Global Tax Audit & Controversy Risk Management Process – PART 1 OF 5
www.TaxRiskManagement.com (“TRM”) have maintained in our publications and workshops over the years that managing tax risk is one of the greatest challenges for tax departments around the world (creating the opportunities to build lasting world class relationships with Revenue Services), starting with the verification audit through to the resolution of tax controversies. A recent big 4 survey supports this contention. More than 540 companies from 18 countries took part in a fairly recent survey aimed to identify global trends in tax function priorities, time allocation and success measures.
Key aspects that emerged can be summarized as follows (key points are highlighted):
Tax risk is everywhere
… companies continue to face increased pressure on the tax function. As a result, tax functions are focused on addressing risks in every major area of the tax lifecycle – planning, provision, compliance and controversy. Improving the tax function is clearly more important than ever, with more than 90% of companies indicating this will be an important area for them over the next two years.
People are a tax risk
87% of respondents identified people issue as an important challenge facing the tax department. Companies are struggling to get enough people to staff their tax department. They are also challenged to train the people they have, with 77% of companies indicating that the lack of skilled resources is a contributing factor to tax risk.
The trend – proactive versus reactive
Today, companies report a significant increase in the time they’re spending identifying, managing, tracking and responding on tax risk. The number of companies who spend at least 20% of their time on tax risk increased over the last two years from 16% to 25%. Leading tax functions are responding by becoming more efficient and broadening their response to risk. Building linkages to other parts of the organization is becoming increasingly important.
Communication is key
According to our findings, companies that have regular communications with their board about tax risk are also more likely to report having specific measures in place to address those risks. The difference seems to be that they take a broad approach to tax risk assessment and work to efficiently leverage their people, processes and technology.
Throughout the world, any tax question or issue (before it becomes material) should be considered at a central division or consultation facility in order to determine what the approach should be to that question or issue – after being exposed to the proper factual analysis, and then to the applicable broad set of legal principles – tax and constitutional & administrative law. Without a central considering authority, one can never know in a large organization exactly where a tax review (potential or actual) may end up. Stated otherwise, group tax will not know exactly what is going on if each and every tax review is not reported to a centralized office that will then in turn decide how the matter should be dealt with.
The lessons learnt from the many clients TRM have consulted to show the following trends must be maintained:
§ up-to-date international best practice;
§ relationships with Revenue Services;
§ engagement with Revenue Services at various levels;
§ analysis and resolution of potential and actual tax reviews;
§ record keeping, filing and data securitization
The aim of this report
The aim of this report is to convince the head of group tax that the appropriate emphasis should be placed on the tax audit process through a tried and tested methodology, where this area of tax risk management can be streamlined and improved, in line with the lessons learnt by TRM in acting for multi-national corporations in reducing potential tax exposure on tax controversies from 100% to a mere 3%.
The focus is a pro-active engagement with Revenue Services, supported by a process (analyzing & strategizing the facts & law, through to a data securitization process) to deal with potential tax exposure issues before they become material risks. This precise methodology is currently not followed by most corporations as expounded in the textbook ‘Tax Intelligence’ written by Prof. D N Erasmus, the Chairman of TRM. It is a process that has significant merit in the correct circumstances.
These circumstances include a global environment where there is:
§ ‘country collusion’ between Revenue Services;
§ increased verification audits through Large Tax Units (LTU’s), and in the areas of indirect taxes, transfer pricing, and anti-avoidance;
§ more litigious Revenue Services; and
§ global tax administration.
The challenge in convincing the head of group tax is that this area of tax risk should be a high priority, and should be implemented on a broad scale across the group, region by region, in a staged manner. The urgency with which this must be done will become apparent from the results of the survey, that will justify the additional time and expense. It is also noteworthy that the benchmark case study recognizes this as a high priority and has commenced an implementation process.
Analysis of various sources to compile this report
This report has been compiled after analyzing various information sources.
The OECD Centre for Tax Policy and Administration released its first report dated 28 January 2009, prepared by the Forum on Tax Administration under the then leadership of Pravin Gordhan. The report is headed Tax Administration in OECD and selected non-OECD countries: Comparative information series.
In addition to this, and the analysis of various EU and Latin America Tax Reform and Development texts, numerous survey questions were prepared. Careful analysis was made of tax policies, processes and procedures to create a benchmark against which group tax information can be compared.
The OECD report covers 43 countries. We applied the information of that report to one of the top 50 taxpayers in South Africa, and established the following:
Of the 43 countries that participated in the report, 15 countries group operations in them. They are as follows:
EUROPE: Czech Republic, Germany, Hungary, Poland, Romania, Italy, Netherlands, Spain & UK
ASIA: Australia & China
AFRICA: South Africa
NORTH AMERICA: Canada, Mexico & USA
LATIN AMERICA: Non – although many Latin American countries are in a tax transition phase, and are in the process of following the tax reforms initiated in some of the former Eastern Bloc countries that have joined the EU.
In addition to the above, the Group Financial Statements make the following disclosure:
Company law requires the directors to prepare consolidated financial statements for each financial year. Under that law the directors have prepared the consolidated financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The consolidated financial statements are required by law to give a true and fair view of the state of affairs of the group and of the profit or loss of the group for that year.
This requires comment – During February 2006 the FASB and the IASB concluded a Memorandum of Understanding stating their intention to seek a convergence of their standards and interpretations by 2008. FIN 48 is the FASB standard, requiring a two-step evaluation:
§ the business determines whether it is more likely than not (50% or greater likelihood) that a tax situation would be upheld in an examination, including resolution of any potential ensuing litigation process, based on the technical merits of the tax situation;
§ the tax situation that meets the more likely than not recognition threshold is measured to determine the amount to recognize on financial statements.
As a result, the advent of FIN 48, like SOX 404, underpins the requirement for businesses to embark upon a systematic TRM process to limit and expose, with the view to efficiently minimizing the incumbent tax risks. IFRS looks to do exactly the same.
The group has an extensive worldwide TRM process in place. The process works on a decentralized basis where each business unit reports to group tax risks when they become material. The gap between the commencement of verification audits and the creation of a tax dispute (when it becomes material) is an area of TRM that we propose requires more careful attention, in each region, to ensure better risk management of any potential emerging tax risk exposure, before it becomes material.
TO BE CONTINUED…
Prof D N Erasmus is teaching the International Tax Risk Management class for the LLM in International Taxation at Thomas Jefferson School of Law, this summer semester. He is co-author of the IBFD Tax Risk Management textbook available from www.IBFD.org, and Tax Intelligence (on Tax Risk Management) available from www.Amazon.com. Connect with him on TaxConnections.