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Tax management in companies 06
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Tax management
in companies
internationaltaxreview
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####### Editorial
Cover image: © yurok - FOTOLIA
Managing the
TaxValueChain
By Robert van der Laan,
PricewaterhouseCoopers,
Netherlands
E
ver since the introduction of the new corporate governance regulations fol- lowing the Enron affair, it has become clear that it is important for manage- ment to demonstrate that the company’s risks are under control. The key area that companies have been struggling to demonstrate that their internal controls are robust and operating effectively is the tax function. Historically the main focus of the tax function is on output. This means the focus was on the corporate income tax return and other local filing requirements. This was also the case in the automotive industry before the ideas of William Deming were introduced decades ago. In the automotive industry, quality control was concentrated at the end of the production line. One took samples from the end-of-the-line prod- ucts to check for defects. One soon started to realize that for things to improve, one needed to consider not only the end product, but the underlying processes. Statistical process control was the name given to this new approach. The American William Edwards Deming (1900-1994) was the father of the new wave of industrial revolution called “integral care for the business”. Deming devel- oped a strategy of continuous analysis of all aspects of the production process with the goal of constant quality improvement. Inspection of the end product tells us how things are going, but it does not point the way to improvement. After World War II, Deming presented his ideas to the car business in Detroit. There was no interest. In the fifties he sold his ideas to Japan. They were very interested in his total qual- ity management. The Union of Japanese Scientists and Engineers even introduced the Deming Prize, which was later won by companies such as Toshiba and Matsushita Electric. In the seventies US companies started to ask the question: “Why do Americans buy Japanese products?” Today the world’s strongest companies recognize the value of optimizing quality in the goods and services they provide. Good total quality, or process control, is now an essential and fundamental way of managing an organization. It is a way of thinking. Modern quality improvement requires the continuing and progressive application of new processes, technology and management. It is a strategy instrument in the glob- al war of competition. Best efforts, to be effective, require guidance to move in the right direction. The total organization has to be concentrated on quality in all aspects of the execution. The stakeholders, including customers, determine what quality is. A product or service has to meet the needs of the stakeholders. In statistics, the realization shift from the end-of-the-line quality control to process control systems occurred many decades ago. This change in thinking, from end-of- the-line control to process control, was a revolution in itself and it took decades before Deming’s process thinking was globally adopted. Is this now happening in the tax context?
Introduction
Tax-risk management is not about minimizing tax risk but about determining what level of risk is acceptable to the com- pany, what response is required to tax risk and monitoring that such response is actually taking place. The company’s tax process design should describe what processes and procedures are in place and what are the internal controls for monitoring these identified tax risks. When defining a tax-control framework all types of control should be included. As a result of Sarbanes-Oxley and other audit requirements there is a tendency to focus on bureau- cratic controls. These controls are easy to monitor, but are time consuming and often regarded as a burden on the organ- ization. This is a first step to be able to demonstrate that the tax department is in control of the tax function. Also it will make it easier to assign resources and budgets to the tax func- tion without increasing the company’s tax-risk profile. However, the so-called market-mechanism controls and social-mechanism controls also need to be considered. The most important element of the latter category is “tone at the top”. Although difficult to document, this is an impor- tant element to discuss with senior management and the audit committee. Many are struggling to find the right balance between documenting the (key) controls and creating a healthy – yet workable – control environment. The increased focus on control and the management of tax risks clearly show that it is imperative for boards to monitor and evaluate their tax control framework permanently and not to rely on end-of- the-line controls. Tax-risk management is not only about documentation, but about making sure that your organization actively monitors tax risks and responds properly to those risks, if and when they occur. It is about people, processes and technology.
####### Global tax planning
Global tax planning will always be an important tool for man- aging the effective tax rate for the organization. However, as a result of the changing attitude of tax authorities and the introduction of new disclosure requirements, the opinion on global tax planning has changed. Therefore it is important to keep in mind that creating value for the organization is no longer limited to the improve- ment of the company’s effective tax rate, but should be based on the organization’s tax strategy and tax-risk policy. There should be a balance between global tax planning and manag- ing tax risks. The right tax-risk policy will help ensure that tax planning is effective and appropriate.
####### Tax accounting, reporting and compliance
Often the responsibility for tax reporting and the knowledge of US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) is not in the tax department. However, in today’s environment and in order to be able to take full responsibility over the tax line
the tax department will need to increase its knowledge about tax accounting and tax reporting. The tax department should become familiar with the basics of accounting for income taxes and the disclosures required under the respective accounting rules. Another improvement towards an effective management of tax reporting and tax compliance is the use of IT tools, which play an important role in making the tax func- tion more effective. IT tools can be very important in effectively managing your global compliance position. A development that will support the tax function to be in control will be technology. The new business reporting language (XBRL) will enable the tax func- tion to integrate its tax reporting and tax compliance process.
####### Culture change
In order to be successful it is imperative for companies to change the culture and attitude of the company towards the tax function. A key element is the development of a tax con- trol framework, which should be aligned with the business control framework. Our firm has developed a methodology called “Managing the TaxValueChain”. It covers all the relevant elements of a tax- control framework. In this publication the key elements of the TaxValueChain will be further discussed by specialists from the field. The right tax control framework can reassure investors and other stakeholders that the company’s tax affairs are under control and that tax risk is being taken seriously. The objective of a tax-control framework is to achieve a tax function that delivers value-added, cost-effective solu- tions that meet the commercial objectives of the company. It can further improve quality, clarity and comparability on the tax provision and therefore provide for shareholder value.
Introduction
Email: robert.van.der@nl.pwc Phone: +31 40 22 44 860, Fax: +40 22 44 635
Robert van der Laan is responsible for the leadership of the tax assurance practice of the Dutch firm (about 300 people) and as well as the tax-risk management role within the Eurofirms (the PricewaterhouseCoopers combination of European member firms). His technical focus is the tax assurance area, being the new tax proposition helping clients to stay in control of their tax function. Robert studied fiscal economics and business law, both at the University of Rotterdam. He later completed the post- graduate programme in European tax studies. He was also instrumental in the development of the post-graduate course at the Tax Assurance Academy at the University of Nyenrode. Robert joined Philips Electronics in 1986 and joined PricewaterhouseCoopers in 1991.
Jurriaan Weerman, of PricewaterhouseCoopers’ Amsterdam office, is co- author of this introduction. Jurriaan (jurriaan@nl.pwc) can be reached on: +31 20 568 6937 (phone) and +31 20 - 568 6949 (fax).
####### Robert van der Laan
Tax and corporate
responsibility
By Urs Landolf,
PricewaterhouseCoopers,
Switzerland
T
he tax conduct of enterprises has recently been caught in the floodlight of the capital market (shareholder activists) and other corporate governance activities. Tax administrations in various countries or their organs responsi- ble for establishing law are reacting to the tax savings potential of tax arrangement measures with increasingly severe legislative measures. Thus it is becom- ing necessary to look at tax planning and compliance in the enterprise under these aspects, long-term, structured and embedded in the overall concept of the enter- prise’s risk management. Over the last few years the discussion about corporate responsibility has gained substantially in importance both at the national and the international level. The sub- jects covered by the expression, corporate responsibility, such as corporate social responsibility (CSR), corporate governance (CG) and corporate citizenship (CC) have within a short period of time established themselves in the public discussion. The various corporate crises, suspected weaknesses in corporate management, inade- quate supervision by the board of directors and the discussion about management remuneration clamour for more rules and transparency in the responsibility of the board of directors and management of listed companies. Corporate responsibility covers in addition to an enterprise’s responsible and last- ing actions (CSR) also the aspects of corporate management and control (CG) as well as its commitment as a good corporate citizen to engage actively in the local civil soci- ety or e. in ecological or cultural matters (CC).
####### Fair share of taxes
The tax attitude of an enterprise has latterly been regarded as a relevant component in corporate social responsibility. On the one hand the expression tax avoidance appears in the context of corporate responsibility. Companies’ legal tax planning prac- tices and activities, which are geared exclusively towards the minimization of the cost factor taxation without taking account of sustainability considerations and of plausi- bility, are increasingly criticized. On the other hand it is expected of companies as corporate citizens that they ful- fil their duties as citizens. For example the duty to pay tax is substantiated as follows: “Tax is the price we pay for living in a civilized society and ... in a fair society we expect to pay our fair share” (Supreme Court Judge Oliver Wendell Holmes). This then raises the (contested) issue, what is the fair share.
####### Tax planning as a crime against the nation
Headlines like “In 1997 Daimler Chrysler, despite making considerable profits, paid neither corporate income tax nor business tax. The gatekeeper paid more taxes than the group itself ” (Suddeutsche Zeitung, January 22 2004) or studies, whose assertions
should become a clear responsibility of the board members. Because in the eyes of the Australian tax authorities board members have for too long neglected the subject of taxation, the companies were in their view not compliant enough. In a letter from Michael Carmody to board of directors, he said they must make a conscious decision as to how high their company’s risk appetite is and define the position on the tax risk spectrum and ensure adequate control. It is expected of board members that they also understand the effects of tax- planning measures and their risks, and that they do not rely only on the professional skills of experts. According to statements by Michael Carmody the Australian tax authorities have been successful with their strat- egy. For example Australian companies are leaders in including the tax function in their risk management. The Australian tax authorities want to proceed even further with their approach, as they state in their Compliance Program 2005-06. All board chairmen of companies listed on stock exchanges in Australia have received a personal letter, in which they have been assured that confidential documents, which the board of directors requires for its tax assessment, do not have to be dis- closed to the tax authorities. However the tax authorities have reserved the right to be able to inspect these documents in exceptional circumstances. This expression however admits various interpretations and the companies have received any- thing but reliable guidance. The linking to corporate governance and the enhanced involvement of the board of directors in the company’s tax strategy result in its becoming more sustainably geared to the longer-term corporate goals and being less aligned with short- term tax minimization.
####### Shareholder activism
In the environment of corporate crises, of intensified legisla- tion and of public awareness, tax planning gained a (negative) news value. The naming and denunciation of suspected tax avoiders is increasingly becoming seen as a risk that is harm- ful to the reputation. Impacts on the share price can be the consequence. The subject has also become very relevant for investors. The asset management company Henderson Global Investors in Great Britain has taken up the subject “Tax, risk and corporate governance’ in a survey of 335 of the FTSE 350 companies. In the opinion of Henderson Global Investors: “Arrangements that minimize the amount of tax paid in the short term may be detrimental in the longer term if they prej- udice the company’s relationship with tax authorities and additional costs are incurred in complex dispute resolution, or if the company’s wider reputation is harmed.” For this reason the management of tax risks should receive adequate attention. Risk management lies within the respon- sibility of a company’s board of directors. Henderson Global Investors wrote directly to the chairmen of each company in
order to obtain information about the treatment of tax mat- ters by the board of directors. The results of this study were published in February 2005. The survey shows that it is increasingly expected of compa- nies that they “demonstrate to tax authorities (and also to society) that they are complying with tax rules”. The survey also shows that there are indications of a growing involvement of the board of directors in tax issues. However it turns out that only about one third of boards have looked strategically at tax issues in the past few years and have adopted a concept or a formal tax policy for their company. As a result of the first survey Henderson Global Investors intensified its discussions with board chairmen of those firms, who already recognized tax-risk management. Based on these discussions, in October 2005 a summary of good practice prin- ciples applied by leading companies, suggesting a self-assess- ment framework for responsible tax, and calling for improved reporting on tax to investors and others was published. The Henderson report recommends all companies to apply these principles and a self-assessment framework, in order that their tax management both satisfies shareholder interests and at the same time fulfils their social responsibility.
####### Why tax is a task for the boardroom
In view of the public sensitivity to the subject taxes, manage- ment must take sufficient account of the aspect of the fair share of taxes. However this means all taxes that a company pays must be considered and not only income taxes. The only information in the public domain is generally the information in the annual report on corporate taxes on profits. There is lit- tle information about precisely what taxes and how much tax companies pay. But corporation tax (or its equivalent in other countries) is not the only tax that is levied on companies. Social security contributions are a feature of all developed countries’ tax sys- tems and add significantly to business tax costs. When consid- ering the tax burden on business we also have to look at such things as business property rates and road fuel duties. There will also be irrecoverable value-added tax for many business- es and other more specific business sector taxes such as petro- leum revenue tax. As the Hundred Group of Finance Directors discovered in a survey about companies’ tax burdens, businesses pay twice as much tax as is reported under their corporation tax disclo- sures. So it would be necessary for companies to draw a clear- er picture of what a company contributes in taxes because taxes represent no longer only a financial risk factor, but can also develop into a reputation risk. Earlier tax risks were understood as financial charges, which a taxpayer had not recognized in advance and for which he had not set up accruals. Now the amount of corporate tax paid by large businesses is coming under increasing scrutiny and public debate. Because the risks in tax matters has become more var-
ied, the board of directors must, within the framework of the risk management strategy for the company as a whole, concern itself with the company’s tax strategy and tax policy. A company’s tax conduct must be managed in a structured way and proactively. Tax-risk management must be embedded in the corporate governance of an enterprise. A company’s tax planning must therefore be based on a framework that is approved by the board of directors. Such a tax strategy is to be issued taking into consideration aspects of sustainability, compatibility with business activities and tax structures, the compliance culture and the fair share of Taxes. Based on such a tax strategy tax policies are to be issued for the individual areas of a company’s tax functions and cor- responding control systems implemented. These elements will be described in detail in the following individual chapters of this report. A long-term company tax policy, supported by implemen- tation controls, on the one hand permits consistent positive publicity and on the other minimizes the risk of unexpected tax costs. This also enhances in the same measure the compa- ny’s credibility with the relevant tax authorities.
####### A broad and consistent framework
The long-term management of taxes is, especially in cross- border businesses, of great importance. It is a matter of the two aspects risk minimization and opportunity optimization. The increasing complexity of fiscal laws and court judgments in various countries, the overlaying demands on accounting for and the disclosure of tax matters, make tax-risk manage- ment a challenge. Coordination between those responsible for accounting and reporting and those responsible for taxation in a compa- ny is essential in order to achieve the most important objec- tives in risk minimization: observance of the legal framework, full compliance in tax matters and no surprises in reporting. Opportunity optimization deals with a company’s organi- zation (legal structures) and the procedures (for example allo- cation of functions within the group, responsibilities and transfer prices) from a tax aspect. Here the task of the com- pany is to minimize the cost factor, taxation. The guidelines for opportunity optimization are to be found in the legal pro- visions. They are, just as the entire entrepreneurial action, to be subjected to the maxim of good corporate governance. That means that tax planning can be explained sustainably, credibly and in its entirety to relevant outsiders. That is, to the tax authorities. Artificial constructs without lasting eco- nomic justification are, even if formally they can possibly be captured by fiscal legislation, not good tax planning. The aspect of fair share of taxes is to be considered in tax plan- ning, however in the context of the totality of a company’s tax yield (such as direct and indirect taxes, other duties, social insurance contributions and income tax on employees’ wages), and not only of corporate income taxes.
Companies should therefore have a broad and consistent framework to calculate and communicate their total tax contribution. In this sense tax planning in a company is to be geared to sustainability and credibility within the framework of entre- preneurial corporate governance principles. Such tax manage- ment, embedded in the corporate governance framework of a company, enables tax planning and tax compliance geared to sustainability and credibility. In this way tax costs become proactively managed costs, both in respect of their amount, and also in respect of the company’s reputation in the eyes of the fiscal authorities and the interested public.
The author expresses sincere thanks to Myriam Isenring for her active support in processing the material and formulating the article.
Additional important contributors are external advisers providing for best practice input, operational people, legal and compliance, risk management people and other departments.
####### Principles in developing a tax strategy
There are lots of areas that could be addressed in a tax strate- gy and, of course, this varies from company to company. It might include effective accounting tax rate, cash tax rate, com- petitor tax rates, tax risks, tax compliance, corporate struc- ture, ethics, reputation with tax authorities and with public, key tax drivers, tax department organization, corporate struc- ture, capital structure, resourcing and resource costs, use of advisers, indirect tax, operational tax matters, human resource tax, performance measurement and many things more. However, a tax department has to decide which of these sometimes competing factors are actually its top priorities – and thus put some focus into where its resources are best used. And this will change over time since the tax strategy should be dynamic and responsive to change. A true tax strategy should set out the goals, outline the route-map for achieving them, be clear as to the timeframe and set out responsibilities. Good objectives will provide the milestones against which effort to achieve the aims of the tax strategy can be measured. The classic test of effective objec- tive setting is whether they are SMART, in that they are spe- cific, measurable, achievable, results-oriented and timely.
Most important is that the strategy needs to be lived or put into practice. Measurement of the achievement against the objectives by management and regular communication with the board are key to making a visible difference.
####### The role of the tax function
We have seen a significant number of the tax functions whose view of their role differs from the perspective of other departments and senior management. For example, is the tax function fully responsible for operational tax matters or only acting as an adviser to another department? Typical areas of different views are human resource tax matters and indirect taxes such as customs duty and value-added tax (VAT). Consequently, a clear definition of roles and responsibili- ties of the tax function and its communication is important to avoid misunderstandings and ensure that the tax function can effectively focus on its strategy and meet expectations. The role of the tax function can be split into four dimensions: strategic planning work, operational/business support, com- pliance/accounting work and management of the tax function and its resources. And for each dimension, the activities and the responsibilities have to be defined. However, the tax function cannot deal with all its activities with the same level of attention but rather has to define and agree on areas of focus and priorities. The next three sections focus on the three areas a tax func- tion can control and which are the key elements of a tax strat- egy document. These are the tax charge, tax risk and the costs of managing the tax position. And clearly, there is a strong link between these three elements.
####### Managing the tax charge
The main focus of senior management still is on the accounts tax charge and the impact it has on earnings per share. However, we also see increasingly interest in the cash tax rate as well as in the overall tax contribution. Corporate income taxes are typically the core business of a tax function. Above the line taxes such as value-added tax, import and excise duties, and (increasingly) environmental levies are of course also taxes on the business. The above/below the line question is particularly pertinent when agreeing respective responsibilities between the tax function and the businesses. We are aware of a number of significant sized businesses where even very senior management is rewarded on a profit-before-tax (PBT) measurement – including, more often than expected, the head of tax. This is hardly conducive to proactive management of the tax charge. Who shall be the owner of the tax charge? If it is the responsibility of business managers to manage the tax charge, then it is more likely that the tax function will act as a serv- ice provider to the businesses, albeit hopefully as a fairly pro- active service provider. The tax function may also need to take on a role of central coordinator, ensuring consistency
####### Andreas Staubli
PricewaterhouseCoopers Birchstrasse 160 8050 Zurich Switzerland Tel:+41 58 792 44 72 Fax:+41 58 792 44 10 Email:andreas@ch.pwc
Andreas Staubli has been an international corporate tax partner with PricewaterhouseCoopers since 2000. He leads the Swiss and Continental European insurance tax practice of PricewaterhouseCoopers. Andreas Staubli is a certified Swiss tax expert and graduated from the University of St with a degree in finance and accounting. He gained his interna- tional tax experience during his secondment to the European Tax Planning Group of PricewaterhouseCoopers in New York in 1999/2000. Andreas Staubli is the lead tax partner for several multinationals and he specializes in international tax structuring, insurance taxation, alternative investment taxa- tion matters as well as tax accounting (US GAAP and IFRS) and SOX 404. Andreas Staubli is the author of various articles on tax matters and a fre- quent speaker at presentations on various tax topics.
####### Biography
between the various businesses and perhaps encouraging the businesses through monitoring and publicizing their respec- tive tax performance. If the tax function owns the tax charge then more of a leadership role will be called for, with the tax function tak- ing responsibility for driving tax performance in all the busi- nesses. In today’s reality, it is typically a mixture of the two. There is a trend though, in that the increasing move towards global management of businesses is reflected in a trend towards stronger head office tax function control of overseas tax affairs. However, in companies where VAT or other indirect taxes are a significant cost these taxes are often given either to the businesses or to local tax functions. As a consequence, we often find that the management of such taxes suffers from a lack of co-ordination between different territories. The tax charge of a company is a significant cost ele- ment. Getting senior management to focus on tax as a man- ageable component of shareholder value can be a powerful way to raise the profile of tax in the business. Often, the first time senior management really think deeply about the impact of tax is when they become involved in helping set the tax strategy. Some elements of the tax charge are obviously going to be more manageable than others. Therefore, understanding the key manageable components of the tax charge, and then man- aging the related drivers will be key. Managing the tax charge has also a time dimension. The tax function has to focus on negotiating prior years’ tax liabil- ities, computing the current year’s liability (including compli- ance, transfer pricing documentation, tax accounting and tax process management) as well as managing future liabilities. Many businesses do not enough focus on the latter, that is, they are not proactively planning their tax charge. When designing a tax strategy document, three to five objectives that work as focus areas for managing the tax charge should be agreed upon within the organization and with top management.
####### Managing tax risk
Uncontrolled or unidentified risk is clearly undesirable, but there will be occasions when a head of tax has to and even will want to take calculated risks. Entrepreneurial behaviour is about taking risks and managing tax is no different. One can distinguish the following main tax-risk areas which are all interlinked with each other:
Transaction risk– risk arising from transactions and tax planning activity (where there can be considerable oppor- tunity). The more unusual and less routine a particular transaction is, then generally, the greater the tax risks asso- ciated with the transaction are likely to be. In addition, improper implementation is a typical source of additional downside risks.
Operational risk– risk arising from the operations of the business units and the extent to which their activities may give rise to unexpected fluctuations in the tax charge.
Financial accounting risk and tax process risk - risk of materially incorrect accounts and lack of management con- trols over tax processes.
Compliance risk– risk of additional liabilities or penalties arising through non-compliance or failures in the tax return process. Risks can lead to surprises, restatement of accounts, material weaknesses in processes, significant additional tax charges, interest, penalties and harmed reputation. A tax function should try to minimize and optimize interlinked with the objectives in the areas of managing the tax charge and manag- ing the costs of the tax function. Again the tax strategy document should focus on three to five risk areas that will get high tax management attention and set objectives. Since managing tax risk is so diverse and important, a structured tax risk management approach is highly recommended and that is in line with the trend we see. What is meant by a structured tax risk management approach? The starting point is the development of a tax-risk policy and in particular the definition of the risk appetite in the various tax risk areas. Of course this has to be discussed and agreed on with senior management and the board. In a second step, a risk assessment should be made which results in a risk map and a plan for managing the key risks. The third step is the design or review or implementation/remediation of the internal controls over tax processes relevant for managing the key tax risks. Next is a communication plan to ensure the appropriate knowledge and information exchange on these matters with- in the organization. The fourth step is monitoring and reporting, which typical- ly is a combined effort of internal audit and tax function. And last, management has to regularly review the tax risk policy and the tax risk appetite.
####### Managing the cost of the tax function
The cost of the tax function is made up of the core tax func- tion, the shadow tax function (staff in other departments which do direct and indirect tax work), adviser’s fees and sen- ior management time. There is a correlation between the costs of managing tax and the ability to manage both the tax charge and the tax risks. When seeking to control the cost of managing the group’s tax affairs, it is important to distinguish between measures to improve efficiency and measures which reduce the level of service the tax function delivers. Nobody is going to argue against improved efficiency, but the level of cost of the tax function has to be set at such level, that the set objectives for managing the tax charge and the tax risks can be achieved. Having a proper tax strategy in place will help to ensure that the tax function receives the appro-
Tax-risk policy
By Tony Elgood,
PricewaterhouseCoopers,
UK
One can imagine tax directors saying: “I know what the key tax risks are in my busi- ness. I know how we are managing these risks. Why do I need a tax risk policy?” This is a very valid question for a tax director to ask. However it is equally valid to be asking whether the board and people out in the business (the tax-risk creators) are in agreement with the head of tax as to how tax risk should be managed and indeed as to what the key tax risks really are. The purpose of this chapter is to address three questions: 1 Why do you need a tax risk policy? 2 What does a policy look like? 3 Who should be involved in producing it? This chapter also sets out what is best practice in this area and concludes with a recom- mendation that for any large organization a properly documented tax risk policy is a must.
####### Why do you need a tax risk policy?
There has never been a greater focus on good corporate governance than where we are today. Additionally there has never been a greater focus on tax from not only rev- enue authorities but also investors and regulators. The focus of these three different constituents is leading to a much greater demand for both transparency and account- ability on tax matters, and also an understanding of tax and its associated risks. We are thus seeing an increasing awareness and interest on tax in the boardroom. The tax function therefore needs to be able to demonstrate that it has proper control of both the tax affairs and, in particular, the tax risks of the organization. Three examples will help demonstrate this growing global trend. The Australian Tax Office has been in communication with chairman and chief executives of Australian groups for a number of years, asking them to explain how they manage their tax risks. In the UK Hendersons (an investment management group) carried out a survey of the top UK companies, looking at the board’s approach to managing tax. This survey was published in early 2005. In late 2005 they issued another report around tax and the corporate/social responsibility agenda. Additionally Citigroup have produced a report entitled An Investor’s Guide to Analysing Tax Risk. The third example comes from the US where over 20% of material weaknesses reported under section 404 of the Sarbanes Oxley Act are around how tax is controlled – and a number of US heads of tax have lost their jobs on the back of these weaknesses. The logical conclusion is that proper risk assessment and controls need to be in place in every organization. However in order to conclude as to what is proper, an overall framework needs to be developed. That is, a properly documented tax risk policy. Without such a framework, different people in the organization will take dif- ferent approaches to managing tax risk – with potentially adverse consequences.
####### What does a policy look like?
There has been some debate as to what a best-practice tax- risk policy should look like. It could focus on each of the indi- vidual taxes paid by an organization. Equally it could focus on the different parts of the business. However in our experi- ence the most effective tax-risk policies focus on the six key areas of tax risk (as defined in PricewaterhouseCoopers’ Tax Risk Management Guide, published in 2004). This definition of tax risk seems to have developed some traction over the last two years and we would suggest that the risk areas which therefore need to be considered in a tax risk policy are:
- transitional risk;
- operational risk;
- compliance risk;
- financial accounting risk;
- management risk; and
- reputational risk. You could also argue that there is a seventh category of risk being external risk. It is perhaps difficult to have a policy around external risk, which by its very nature is something over which you have no control. However we are aware of some groups that have included this as part of their tax-risk policy. The key point to note is that the tax-risk policy under the above six headings, should cover not only all taxes but also all parts of the business. Different people will have different ideas as to the format of a tax risk policy. Indeed some organizations will already have a standard format for all such policies – and the tax risk policy should probably follow the internally agreed methodology. However for those starting with a clean sheet of paper, set out
below are two very different examples of tax risk policies. The first puts specific wording around policies for each of the areas of risk, the second shows the tax risk policy in dia- grammatic format.
####### Example 1
Some of these policies are at a high strategic level and some are much more operational. We would expect a tax risk policy to contain both. For any particular organization, we would also expect the policies to be very explicit around the key areas of tax risk for that organization.
####### Example 2
For those people who prefer a more pictorial look to their policies, we have produced a diagrammatic format for a tax risk policy. The guardrails show the boundaries within which the tax function (and the rest of the business) may operate. For each type of risk they show a lower limit, below which managing the risk is not cost effective. They also show a high- er limit, beyond which people may not go without consulting with the board (or audit committee). The policy might look like this: Whichever type of risk policy you prefer, and there are many other ways of presenting it, some form of document which can be shared with others in the organization is important.
####### Who should be involved in producing the policy?
Tax risk, and hence tax-risk management, involves a large number of people from different parts of any organization. There are the risk creators out in operations, there is the shadow tax function dealing with tax returns and the informa- tion for them, and there is the board that is responsible for managing the business as a whole. So who should be involved both in the setting of the tax risk policy and once it has been set, in its implementation? It is the head of tax that needs to be responsible for driv- ing the overall process. The tax function will clearly have a better understanding of the tax risks in a business and they need to have ownership of the tax risk policy. However it is important that the board put their weight and support behind whatever needs to be done. Any policy will lack traction if senior management and, in particular the board, are not sup- portive of it. The board (or at very least the audit committee) needs to sign off on a tax-risk policy. Not only should they do this, it is best practice for the head of tax to present to them, in per- son, at least once a year to explain the group’s tax position, the risks and how they are being managed. But it is not only the board that needs to understand and buy-in to the tax risk policy. This chapter has already men- tioned the risk creators in a business and their role in tax risk management. An example might help illustrate this point. Let us assume that the sales people want to open up a new market in a country in which you have not done business before. From a tax point of view there are two ways they can do this.
####### Anthony B Elgood
PricewaterhouseCoopers 31 Gt George St Bristol BS1 5QD UK Tel:+44 117 9307025 Email:anthony.b@uk.pwc
Tony is an UK based tax partner from PricewaterhouseCoopers’ Global Compliance Services (GCS) team. Tony specializes in tax function best prac- tice and tax risk management. He regularly speaks at conferences and has written the leading guides on the two subjects, namely Pricewaterhouse- Coopers’ ‘Best Practice’ tax function and Tax Risk Management guides. He works with in house tax functions, usually at a strategic level, helping them think through what they are want to achieve and how they best get there - with an increasing emphasis on risk management.
####### Biography
In the first alternative there is a high chance that the struc- ture will not be tax optimized, in the second it is much more likely that it will be. The tax-risk policy needs to set out what they should so in such circumstances and this tax policy needs to be communi- cated to these risk creators. The policy therefore needs to be practical and not a hindrance to the people driving the busi- ness forward. It is therefore important that they have some involvement in helping draft up the policy. An exercise tax advisers can carry out with our clients is to look at who the stakeholders are for a tax risk policy, with a view to deciding which of the stakeholders need to be involved in producing the policy and which of them need to understand the policy once it has been prepared. In each case a proper communication plan is important to get appropriate buy-in and acceptance of what needs to be done. These stake- holders can include both people within the organization and those outside, such as advisers and, in some cases, even rev- enue authorities.
####### Implementing the policy
There are three types of policy. Firstly there is poor policy and poor implementation, secondly there is a good policy
and poor implementation, and thirdly there is a good policy and good implementation. It is beyond the scope of this chapter to go into the implementation of the policy. Suffice it to say that the real value of a good policy is only when it is implemented.
####### Best practice
It is best practice, particularly in the present corporate gover- nance environment, to have a properly documented tax-risk policy. This policy should be signed off by the board. There are a number of different formats for a tax-risk policy; we believe the most effective is one which focuses on the individ- ual types of tax risk. Finally there are a number of different parties both within and outside an organization that are stake- holders and appropriate communication with each of these stakeholders needs to be thought through.
Audit Committee risk guardrails Guardrails approved by the Audit Committee set tax risk boundaries
Tax risk profile Using the spectrum, tax visually communicates the relative riskness of its activities, its tax risk appetite, in a horizon-line risk profile
Low Medium High
Low Medium High
Low Medium High
Low Medium High
Low Medium High
Low Medium High
1 Transactional risk Application of decisions and regulations to specific transactions
2 Operational risk Inherent risks in everyday business operations
3 Compliance risk Statutory risks associated with tax return preparation, completition and submission
4 Financial accounting risk Risk associated with tax accounting, financial statements and internal countrols
5 Management risk Failure to manage the above listed risks in a manner consistent with tax risk policies
6 Reputational risk Risks that impact the company’s image as perceived by the public
Risk categories Spectrum of risk results Illustrative
Escalation trigger Risk position clearly outside the guardrails trigger communication to the Audit Committee for guidance and possible remediation
####### Diagram 1: Tax risk guardrails
How to design efficient
tax processes
By Tony Fulton,
PricewaterhouseCoopers,
Australia
O
ne of the impacts of the focus on risk management, compliance and internal controls has been a push for companies to review, reassess and seek to optimise their processes across all aspects of the business, includ- ing the management of tax. A number of corporate governance developments in different territories are driv- ing a climate of business change and increased expectations regarding risk manage- ment and internal controls. Also, the unrelenting pressure on costs is pushing compa- nies to extract efficiencies in business processes. The tax function has not been immune to this pressure, with increased focus on the tax processes and how they relate to other business processes. Of all the corporate governance developments, the US Sarbanes-Oxley legislation has had the most profound impact in tax, and is leading to similar legislative respons- es in many other jurisdictions. The focus of the Sarbanes-Oxley legislation, princi- pally through Section 404, is on the operation of internal controls in relation to financial reporting, including reporting of tax results. Tax has particularly come into focus, given it was among the most common weaknesses identified during the first two years of reporting under the new code. For companies registered with the US Securities and Exchange Commission (SEC), remediation of potential weaknesses might result in the need to review the effectiveness of existing tax processes or to design new tax processes.
####### The trend towards tax process design
Unlike many other business processes, tax processes have traditionally been manual in nature, with limited automation, checks and controls. Tax controls often rely heav- ily on the skill and experience of the individuals who own the process, and there tends to be limited monitoring. A recurring theme is that individuals with the right skills, experience and application tend to compensate for poor processes and systems. Issues arise where there is a frequent turnover of staff or an inappropriate mix of available resources to ensure quality outcomes. For many organizations tax processes and controls are not within the scope of internal audit and risk management review processes. However it is becoming more commonplace for companies, often driven by the board audit committee or risk com- mittee, to require that tax processes and internal controls be reviewed to ensure com- pliance with the company’s tax obligations. A company might wish to look at the design of tax processes for a number of rea- sons. These include a desire to improve risk management, cost and time efficiencies, or the need for new or changing tax functions to establish appropriate processes and controls for the first time. Benefits can be realized in all these areas if the right approach is taken to the design and improvement of tax processes.
Tax management in companies 06
Course: Accounting and finance
University: Kyambogo University
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