Independence on a listed lessor: rotation, non-audit services and fee dependency

(i) Partner rotation – not permitted as planned. Under Article 17(7) of Regulation (EU) 537/2014, key audit partners of a PIE must rotate after no more than seven years, with a cooling-off period (three years under the IESBA Code and Czech implementing rules). Petr has signed for seven years; he cannot sign the 20X5 report. A successor must be appointed, with a transition plan covering knowledge transfer and the file review, and the engagement quality control reviewer should also be considered against the rotation rules.

(ii) Tax services – split answer. Transfer-pricing documentation is a tax service that may be permissible for a PIE only if it has no direct effect on the financial statements, is approved by the audit committee and does not create a self-review threat; the amounts involved here feed the tax charge and deferred tax, so the self-review threat needs a documented evaluation. The purchase-price allocation is prohibited: it is a valuation service with a direct effect on the amounts recognised (Article 5(1)(d) of Regulation 537/2014). It must cease, and the client must re-perform or re-source the work; an independent expert should be engaged for the fair-value exercise.

(iii) Fee dependency – at the limit. 15.6/96 = 16.3% in 20X5 and 14.8/96 = 15.4% in 20X4: above 15% for two consecutive years. Under IESBA (fees, 410) the firm must disclose this to those charged with governance and apply safeguards; for a PIE the additional fee-dependency provisions of Article 4 of Regulation 537/2014 and the Czech Auditors Act must be assessed before accepting any further engagement. The realistic safeguard is to reduce dependency, not to describe it.

(iv) Internal audit outsourcing – prohibited. Article 5(1)(b) prohibits internal audit outsourcing to the PIE audit client. Decline, and record the refusal.

(v) Success fee – prohibited. Audit fees may not be contingent (Article 4(1) of Regulation 537/2014; IESBA 410). The mandate must be priced on time or a fixed fee, or declined.

(vi) Close family relationship – evaluate, likely manageable but not automatically. A spouse of the CFO working in the tax department is not on the engagement team, but she is in a position to influence the client relationship. Remove her from all Bystřice work, document the reporting lines and the compensation arrangements, and assess whether the familiarity or intimidation threat can be reduced to an acceptable level. If she is a key participant in the tax services that remain, the relationship is not manageable.

Test the test: safeguards must actually reduce the threat, not merely be described. Go threat by threat and ask whether the threat is at an acceptable level after the safeguard, and whether a reasonable and informed third party would reach the same conclusion.

Mandatory changes.

1. A new engagement partner and, if not already in place, a new engagement quality reviewer; Petr moves to a non-client role with no influence over the engagement.
2. Terminate the purchase-price allocation and any valuation work with a direct effect on the financial statements; the CZK 480m allocation is re-performed by an independent expert and the auditor tests the result like any other estimate.
3. Decline the internal audit mandate and the success-fee arrangement.
4. Remove the tax senior manager from all Bystřice work; document the CFO relationship and the mitigation.
5. Non-audit fees must be pre-approved by the audit committee, with the nature of each service described, and disclosed.

Fee dependency. Cutting the CZK 2.4m internal audit mandate and re-pricing the tax work helps, but the ratio only falls below 15% if total fees rise or Bystřice fees fall. The firm should model the ratio for 20X6 and decide now whether the relationship is sustainable; disclosing the dependency to the audit committee and doing nothing else is not a safeguard.

Quality management. Under ISQM 1, acceptance and continuance decisions, independence monitoring and the response to breaches sit with the firm's leadership, not the engagement partner. A breach of the rotation rule is an independence breach requiring evaluation of its effect on the 20X5 opinion, root-cause analysis and, where relevant, communication to the audit committee and consideration of whether the report already issued is affected.

Documentation. Record each threat, the evaluation, the safeguard, the conclusion and the person responsible, and the communication to those charged with governance, including the written independence statement provided to the audit committee each year. Assume a KAČR inspection will read this file with the six facts above in front of it.

Tone. Be direct and specific; the audit committee, not the CFO, is the counterparty for independence matters, and the request in item (iv) comes from them.

Structure of the communication.

1. Partner rotation. "Petr H. has completed the maximum seven years as key audit partner. He will not sign the 20X5 report. We are appointing X as engagement partner and will run a structured handover, including a review of the 20X3–20X4 files and a joint meeting with your finance team in May."

2. Prohibited services. "We must withdraw from the purchase-price allocation on the CZK 480m portfolio acquisition; it is a valuation service with a direct effect on your financial statements. We recommend an independent expert and will audit the resulting estimate. Your transfer-pricing documentation can continue only with your committee's approval and only on the basis that we do not prepare figures you then book without our own challenge."

3. The internal audit request. Decline clearly, with the reason: "We cannot provide internal audit to an entity we audit. The prohibition is in Article 5 of the EU Audit Regulation and cannot be managed by safeguards. We can help you design the specification for an external provider and we can share our understanding of the treasury risks, but the function itself must be independent of us." Offer the practical alternative rather than a bare refusal.

4. Fees. Present the ratio transparently: 16.3% of firm income, above 15% for a second year; set out the actions being taken and the consequences if the trend continues.

5. The success fee. Explain that it is not permitted and that the mandate will be quoted on a time basis or not at all.

6. The CFO relationship. Disclose it, describe the mitigation (removal of the individual from all client work) and invite the committee to tell you if it sees the matter differently.

7. Ask for decisions in writing – approval of permitted non-audit services, acknowledgement of the rotation and the fee position – and minute them. Verbal comfort is not a safeguard.