Tax Risk Management and Board Responsibility - International Tax ...

Tax Risk Management
and
Board Responsibility
Dr. iur. Bernd Erle
Partner KPMG Deutsche Treuhand-Gesellschaft
Germany
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Contents
I. Introduction ............................................................................................................3
II.
The changing Landscape – Why has tax risk management become increasingly
important? ..........................................................................................................5
1 Tax is in the news ...............................................................................................5
2 Relevance of tax for business performance and financial statements ...................6
3 Compliance and reporting an ongoing challenge .................................................7
III. Tax is in the boardroom – What is the perspective of the board? .........................9
1 Awareness ..........................................................................................................9
2 Tax risk attitudes versus actual behaviour ......................................................... 10
3 Managing tax risks – what is the challenge for the board? ................................. 11
IV. Tax Risk Management in practice ..................................................................... 12
1 Defining a tax philosophy and setting a framework ........................................... 12
2 Components of the tax risk management framework ......................................... 13
V. Board responsibility .......................................................................................... 17
1 International focus on board responsibility for tax risk management ................ 17
2 Decisions to make and questions to ask ............................................................ 18
VI. Future developments ........................................................................................ 23
VII. Conclusion ....................................................................................................... 25
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I. Introduction
Is the board responsible for tax? This question might have caused interesting discussions
among board members a few years ago. Statements such as “It’s a CFO issue”
and “tax is under control” might quite possibly have been among the responses. Taxation
gives rise to complex, multi-faceted problems in every country in the world, that can only
be dealt with by tax specialists. This argument used to be met with some sympathy,
especially by members of the public who were familiar with the complexities of filing their
own income tax returns every year. But the question remained: how can an issue that might
encourage a corporate reorganisation or influence the payment of dividends to
shareholders, or which might affect a merger or take-over, possibly stay out of the board
room?
Particularly in the wake of corporate scandals like Enron and WorldCom, or the
collapse of the new economy in Germany it has become clear that there is a need for the
board to set up a transparent governance system throughout its company. Legislative
requirements as regards internal control systems have increased significantly, as well as
other initiatives from governmental and non-governmental bodies.
Stakeholders are showing increasing interest in obtaining comprehensive information on
how tax risk management and corporate conduct are implemented and supervised.
Financial key performance indicators used to be the most important measures for the
performance of companies and therefore “the lower the tax charge the better” was the
simple rule. Now concepts of sustainability and the management of long-term value added
are assuming increased importance. The value of tax avoidance strategies is increasingly in
doubt especially when taking the potential damage to reputation into account. Stakeholders
demand sufficient long-term information on how tax risks are being controlled, the tax risk
management system is implemented and the corporate conduct is supervised.
In theory there is no doubt that tax risk management is part of the corporate governance
system and therefore it is the responsibility of the whole board.
From every theory arise a number of practical questions. Are the board members aware
of their responsibility for tax risk management? What impact does tax risk management
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have on corporate structures, processes and transactions? Tax issues are complex, multifaceted
and subject to ongoing change. What qualifications do the board need to actually
understand and govern tax risks? What exactly does the board need to do to implement a
tax risk management system? What communication and documentation requirements need
to be fulfilled? What kind of future developments need to be considered?
This paper will address most of the issues raised, mainly from a practitioner’s point of
view. The study starts with a short look at the developments that have given rise to the
increasing importance of tax risk management for the board. Following this analysis the
key results of a recent KPMG survey of the views of board members on tax risk
management are outlined. The third part will show the challenges of tax risk management
and introduce practical solutions. In chapter four the paper focuses on the responsibilities
of the board for managing tax risks.
Where do we go from here? The final chapter considers what the future might look like
with regard to tax risk management and the board’s role in this area.
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II. The changing Landscape – Why has tax risk management become
increasingly important?
1 Tax is in the news
“Non-compliance a growing problem” 1 , “Tax: Multinationals’ low bill in poor nations
under fire” 2 , “Managers under pressure to give tax its due – as rules and scandals
proliferate, the issue of how to manage tax has become far more urgent” 3 , “Cut tax or lose
business” 4 , “HSBC says tax regime may force it to move” 5 , “IFRS brings tax out of the
back room – TAXING MATTERS – a company’s tax policy, traditionally a mere technical
issue, is increasingly viewed as a strategic matter” 6 .
Major business headlines deal with non-compliance of companies, tax as a significant
cost factor for business and increasing regulation on the disclosure of tax information.
Primary goal for the board is to achieve excellent financial results. Tax is a significant
cost factor for companies. That implies that minimizing tax will increase profitability. But
besides the obvious tax payments there are other costs that are harder to measure but that
need to be taken into account.
There is a strong interrelation between the success of a business and its reputation
which significantly depends on the general perception of the company. The public interest
in corporate social responsibility of businesses (CSR) is growing. Paying the taxes legally
required in any country where the company operates is considered an important part of
being socially responsible. CSR is no longer the concern only of non-government
organisations. It has been raised to the agenda of international organisations like the United
1 Financial Times, October 13, 2006
2 The Guardian, September 18, 2006
3 Financial Times, August 19, 2005
4 The Times, October 10, 2006
5 Financial Times, October 6, 2006
6 Financial Times, July 4, 2005
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Nations and the Organisation for Economic Co-operation and Development (OECD).
“Business practices rooted in universal values can bring social and economical gain” 7 .
Stakeholders are enquiring more into the values that underlie a business’s actions.
Companies that move to tax shelters without obvious business reasons risk reputational
damage in addition to the possibility of legal actions. In 2004 Swatch, the Swiss
watchmaker, featured in the newspapers over its transfer pricing arrangements, while US
clothing group Tommy Hilfiger could find itself in court over the commissions paid to a
non-US subsidiary. 8
Stakeholders’ demand for ethical behaviour is increasing significantly and tax is one
area where businesses have to show value-based behaviour. Socially responsible investors
have been active in the US at companies such as Pepsi and Raytheon, and have demanded
curbs on tax havens used by Tyco and others 9 . In the UK Henderson Global Investors
encourages all companies to consider whether tax matters are among the principal risks
and uncertainties facing the company, or are included in the main trends and factors which
are likely to affect the company’s future development, performance and position 10 .
Tax has become an ethical and reputational issue and the board is responsible to ensure
awareness of tax issues throughout the organisation.
2 Relevance of tax for business performance and financial statements
Certainly the board is primarily accountable for the financial performance of a business.
And it should not be forgotten that, as Josef Ackermann stated, financial success is
important because the more a company earns the more taxes it is able to pay 11 .
Taxes are important figures on the face of the balance sheet and the income statement of a
company. They have strong implications for the year end results as well as the profitability
and the ability to pay dividends. Tax considerations can influence the decisions on major
7 Ban Ki-Moon, Secretary General of the United Nations.
8 Ethical Company, December 2004, page 25
9 Ethical Company, December 2004, page 25
10 Henderson Global Investors, “Responsible Tax”, October 2005
11 “Wir wollen Deutschland nicht verlassen”Süddeutsche Zeitung, 10 march 2007, page 25;
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usiness transactions such as mergers, acquisitions and disposals of companies. Thus if
something goes wrong this does not only affect the balance sheet but may also affect the
share price significantly. In February 2006 Google announced reduced earnings due to a
higher than expected tax charge. Market value fell by 20 billion dollars.
An analysis of companies listed on the Dax-30 Index in Germany shows that the deferred
tax assets can easily amount to forty percent of the equity of a business. This means that if
the tax asset is impaired almost half of the equity may be wiped out.
Due to the importance of tax effects on business performance and financial statements the
board will be accountable for implementing processes that ensure the quality of tax figures
reported. This implies specifically that tax provisions and liabilities must be calculated
accurately and the correct valuation of deferred tax assets in the balance sheet must be
ensured. The board must therefore bridge the gap between being profitable and not taking
tax risks that could have negative impacts on the business performance and the financial
statements. But tax in many cases has a long term perspective. So the implication go far
beyond the financial statement of one year.
3 Compliance and reporting an ongoing challenge
The trend of globalisation has developed further as emerging markets offer new
business opportunities. An international survey among 250 chief financial officers of
successful global companies shows that the majority sees foreign expansion as one of their
top priorities 12 . However, globalisation has become a ‘two-way street’ where emerging
economies show increasing amounts of foreign direct investment. At the same time, there
are significant flows of investment into emerging markets to take advantage of low costs
and access to new markets 13 . Multinational companies now have to take into account
different local regulations, customs and stakeholder expectations as well as market
demands.
In addition the complexity of tax laws at national and international level has increased
significantly and is subject to ongoing changes. Furthermore, tax law often inter-relates
12 ,Emerging Markets, KPMG 2007 January 2007, pg. 1
13 World Investment report 2006 United Nations Conference on Trade and Development Oct. 2006
www.unctad.org
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with other legal issues. Uncertainties with regard to interpretations of legal regulations are
also not uncommon. To ensure full compliance with all legal requirements has become a
challenge for almost every corporate governance system. As the OECD Principles state:
“Corporate governance requirements and practices are typically influenced by an array of
legal domains, such as company law, securities regulations, accounting and auditing
standards, insolvency law, contract law, labour law and tax law. Under these
circumstances, there is a risk that the variety of legal influences might cause unintentional
overlaps and even conflicts, which may frustrate the ability to pursue key corporate
governance objectives.” 14
Global markets and the free flow of capital made it possible to control the jurisdiction in
which profits arise which is a challenge for tax authorities. As a result the enforcement
processes through civil and criminal actions have been strengthened in many countries and
on an international level.
Reporting and documentation requirements have been enhanced to address the problems
of information asymmetries resulting from the principal-agent conflict - between
shareholders and the management - and in the light of corporate scandals like Enron and
WorldCom. Most notably the Sarbanes-Oxley Act (SOX) was introduced in the United
States which required a significant effort from companies in documenting their internal
control systems. The Financial Accounting Standards Board (FASB) Interpretation No. 48
(FIN 48) also intensifies the focus on accounting and disclosures for uncertainties in tax
positions in the financial statements 15 .
In the light of these developments tax cannot stay in the splendid isolation in which its
technical nature has historically placed it. The management of tax risk has become even
more important in the light of recent changes. The public, shareholders and legislators
expect board members to address these effects through the corporate governance system of
a business.
14 OECD Principles (2004), I.C Annotations, page 31.
15 FASB Interpretation No. 48, Accounting for Uncertainties in Income Taxes, an interpretation of FASB
statement No. 109
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III. Tax is in the boardroom – What is the perspective of the board?
1 Awareness
The OECD states: “What is clear is that the recent spate of corporate scandals, the
success of a number of tax administrations in challenging aggressive tax schemes and the
general change in attitudes towards tax planning, will all combine to produce a greater
awareness in the Boardroom of the importance of tax issues” 16
KPMG has undertaken surveys and asked board members for their views on the
relevance of tax issues for the board over recent years. The directors of many companies
acknowledge the need to change their attitudes towards tax. There is a general
understanding that tax cannot be managed independently from the main business and can
have a significant influence on decisions as regards the transactions undertaken 17 .
Survey results from 2006 show that 72 % of the respondents consider tax and its risks to
be boardroom issues (an increase of 11% over a two year period). There is awareness that a
reduction in taxes can increase the value of a company. They also consider that the most
significant areas where tax has an impact are changes in capital structures, intra-group
funding arrangements, transfer pricing and similar transactions. 18
The issue has therefore become more important in recent years. But this does not mean
that changes follow at the same speed. Various major critical issues remain. Many tax
departments are isolated so that their presence is not felt throughout the business. There is
a lack of general understanding and awareness of tax issues. Tax considerations are not
integrated into the main business processes. Tax may be considered on central projects, but
is often ignored in routine day-to-day transactions. The performance measures for
management are mainly based on pre-tax figures such as earnings before interest and tax
(EBIT).
16 Good Corporate Governance: the Tax Dimension – OECD Forum on Tax Administration – September
2006
17 KPMG’s Wired Tax survey 2004
18 KPMG’s Wired Tax survey 2004 and 2006
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The results of the survey show that only 14 % of the companies included in the research
had board-approved tax objectives. Regular formal reviews of the tax department by
internal audit were carried out in only 22% of the companies. Only 10% of the tax
departments felt that they were widely understood outside the tax function. 19
The reasons for the contradiction between the awareness of the board and the lack of
implementation are many. It is mainly caused by the increasing complexity of tax law as
well as increasing reporting requirements that leave less time to consider strategic issues
and debate the big picture. A lack of expert staff makes change even more difficult. Finally
there is a lack of understanding on how the world’s tax authorities are changing their
approaches.
2 Tax risk attitudes versus actual behaviour
When informally asked about their risk appetites the majority of the board members
questioned would designate themselves ‘conservative’. Only very few would see
themselves as ‘very conservative’, meaning that they would do nothing to provoke the tax
authorities. The majority require a legal opinion comfort of more than 50% on their tax
planning. Companies are mainly willing to defend their tax planning in court, but none of
the board members questioned think a reputational risk is acceptable. The research
suggests also that attitudes have shifted towards the risk-averse end of the spectrum. 20
Surprisingly there is a gap between tax risk attitudes and actual behaviour as the results
of legal proceedings from tax authorities often show. Since that is the case the board
members are facing significant problems due to the fact that the company’s behaviour does
not reflect their attitudes and might trigger inquiries by tax authorities.
Tax authorities have shifted to a risk-oriented approach to identify non-compliant
taxpayers and look especially at questions like: Is a clear direction from the board given as
regards tax matters? Does the audit committee request information on tax issues and is
adequate supervision in place? Have there been compliance issues in the past? Is there
19 KPMG’s Wired Tax survey 2004 and 2006
20 KPMG’s Wired Tax survey 2004 and 2006
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extraordinary pressure from investors to deliver results and are directors or management
under pressure to achieve personal goals? 21
A key challenge is to ensure that the risk attitude of the board is reflected in the
company’s actual behaviour and in the mindset of everybody involved. There cannot be
two policies: one for the board and one for the tax department.
3 Managing tax risks – what is the challenge for the board?
Tax risks include the risk of overpaying taxes or of paying less tax than legally required.
Reputational damage resulting from such errors can incur additional costs which are hard
to measure. Errors in assessing the tax effects of transactions can lead to wrong business
decisions. For many businesses tax is a cost factor that can be important for its
competitiveness. To summarise: tax risks mainly consist of compliance risks, transactional
risks, and operational and reputational risks 22 . These are good reasons for the board to be
involved in tax risk management.
The goal for the board is to implement a tax risk management process that has the right
balance between risk and opportunity. The business processes need to ensure that taxes are
not overpaid but that legal obligations are fulfilled.
Going forward, organizations will need a dual focus: (1) sustaining an ongoing
assessment process for compliance and (2) balancing risk and controls while identifying
and pursuing process improvement opportunities to better the business. 23
The question of how to implement a tax risk management system that ensures this
objective is met will be addressed in the following chapter.
21 KPMG Tax is in the Boardroom, A Discussion Paper, 2004
22 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix II
23 KPMG The Compliance Journey Balancing Risk and Controls with Business Improvement, 2004
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IV. Tax Risk Management in practice
1 Defining a tax philosophy and setting a framework
The board has to set the general standards for tax issues by defining a global tax
philosophy and setting a framework for the governance of tax issues throughout the
business. The tax philosophy on a practical level is the code of conduct for tax issues 24 . A
code of conduct is intended to establish the ethical norms of the company and to set
standards for ethical behaviour when dealing with those inside and outside the firm 25 . So
the tax philosophy as code of conduct with regard to tax issues states the overall position of
the company towards tax.
The OECD Guidelines for Multinational Companies indicate what can be addressed: “It
is important that enterprises contribute to the public finances of host countries by making
timely payment of their tax liabilities. In particular, enterprises should comply with the tax
laws and regulations in all countries in which they operate and should exert every effort to
act in accordance with both the letter and spirit of those laws and regulations. This would
include such measures as providing to the relevant authorities the information necessary
for the correct determination of taxes to be assessed in connection with their operations and
conforming transfer pricing practices to the arm’s length principle.” 26
The tax philosophy needs to be embedded in the overall goals of the business. As the
code of conduct it must not only be a set of rules for good behaviour but must be part of
company’s culture and become a factor in everyday business dealings 27 . Establishing a
position requires the board to decide on the focus areas for tax management. Is tax mainly
seen as a normal cost factor that needs to be minimized as a duty to shareholders or is its
payment a social obligation and a duty to the local community. Most companies take a
position closer to the idea that ‘tax is a cost factor’ and therefore a decision needs to be
24
25
26
27
KPMG Tax in the Boardroom, A Discussion Paper, 2004, page 6
Eric Banks, Corporate Governance Financial Responsibility, Controls and Ethics, 2004 page 47
OECD Guidelines for Multinational Enterprises, 2000, page 27;
http://www.oecd.org/dataoecd/56/36/1922428.pdf
Eric Banks, Corporate Governance Financial Responsibility, Controls and Ethics, 2004 page 47
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made on how aggressive tax management should be and what level of risk is acceptable for
the company. Furthermore short term and long term effects have to be balanced properly.
The tax risk management system will be derived from the tax philosophy. It is
embedded in a framework which is outlined below.
The aspects of the framework are at the same time practice indicators on the operation
of the tax risk management system 28 .
Once the framework and the policies are defined it is important to give guidance to the
staff on how they should be implemented. 29
2 Components of the tax risk management framework
Strategy
Tax risk strategy is derived from and aligned with the tax philosophy as well as the
business strategy. Tax strategy should reflect where in the spectrum of positions the
28
29
KPMG Tax in the Boardroom, A Discussion Paper, 2004, page 11
Henderson Global Investors, “Responsible Tax”, October 2005 page 61
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company wants to place itself. Businesses are not limited to compliance with tax
regulations, but can claim leadership through engaging in discussions about the tax policy
development with legislators 30 .
It can be left to the tax department to develop an action plan and deal with risk areas,
but the tax strategy should be understood and approved by the board and communicated
within the business.
Policies around key strategies and risks need to be documented and communicated. This
is not only a requirement of SOX 404 31 but also sends an important message to
stakeholders of the company. It will also help align the tax behaviour of managers
throughout the organisation 32 .
Risk management and control
Tax should be an integral part of the internal control and the risk management system of
a business. Hence the same rules apply for tax risks as apply for recognition and control of
general business risks. Publishing the tax philosophy and tax strategy is important as is a
control environment that ensures that deviations from rules are dealt with. Only then does a
control environment actually exercise control. Establishing the control environment is
normally the duty of the board.
Effective control also implies that the tax department is subject to independent reviews
from internal audit. To review the tax processes professionals need to have adequate
knowledge and experience in tax. The review should address compliance with strategy and
policies as well as the quality of advice provided by tax staff to other functions 33 .
Profile, relationships and communication
The profile of the tax department should be one of a business partner across the various
business functions with clear contact points. The tax department has a role as both an
external and an internal contact point and therefore needs to be aware who its stakeholders
are (e.g. the tax authorities, financial market, legislators) are. Communication from the tax
30 KPMG Tax in the Boardroom, A Discussion Paper, 2004, page 7
31 SOX 404, 2002
32 Salzberger, 2005, Corporate Governance – Begriff und Aufgaben, page 167
33 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
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department needs to be in line with the established tax philosophy and tax strategy of the
business. External and internal relationship management is a key success factor.
Furthermore, it is important that the tax department goals and strategic drivers are
understood by the business as a whole and that there is awareness of tax issues throughout
the business.
The tax department should have a clear reporting line to the board. Boards need to be
informed about issues that could have material impact on the business. Frequency and
method of reporting can vary but should include a regular annual report on the state of the
company’s tax affairs. It is important to ensure that the board receives adequate data in a
digestible form. Reporting should embrace all taxes and include all tax systems at group
and business unit levels 34 .
Processes and technology
Processes and controls in a tax department should be documented not only to comply
with SOX and other corporate governance regulations but to allow regular evaluation and
improvement. The tax technology system should be part of the accounting system of a
business since significant information for the taxation process will be obtained from it.
Staff
The tax team needs to understand the business model a company acts upon. This
includes being aware of their role in achieving the business strategy. The mindset of the tax
department should be one of a service provider to internal clients. Within the department
clear roles around tax management and adequate support to internal clients will have to be
defined.
The success of a tax department depends to a great extent on the appropriate
qualification of the staff. The complexity and speed of change in tax regulations demands
ongoing training and specialisation 35 .
34 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
35 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
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Compliance
Compliance can only be assured if tax issues are identified and dealt with in a timely
way. This will only be achieved by awareness of tax issues throughout the business. A
close link between the compliance process and other tax functions (e.g. planning) is
important. One of the department’s goals will be to manage compliance efficiently to
ensure that tax processes are cost effective and also that no overpayment of taxes takes
place 36 .
Accounting
The accounting system is the basis for sufficient and accurate information for the tax
department. Accounting principles need to be understood by the tax department, just as the
accounting department should be competent to identify potential tax issues 37 .
Planning
The planning process should ensure that the tax department gets involved at the
strategic level at an early stage of projects. Tax planning can only be effective if there is
access to management information and decision makers of the business. Procedures need
to be aligned with risk policies. Furthermore it is essential to establish processes to monitor
the implementation and post-implementation stages 38 .
Coverage
Tax issues need to be on the agenda of the board. The tax department has to cover all
taxes adequately. If there is no operational control over certain taxes the tax department
should at least be able to exercise oversight and ensure that any necessary action is taken
by the appropriate party or engage specialist help as necessary. Any taxes not dealt with
within the tax department need to be clearly designated as the responsibility of another
department, i.e. wage tax dealt in the HR-department.
36 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
37 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
38 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
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Processes to raise awareness of tax issues throughout the business should be
implemented 39 .
V. Board responsibility
1 International focus on board responsibility for tax risk
management
The OECD has stressed the importance of board involvement in tax strategies of
multinational companies: “Encouraging management and audit committees of large
enterprises (e.g. CEOs and boards of directors) to take greater interest in, and responsibility
for, their tax strategies” 40 .
There is a clear expectation that the OECD will extend its guidelines on corporate tax
governance in the near future. The main responsibility for determining the global business
strategy on tax and ensuring that the system of internal controls is effective in facilitating
the application of this strategy is seen to rest with the board.
International reporting requirements have been extended with the introduction of SOX
404 and corporate governance guidelines in various countries. The standard FIN 48 under
US GAAP intensifies the focus on accounting and disclosures for uncertainty in income
taxes. The extension of reporting obligations is accompanied by an increasing interest by
stakeholders in risks resulting from tax issues.
So, to summarize, there are two very important challenges for the board. One is to
ensure the creation of an internal corporate environment that is handling all tax matters
appropriately and in line with the tax strategy. The second is adequate external
communication addressing the requirements of international reporting standards as well as
the information needs of external stakeholders.
39 KPMG Tax in the Boardroom, A Discussion Paper, 2004, Appendix III
40 OECD Final Seoul Declaration, September 2006
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2 Decisions to make and questions to ask
The board is responsible for the strategic direction of the company, the control
environment and the implementation of the internal control system as well as
communication with stakeholders. Each organisation will need to develop its own
particular way of managing tax. There is no ‘one size fits all’ answer because each
business has its own drivers and constraints. The following illustration outlines factors
with regard to direction and control that need to be considered. Additional influences come
from the external environment such as customers, investors and competitors. It is important
that the board delivers clarity around its direction and control of tax.
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Direction
The tax philosophy has to be determined by the board, documented, communicated and
implemented. It should be derived from and aligned with the overall management strategy.
One of the aspects that need to be taken into account is the general risk appetite of the
board which will be reflected in the tax risk attitude chosen. As the surveys have shown the
majority of board members would take a conservative view.
There is a spectrum of approaches towards tax that the board can adopt as the following
illustration outlines.
The board needs to decide whether the business should: be a leader by progressively
adding value through tax-driven business process and transaction design; take advantage
by devising and implementing progressive tax planning; or add value by exploring
opportunities including those above the profit line. Maintenance includes the enhancement
of commercial decisions already made and compliance requires fulfilling legal and
statutory obligations.
When determining the direction the board will also have to consider internal and
external business-specific factors. The internal factors mainly result from business goals
and strategy reflected in the core business processes which include the procurement
process, the provision of services or production and the sales process. As an example the
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decision as to the jurisdiction in which a production site is located will determine the
amount of labour taxes, transfer pricing requirements and customs duties.
In addition external factors such as market development, position of competitors,
expectations of customers and investors, as well as differences in national tax systems, will
have an influence on the tax direction of a business.
A final check of the areas outlined in the following illustration will cover most
significant questions.
For multinational businesses compliance is not a question but an obligation. Aspects to
consider on tax management are the cost compared to the gains from tax savings achieved
and tax risks avoided. Planning and accounting should take into consideration effects on
the profit and loss account and the balance sheet. This includes the deferred taxes shown in
the financial statements, that also need to be managed. Controls and reviews will involve
ensuring that the risk attitude of the board is reflected in processes and transactions. The
effective tax rate is an important factor for a company to increase value and stay
competitive in the market and with regard to attracting investors.
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Control
It is the responsibility of the board to ensure a control environment where there is a
common awareness of potential tax issues throughout the company. An effective risk
management system includes, essentially, controls that identify risks, analyse the impact
and define measures to manage risk 41 .
Control over tax issues is mainly executed through the tax department. The tax
department is responsible for the implementation of the tax strategy and for providing
adequate information to the board, but it is also part of the internal control system and
needs to be reviewed by internal audit. Adequate staff and ongoing training are critical
success factors to watch over.
To obtain an overview of the state of control the board can check on questions such as
the following: Does the board receive sufficient data and in a digestible form? Has the
company appropriate reporting lines and access to the tax function? Are responsibilities
defined and authority delegated as appropriate? Is the tax department set up in such a way
as to provide appropriate resources to implement the strategy? Is the quantity and quality
of staff appropriate? Are the appropriate controls in place? Are independent reviews of the
tax function carried out? As with any risk management system, effective tax risk
management requires that tax risks are identified, that they are analysed with regard to
their impact, and that measures are defined to manage them.
Communication
The right communication on tax issues is a significant factor for the reputation of a
company and therefore for the success of the business. In practice a reluctance to disclose
information on tax issues and tax risks in the annual report can still be found. This is often
because tax authorities have access to such information as well. There is a general concern
that through the report critical areas could be identified which then might be subject to
inspections by tax authorities. As a result statements on tax issues often remain generic and
too unspecific. However, communication of this sort is likely to trigger insecurity and
distrust and not to achieve its aim since tax authorities are focusing more and more on a
risk-oriented approach.
41
Dörner, Horvath, Kagermann, Praxis des Risikomanagements, 2000, page 109
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The main question that arises, therefore, is how to establish a system of communication
that informs stakeholders adequately and gives comfort to tax authorities as well. The right
message to investors, authorities and legislators is the key. One vehicle to convey this is
the annual report of the company. This gives the opportunity to state the overall tax
philosophy and strategy of the business. It should also outline the internal control process
for tax risks and include information on tax department structure and training. A
commitment to compliance with legal requirements is a significant statement to establish
confidence among stakeholders. Also important for investors is the message that within
legal boundaries the company seeks tax efficiency in the corporate structure, the supply
chain and acquisitions and disposals 42 .
Besides the question of what to communicate the company also needs to address the
questions of who to communicate to, and how. It is the responsibility of the board to
implement processes that identify, and establish relations, with stakeholders who have a
specific interest in tax issues of the company. This naturally includes the tax authorities.
An international business whose tax strategy is to be a leader will, for example, engage
actively in communication with legislators and international standard setters such as the
OECD. If the main focus of the tax strategy is on compliance and maintenance the
relationship management will concentrate on local tax authorities.
Good and consistent communication can only be achieved if the information reported
has substance. Unsupported general statements are likely to have an adverse effect on the
company if there are grounds to challenge them at a later stage. What the company
communicates has to reflect its policies and organisational culture as well as its relative
appetite for risk and opportunity.
42
The governance of tax, A Discussion Paper, KPMG Global Tax, 2006, page 15.
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VI. Future developments
Stakeholders do not always have the same interests when it comes to taxes. Companies
will need to balance the demands of reducing tax to become more competitive and at the
same time being good citizens and thus paying taxes. Tax may be expected to pose an
increasing reputational issue because of growing awareness of its ethical dimensions. The
expectation on companies to apply the concept of corporate social responsibility is gaining
more and more importance.
The OECD has announced that the Corporate Governance Guidelines will be expanded.
There will be a greater attention to the linkage between tax and good governance.
Furthermore the OECD produces statistics of international comparisons, engages in
monitoring and encourages the exchange of information between national tax authorities 43 .
Legislators are beginning to work globally on solutions for tax problems. The OECD has
established the “Forum on Tax Administration”, as a panel of national tax administrators.
Regulators such as stock exchange supervisors will extend the focus on internal control
systems 44 . In the US the Public Company Accounting Oversight Board (PCAOB) was
created by the SOX and is already focusing on audit of internal control systems to protect
the interests of investors and the public 45 .
International co-operation and information sharing between tax authorities will increase
significantly over the coming years. A joint international tax shelter information centre
taskforce was set in place by Australia, Canada, the UK and the US in 2004 46 . The
Committee on Fiscal Affairs of the OECD is working to improve exchange of information
both from a legal and a practical perspective. 47 The establishment of the “Leeds Castle
Group” which will be an extension of the IRS was agreed in 2006 and nine countries have
43 OECD, 2007, http://www.oecd.org/topic
44 Internal Revenue Services, Department of the Treasury , USA
http://www.irs.gov/newsroom/article
45 PCAOB, 2003-2006, http://www.pcaobus.org/
46 Internal Revenue Services, Department of the Treasury , USA, May 3, 2004
http://www.irs.gov/newsroom/article
47 OECD, 2007, http://www.oecd.org/topic
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already joined. The main goal is to discuss compliance challenges. For the first time China,
India and South Korea are included in such discussions 48 .
From an investor’s perspective there is a demand for increases in the value of the
company through sustainable tax rate reductions, and for ‘no surprises’. Long-term aftertax
performance indicators give a clear indication of the effectiveness of tax risk
management. Consequently, after-tax goals are greatly to be preferred as performance
measures for management.
The change in the role of tax from an internal domain of the tax department to the
external domain of stakeholders will continue and the challenges for the board will
increase. The changing environment will require tax risk management to move towards a
tax governance system.
Tax governance will have to cover the tax philosophy, tax strategy, internal policies and
processes with regard to tax risks, and external communication on all tax issues. The board
will be held accountable for setting a direction, implementing a tax governance system and
of course for value enhancement through tax reduction.
48 Internal Revenue Services, Department of the Treasury , USA
http://www.irs.gov/newsroom/article
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VII. Conclusion
The board is responsible for tax risk management and will be held accountable for it by
the stakeholders of the company. Challenges in the global capital markets result in
increasing expectations from stakeholders and in tightening regulation on corporate
governance with a strong focus on internal controls. Furthermore, companies are more and
more relying on their reputation of behaving in a socially responsible way as a factor
contributing to their success. These developments will cause a shift from the board being
in charge of tax risk management to a responsibility for tax governance as more widely
conceived.
Increasing requirements and challenges will cause ongoing changes for business with
regard to tax risk management and governance. The vision of an effective tax governance
system is to continually minimize the effective tax rate and add sustainable value to the
company. From a long-term perspective this is the best strategy for all stakeholders since
only a company that remains competitive and successful in the market can pay taxes and
contribute to society.
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