Accounting & Business June 2008
FRC repeats warning of a Big Four collapse
A collapse of a Big Four firm remains the biggest risk to the effective functioning of the audit market, the UK’s Financial Reporting Council has warned.
As part of the ongoing implementation of recommendations from the Market Participants’ Group to improve audit market efficiency, the FRC has published a discussion paper on the possible impact on audit choice of changes to audit firm ownership rules and launched a consultation on the use of audit firms from more than one network. These papers consider how easy it is for mid-sized firms to increase market share; the potential impact on audit quality and on the supply of appropriately qualified auditors of firms using outside capital; and the threat to audit quality from conflicts of interest arising from changes in firms’ ownership structure.
FRC Chief Executive Paul Boyle said: “A good start has been made on the implementation of the recommendations of the Market Participants’ Group in the UK and there are also promising developments in Europe and the United States.”
Several initiatives have followed the publication of the Market Participants’ Group. Proposed changes to the Guidance for Audit Committees advise audit committees they should explain to shareholders how they reach recommendations on the appointment, reappointment or removal of external auditors. New audit regulations and guidance allow access by an incoming auditor to information held by the outgoing auditor. Revised corporate governance policy and voting guidelines covering auditor selection have been issued by the National Association of Pension Funds. And a working group has been formed by the Consultative Committee of Accountancy Bodies to develop guidance on the voluntary disclosure of the financial results of work on statutory audits.
Grant Thornton welcomed the FRC report. Michael Cleary, chief executive of Grant Thornton UK, said: “The FRC is helping to create an environment which fosters greater choice in the public interest market and we welcome their programme.” But he argued that more needed to be done by regulators, companies and the profession to bring about substantial change in the market.
EU regulatory integration moves closer
Closer cross-border financial market supervision should be in place next year, the European Council has decided. Improved information sharing, the creation of a shared regulatory culture and common reporting systems were all agreed by the EU’s heads of government.
EU member states want to see a converged system of financial reporting across the EU, including convergence of regulatory systems. Mandates will be revised for the EU’s committees of supervisors – overseeing securities, banking and insurance and pensions – to ensure greater consistency of approach, more co-operation and increased decision-making coherence.
The supervisory committees will also be given tasks to enable regulatory convergence, including creating a common regulatory culture across the EU. It is essential, the governments believe, that information held by one supervisory authority should be shared with peers across the EU where a company trades cross-border. European regulatory bodies need to improve, the ministers agreed.
But despite the Council’s focus on structural reform, ministers announcing the measures attacked the culture of modern business, implying this had contributed to the economic crisis. Chairman of the Eurogroup of finance ministers and Luxembourg prime minister, Jean-Claude Juncker, said that his colleagues were interested in taking legal action against what he termed “scandalous” executive pay, including increased taxation of bonuses. Action on executive salaries was particularly necessary at times when inflationary pressures meant that staff wages were subject to strict controls, said Juncker.
European ministers’ complaints were echoed by criticisms of UK banks’ reward packages by the Governor of the Bank of England, Mervyn King. He told the House of Commons Treasury select committee: “I think that banks have come to realise, in the recent crisis, that they are paying the price for having designed compensation packages which provide incentives that are not in the long run in the interests of the bank themselves, and I would like to think that that would change.”
More caught defrauding public purse
Detected fraud against UK public bodies has escalated, according to the latest report of the Audit Commission’s National Fraud Initiative. The NFI recorded a 26% increase, to £140m, in detected fraud in 2006/7 over the previous exercise two years before.
The NFI is a data matching operation that compares information from various public sector sources. In its first decade of operation it has detected £450m of fraud, at a cost of under £10m.
One fraud investigated by the NFI involved a man who told the London Borough of Southwark that he was homeless and was allocated a council home. But he was found to be sub-letting both this property and another he obtained from the borough using a false name, while actually owning a property elsewhere. Other examples of detected frauds included the continued cashing of pensions of deceased relatives; simultaneous ‘full-time’ employment at more than one public body; and fraudulent claims for housing benefits.
The Audit Commission says it is unclear whether the increase in detected fraud reflects higher levels of fraud or improved detection. But it urges public bodies to apply more resources to fraud investigation.
“These are not victimless crimes and some of the fraud found is both blatant and shocking,” says Michael O’Higgins, chairman of the Audit Commission. “People are stealing homes, pensions, student loans, parking places and benefits, seemingly confident that no one is tracking them. They are wrong. We urge all public bodies to put in place the necessary trained staff to work with us and follow up any matches. It makes both moral and financial sense to detect fraud and overpayments.”
The report was welcomed by the Local Government Association – but it argued the results showed that councils had already made major progress in tackling fraud. The LGA’s chairman, Sir Simon Milton, said: “This report demonstrates that councils are working hard to crack down on illegal claims for benefits, council tax discounts, compensation and disabled parking badges . All councils have dedicated fraud teams and there are many examples in the report of authorities which have recouped significant amounts of revenue and resources.”
Sir Simon added that the frauds “are depriving frontline services of much-needed money and resources”. He added that councils and the Audit Commission “have increasingly sophisticated methods of detecting fraud”.
Treasury reviews CT
A forum has been established by the UK Government to consult with big business on tax policy. The move follows the decisions by Shire Pharmaceuticals and other corportions to relocate their tax domicile from the UK to Ireland, taking advantage of lower corporation tax rates.
Chancellor of the Exchequer Alistair Darling said: “We need to anticipate a growing problem for all governments – how to protect revenues in an increasingly global market place for goods and services, while promoting the competitiveness of our businesses so that they can take advantage of open markets.”
The forum will be chaired by financial secretary to the Treasury, Jane Kennedy. Its creation was welcomed by the director-general of the CBI, Richard Lambert, who said it was encouraging “that the Government wants to provide certainty and consistency for the long-term”. Members include Lambert and senior executives from major UK-based multinationals, including HSBC, BP, BT, GlaxoSmithKline, Unilever and Rolls-Royce.
The Chartered Institute of Taxation responded that the main factor for companies leaving the UK was not the headline tax rate, but the uncertainty and confusion over tax policy. Ian Menzies-Conacher, chairman of the Institute’s technical committee,said that the UK Government would best protect its corporate tax base through a more consultative approach.
Mr Menzies-Conacher said: “It is far better to use the various consultation mechanisms available – informal, formal and responses to consultation documents – than to produce a ‘rabbit from a hat’. As tax is complex, the latter almost inevitably leads to unintended consequences and it is much better to take the time necessary to get it right. The whole point of a consultative approach is to listen to what is said, reflect on it and consider proposed changes.”
The Institute also argued for more targeted measures than using the proposed ‘controlled companies’ regime. The Treasury’s proposals would create a heavy compliance burden on UK-based groups that required detailed annual calculations for overseas subsidiaries, said the Institute. It pointed out that historically little revenue has been raised by the UK exchequer on profits earned outside the country – where profits are mostly already taxed.
Income tax cut saves Budget legislation
The UK Government has raised individual personal tax allowances by £600 to buy-off a threat by MPs to reject Budget legislation.
By raising the personal tax allowance to £6,035, Chancellor Alistair Darling refunded most of the losses felt by people on low incomes from the previous removal of the starting rate 10 pence tax band. The measure will cost £2.7bn in 2008/9, increasing pressure on government spending plans and borrowing requirements. Darling said that 80% of people of people who would have lost will now be fully recompensed, with the other 20% recovering half the money they would have lost. Some 600,000 low income taxpayers will no longer pay tax. Higher rate taxpayers will not gain from the move because the threshold for paying the 40% rate is reduced from £36,000 of taxable income to £34,800.
Chas Roy-Chowdhury, head of taxation at ACCA, warned that the measure created burdens on employers. “The Chancellor’s increase in the individual tax allowance by £600 is to be welcomed,” said Roy-Chowdhury.
“But the downside to this income tax change is that business’ systems and processes will have to be updated half way through the tax year in September. SMEs represent over 99% of UK businesses, and they will have to change their PAYE codes and tax systems. This is the administrative knock-on effect which happens when policy decisions are altered because they were not clearly thought through in the first instance. ACCA also questions how many tax payers will now be dragged into the higher rate tax band of 40%. Due to these changes, there will now be people who were on the 20% tax band who will be brought into the higher rate because of the decrease in the 40% tax band.”
More companies – and people – go broke
There has been a 4% increase in corporate liquidations in the last year, according to the latest figures for England and Wales produced by the Official Insolvency Service. The figures suggest a complex picture – there was a 22% fall in compulsory liquidations from the same quarter a year ago, but a 25% increase in voluntary liquidations.
While personal insolvencies rose by 1.7% over the previous quarter, they actually fell by 13.2% on the same period last year. This reflected a 22% fall in the number of Individual Voluntary Arrangements from the level in the first quarter of 2007. There were over 25,000 personal insolvencies in England and Wales in the first quarter of this year, with over a thousand compulsory corporate liquidations and over two thousand creditors voluntary liquidations.
Analysis by PricewaterhouseCoopers analysis shows that the rise in corporate liquidations was driven by trading failures in the retail and construction sectors. Mike Jervis, partner in the business recovery services practice at PwC, said: “Our message to businesses is not to panic, but to ensure they are doing all they can to manage their way through the potential downturn as soon as they see signs of financial distress. The four key areas to focus on are: reviewing their business strategy so they can be certain it is still relevant; making sure they have access to adequate finance and cash; looking at their operational capability to ensure it is correctly deployed around the profit making areas of the business; and finally managing and communicating with their stakeholders from staff to banks and suppliers.
“History has shown that the companies who emerge from the downturn as sector leaders will be those who proactively undertake a strategic, financial and operational review now, while carefully and positively managing their stakeholders differing agendas.”
Statistics on housing repossessions, issued by the Ministry of Justice, also showed a worrying situation. Repossessions rose in the first quarter of this year by 17% over the same period last year and by 9% over the final quarter of 2007. The Council for Mortgage Lenders said the figures were not surprising. It added that with repossessions currently running at one in 300 mortgages, the rate was less than half that of the housing crisis in the early 1990s. Unemployment also rose in the UK, with an increase of 7,000 people claiming job seekers’ allowance in a month.
E&Y to integrate global firms
Ernst & Young is to integrate 87 national practices in Europe, the Middle East and Africa (EMEIA) into a single operational area. Similar integration will take place in the Far East across 15 countries and territories. The new EMEIA area will bring together over 60,000 people, with a turnover in excess of $11bn. Subject to a confirmatory vote, the new EMEIA area will be effective from July. The Far East area will comprise more than 20,000 people and a $1.2bn turnover. Mark Otty, the head of the UK practice, has been nominated to head the EMEIA area, while David Sun and Jim Hassett will be Far East co-area managing partners.
Restricted audit choice boosts Big Four profits
Higher audit fees are directly linked to concentration in the audit market, according to research produced by the London School of Economics and sponsored by BDO Stoy Hayward. The collapse of Arthur Andersen was followed by a 2.4% increase in audit fees paid by UK listed companies, the research found. It also suggested that changing audit firms can reduce audit fees by about 5% to 7% in the short term. If the Big Four firms lost 10% market share, UK listed and large private companies could expect to shave about 7% from their annual audit fees, the report concluded. Its findings were rejected by the Big Four.
Death and Taxes
Tax evasion, tax avoidance and tax competition are responsible for the deaths of millions of children, according to a new report from Christian Aid. Almost a thousand young children a day die in developing countries just from illegal, trade-related, tax evasion, says the charity – with nearly three million dead in the last eight years. The global tax system “allows the world’s richest to duck their responsibilities, while condemning the poorest to stunted development, even premature death,” concludes the report.
Mortgage fraud ‘funding terrorism’
Mortgage fraud is being used by organised criminal and terrorist gangs to finance terror attacks, drug operations, prostitution and human trafficking, says Bob Ferguson, head of financial crime policy and intelligence at the FSA. The scale of the fraud is difficult to estimate, but the police have suggested it may be about £200m annually. Over 250 cases of possible fraud have been referred to the FSA.
‘Tax clampdown on second home owners’
The UK’s HM Revenue & Customs is pursuing second home owners who fail to properly declare rental income, says tax advisors DTE. It warns that people who have assumed they do not owe tax because their rent is less than their mortgage payments could face large fines. “HMRC is confident of success because information from stamp duty land tax returns means it can match properties to individuals’ declared principal private residences and take matters from there,” says Alan McCann, a director of tax at DTE. He suggests that HMRC is expecting to “generate significant arrears” from its campaign.
Tighter tax evasion rules proposed
The European Commission is proposing tougher rules against tax evasion, with more effort aimed at offshore accounts. Measures stem from the conflict between Germany and Liechtenstein over investigations into the use of offshore accounts by German citizens and the alleged failure of Liechtenstein banks to ensure that customers properly paid tax in their home countries. Recommendations include greater requirements on offshore territories to information share with the EU and action against the use of trusts by EU citizens to evade or avoid tax.
EU IFRS opt-out ‘adds business risks’
The failure of the European Union to completely adopt IFRS represents an ongoing business risk, according to the Financial Reporting Council’s latest Plan & Budget. Using amended variations of IFRS may lead to financial reports not being compatible with those of other territories, increasing the cost of capital, says the FRC. Another identified risks is that actuarial technical standards may not match the legal and regulatory environment, leading to the production of insufficient information to be useful to investors and regulators.
UK breaks EU budget deficit rules
The European Union is to propose spending cuts and tax rises to the UK, after breaches of the EU’s budget deficit rules. Only Hungary and Romania of the EU’s other 26 countries breach the rule limiting deficits to 3% of GDP: the European Commission expected the UK deficit to reach 3.3%, even before the £2.7bn cost of emergency income tax concessions. The Commission predicts growth in the UK to be limited to 1.6% and 1.7% for the next two years.
Slovakia ready for euro
Slovakia is ready to join the euro currency from January next year, according to the latest European Union convergence report. This will expand to 16 the number of EU countries using the euro – up from 11 when the currency was launched nine years ago. Of the most recent wave of members, Slovenia, Malta and Greece have already joined the eurozone. Denmark, Sweden and the UK remain outside.
AXA subsidiary fined £900,000
One of the UK’s largest independent financial advisory firms, the Thinc Group, has been fined £900,000 by the FSA for record keeping failures, inadequate risk management and weak compliance systems. Thinc was unable to demonstrate that it gave suitable advice to customers regarding the sale of sub-prime mortgages in the period from January 2006 to late 2007. The Thinc Group was purchased by AXA in 2006.
Conacre ruling ‘damages farmers’
Farmers are threatened with massive increases in inheritance tax bills and the potential break-up of their farms, the Ulster Farmers’ Union has warned following a ruling by HM Revenue & Customs special commissioners. Conacre is a system of letting land to farmers to increase the size and efficiency of their farms. Traditionally conacre has been treated as agricultural land, which meant it did not attract inheritance tax. Now special commissioners have decided that conacre land with development potential should be subject to IHT. A third of farmland is Northern Ireland is conacre and PwC has warned that farms may have to be broken up to pay IHT bills.