Question

You are a manager working in the Technical Department of GPKM, a large partnership which offers audit and other financial services. Jade Frances has been referred to you, as she requires advice regarding Yobro Ltd, a new company that she is in the process of starting up. She is planning to list the company on the New Zealand Stock Exchange, as future operations will depend upon a successful offer of shares to the public. She will be seeking to raise $75 million in capital to fund the acquisition of the assets the company will require. Current expressions of interest indicate that the company will have at least 500 shareholders. Jade would like to clarify what statutory and corporate governance requirements the new company will need to comply with. In particular, she would like to check on some details regarding reporting and audit requirements. She understands that companies are required to have auditors, who in turn are required to prepare annual reports but is not sure what company records are required for this. Jade has also been told that it will be important to good governance to set up an audit committee. She assumes it will consist of members of your audit firm, but has asked if you can clarify what an audit committee is and what it does.

Required:

Provide answers to Jade’s questions, which are set out below:

a) Identify the main four New Zealand statutes concerning external reporting, with which Yobro Ltd will need to comply and explain why this is so.

b) Explain whether Jade’s understanding of statutory requirements regarding auditors and annual reports are correct, in particular: i) State and explain whether Yobro Ltd is required to have an auditor and, if so whether options or exemptions from this requirement exist which they may use.

ii) State who is responsible for ensuring that the preparation of annual reports occurs and how long they will have within which to do so.

c) Briefly explain what an audit committee is and what it does. Your explanation should include reference to best practice as to how it operates, as well as at least three points concerning each of the following:

i) Requirements relating to members/composition of the audit committee;

ii) Purposes and responsibilities of the audit committee.

Answer 1

A radical revamping of the partnership audit rules will impact every partnership and LLC taxed as a partnership, starting in 2018.

Although mandatory compliance is nearly two years away—and many unknowns exist—now is the time to begin to educate clients, review business structures, and amend partnership and operating agreements in preparation for the impact.

Current Law: TEFRA and ELPs
In 1982, TEFRA changed the partnership tax audit landscape by shifting the focus of a partnership audit from the individual partner returns to the partnership return. This eliminated the inconsistencies that had plagued the process when each partner’s return was examined individually, with the partnership itself merely an addendum to the process. However, any adjustments passed through to the partners’ returns, keeping collection at the partnership level.

TEFRA’s approach became increasingly unwieldy as the number of large partnerships grew. Legislative and administrative tinkering attempted to reduce administrative headaches and speed revenue collection. As a result, currently there are three audit procedures for partnerships and LLCs taxed as partnerships:

• For 10 or fewer partners: Audits are at the partner level, much as was the case pre-TEFRA.

• For 10 to 99 partners: The TEFRA procedures apply. The partnership return is the focus of the audit; any adjustments are binding on the partners, who must file amended returns for the year under audit.

• For 100 or more partners: TEFRA applies, unless the partnership is one of the very few that opted to be an ELP. If the ELP rules apply, the focus is the partnership return but any adjustments are taken into account on the partners’ current year returns, rather than the amended prior year returns.

New Law: Partnership-Level Liability
The rules under the Bipartisan Budget Act break new ground in pass-through taxation. While the audit focus continues to be on the partnership return, the approach to adjustments and payments is radically different. Once the law is in effect:

• Required adjustments are taken into account at the partnership level—not by the individual partners.

• Adjustments are reflected in the year the audit is completed (or subsequent court proceeding is concluded), not the year under review.

• The IRS will collect the assessed amount, plus penalties and interest, from the partnership—not the individual partners.

These new provisions transform a pass-through entity into a tax-paying entity, with respect to adjustments arising on audit. Plus, the economic impact falls on partners in the adjustment year, not those in the year under review. If the partners have changed, those who pay the price may be different from those who reaped the benefit.

There are options that enable the partnership to pass the adjustments through to the partners. However, short timeframes for making the election and increased interest rates are among the factors that limit the desirability and utility of this option.

Opt-out for Small Partnerships
Partnership-level audits and collection proceedings are the default for all partnerships, even those with only a few members. However, a partnership with 100 or fewer qualifying partners can opt out by making an annual election on its partnership return. This is a true “opt-out.” Affirmative action is required on each tax return. If the partnership opts out, the audit will proceed against each partner separately.

As the law stands now, even a very small partnership might not be able to opt out. To opt out, every partner must be a qualifying partner. A qualifying partner is

• an individual;
• a C corporation (or non-U.S. corporation that would be a C corporation under U.S. law);
• an S corporation; or
• an estate of a deceased partner.

This may be particularly significant for businesses that have tiered structures, whether for asset protection or tax purposes. For instance, an LLC that has multiple LLCs as members in order to shield operating assets from risk may be unable to elect out of the new audit rules.

Delayed Effective Date Means Ample Time for Planning
Although the impact of the new rules is significant, there is ample time to consider planning strategies. These new rules will apply to returns for partnership tax years beginning after 2017, although most partnerships can elect to apply them to any partnership tax year that begins after Nov. 2, 2015.

Practitioners should begin to act now because the new rules will affect all partnership and LLC clients, regardless of size. Partnerships must either comply with the rules or make an annual election to opt out. In either case, client education and modification of partnership and operating agreements in advance of issues arising are crucial. The following issues should be considered:

• Identify clients that are candidates to opt out of the new rules. Monitor them to ensure they do not add non-qualifying partners or outgrow the opt-out, and that the annual opt-out election is filed. Also, determine whether membership should be restricted to qualifying partners.

• Identify clients barred from the opt-out because of non-qualifying partners. Determine if it is prudent to convert to a qualifying entity type or to amend the partnership/operating agreement to protect existing partners.

• Amend existing agreements to indemnify partners from the economic impact of an assessment based on a review year when they were not members. (Indemnification should be a standard item of discussion for each new agreement.)

• Amend agreements to specify rules for electing a partner-level assessment, given the short timeframe for the decision and the possibility of a disproportionate impact on the partners. The agreement also should designate a “partnership representative” for the audit process and the representative’s duties to the partners.

a(ii)

main duties and responsibilities of a financial or accounting nature owed by directors to their company and its shareholders and others, but also including an overview of more general duties and responsibilities. It sets out, where appropriate, what is considered to be good practice rather than what may be acceptable as the legal minimum required. It is hoped that the statement will be useful to members acting as directors and to members generally in conveying to directors the extent of these responsibilities. It is stressed, however, that the statement is not intended to cover other aspects, however important, of a director's position.

The statement is concerned with companies in the United Kingdom subject to the provisions of the Companies Act 2006. It has, with one exception (see below), been prepared on the basis of the complete implementation of that Act, in relation to a company formed under that Act, whereas at the time of issue some provisions of the Acthave not yet commenced and readers should be aware that certain 1985 Act provisions and transitional adaptations remain in force until 1 October 2009 (see Appendix B for a list of commencement dates, extracted from the Final Implementation Timetable published by BERR in December 2007).

The exception is in relation to the model articles. Under section 20 a company formed under the 2006 Act will, unless it adopts articles that provide otherwise, have as its articles the model articles prescribed by secondary legislation under section 19. At the time of issue no model articles are yet prescribed. Accordingly references to typical articles herein are to the 1985 Act Table A (modified in 2007) that apply to companies formed under the 1985 Act (on or after 1 October 2007). Where Table A articles apply by default to a company - i.e. by statutory provision in lieu of specific provision by the company - it is the version of Table A in force at the time of the company's formation that is relevant.

References to legislation should be taken to mean legislation as amended up to 1 October 2008. The meaning of terms can be found in the Glossary at the end of the statement.

This statement replaces its predecessor issued in 1996 as revised in 2000, which was itself an updated version of that originally issued in 1970.

c)

This Professional Practice Statement focuses on the role and function of an audit committee and its reporting relationship to the board, which has ultimate authority and responsibility for the direction and operations of the association.

POLICY STATEMENT

The board should designate a group of individuals to oversee the audit process within the organization. For purposes of this practice statement, this group is referred to as the “audit committee.” The audit committee reports to the board. The board should adopt a charter for the audit committee which outlines its authority, primary responsibilities and specific duties.

The officers and directors of the association maintain ultimate responsibility for the decisions of the association, and owe fiduciary duties to the association. The duties associated with the audit function are one of the board’s fiduciary obligations. As such, decisions regarding audit issues must be made by a committee having the authority of the board. For that reason, the audit committee must be composed primarily, if not exclusively, of board members because only committees consisting primarily of board members are entitled to exercise the authority of the board. Please note that the language of the statement does not prohibit participation by individuals who are not board members. Indeed, it recognizes that, in some organizations, it may not be practical for the audit committee to be composed only of board members. While the participation of individuals who are not board members may be appropriate, it nevertheless is essential that the audit committee consist primarily of board members.

The audit committee should include at least one individual who understands, and can ask meaningful questions regarding, audited financial statements. No one with management responsibilities may serve on the audit committee. However, staff may act as liaison and provide support to the audit committee. In any event, the audit committee should have some opportunity to meet with the independent auditors without any staff present.
The role of the audit committee is separate and distinct from that of the association’s finance or budget committee. The primary functions of the audit committee are to oversee the audit of the association’s books and records and to review the association’s internal financial controls and procedures. As part of its role and function, the audit committee makes a recommendation to the full board regarding the selection, retention, and termination of an independent organization to conduct the audit services. The audit committee, in consultation with staff, should establish the criteria by which a provider of audit services is selected. Specific tasks can be delegated to staff (such as distribution of the request for proposal); however, the audit committee should evaluate responses and make final recommendations. It is ultimately the responsibility of the full board to select the auditors.

It is generally the role and responsibility of the audit committee to review with management and/or the independent auditor the following:

• Review the adequacy of this policy on an annual basis and obtain board approval of any revisions of this policy.
• Review the annual engagement letter, which includes the fee arrangement. In addition, pre-approve any non-audit services provided by the independent auditors, including tax services, before the services are rendered.
• Review the organization’s significant accounting policies, practices and financial reporting controls and the adequacy of such controls.
• Review the organization’s significant accounting and reporting principles, practices and procedures applied in preparing financial statements. In addition, discuss with the independent auditors their judgments about the quality of the organization’s accounting principles used in financial reporting.
• Review the scope and general extent of the independent auditor’s general audit, including the factors considered in determining the audit scope, including the major risk factors. The independent auditors should confirm to the committee that no limitations have been placed on the scope or nature of the audit procedures.
• Inquire as to the independence of the independent auditors and obtain from them, at least annually, a formal written statement delineating all relationships between the independent auditors and the organization, including other consulting work, if any, performed by the independent auditors for the organization.
• Review the results of the audit with the auditors and management, including:
  • The independent auditor’s audit of the financial statements and their report
  • Matters required to be discussed by Statement on Auditing Standards (SAS) No. 61, Communications with Audit Committees, as amended (AICPA, Professional Standards, vol 1, Au sec 380) related to the conduct of the audit.
  • Investigate and respond to serious disputes or difficulties arising from the audit, if any.
  • Once management has received and commented on the findings of a draft management recommendation letter, if any, from the auditors, it is the function of the audit committee to receive the final management letter and follow up with management on recommendations on how to better adhere to “best practices” from the auditors.
• Monitor the Association’s compliance with legal and regulatory requirements.
• Review annually the Association’s Standard of Conduct and Code of Ethics policy, if any, and insure that management has established a system to enforce this policy.

The audit committee should meet at least once per year (via teleconference or in person) to review the independent auditor’s report and management letter. The audit committee also should meet with the auditors (without staff present) at least once per year. In addition, the chief staff executive should work to foster an environment of transparency and full disclosure with the auditors and the audit committee

To raise additional revenue and increase audit effectiveness, the Bipartisan Budget Act of 2015 (P.L. 114-74) repealed the 33-year-old Tax Equity and Fiscal Responsibility Act (TEFRA) regime and the decades-old Electing Large Partnership (ELP) provisions. The new regime dramatically changes the pass-through landscape by making the partnership, not the partners, liable for payment of the assessment. Further, the audit adjustments are reflected on the return for the year the adjustment is finalized, not the year under review.

c(i)

Usually, membership of the Committee is subject to the maximum number of 6 persons. In the USA, a qualifying audit committee is required for listed publicly traded companies. To qualify, the committee must be composed of independent outside directors with at least one qualifying as a financial expert.

c(ii)

The purpose of the Audit Committee of Lightbridge Corporation (the “company”) is to represent and assist the board of directors in its general oversight of the company's accounting and financial reporting processes, audits of the financial statements, and internal control and audit functions.