A New Era for Tax Controversy Risk Management
23 August 2013
Posted by: Author: Charl Geldenhuys
Author: Charl Geldenhuys (Taxtalk)
Developed and emerging countries are applying more and more pressure on their Governments to increase the inflow of revenue and broaden the tax base. This puts more strain on the tax lifecycle of the taxpayer. An effective tax framework needs to incorporate "Controversy Thinking” in order to improve the planning, provision, compliance and reporting. Businesses are expanding into new geographic areas and jurisdictions. Combined with the development of new and more complex tax models, the challenges of risk management and tax controversy are increasing significantly. A new trend, as guided by the OECD, has emerged where governments from around the world unite to perform joint or simultaneous audits on a taxpayer in their respective jurisdictions.
This new era makes it more challenging for the tax director to manage tax risks. According to Chris Oates, the Head of the Tax Controversy and Risk Management practice at Ernst & Young in the United Kingdom - "The role of the Head of Tax Controversy is as much about reputation and governance as it is about managing a company’s exposure to tax. It is no longer just a question of managing things on a real-time basis but of weighing up how transactions entered into in the past may be viewed against today’s standards of disclosure, and how current decisions may be regarded in the future”
Tax risk management models that were effective five years ago may no longer provide adequate protection for companies today or in the future. Thus, there is a need for organisations to update their tax controls regularly in order to keep up with the fast paced economical developments.
The decisions and operations undertaken by companies in the course of their business give rise to various uncertainties. These uncertainties lead to the creation of tax risks. Managing your tax risks is therefore about managing these uncertainties. A survey conducted by Ernest & Young amongst 541 companies provided insightful information regarding tax risks. Around 77 per cent of the respondents believe that managing tax risks and controversy will become more important in the upcoming years. This figure increased to 88 per cent for larger companies. 78 per cent of the world’s largest companies said that they already experience greater risks around legislation. Tax directors emphasised that fast-growing emerging markets are a main area for tax risks and uncertainties.
The first underlying principle of business is that the bigger the risk, the bigger the reward. But how far are businesses willing to push their boundaries? Companies incorporate different frameworks to manage their exposure to business risks and audit risks. But tax controversy and tax risk should be approached in the same manner as any of the other risks within an organisation. A comprehensive tax risk framework can communicate the organisation’s relative risks of business activities and risk appetite to internal and external stakeholders.
the technical aspects of compliance, for example the risks associated with late submissions or failed tax planning schemes. With the fast expansion of globalisation and emerging markets, risks are more imminent and growing in volume and complexity. Such a tax framework can construct the necessary guardrails to help identify any risk triggers.
Large companies and organisations are more likely to be exposed to the following:
• Transactional Tax Risks
• Operational Tax Risks
• Compliance Tax Risks
• Financial Reporting Risks
• Management Tax Risks
• Reputational Tax Risks
Transactional Tax Risks are driven by business transactions. It involves the correct implementation of agreed upon terms and complying with the necessary rules and regulations to the specific transaction. This risk arises where the company enters into a transaction that is outside the day-to-day activities of the company. Operational Tax Risks is the inherent risks in the everyday business operations. This risk arises when a company, for example sets up a new business overseas or when the company’s managers/senior staff members don’t understand the tax implications of their business decisions.
Compliance Tax Risk has recently received immense attention with the amendment of the Tax Administration Act (TAA). The risk, in relation to compliance, increases when not taking reasonable care when filing a tax return or when being grossly negligent. Section 223 of the TAA introduced new aggressive penalties on non-compliance. A penalty ranging from 25%-150% may be charged, on a standard case, when one fails to comply with the law.
Financial Reporting Risk is the risk associated with tax accounting, financial statements and internal controls. This risk increases when the organisation’s internal controls are not properly in place or if your bookkeeper, tax manager or accountant changes. Long-serving staff members are more familiar with the internal controls and procedures of the company than new recruits.
The person responsible for managing these risks is most likely to be the Tax Risk Manager, Tax Controversy Manager or Tax Director. A lack of proper planning will increase tax risks which may end up in disputes with the tax authorities. Incorporating tax policies and a tax strategy plan will support the tax framework and lower tax risks that may arise. Legislation like Sarbanes Oxley and the TAA has put more pressure on companies to be more transparent. Proper disclosure of your company’s tax practices will increase the company’s tax transparency. When a company’s tax affairs become public knowledge, it better be good news. Reputational Tax Risk could have a massive impact on a company. Therefore, disclosing good tax practices can only be of benefit for you and your company. When labelled as a "problem taxpayer” by the South African Revenue Service (SARS), numerous audits and inspections will await you in the future.
How can you combat these risks? A proper, tailor made tax controversy and risk management plan will treat tax risks accordingly, for example a plan needs to:
• Address tax risks on a strategic level and execute the plan well;
• Prioritise strong corporate governance in tax;
• Stay up to date with legislative, regulatory and tax administration changes;
• Evaluate global resources, processes and systems for tax controversy and risk management;
• Adopt a global approach to tax risk management.
A well developed tax function of an organisation will also help to manage tax risks. Such a tax function has numerous enablers that will help the management team with their duties, with the employees of the organisation contributing a big part to the tax function. It is of utmost importance that the personnel are competent and have sufficient experience in identifying tax risks, evaluating them and responding in an effective manner to treat them. Smaller companies may also make use of competent external tax practitioners in managing their tax risks and ensuring that their controls are in place. The implementation of effective controls and applying up to date technology within an organisation will lead to increased reaction planning for unexpected risks that may arise. A comprehensive tax function structure will improve the quality of tax risk reports and ease the review process.
It is now the time to start getting a grip on the new era of tax risks and to begin incorporating your tax framework in order to win the fight!