The Economic Consequences of Tax Service Provider Sanctions: Evidence from KPMG's Deferred Prosecution Agreement

Abstract

This study investigates the effect of KPMG's Deferred Prosecution Agreement (DPA) on the accounting firm's ability to sell auditor-provided tax services (APTS) and its clients' tax avoidance. We document that following the DPA, clients were more likely to discontinue or reduce purchasing APTS from KPMG relative to the other Big 4 accounting firms. However, we do not find any evidence of a change in tax avoidance among KPMG clients continuing to purchase APTS following the DPA relative to other Big 4 clients. Broadly, our findings highlight how elevated reporting standards and external monitoring impose significant negative economic consequences on the service providers subject to these sanctions. At the same time, it appears clients do not suffer any observable tax costs by continuing to engage a sanctioned tax service provider.

External Auditor Responses to Tax Risk

“…Our results are again consistent with this prediction. We find that the positive association between tax risk and external audit fees is significantly lower among clients purchasing an economically meaningful level of tax NAS, which we define consistent with prior literature as tax fees in excess of 10% of external audit fees (Finley & Stekelberg, 2016). Indeed, our results indicate that, among clients not purchasing tax NAS, a one standard deviation increase in tax risk measured using cash (GAAP) ETRs is associated with a 4.53% (5.82%) increase in audit fees.…”

“…If external auditors share these concerns, an increase in the likelihood of large settlements with tax authorities may lead to an increase in engagement risk and therefore audit fees. Relatedly, given that tax rate volatility may imply that a prior tax position was disallowed by the relevant tax authority, tax risk may subject the auditor to negative publicity and regulatory scrutiny that can impair the auditor's reputation (D. L. Brown et al, 2013;Finley & Stekelberg, 2016). As an example of this type of scrutiny, in 2014 PricewaterhouseCoopers (PwC) became involved in a Senate inquiry into its audit client, Caterpillar, regarding the firm's tax practices (Rapoport, 2014).…”

“…We expect that the knowledge spillover benefits of tax NAS will only be evident when the auditor performs an economically significant amount of tax work for the client. As such, we control for APTS, which is defined as an indicator variable set equal to 1 if the ratio of tax fees to audit fees paid to the auditor is greater than 10% (Finley & Stekelberg, 2016), and 0 otherwise. 9 We expect a positive coefficient estimate on APTS.…”

“…Moreover, tax risk may be indicative of large settlements with tax authorities (Finley, 2019), which in turn may trigger financial restatements (Chasan, 2012) that can damage auditor reputation (Irani, Tate, & Xu, 2015) and/or trigger litigation against the auditors. Relatedly, tax risk may invite negative publicity and scrutiny of the auditor from regulatory bodies (D. L. Brown, Shu, Soo, & Trompeter, 2013;Finley & Stekelberg, 2016;Rapoport, 2014;Tabuchi, 2017). In turn, auditors may respond to this increased scrutiny and reputational risk by charging higher audit fees.…”

Sintesis Sistem Akuntansi Perpajakan

“…Pendukung kelompok ini berpendapat bahwa perilaku dipengaruhi oleh hubungan antarindividu, hubungan individu dengan kelompok, dan hubungan kelompok dengan kelompok atau hubungan sosial. Oleh karena itu, faktor seperti friendly persuasion (Amponsah & Adu, 2027;Sipos, 2015); perceived servise orientation (Finley & Stekelberg, 2016); undang-undang yang adil dan perlakuan ramah petugas pajak selama proses pemeriksaan (Thornton & Shaub, 2014); treatment petugas pajak (Williams & Horodnic, 2015); persepsi Wajib Pajak terhadap kualitas layanan pajak (Alabede, 2011); perilaku petugas pajak terbukti berpe ngaruh terhadap kepatuhan WP (Eichfelder & Kegels, 2014).…”