Asymmetrical Reporting: A Trap for the Unwary

Feb 19, 2015   


By Joseph DiRuzzo III
February 19, 2015

As the regulatory state continues to grow with every passing year, businesses’ obligations to provide information to, and file reports/forms with, local, state, and federal governmental agencies increases. Whether it be periodic reporting, e.g., IRS Form 1120, SEC Form 10-Ks, or upon the consummation of a specific transaction or event, e.g., IRS Form 8300, SEC Form 8-K, each filing represents an opportunity to incur a potential liability for incorrect or improper reporting. To that end, each filing also represents justification to the IRS to audit a business (to the extent that justification is needed).

It should come as no surprise that compliance costs make the list of corporate counsel’s top concerns. However, reducing compliance costs often comes with an unseen price — the cost of the audit and any attendant fines and penalties that result. Accordingly, corporate counsel is placed in the unenviable position of attempting to balance the unknown risk of future audits and contingent (and often speculative) governmental liabilities with known (and quantifiable) costs of short and medium-term governmental compliance. Indeed, before a governmental audit commences corporate counsel can be viewed as a “chicken little,” always attempting to minimize exposure that may never come to pass, while after a governmental audit starts, and there is an internal assessment that there was corporate shortcomings, corporate counsel is blamed with not doing enough. Given these mutually exclusive competing interests, what is a savvy corporate counsel to do?

Avoid Asymmetrical Record-Keeping

The answer is to do more with the limited resources available. While this may seem like a statement of the obvious, understanding where governmental auditors look for evidence of non-compliance, and how to provide evidence of compliance and minimize and/or eliminate evidence of non-compliance is key to minimizing audits and, just as importantly, minimizing the length and intrusiveness of the audit.

One common business practice that often will draw special scrutiny from government auditors is asymmetrical record-keeping (and the related practice of asymmetrical reporting). While such procedures may be justified for business and accounting reasons, asymmetrical record-keeping also may lead auditors to extend an audit or, worse yet, reach audit conclusions that, but for the asymmetrical record-keeping, would not have resulted in fines or penalties being assessed.

Where does asymmetrical record-keeping typically occur? Do the individuals tasked with interacting with the government auditors have sufficient understanding to provide the correct data? And perhaps more importantly, do these individuals sufficiently understand why the record keeping is asymmetrical and do they have the ability to effectively communicate this information?

If corporate counsel is not absolutely confident that he/she is comfortable with the answers to these questions (or if corporate counsel is asking himself/herself these questions for the first time) an internal assessment of the business’ capabilities and consideration of how to address any internal weaknesses should be performed.

The Questions to Ask

Starting with the data itself, corporate counsel must have a sufficient understanding of the business information technology (IT) infrastructure and accounting information systems (AIS) within the business to be able to respond to a governmental request. The days are long gone when corporate counsel could rely on IT personnel or lower level accounting staff to be able to assess nature, extent, and scope of the governmental information requests. The reason is that data is often processed into information that suits the information end-user’s specific needs. In other words, it might not be entirely clear to the person tasked with responding to the audit what information is

actually being provided, and how such information may differ based on certain query parameters. Moreover, the data in its unprocessed form may not impart any useful information; the data itself may be incomprehensible without further refinement, thus necessitating legal and accounting acumen.

For example, accounting records may be kept in accordance with U.S. Generally Accepted Accounting Principles (GAAP), in accordance with International Financial Reporting Standards (IFRS), for cost-accounting purposes, on a cash basis, for federal income tax purposes, or a combination of some, or all, of the above. While U.S. GAAP and IFRS do have some substantial similarities, and have been converging over the years, substantial differences remain.

Cost-accounting differs in key respects from financial accounting, i.e. , GAAP. Cost-accounting is designed for the managers of a business. Since managers of a business make decisions based on the business they are running, there is no need for the information to be comparable to information in other businesses. In contrast, GAAP is designed to provide consistency and comparability among and between businesses. Importantly, cost-accounting need not comply with GAAP. Generally speaking, cost-accounting focuses on operating profit, which is the excess of operating revenues over the operating costs incurred to generate the revenues. Operating profit almost always varies from GAAP net income, which is operating profit adjusted for certain items such as interest, depreciation, amortization, taxes, extraordinary losses or gains, and other adjustments needed to comply with GAAP (or in the case with income taxes with the Internal Revenue Code).

While the data that resulted in the specific accounting information may, or may not, have been the same, the ultimate accounting information will be very different. This asymmetry may be compounded by the fact that business may need to keep two or more “sets of books” for their different reporting obligations. There is nothing uncommon about this practice, but providing information to an IRS auditor what was based on cost accounting, instead of tax accounting (see the “Uniform Capitalization” provision of the Internal Revenue Code – 26 U.S.C. § 263A), could extend an audit as the IRS auditor now has been provided source documentation/information that may directly contradict what was reported on an income tax return. It may take weeks, if not months, to fix the damage and put the audit back on track. At worst, if the mistake is not corrected, the IRS auditor may use the business’ own records against it to justify the imposition of additional tax, interest, and penalties.

This problem is exacerbated by governmental auditors who do not have a robust accounting background, or lack the ability to understand the differences or nuances between different accounting methodologies. At times this problems is unavoidable because low level governmental auditors use “check-the-box” audit lists that require auditors to ask for accounting information that is often inappropriate for the audit’s purpose. Indeed, the use of audit checklists has taken the discretion away from auditors, resulting in a one-size-fits-all approach leading to incorrect audit findings.

For example, transfer pricing (26 U.S.C. § 482 and 26 C.F.R. § 1.482-1, et seq.) between related business entities has recently been the focus of the IRS, which has bolstered its transfer pricing operations. Transfer pricing is an attempt to approximate what an “arm’s-length” transaction would be between unrelated parties. A common method of transfer pricing is the “cost-plus” method, 26 C.F.R. § 1.482-3(d), in which the purchasing entity pays for the goods and from the selling entity at the cost of producing the goods, plus a reasonably commercial mark-up for the production. If the selling entity is audited by the IRS and the wrong information is provided (e.g., the GAAP information is provided instead of the cost-accounting information on which the inter-company agreement was based) the IRS auditor could come to the conclusion that the “correct” arm’s-length transaction should have resulted in substantially more income to the U.S.-based entity and, by extension, increased the taxable income underreported and subject to penalties and interests.

More Than Just the IRS

However, problems with asymmetrical record-keeping can cause issues with state and local taxing authorities as well. Using the example above, but shifting the paradigm to high-tax jurisdictions such as California, one can see how a state tax auditor could conclude that a consolidated group of entities has improperly attempted to shift income from his or her state to a low-tax jurisdiction such as Washington, which has no state income tax, or has improperly attempted to shift expenses or deductions from low-tax jurisdictions to high-tax jurisdictions.



Additionally, in the non-income tax environment, U.S. Customs and Border Protection (CBP), under 19 U.S.C. § 1500 and 1401a, is responsible for appraising imported merchandise by ascertaining its proper value and other information. Using a CBP Form 28, ”Request for Information,” as authorized under 19 C.F.R. § 151.11, CBP can request additional information about imported merchandise from an importer. While CBP does this routinely when the invoice or other documentation does not provide sufficient information for appraisement, CBP also uses supplementation information on value to monitor whether there is no illegal “dumping” of goods into the American market, or to prevent trade-based money laundering.

The automated systems used by CBP to monitor imported merchandise is quite sophisticated and when the reported value of an imported item is outside of an acceptable range it may result in the issuance of a CBP Form 28 (or even a CBP audit or full-scale investigation). CBP will issue Form 28, which among other things, asks for the “[b]reakdown of components, materials, or ingredients by weight and the actual cost of the components at the time of assembly into the finished article.”

If the information provided to CBP in response to an audit is inconsistent, e.g. , IFRS information is provided instead of the cost-accounting, with the customs declaration the CBP might conclude that there has been an attempt to avoid duties or break other laws. Further, if the information provided in response to Form 28 is inconsistent with information provided on prior occasions CBP might conclude that there is a significant change or anomaly with the importation of the goods. Indeed, as part of a standard CBP audit, CBP auditors are instructed to request readily available information such as flowcharts, working trial balances, and other financial information. Moreover, CBP auditors are to consider whether there are procedures in place to ensure that additions to declared value, i.e. , price, includes packing, proceeds, royalties, selling commissions, transportation costs, and currency exchange adjustments, to name a few. Thus, providing the correct data is often key to demonstrating compliance and minimizing audit costs.

Further, because governmental agencies share information, it is not uncommon for CBP to provide information to the IRS that may result in an IRS audit (of transfer pricing practices or otherwise), or if an IRS audit is ongoing, the IRS may request the information from CBP.


Understanding the differences and the similarities in the information is key to both providing the correct information in the appropriate context and, just as importantly, being able to articulate the rational and legitimate basis for the inconsistencies in data when a governmental auditor obtains information and applies it in the wrong context.

Joseph A. DiRuzzo III is a senior attorney with Miami law firm Fuerst Ittleman David & Joseph. He may be reached at