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Tax risk management – cutting through the complexity

20 October 2015   (0 Comments)
Posted by: Author: Joubert Botha
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Author: Joubert Botha (KPMG)

Joubert Botha argues for a consistent methodology and approach to tax process management with clarity on accountability and responsibility between the tax function and the organisation

A lot has been published, and even more said, about the importance of tax risk management (TRM), the advantages of TRM and the importance of a good TRM framework that should be embedded into an organisation’s corporate governance regime. It has been said that TRM can even bring a competitive advantage to an organisation:  

"An interesting point is made; namely that TRM should not be undertaken purely to satisfy the expectations of revenue authorities, but also because TRM could bring competitive advantages. Those that succeed will incorporate tax risk management into the core of their business decisions – from the boardroom and audit committee agendas to the operations on the ground in various tax jurisdictions. Getting global tax risk management wrong can mean material financial and reputational damage. Getting it right can yield significant competitive advantages.”1

The Australian Tax Office states: 

"Managing your tax risk well is core to good corporate governance, particularly if you are operating in international markets.”2

…and the importance of TRM has been explained as:

"The need to address risk management at all in a tax context arises due to the inherent indeterminacy of tax laws, which give rise to uncertainty around their interpretation. Where there is uncertainty, there is a risk to be quantified and managed, which ultimately links risk management with degrees of tax aggressiveness and attitudes to the law.3

Not a lot is said, however, about what TRM really is and the different elements of the tax risk management framework. 

An appropriate definition for TRM could be said to be:

The proactive management of the tax life cycle as a business risk through the implementation of embedded strategies, policies and procedures.

The above definition may, on the face of it, appear very simple; however, there are a number of key fundamental aspects. Following below is an analysis of the fundamental aspects of this definition.

TRM needs to be proactive

Tax is often considered too late during a transaction or not considered at all. It is imperative to implement tax strategies and policies in order to be able to proactively identify legislative changes, changes to tax risks due to the ever changing business environment, and tax opportunities. 

The tax strategy should set out the strategic direction and objectives around taxes. This could, for example, include the way in which taxes are managed to ensure legal compliance (the right amount of tax being paid) while creating sustainable shareholder value and keeping in line with ethical and philosophical principles. The tax strategy should balance commercial imperatives with strategic decisions; it is therefore important that the tax strategy is aligned with the overall business strategy and company philosophy and objectives.

Given the importance of transparency and reputation, more and more companies are communicating the tax strategy, in one form or another, to external stakeholders.  

The tax policies should be aligned with the tax strategy. The policy should provide clear guidance on the principles that govern the approach to tax, the tax governance framework, and the tax delegation authority. The policy could inter alia include aspects such as: 

  • Tax coverage
  • Accountability, roles and responsibility
  • Tax review policy
  • Documentation policy
  • Technology policy
  • Recruitment and training policy 
  • Use of external advisors

Awareness of taxes and TRM throughout the organisation are important to ensure a proactive approach to tax. The tax policy should be clearly communicated within the organisation in order to ensure not only organisational awareness but also consistency and clarity in the treatment and management of taxes throughout the organisation. It is therefore important that tax management includes an organisation-wide communication plan with clear tax and tax function objectives. 

The tax strategy and policy should be approved and supported by the highest authorities within the organisation, for example, the board and executive committees. 

Accountability in terms of the enforcement of the practical application of the tax strategy and policy is key, as what is written on paper should be applied in practice.

Management of the tax life cycle 

The responsibility to manage taxes is substantial, and the tax charge is only a small component of the overall tax management responsibilities of the tax function. Modern tax functions have evolved and their responsibilities are no longer limited to compliance and the calculation of the tax charge in the Annual Financial Statements (AFS). Their responsibilities encompass a tax governance framework that will ensure that all taxes are managed in accordance with the relevant tax laws in place at any point in time. 

The tax life cycle should thus be managed through a well-established tax governance framework that includes documented processes and procedures. These processes and procedures should include the identification of key activities, risks and controls that are in place to detect and prevent risks. An important focus area of the governance framework is the operational aspects of the tax life cycle, which sets the basis for how tax is managed within the tax life cycle. 

The tax life cycle can be illustrated as follows:

The transaction

All transactions entered into will result in either a direct or indirect tax implication or a combination of both. Tax management requires tax involvement from the start of a transaction (negotiation) to the conclusion of the transaction.

Proper processes and procedures should be implemented in order to ensure that:

  • A detailed tax evaluation is performed prior to entering into critical and significant transactions. Tax management is not only the evaluation of the tax implications and tax planning aspects of the transaction (for example cost, technical, legal, operational and reputational), although these are very important elements, but also wider aspects such as evaluating which transactions require tax involvement based on size, complexity, frequency and risk, which transactions require internal or external opinions, and rulings etc.
  • Transactions are in line with the tax strategy and policy of the organisation.

As stated earlier, organisational awareness around taxes is important. It is therefore vital that the tax governance framework includes processes and procedures to create an awareness of tax throughout the organisation. This will ensure that tax is proactively considered on all levels within the organisation prior to entering into a transaction. 

Processing of transactions 

All transactions are processed in the accounting records utilising accounting and financial systems. There are various technological solutions to ensure that transactions are effectively and efficiently processed. The technological solutions should be "tax sensitised” and as far as possible be linked to tax-management software to create an end-to-end tax information system. This system should support automation and a clear audit trail. 

In the case of recurring transactions (daily, weekly, monthly) such as sales, procurement and payments, there are usually well-established financial processes and procedures to ensure that the transactions are completely and accurately processed. These financial processes and procedures often lack consideration for the tax implications. It is important that proper tax management controls and procedures are implemented as part of the financial processes and procedures to ensure that transactions are accurately and completely processed in line with the tax principles as set out in the tax strategy and policy. Tax technology tools and software can play an important role in controlling, monitoring and reviewing these transactions. Preventative and detection controls are key to monitoring and reviewing what has been implemented to ensure it continues to work as intended.

It is often found that a detailed tax investigation is performed and tax opinions are obtained prior to entering into a transaction; however, proper implementation and post-implementation reviews are often not performed. It is important that the implementation of the transaction is aligned with the agreements, the opinions, and conclusions reached. Proper controls and procedures should be implemented to ensure that transactions are accurately and completely processed in conformity with the tax principles.

A critical success factor is to create and maintain an enterprise-wide information system and performance framework that will enable the organisation to assess and monitor the effectiveness and efficiency of the ‘end-to-end’ tax processes in line with the rest of the organisation.

The transaction and the related tax are recorded in the AFS

The accounting records are ultimately reflected and disclosed in the AFS. It is important to ensure that the tax implications relating to a transaction are accurately and completely calculated and ultimately correctly disclosed in the AFS. Tax controls and processes should not only include the calculation of the taxes but also the identification of key transactions that impacts the taxes calculated, the review of the tax treatment, and the disclosure. 

It is important to obtain clarity over the coverage of the tax within the organisation: which taxes are paid by the organisation, how are they recorded and accounted for, and for which taxes the tax function is accountable. The tax function (and those with tax responsibilities outside the tax function or a material interface or input into tax) should recognise their roles and responsibilities and have the required technical and managerial skills to deliver these responsibilities. The training and development needs of the tax team, including those with tax responsibilities outside the tax function or a material interface or input into tax, should be managed and monitored. It is necessary that the team has a detailed career-and-development structure and is properly rewarded, not neglecting a robust succession plan. 

Reporting to the board and the audit committee

Clarity over the tax information required will ensure that the needs of the stakeholders are met as far as tax reporting is concerned. Without the correct information being available, it is less likely that the tax function will be able to meet the key performance indicators for its stakeholders (both internal, the executive and the board, and external, the revenue authorities and shareholders).

Communication with the Revenue Authorities

There are various ways in which organisations communicate with the Revenue Authorities and vice versa:

  • Submission of returns: The completion of the tax return is based on the information as reflected in the financial systems of the organisation, and includes the processing of the individual transactions. The stronger the tax governance framework, the more confidence there will be in the information disclosed and submitted to the Revenue Authorities. Technology and tools (for example, tax-reporting and tax-calculation tools) can play a major role in assisting with the effective and efficient completion and submission of returns.
  • Assessments received: A timely and consistent approach should be followed to review assessments and reconcile the assessments to the returns submitted and the tax information reported and disclosed in the AFS. Where necessary, objections should be submitted in timely manner. 
  • Queries and audits: Often queries and audits are received throughout the organisation and not necessarily by the tax function. This tends to result in the queries and audits not being addressed at the right level within the organisation or not addressed in a consistent or timely manner. Organisational awareness is critical to ensure that all queries and audits are directed to the right person within the organisation and are in line with the tax policy to ensure a consistent methodology. 

Taxes must be managed as a business risk 

Tax should not be disconnected from the business operations. It is important that tax is managed in the same way that an organisation would, for example, manage its stock or its debtors. Accordingly tax should receive the same degree of attention compared to any other business risk within the organisation. 

Embedded strategies, policies and procedures 

Tax strategies, policies and procedures cannot operate in isolation from the financial and business strategies and policies of the organisation. These strategies, policies and procedures need to be aligned and embedded within the organisation to form part of the organisation’s wider strategies, policies and governance framework. 

A consistent methodology and approach to tax process management across the organisation should be adopted, with clarity on accountability and responsibility between the tax function and the organisation. Ideally, the processes and controls should be standardised, harmonised and automated to provide confidence in the underlying tax numbers. A common testing, monitoring and validation approach should be introduced to ensure effective management, continuous improvement and independent verification of the key tax processes both within and outside the tax function.

The amount of tax managed by an organisation is significant and in the absence of an appropriate tax risk management framework, the potential of penalties and interest on the underpayment of taxes may be significant.

The modern tax function will be responsible to both manage tax risk and to create value. It will never be possible to discharge tax risk in totality; however, the implementation of a tax risk management framework will provide a level of acceptable risk. In this regard it is noted that:

"Tax risk management is not necessarily about minimising tax risk but rather about a determination of the level of risk that is acceptable to the particular corporation and putting in place processes and procedures that ensure tax risks do not exceed acceptable levels.”4

On the other hand, the implementation of a tax risk management framework will create and add value by allowing the tax function to focus its resources on value creation initiatives such as:

  • Improved communication internally and externally, with the Revenue Authorities, boards, audit committees, the broader public etc.
  • Tax consequences of proposed transactions being addressed timeously and proactively.
  • Proactive identification and addressing of key tax risks, changes to the tax legislation, and tax planning opportunities.
  • Increased protection of the organisation’s reputation and reduced risk of negative press coverage with regard to taxes.
  • Improved and focused relationship-building with tax authorities, including pro-active relationship management.

1  "TaxTalk issue 51 at p. 53. and Governance and risk in a global economy"

2  "Large business and tax compliance publication” at par. 3 under "Good tax governance – Sound tax-risk management processes”

3  Emer Mulligan and Lynne Oates, "Tax Risk Management: Evidence from the US”

4  Catriona Lavermicocca, "Managing tax risk and compliance”, the tax specialist, Volume 13, No 2, October 2009, at p. 69

This article first appeared on the September/October 2015 edition on Tax Talk.    


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