The Art of being Regulated
11 July 2013
Posted by: Author: Telita Snyckers
Author: Telita Snyckers (Norgaard)
Tax risk and tax controversy are on the increase in part at least due to the effects of globalisation; changing business models; the uncertainties created as more companies venture into emerging markets; more investigative journalism; self-styled watchdog activist groups; and various corporate failures. Tax compliance is now everybody’s business, and tax risk management is becoming ever more complicated, more subtle, and more challenging.
We are also seeing tax administrations becoming more aggressive (they would say more focused), with a higher rate of legislative changes and an increase in disclosure and transparency requirements.
There are admittedly a number of aspects of tax risk and controversy management that do not fall within your control, but the majority of them, as it turns out, do. There are issues in respect of which you are, it must be said, at least in part at the mercy of the taxman – but there are many in respect of which you aren’t. This then, is about looking at ways of managing your tax risk and tax controversies more proactively and pre-emptively:
Controversy is everywhere
You are not alone (and SARS is not unique in the positions it takes). The country with the highest tax controversy levels? Singapore. The country where tax controversy has increased the most? Singapore. Even a country that is known for its efficiency and for being business friendly cannot escape the controversy paradigm. Tax administrations the world over are becoming more focused in their risk profiling, targeting and enforcement activities. With the rise of ever more whole-of-government initiatives, information exchange with other tax administrations, joint audits and third party data matching opportunities there are fewer places to hide (choose your haven of choice – if it hasn’t fallen yet, it will - soon). If you have a big risk appetite, expect more controversy.
It starts at the top
The majority of companies’ boards do not have a documented tax strategy and most have not discussed any tax issues in the board over the past 2 years (and yet the overwhelming majority of boards report that management of the tax function is their greatest risk). Research shows that in common: a board-reviewed tax risk strategy; strategic guidance from its board; and a board-adopted tax policy. (The average tax department, though, has not had its tax risk strategy reviewed by the board recently; does not have tax representation on risk management committees; does not have strategic guidance from its board; and does not have a board-adopted tax policy). Boards should ensure that tax risks are worth taking and are taken in the interests of the business. This is not a question of whether or not a company should seek to minimise its tax burden, but more an issue of the board’s responsibility to assess the financial and reputation risks associated with any particular tax strategy. Want to better manage tax risk and controversy? If you do nothing else, make tax a board-level issue.
You cannot manage what you don’t know
Increase the focus on risk transparency and insight: A formal process should be in place to identify, assess, manage, account for, disclose, and audit tax risks. Only around 46% of companies have an individual whose job this is. And only 40% of tax directors feel they have full visibility of tax-related deadlines across their business. And perhaps not surprisingly, only 38% of businesses have a tax risk improvement process in place. Boards and tax executives need to address the tax risk assumed by their business before they become aware of it for the wrong reasons. Conduct audit readiness reviews. Review your processes for incomplete records, procedural or IT system weaknesses, analyse pre-audit risk exposure, and review opportunities for improvement post-audit. The better insight you have into the risks you face, the easier they are to manage.
Be explicit about your tax risk appetite and strategy
Despite the general lack of visibility on the boardroom agenda, attitudes are certainly shifting towards the risk-averse end of the spectrum. Many companies are now less inclined to engage in tax planning activity that might be construed as aggressive, because they do not want to be seen as high risk by the tax authorities or presented by the press as engaging in unethical tax behavior. For those boards that do discuss tax, just under half describe their tax strategy as conservative or risk averse (only 1% of boards reportedly adopt an overtly aggressive tax strategy). At the heart of good tax risk management is an explicit decision on the company’s tax philosophy. Do you want to use tax as a lever to establish a competitive advantage, or are you happy to get some additional value from tax planning using uncontested approaches? If you have a big risk appetite and can stomach the potential reputational and financial risks associated with a very aggressive tax position, expect to court controversy. Choose your philosophy and tax risk appetite, then manage the consequences.
Don’t have a risk governance framework in place? You’re not managing risk
Tax avoidance opportunities need some level of obfuscation, which in the process opens the door to unscrupulous opportunists. Several high-profile cases - Enron, Tyco, and Dynegy - had their beginnings in tax-planning activities. These activities, and the secrecy they needed, became the cover for activities that were not in shareholders’ best interests. Good governance should include robust day-to-day accounting and control mechanisms; reviews by an independent external audit committee; clear accountabilities in respect of tax decisions; a board and senior management who are aware of the risks and issues and know which transactions the revenue authority is likely to view as risky, including tax as part of the decision- making process for all major transactions; and issuing letters of assurance. And yes - good governance pays: at least three-quarters of institutional investors would pay a significant premium for good governance while 60% are likely to avoid investing in companies if they had concerns about governance. Good corporate governance may not obviously boost the performance of a business, but without it investors face the risk that the economic value that has been created will be lost. (Some research suggests a 10 point improvement in corporate governance is associated with 7.3% additional performance for a stock over the following nine months.) Ultimately, though, governance is about more than money: you can always borrow money to pay a penalty, but you can’t borrow a reputation.
Tax risk management is everybody’s business
Tax risk – and how to reduce subsequent controversy - is often not widely understood outside of a company’s tax department. Tax is often ignored at the coalface, because it is seen as a head office matter. Tax may be considered on central projects, but is often overlooked in routine day-to-day transactions with tax risks receiving only cursory attention outside the finance function at many companies. A large majority of tax departments report that their CFO’s don’t fully understand the tax risks involved when expanding into emerging markets. Unless tax risk management is woven throughout all of your business processes, expect to see more controversy.
You get what you measure
In many instances tax departments are held up to the wrong standards which does little to reduce downstream controversy. Non-tax manager below board level are frequently evaluated on pre-tax numbers, which means that managers are not taking the tax consequences of their decisions into account (although, of course, focusing too much on post-tax measures could also increase tax risk). What behaviour are we driving when a tax department is given an objective to maximize after tax profits, or to maintain a set effective tax rate, or when tax managers are remunerated as a percentage of the decrease in the company’s consolidated tax bill? Performance measures for tax departments need to reflect this constant tension between creating value for shareholders, and acting ethically. You cannot reduce risk if you incentivise risk-taking behaviour.
Actively manage your risk rating with the tax administration
The higher your risk rating, the more likely you are to be on the receiving end of targeted enforcement action, and the more likely you are to end up being involved in protracted controversy proceedings (where the only winners are the lawyers.) Many elements contribute to your risk rating, almost all of which you control: your compliance history over time; how aggressive you are in the positions you take; the adequacy of your internal controls and processes; your responsiveness to requests for information; and the extent to which you engage with the tax administration proactively and constructively. Want to reduce controversy? Work on reducing the risk you pose to the tax system.
Stay on top of global legislative and tax administration developments
You cannot proactively manage risk – and avoid taking a position that may lead to controversy down the line if you don’t plan ahead. Expect to see tax administrations continue their focus on indirect taxes, anti-avoidance legislation, increasing disclosure requirements, more information reporting and withholding requirements. Expect to see more developments around the taxation of electronic commerce transactions, and a bigger focus on short-term business travellers. And certainly expect to see more targeted enforcement. But also expect to see more administrative simplification, the rewarding of good governance, and more opportunities for enhanced relationships. Make sure that your risk management process pre-empts and embraces these changes.
Managing tax risk more smartly is the smart thing to do
It will reduce the number of unresolved controversies and prevent new controversies from arising. It will reduce the size of your tax provisions, which means the release of more cash. And it will almost certainly reduce your compliance costs, and increase the prospects of lighter-touch audits in future. The fact that you end up with better relationships with the tax administration, business analysts, self-styled activist watchdogs, the media and consumers cannot be bad for business either.
These are not a panacea. An element of tax controversy is likely here to stay, and there will likely always be contentious issues that muddy the waters with the taxman. What we can – and should – demand of ourselves and our tax system is that we work towards reducing the number of unnecessary, avoidable tax controversies, whatever it takes. Starting today, embrace the art of being regulated.
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