Auditors are confronted with enough challenges when identifying needed adjustments to financial statements without their tax accounting brethren causing trouble. Conversely, sometimes the tax accountants allow bogus deductions to slip by when audits fail to accomplish the mission outlined in courses for CPA study. Adding to the complexity is company management that endeavors to disguise fraudulent financial reporting. This transpired in the past at several large public corporations, such as Tyco International, Ltd.
Tyco executives succeeded in deceiving auditors along with investors in the company’s stock as the 20th century came to a close. Consequently, inaccurate tax deductions occurred after audits fell short of unraveling material factors consistent with CPA course principles. Moreover, IRS problems remain for the restructured company. Thus, financial reports from Tyco are still affected by conduct of the past.
The IRS has recently disallowed another $2.86 billion of interest deductions on Tyco tax returns from 1997 through 2000. This leaves the company exposed to $883.3 million in taxes plus another $154 million of penalties. The tax liability is attributable to former subsidiaries of Tyco, which had grown into a huge conglomerate in the 1990s. That growth seemingly complicated the audit process. Erroneous tax calculations then followed.
The trail of Tyco intercompany debt transactions overwhelms the typical exercises in CPA preparation courses. In fact, present Tyco managers disagree with the IRS assessment of these matters. The company resolved other tax issues with the IRS dating back to 1997. Only the tax effect of intercompany indebtedness remains disputed.
Tyco has stated that it intends to pursue resolution in Tax Court. That process could take several years. Until then, no tax payments are required. However, the situation calls for deploying additional CPA study standards. That is, the uncertain outcome of the tax case has a material impact on the company’s financial condition. This is a required disclosure on the current audited financial statements.
The IRS conflict could also spill over to tax years after 2000. Tyco notes that it deducted another $6.6 billion of intercompany interest in subsequent years. If the IRS prevails in its claim regarding 1997 through 2000, similar action seems likely for other periods.
Tyco indicates that it shares the tax obligation with companies it spun off in the past decade. These entities are Covidien PLC, TE Connectivity, ADT, and Pentair. Tax sharing agreements reportedly state that Covidien shares 42 percent of tax liabilities and TE Connectivity is obligated for 31 percent. ADT and Pentair also share some of Tyco’s tax liability, depending upon whether the amount exceeds $500 million or $750 million.
Exposure to IRS claims for additional years plus possible inability to enforce tax sharing responsibilities complicates the current year financial reporting by Tyco. The company should certainly disclose its potential tax obligations according to standards in CPA materials. This includes the fact that the IRS can seek to collect the full tax assessment from Tyco, regardless of how the obligation is contractually allocated among spinoffs.
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