a performance materiality of 750 thousand” – Audit Partner]
4.2 Tax audit and materiality
This section shows the results on the third sub question: ‘How do auditors of the Dutch tax administration use the materiality concept in their audits?
Materiality
In the interviews with the auditors of the DTA the use of the materiality table from the CAB to determine the materiality is confirmed. One of the auditors of the DTA describes the use of materiality as follows:
[“We use materiality for setting up our audit activities. The materiality table basically is there to come at a more or less objective approach of materiality, but just like with external auditors it is also a whole share of professional judgement and consideration of the results of the pre-planning which you perform at an audit and your risk
analysis. Also, the inherent risks and other risks can be decisive for determining the materiality. But in determining the amount of work is usually being held to the materiality table. But the table is not, let me put it like this, something you cannot deviate from” – Auditor DTA]
Just like this auditor also the other two auditors of the DTA mentioned the term professional judgement in determining the materiality.
All three auditors mention the possibility to deviate from the materiality table. The following example is given by one of the DTA auditors:
[“A start-up has in the beginning a lot of costs and low revenue. In this case the materiality table leads automatically to a low materiality, the used measure is after all the low revenue. In this case you would perform relatively many audit activities. But for a start-up you could also use the cost amount to apply on the table instead of revenue. In fact, the relevant measure is the company size. The cost amount is then a better indicator for the company’s size than its revenue” – Auditor DTA]
Tax layer model
As is shown in the theory section the DTA relies in its audit activities on the work of external auditors. The auditors of the DTA mention that they have audit dossier reviews and
conversations for explanation with the external auditors to take notice of their work. They take note of the materiality used by external auditors.
[“When it is a super high materiality, then the external auditor likely have looked at less and so we are less able to rely on it. Then you expect to see less activities in the dossier where we are able to rely on and so we have to do more by ourselves” – Auditor DTA]
[“When it is a very different materiality, a very high materiality than you have to do something with that. Then it is possible that we are less able to reduce our work, than in a situation where the materiality is more similar to ours” – Auditor DTA]
Further, all three auditors of the DTA state that when auditing large enterprises they rely on the work of the external auditor, especially for corporate income tax. However, two of the four external auditors are not familiar with the fact that the DTA relies on work of the external auditors. The other two had experienced it, though not often.
[“Yes, that is being done. I think I have experienced it two times in 11 year that they asked for a dossier” – Audit Manager]
4.3 Comparison audit of tax and tax audit regarding materiality
This section shows the results for the second and third sub questions: ‘How do external auditors use the materiality concept in their audits?’ and: ‘How do auditors of the Dutch tax administration use the materiality concept in their audits?
According to the literature the materiality thresholds of external auditors are often
significantly higher than in tax audits (Wesdorp, 2015) and the DTA would use no or very low thresholds. The auditors of the DTA wonder whether the materiality threshold of the DTA is – as hypothesized – lower than that of external auditors. It is mentioned the hypothesis may be true for very large enterprises, but for smaller large enterprises the materiality amounts are often quite similar, or the materiality of external auditors is maybe even lower. Reason is the difference in tasks for external auditors and the DTA.
[“The objective of external auditors is to audit the financial statements and determine whether it is correct in all material aspects. The goal of the Dutch tax administration is to get the money they are entitled to” – Audit Partner]
4.4 Material tax risks
In this section the results are given for the fourth sub question: ‘What do external auditors and auditors of the Dutch tax administration perceive as material tax risks in audits of large enterprises?’
4.4.1 External auditors
Interviewees is asked how they determine material tax risks in their audits. Risk-assessment is deemed as the base for an audit. Tax risks are also incorporated in that, but the external auditors not really use the distinction in tax risks from the literature as shown in the theory section, except for the external auditor of PwC. As mentioned this firm has published the seven types of tax risks. In accordance with the literature the interviewees mentioned transfer pricing as important risk. Enterprises can use cross-border transactions for profit shifting between countries for profit optimization. Also deferred tax positions are mentioned due to the estimation uncertainty in the valuation. Compliance and reputation risks were also often mentioned, because of the increased attention to tax policies of companies in the last years. One of the auditors also links this to reputation risk for the audit firm when companies get negative media attention regarding their tax policy. Two auditors use the TCF of their clients in their risk assessment and the other two do not use it at all.
All external auditors were asked what kind of influence the height of the materiality has on the audit of tax positions. One of the external auditors described it as follows:
[“When we determine our overall materiality and performance materiality we assess all accounts on whether it can contain a material misstatement. So, it means that when an account is small enough it cannot contain a material misstatement. In that case we do not do anything with it, or little. So, it means the higher the materiality thresholds the higher the change that a tax account is not material” - Audit Partner]
This is in line with the answers of all external auditors. The tax accounts are treated in the same manner as all other accounts. When the performance materiality threshold is above the amount of the tax position in principle it cannot lead to a material misstatement and so it leads to non or little audit activities on that account and vice versa.
The external auditors were asked how important the audit of tax accounts is in practice. Two of the external auditors state:
[“It is perceived as important. Especially at large enterprises tax accounts are material accounts and they are just as important as all other material accounts… I think that they are more often material than not” – Audit Partner]
[“Auditing of tax positions; yes important, provided that it is material” – Audit Manager]
The other two auditors mentioned the audit of tax is less important than that of other accounts, unless for example in international situations due to the high tax risk.
4.4.2 Auditors of the Dutch tax administration
The interviewees were asked how they determine the material tax risks for large enterprises. They said that this is done on the basis of: the tax return, conversations with the taxpayer, risks mentioned by the organization and the TCF. All three auditors indicate that they do not explicitly use a distinction of different types of tax risks in their audits. As the most important tax risks for large enterprises they mention: profit shifting between countries (transfer
pricing), tone at the top and culture of companies, deferred tax positions and the risk of an incorrect tax return.
The interviewees were asked whether they also look at the material tax risks that the external auditor has identified. They indicate that they ask about it, but this is done after they finished their own risk analysis. Then they are going to look which risks the external auditor has identified.
[“We are going to the external auditor after we performed our own risk analysis. Then we are going to look which risks the external auditor has identified” – Auditor DTA]
4.5 Suitability of law and regulations regarding materiality and tax
This section shows the results on the fifth sub question: ‘What do external auditors and auditors of the Dutch tax administration think of the suitability of law and regulations regarding materiality and tax?’
4.5.1 External auditors
All four external auditors feel that the current regulations for the determination of the materiality threshold is suitable for the audit of tax positions. Three of the four auditors are not convinced that enforcing a (lower) materiality that would only apply for auditing tax positions would be beneficial. Two of the auditors wonder whether the society needs this and are wary for the extra costs this would mean for clients.
[“Suppose that society thinks this is necessary, then it would mean a significant increase of the audit pressure and with that an increase of costs. Then it is the question whether it would give more assurance for the user of the financial statements” – Audit Manager]
Three of the four auditors mention the possibility in the current auditing standards to use an additional materiality threshold. Reasons that are mentioned are high tax risks for example for public companies and companies that operate internationally as well as the societal attention regarding taxes. One of the auditors mentioned:
[“Societal attention would be a good reason. So that for a specific account we use a lower materiality because we think it is important. Maybe something is not material for the financial statements, but because it is important from a societal perspective. So that could be a reason to apply a lower materiality for that. I have to say honestly, I do not see it very often in my files. But now that we are talking about it, it could very well be” – Audit Partner]
4.5.2 Auditors of the Dutch tax administration
The auditors of the DTA were asked whether the materiality table is the right tool to
determine the materiality or if another tool would be better. An advantage of the table which is mentioned is that it is robust. It can easily be explained to someone, and taxpayers are treated equally. But interviewees mention that the table ends at a revenue of 140 million and thus the highest materiality used is 3 million. For very large companies this can lead to a disproportionate high amount of audit activities. Also, a deviating ratio of revenues/costs was mentioned, which would lead to a very low or high materiality. In certain situations this does not correspond with the amount of audit activities they would like to perform, for example with start-ups as mentioned in subparagraph 4.2. Solutions that are mentioned are: to add some additional thresholds for companies with revenue above 140 million and adding
different benchmarks for example profit before tax or EBITDA. Also mentioned is taking into account: different typologies of companies, when a company has no unqualified audit opinion or when a company is loss-making.
The auditors of the DTA were asked how they feel about external auditors using either voluntary of obligatory an extra (lower) materiality threshold for auditing tax positions. The auditors agree that this would be beneficial for auditing tax positions, in particular regarding corporate income tax because they rely the most on the tax administrations’ audit activities of this tax. One of the auditor states:
[“The more the external accountant does the more we can rely on their work. Then we are able to step back in our audit activities” – Auditor DTA]
But another auditor also mentions:
[“That would be nice. But there are more users of the financial statements than the Dutch tax administration and maybe another user does not need that information. Maybe they agree with a certain degree of material misstatement. So, the question is whether it would also be beneficial for other users” – Auditor DTA]
In the next chapter the research is concluded and an answer on the research question is given. Further, theoretical and practical implications for the research are discussed. Finally,
