Ethics in Accounting and Audits

Chapter 6
The Ethics of Tax
Accounting
 The ethical environment facing tax
professionals is of particular interest because
a tax professional’s role is markedly different
from that of an auditor.
 Auditors are required to be independent of

their clients, while tax professionals are

required to be advocate for their clients.
 Tax professionals should help people pay

what they owe – not more, not less.

 The tax accountant has several responsibilities
to the public, through the government.
 First, the tax accountant has an obligation not
to lie or be party to a lie on a tax return.
 Second, “ the signature on a tax return is a
declaration under penalty of perjury that to the
best of the preparer ’ s knowledge, the return
and accompanying schedules and statements
are “ true, correct, and complete ” .

 Why that ’ s the case is clearly laid out in the
AICPA ’ s Statement on Standards for Tax
Services No.1, numbers 10 and 11.
 10. Our self - assessment tax system can only

function effectively if taxpayers report their

income on a tax return that is true, correct and
complete.
 A tax return is prepared based on a taxpayer ’ s

representation of facts, and the taxpayer has

the final responsibility for positions taken on
the return …
 11. In addition to a duty to the taxpayer, a
member has a duty to the tax system.
 However it is well - established that the taxpayer

has no obligation to pay more taxes than are

legally owed, and a member has a duty to the
taxpayer to assist in achieving that result …
 Number 11 clearly spells out the fact that tax

accountants have a duty not only to their clients

but also to the system.
 The client ’ s duty is to pay the taxes they legally

owe, no more, no less.

 The taxpayer has the final responsibility for
the representation of the facts and for the
positions taken on the return, but the
accountant has the responsibility to point out
to the client what is legally owed and not
owed, and the responsibility not to go along
with a client who wants to take advantage of
the tax system.
 There are seven standards presented in the
Statements on Standards for Tax Services.
 As found in the explanation sections, the

following summarize the central themes of

each standard:
 (1) A member should not recommend a tax
return position unless it has a realistic
possibility of being sustained on its merits.
 (2) A member should make a reasonable

effort to obtain from the taxpayer the

information necessary to answer all questions
on tax returns.
 (3) A member may rely on information furnished by
the taxpayer or third parties without verification.
 However a member should not ignore the

implications of information furnished and should

make reasonable inquiries if the information
appears to be incorrect, incomplete or inconsistent
either on its face or on the basis of other facts
known to a member.
 Further, a member should refer to the taxpayer ’ s

returns for one or more prior years whenever

feasible.
 (4) Unless prohibited by statute or by rule, a
member may use the taxpayer ’ s estimates in
the preparation of a tax return if it is not
practical to obtain correct data and the
member determines that the estimates are
reasonable based on the facts and
circumstances known to the member.
 (5) A member may recommend a tax return
position or prepare or sign a return that
departs from the treatment of an item as
concluded in an administrative proceeding or
court decision with respect to a prior return
of a taxpayer.
 However, the member should consider

whether the standards in SSTS No. 1 are met.

 (6) A member should inform the taxpayer
promptly upon becoming aware of an error in a
previously filed return or upon becoming aware
of a taxpayer ’ s failure to file a required return.
 A member should recommend corrective
measures to be taken.
 (7) A member should use professional
judgment to ensure that tax advice provided to
a taxpayer reflects competency and
appropriately serves the taxpayer ’ s needs.
Standard Statement No. 1.
Tax return positions
 Statement 1, 5.a. States that “ A member
should not recommend a tax return position
or prepare or sign a tax return taking a
position unless the member has a good -
faith belief that the position has at least a
realistic possibility of being sustained
administratively or judicially on its merits if
challenged.
Standard Statement No. 2. Answers to
questions on returns
 This statement is nonproblematic and
prescribes the following: “ A member should
make a reasonable effort to obtain from the
taxpayer the information necessary to provide
appropriate answers to all questions on a tax
return before signing as preparer. ”
Standard Statement No. 3.
Certain procedural aspects of preparing returns
 A preparer can rely on the good faith of the client to
provide accurate information in preparing a tax return,
but “ should not ignore the implications of information
furnished and should make reasonable inquiries if the
information appears to be incorrect, incomplete or
inconsistent. ” Here the obligation to the tax system is
clear. The preparer will sign the statement attesting that
the information contained therein is true, correct, and
complete to the best of the preparer ’ s knowledge.
 Consequently, if the preparer concludes because of an

inconsistency that the information can ’ t be correct or

complete, the preparer has an obligation not to sign the
return.
Standard Statement No.4.
Use of estimates
 This is another nonproblematic standard. A
preparer may use the taxpayer ’ s estimates if
it is not practical to obtain the exact data and
if the preparer determines the estimates are
reasonable, based on the preparer ’ s
knowledge.
Standard Statement No.5. Departure
from a previous position
 Here again is a rather technical standard. As
provided in SSTS no. 1, Tax Return Positions,
“ a member may recommend a tax return
position or prepare or sign a tax return that
departs from the treatment of an item as
concluded in an administrative proceeding or
court decision with respect to a prior return
of the taxpayer. ”
Standard Statement No. 6. Knowledge
of error
 What needs to be done when a preparer becomes aware
of an error in a taxpayer ’ s previously filed tax return?
The member should “ inform the taxpayer promptly ”
and “ recommend the corrective measures to be taken. ”
 If in preparing the current year ’ s return the preparer
discovers that the taxpayer has not taken appropriate
action to correct an error from a prior year, the preparer
needs to decide whether to continue the relationship
with the taxpayer.
 This withdrawal should occur if the taxpayer is unwilling
to correct the error, if the error has a significant effect
on the return.
Standard Statement No. 7.
Form and content of advice to taxpayers
 This is a new statement added in 2009 which
requires “ a member … to use professional
judgment to insure that tax advice … reflects
competence and appropriately serves the
taxpayer ’ s needs. ” The communication of
tax advice should also “ comply with relevant
taxing authorities standards. ” This recalls the
criteria of professionalism we saw in Chapter 4
as well as the notion that the tax accountant
has a responsibility not only to the client but
also to the taxing authority.
Ethical considerations of tax
minimization scheme
 In discussing the ethical ramifications of the
tax scheme described in the Paterson Company
case, two viewpoints will be presented.
 The first viewpoint, labeled "tax avoidance,"
will defend the actions taken by the company.
 The second viewpoint, labeled "moral ethical,"
will challenge the actions taken by the
company. By presenting two strongly opposing
viewpoints, a better assessment of the issues
can be made.
 The tax avoidance view
 Tax practitioners are faced with the challenging task

of applying existing tax law to the factual situation

of a particular entity for purposes of complying with
requirements under the law.
 The solution(s) which flow from this process often

are not clear and concise.

 When there is a lack of specific authority, or the law

allows a choice between two or more alternatives,

the tax practitioner will select the approach or
alternative which minimizes the tax liability of the
entity.
 Tax avoidance must be distinguished from tax evasion.
 Tax evasion would clearly be viewed as unethical. It is also illegal.
 Tax evasion entails deception and concealment.
 On the other hand, the taxpayer practicing tax avoidance is

merely behaving in a way which hopefully will reduce tax liability.

 Such action is part of a sound business plan.
 Our purpose of business planning is tax avoidance.
 The taxpayer is fully prepared to make disclosure to the IRS. The

position(s) which are taken to avoid tax should be based on "a

good faith belief that the position has a realistic possibility of
being sustained. . . ." (AICPA, 1988, Statement .02a).
 If the "good faith" threshold is met then tax minimization is

ethical and appropriate.

the Ethics of Tax Evasion
 Three Views on the Ethics of Tax Evasion
 View One: Tax Evasion Is Never Ethical
 One strand of this view is that individuals owe

a duty to the state to pay whatever taxes the

state demands.
 There is no such thing as taxes that are too

high because the people determine the level

of taxes.
View Two: Tax Evasion Is Always
Ethical
 The second view, which I label the anarchist view
for lack of a better term, begins with the premise
that all government is illegitimate.
 Government is a mere thief, which confiscates
assets, percentages of paychecks, etc., without
the consent of the owners of the property.
 The definition of theft is the taking of property
without the owner’s consent.
 The fact that it is sometimes some government
that does the taking does not alter this basic
definition.
View Three: Tax Evasion Is
Sometimes Ethical
 View three is the prevalent view, based on the
existing literature. This view holds that tax
evasion is ethical in some cases and unethical
in others.
 Angelus of Clavisio ( 1494 ) took the position

that there is no ethical obligation to pay taxes

if the government does not use the revenues
collected to provide for the common good, at
least as long as neither lying nor perjury are
involved.
 Lehmkuhl ( 1902 ) takes the position that it is
unethical to evade taxes when the result is
that nonevaders have to pay more.
 In other words, there is some moral duty to

other taxpayers even if there is no moral duty

to the government.
The Ethics of Tax Evasion: An Islamic
Perspective
 The Islamic tax system contains both “general”
and “selective” or “classifi ed” taxes , and it
considers both the nature of the property and
the owner’s conditions in the calculations.
 Different categories of wealth and real
properties are treated and taxed differently.
 In some cases, even items within the same class
of property are treated dissimilarly, e.g.,
treatment and taxation of real properties and
personal properties, tangible and intangible
assets, farm and residential lands.
 The first Islamic tax was Khums, which was imposed
after the Battle of Badr in the second year of Hijra
(Muhammad’s migration from Mecca to Medina on
622 AD).
 Zakaat-ul-Fitr was also made mandatory in the
same year.
 Kharaaj was imposed on the 7th year, Zakaat,
which was voluntary at first, was declared
mandatory on the 8th year and Jizya was established
in 7th or 8th year after Hijra (Sadr 1989 , p. 123 and
143, Ijtihadi 1985 , p. 187, Zaman 1981 , p. 44).
 According to Islam, Muslims have a moral
obligation to pay zakat for the support of the poor
and for the legitimate functions of government.
 Thus, evading one’s duty to pay zakat is classified

as an immoral act.
 The Islamic system of taxation is a voluntary one,

at least partially, although Islamic literature makes

it clear that a government is justified in forcing
people to pay taxes if the amount raised by zakat
is insufficient to cover all the legitimate costs of
government.
According to Ahmad, “the adoption of any
methods that create an artificial rise in the
prices is strictly forbidden.”
 Price fixing and protectionism are only two

actions that cause prices to artificially rise.

Other causes mentioned by Ahmad include
the sales tax and excise taxes.
 “The term maks is used for sales-tax.
 The Prophet (peace be on him) had reportedly said:

‘He who levies maks shall not enter Paradise’.

 Since the imposition of sales-tax (or, for that

matter, of octroi and excise duties) results in

raising the prices unjustly, therefore, Islam does
not approve of it.
 The Caliph ‘Umar ibn ‘Abd al-’Aziz had abolished

maks, interpreting it as bakhs (diminution in what

is due to others) which is expressly prohibited by
the Qur’an.”
 The first step in addressing the ethics of tax
evasion is to answer a fundamental question.
Is taxation, in general, legitimate? If the
answer is negative, then taxation amounts to
theft. In that case, tax evasion is simply an
act of defending one’s property against theft,
and defending one’s property against thieves
not only does not constitute an unethical act
but it may even be considered a duty.
 The tax evasion issue, from an Islamic
perspective, may be considered under two
different scenarios.
 First, the state is a pure Islamic state and its

ruler(s) can be considered as Ulul-Amr.

Second, when the state is either not a pure
Islamic state (Mixed) or it is Secular or non-
Islamic.
 In islam, tax evasion is an illegal and unethical act that
attracts serious penalties, yet evasion of tax is on the increase.
 The effect of tax evasion is not only harmful to the economy,
but it also derailed from its purpose in helping the poor as
enshrine in islam.
 Therefore, the need for ethics in tax is important for the
society to generate revenue to the government.
 Ethical attitude means someone has good and clear
judgement and responsibility. Islam as an important system
has ethics as its core value.
 Faisal (2016) reported that ethics is an important theme for
muslims as primary source of word view on islam, from the
Holy Quran as well as the Sunnah of the Prophet Muhammad
(peace upon him).
Allah has stated in the Holy Quran that;
 END

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