Tax Risk in the Boardroom - Deloitte & Touche Canada

The Directors’ SeriesTax Risk in the BoardroomNovember 18, 2004

Our Panel• Mark Robinson• Harry Schaefer• David Ward• John Stacey• Rob O’Connor

Pressure on Boards of DirectorsPoliticians PoliticiansSecurities SecuritiesRegulators RegulatorsInstitutionalInstitutionalInvestors InvestorsProfessional Professional &Business Business Groups GroupsHarmonizationHarmonizationWith With SEC SECBoards of DirectorsAndAudit CommitteesSmall Small Cap CapCompaniesCompaniesPhase 1 Phase 2 Phase 3FinancialReportingCorporateGovernanceCivilLiabilityMultilateral Instruments(52-108 to110)National InstrumentProposalProposed Legislation(BC and Ontario)

Agenda• Tax Risk and the Corporation• Panel Discussion• Tax and Issues of AuditorIndependence• Panel Discussion• Open Forum: Ask the Panel Q&A

On a scale of 1 to 5 rate yourlevel of knowledge with respectto tax risk.1. Poor level2. Low level3. Intermediate level4. Good level5. Excellent level

De-Mystifying the “Black Box”• The importance of tax• Where tax risk resides• How tax risk is like any other risk• The issues surrounding the taxprovision• How SOX fits in• How to manage tax risk• What should Boards be doing

Lucent TechnologiesMicrosoftWasteManagementDynergyGlobal CrossingCMS EnergyTrumpHotelsWorldcomNortelComputerAssociatesAdelphiaCommunicationsMerrillLynchTyco

… And visibility will continue...

Regulatory Focus on Taxes“Sunlight is said to be the bestdisinfectant, and the area ofincome tax accounting coulduse more sunlight.”Donald T. Nicolaison,Chief Accountant of the SEC,February 11, 2004

“… as with other risks, I think it isimportant that the board identifythe taxation risks associatedwith their organizations’ operations,which risks are acceptable andappropriate, and which are not,and put in place a process for themanagement of those risks.”Australian Commissioner of Taxation

Defining TaxOur educated guess: “taxes”broadly defined might representabout 1/3 of total costs ofcorporationTax is perceived as a meaningful part of thebreakdown of public accountability. It mustalso be seen as a meaningful part of thesolution.

Examples of tax impacts on thefinancial statementsIncomeStatementSalesCost of GoodsSoldS, G, & AIncome TaxExpenseBalance SheetExamples of Where Tax is Embedded• Sales and use taxes (GST, PST)• Cross-border issues• Custom duties• Transfer pricing issues• Property taxes• Payroll taxes• Employee benefits• Provincial Capital taxes• Federal income taxes• Provincial income taxes• Foreign income taxes• Taxes payable/receivable• Future income tax assets/liabilities• Unclaimed property liabilities

What percentage of a company’stax risk is under the control ofthe tax department?1. 100%2. 80%3. 50%4. 30%5. 10%

TEI SurveyWhich of these business areas is yourorganization’s most significant sourceof tax risk?

2%21%36%Cross BorderM & AMarketingHead Office18%Tax Function14%3%6%Business UnitsNo response

“Tax Risk” – What is it ?Tax Risk is found in thetransactions, routine and nonroutine, that a company undertakesand in the people, policies andsystems that are employed andchange over time.

SOXCan’t afford to abdicateresponsibility for tax issues andyou also can’t depend solely onSOX

SustainabilityIdentification&AssessmentCommunicationPolicy& StrategyCLIENTRisk Areas& ControlsExecution

Number Specific Risk Exposure %1Unexpected tax costs and missed opportunities arising from complex,historical transactions, claims and elections - -2 Transfer pricing adjustments or errors due to cross border transactions, f 10,000,000 803 Inadvertent creation of CFCs or failure of CFCs to meet exemptions - -4 Inadequate or inappropriate provisions 5,000,000 805 Tax exposures arising from Treasury policy - -6 Inaccurate valuation of IP 5,000,000 707Tax law & environmental changes impacting Group tax profile &/orincreasing risk of additional challenges - -8 New tax products and services launched without adequate tax analysis- -9 Advers e impact arising from inadvertent change in company residence- -10 Tax risks arising from joint ventures (eg. Timing/flow of money) - -11Failure to maximize use, or lack of consideration outside tax function,of tax attributes & assets - -12 Management fees 5,000,000 9013 Loss of tax knowledge when people leave - -14Additional tax costs due to insufficient/in effective implementation &maintenance of planning & strategies - -15 Withholding tax errors on royalties and interest 4,000,000 8016 VAT errors on financing and cash-pooling - -17Tax costs arising due to inaccurate/unrealistic forecasts & financialinformation - -18Unexpected tax costs and missed opportunities on fixed assetpurchases, leasing or financing - -19Tax compliance inefficiencies/inaccuracies caused by inefficientaccounting systems & local GAAP reporting - -20 Availability of historical information & inadequate document retention - -21Tax advisers unaware of cross-border transactions or other significanttransactions - -

SustainabilityIdentification&AssessmentCommunicationPolicy& StrategyCLIENTRisk Areas& ControlsExecution

TEI SurveySelect the top three most significant factorsyou take into account when decidingwhether to go ahead with a tax planning idea(in order of significance).

4035302520Rank #1Rank #2Rank #3151050Technical Strength Reputational Risk Exit Strategy Aggressiveness Size Downside Ability to Execute

Decision Support SystemTax risk managementPolicy & strategy – Making the right decisionAbility to execute10PolicyTax structureAggressiveness86Return on investment4Reputational impact20TermSizeStrength of Advisers' opinionChange of law risk

TEI SurveyDo you currently have a formalized anddocumented policy that stipulates whenthird-party approval (e.g. CFO, AuditCommittee) is required in decision-makinginvolving tax matters?

2%26%YesNoNo Answer72%

What do we believe Boardsshould be doing• Involved in policysetting/approval• Discussing critical risk areasand risk mitigation strategies• Considering disposition of nonroutinetransactions andsignificant exception items

Benefits Beyond Compliance• A tax risk management framework• Improved communication• Simplified provisioning process• Achieving a balance between riskand opportunity• Better employment of taxdepartment resourcesThe need for proactive tax riskmanagement has never been greater

Have the companies where yousit on the board separated theiraudit and tax service providers?• Press the Greenbutton if theanswer is ‘YES’.

Capital Market Reform – U.S.• Sarbanes-Oxley – reforms onauditor independence, corporateresponsibility, accountability andfinancial disclosure obligations• PCAOB – sets public company auditand independence standards,effected through SEC approval

Capital Market Reform -Canada• Legislative Reform – Ontario Bill 198• Regulator Reforms• The CA Profession• CPAB

Guiding Principles forAuditor IndependenceAn auditor cannot:1. Audit his/her own work2. Function as part of managementor as an employee of the client3. Act as an advocate for the client4. Promote the company’s stock orother financial interests

Key Messages:• Tax Services are Permitted• Auditors have traditionally providedtax services to their audit clients• Generally, tax services are not seenas a threat to auditor independence

Pre-approval by the auditcommittee needs to begranted for all servicesprovided by the auditor,including tax services

Benefits to Using Your Auditorfor Tax Services1. Client service can be strengthened bythe tax and audit Relationship2. Better tax advice can result frombroader knowledge3. Broader information can reach theBoard4. Cost saving to the audit5. Financial statement disclosure can bebetter served

Tax Services seen to impairauditor independence1. Tax outsourcing2. Tax ideas promoted by theauditor only to save tax3. Representing an audit or reviewclient in a court or court-likeforum that has the jurisdiction todeal with tax matters? Compensation planning forsenior executives

Contingent Fees• By their nature, are controversial• Potential for alignment of interestthat needs to be considered• Mitigating factors that offsetalignment

Research• What are Canadian CompaniesDoing?• Deloitte surveyed 26 of themost highly ranked companiesfor governance and in the top250 of the FP500

Research Results27% Auditor as prime tax provider42% Restrict Auditor31% Do not use Auditor for tax

Board Considerations• Boards may be faced withtradeoffs - public perceptionand best service• Set policies that do not blockaccess to the best servicesprovider• Protect reputational risk

Q & A Session:• Jim Goodfellow• Mark Robinson• Harry Schaefer• David Ward• John Stacey• Rob O’Connor

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