Are CPA's responsible for tax risk failures? The tax risk environment is changing rapidly...

Following my article on meeting the American CPA who took the view that American corporations would not be bullish about a tax risk management process where potential major contentious tax issues of that corporation are settled with the IRS, I would like to point out a few related issues on potential intentional misrepresentation or deceit on the part of tax advisors, including CPA’s:

Misrepresentation or deceit?

An action for misrepresentation or deceit requires the following elements:

1.Misrepresentation of a material fact by the defendant;

2.Knowledge by the defendant of the falsity;

3.The defendant’s intent to induce reliance on that false statement;

4.Reliance by the innocent party; and

5.Damages to the innocent party.

In order for the plaintiffs to recover under an action of deceit, the plaintiff must prove that the defendant made a misrepresentation of a material fact. Any misrepresentation involving an opinion may constitute a misrepresentation of an existing fact, namely, the speaker's state of mind. And the evidence (whether direct or circumstantial) must be sufficient to show that the defendant, at the time the contract was entered into, deceived the plaintiff.

Fraud by silence can also take place in a situation where there is a fiduciary relationship between the plaintiff and the defendant. A classic fiduciary relationship exists between CPAs and their client’s, who rely on their CPAs to review their tax positions and to give them advice on those tax positions. Which client doesn’t think that with the annual audit their tax position has been reviewed as well? So often advisors do not tell their clients that a specific tax position review in a detailed manner is not part of the usual audit brief? Clients often do not know this!

If a CPA advisor realizes that their clients may be exposed to historical tax issues in their businesses that have not been previously exposed, which tax issues can be uncovered and properly dealt with in a tax risk tax risk management process the question arises whether there is misrepresentation or deceit by silence on the part of that CPA? At the very least, has there not been negligence? A duty to speak exists where there is a special relationship between the plaintiff (the taxpayer) and the defendant (the CPA or tax advisor).

Even where there is no special relationship between the plaintiff and defendant, in many cases where defects are known to the defendant, or should reasonably be known to the defendant, when a relationship is entered into between the defendant and the plaintiff, the defendant may be duty bound to make the appropriate disclosures to the plaintiff, and if not this failure may amount to a fraud. So often this is the situation with a CPA and a taxpayer client. In an audit the CPA should have brought the inherent tax risk situation that exists in most businesses to the attention of the client, so that a comprehensive tax risk management process can be followed, and it is not.

Of course, in order to be actionable, the deceit must have been material to the transaction between the defendant and the plaintiff. A reasonable person would have attached importance to the statement, or lack of statement, made by the CPA in determining their choice of action going into the future – to conduct a comprehensive tax risk management process or not.

From the defendant's point of view, the defendant must have made the false statement knowingly, or with reckless disregard as to whether it was true or false. This becomes a fairly tricky area. Except, now that CPAs are aware of the fact that there is a tax management process that can be embarked to help taxpayer clients in determining whether or not there are historical tax issues in their organization, a defense that they did not do anything knowingly, wears thin.

From the plaintiff's perspective it would be relatively straightforward to show that they had relied upon the defendant’s f false statements to their detriment. These false statements, obviously, are those made by the CPA that the client’s tax affairs are in order, when a tax risk management process has not been properly embarked upon in order to determine whether or not this is the case.
The plaintiff in an action for deceit may recover damages. In this instance the damages would be any out-of-pocket damages and benefit-of-the-bargain damages. Benefit-of-the-bargain damages includes cost of correction damages where the defendant is required to pay the plaintiff the cost of remedying the defect, together with such incidental losses.

This means that if the taxpayer client faces an IRS audit and is expected to pay an additional penalties and interest, over and above the amount of tax that should have been paid, the defendant CPA may find himself in a position where he must pay these penalties and interest charges.