October 27, 2020 · 4 min read
Although financial (bookkeeping) accounting and tax accounting have grown closer in recent years, and despite their apparent similarity, many factors still support treating them as two distinct types and systems of accounting.
Penalties for non-compliance with tax law grow stricter every year, while the legislation itself changes frequently and can be hard to keep up with. As a result, the value and relevance of a tax audit are not decreasing — they are steadily increasing.
In essence, a tax audit is the same as a financial audit, except that its subject is the company’s tax reporting. The auditor’s task is to verify and confirm that the tax returns have been prepared correctly and, where violations are found, to provide clear, practical recommendations on how to correct the deviations as quickly as possible and how to avoid them in the future. A tax audit can cover all tax returns or only the specific taxes the client selects.
The audit covers the reporting period defined by the client — usually the company’s three most recent years of activity, since, as a general rule, the tax authority may not review the accuracy of a taxpayer’s declared tax liabilities beyond that period. In certain cases, however, the tax authority may still examine documents and returns for earlier periods — up to seven years from the date of the source documents or the related returns. In practice, an audit most often covers a period ranging from one month to three–five years.
Tax returns are very likely to be examined in detail by the regulatory authorities in the future — and, unfortunately, often with a bias. The auditor must therefore not only have a solid command of the specific tax legislation but also understand the position the tax authority is likely to take on any given contentious or ambiguous issue. In some cases, returns should be prepared in line with the tax authority’s guidance rather than strictly with the letter of the law; otherwise, even when a company is confident it is right, it may well have to defend a position that differs from the tax authority’s in court. That is why, during a tax audit, we consider it essential to show the client every alternative way of preparing a given return, along with the possible tax consequences of each option.
As part of the audit, we perform a full calculation of the company’s potential tax risks — the financial losses that could arise from breaching tax law. We recommend that large and medium-sized businesses undergo a tax audit at least once a year, and preferably every six months or every quarter, in order to minimize the risk of underpaying (or, in some cases, overpaying) taxes. In practice, it is always better and easier to take the necessary preventive measures than to correct actual violations — especially when they are not one-off but have persisted over time.
There are two very different ways to conduct a tax audit:
— before the relevant tax returns are filed;
— after the returns are filed.
Conducting a tax audit before returns are submitted to the regulatory authorities is certainly the more effective approach: the company can reflect any identified deviations directly in the returns for the relevant tax period, without later filing an adjusting calculation that often triggers additional fines and penalties.
A further benefit of our tax audit service is that we provide recommendations for correcting errors and support the company in defending its position on contentious issues during and after the tax authority’s review of its returns. Most importantly, our firm follows a practice of financial accountability for the tax audits we perform: if the tax authority identifies deviations that we did not, we are prepared to compensate the company for the resulting fines and penalties.
