Is PwC Helping Cisco Dodge Taxes In Brazil?

Is PwC aiding and abetting Cisco’s tax dodge in Brazil? It’s easy to get distracted in the land of Carnival.

Cisco denies wrongdoing in Brazil tax fraud case

U.S.-based technology and network company Cisco Systems Inc, reacting to the arrest of company executives on tax fraud charges, denied acting inappropriately…

Authorities said Cisco’s Brazilian unit had imported $500 million worth equipment over the last five years without paying import duties and is estimated to owe 1.5 billion reais ($826.4 million) in taxes, fines and interest. The company said four of the 44 people arrested on Tuesday were Cisco employees. Police said they included Cisco executives.

Cisco did not import products directly into Brazil but through middlemen, it said.

The investigation, which has been going on for two years, alleges that Cisco’s Brazilian unit used companies based in tax havens like Panama, the Bahamas and the British Virgin Islands to avoid paying import taxes in Brazil.

Middlemen, subcontractors and alliance partners, they’re a funny thing. They can be a great boon to growing your business and they can also be a huge vulnerability. We’ve mentioned before the connection between PwC and Cisco. PwC is Cisco’s external auditor and has placed many a financial executive there from its alumni.

You’ve got to keep an eye on middlemen and alliance partners. Especially in places like Brazil, where business operates on a different rhythm than many other places…

But PwC is also Cisco’s tax advisor. The following is a summary of the fees billed to Cisco by PricewaterhouseCoopers LLP for professional services rendered for the fiscal years ended July 28, 2007 and July 29, 2006:

Audit Fees
Fiscal 2007 Fees $15,536,000
Fiscal 2006 Fees $13,834,000

Audit-Related Fees
Fiscal 2007 Fees 687,000
Fiscal 2006 Fees 369,000

Tax Fees
Fiscal 2007 Fees 1,403,000
Fiscal 2006 Fees 986,000

Tax Fees. Consists of fees billed for professional services for tax compliance, tax advice and tax planning. These services include assistance regarding federal, state and international tax compliance, assistance with tax reporting requirements and audit compliance, assistance with customs and duties compliance, value-added tax compliance, mergers and acquisitions tax compliance, and tax advice on international, federal and state tax matters. None of these services were provided under contingent fee arrangements. Tax compliance fees were $1,367,000 and $979,000 in fiscal 2007 and fiscal 2006, respectively. All other tax fees were $36,000 and $7,000 in fiscal 2007 and fiscal 2006, respectively.

The numbers seem a little light for tax given the breadth of services they say they provide. Unless the numbers are skewed towards reporting most of the expense under traditional audit fees so as not to have a Northern Rock type conflict. Or maybe PwC is giving Cisco a deep discount on their tax work. Not typical of PwC, though. The Tax Practice rates are some of the highest in the firm, and there is a huge opportunity cost for them to give this capacity, which is constrained, to Cisco for a song.

Even if PwC was not directly involved in the Brazilian tax avoidance and potentially fraudulent tax evasion strategy, they are the external auditors. But a US based company, with a US based audit engagement team, will most likely not have spent much time or money on looking at what the Brazilians are doing.

When I was at BearingPoint in Latin America, we were always amazed at how rarely we saw US executives or senior US based auditors visiting the Mexican and South American operations of US based multinationals. Oh, occasionally a sales executive or maybe even the CEO did a flyover visit. Lots of tequila or caipirinhas were imbibed, along with a good steak. But actually spending time looking into what the local managers were really doing to make money or produce required margins? Not often. Better not to know…

And Auditing Standard 5 does not help. When Sarbanes-Oxley was passed, I actually thought that auditors would now have to look at significant foreign operations, especially if those operations were not integrated from a financial systems perspective with their US based headquarters. But the initial rush of Sarbanes work, resource scarcity, lack of enthusiasm and cooperation from foreign operations and general bias of US based professionals towards going anywhere the least bit difficult, meant that these locations were often avoided. They were scoped out based on materiality calculations that were “made to fit” the conclusion that was desired by management.

But at least under Auditing Standard 2 there was a coverage requirement. Under Auditing Standard 5, auditors have “Permission to refocus the multi-location testing requirements on risk rather than coverage.”

B10 In determining the locations or business units at which to perform tests of controls, the auditor should assess the risk of material misstatement to the financial statements associated with the location or business unit and correlate the amount of audit attention devoted to the location or business unit with the degree of risk.

Note: The auditor may eliminate from further consideration locations or business units that, individually or when aggregated with others, do not present a reasonable possibility of material misstatement to the company’s consolidated financial statements.

In other words, they are leaving it up the the auditors’ and the companies’ judgement where to go. In the interest of cost savings, you are bound to see less foreign locations covered.