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 News | November 21, 2008 |
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Tax risk management in Australia: key stakeholders and their obligations?
The tax world is changing. Mick Hall discusses the issues and their impact on stakeholders, as well as recommending actions a corporation can take to best respond to the new environment
A complex and diverse tax environment
Business today is dealing with a complex and diverse tax environment. Not only is there unprecedented volatility in the tax regime, but also in June 2003, the Australian Tax Commissioner, Michael Carmody, articulated that he expects tax planning, compliance and processes to become part of a corporation’s good governance protocols.
These developments have significant implications for the role and responsibility of the key corporate stakeholders. Company directors, board audit committee members, the chief executive officer (CEO), the chief financial officer (CFO) and the tax manager now need to be fully on top of tax in their company. Each stakeholder will have different areas of focus and a different attitude to risk and the levels of comfort required to sign off on their new-found obligations.
Board of directors
Expectations of good governance have put tax firmly on the boardroom agenda. Obligations stem from the Income Tax Assessment Act, the Corporations Act and the Australian Stock Exchange (ASX) Principles of Good Corporate Governance and Best Practice Recommendations.
Principle 7 of the ASX guidelines impacts directly on the tax dimension of the listed entity. This principle requires companies to “recognise and manage risk”, and the board is required to “establish policies on risk oversight and management”. The annual financial report for periods commencing after 1 January 2003 will require the company to identify where this guideline has not been met.
Tax Commissioner Michael Carmody also has expectations of company directors: “Judgements about tax compliance need to be part of the Corporate Governance processes of every Company and Board” (ATO Large Business and Tax Compliance, June 2003). The Tax Commissioner has further detailed advice for individual directors and executives. In his view, each director needs to focus specifically on at least seven dimensions of the tax affairs of the corporation, ranging from tax compliance systems to analysing the tax outcomes of transactions contemplated by the company.
These expectations mean company boards must create tax risk frameworks and tax management processes to ensure they are fully informed on the outcomes of the company’s tax process, enabling them to meet their external reporting obligations. Major transactions will also require a board to be fully, and possibly independently advised on tax aspects of the transaction.
This approach might be seen to create a significantly more conservative rather than an aggressive tax outcome and possibly a reduced appetite for disputes with the revenue authorities. On the other hand, we should expect directors to elevate the level and breadth of debate in the business community on development of tax policy, tax law, and good tax administration.
It is hard to imagine that causing board-level company officers to get deeply involved in tax as outlined above won’t allow for a more significant review of the tax obligations expected of the large corporate sector.
Board audit committee
The board audit committee will ensure that management, external auditors and external advisers understand the company’s risk appetite and policies. Typically, the committee will expect these people to operate within established guidelines and create the channels that ensure access by the board to all relevant data. The committee will also be charged with oversight of a risk framework and risk management policies and strategies that deal specifically with tax.
Chief executive officer
CEOs are typically responsible for development of strategy that will achieve the goals set under board direction. Delegation to line executives will need to include an accountability structure that realises the vision of governance and disclosure protocols adopted by the company. Satisfying the Commissioner’s vision will require another level of performance.
Clearly the CEO will need to ensure board reporting is driven by a properly defined risk framework and that resources are appropriately deployed to achieve the level of managed risk and tax outcome that is accepted by the corporation as a whole. Given current heightened expectations, it is possible that resources allocated to tax management will need to be increased.
The CEO will also need to provide leadership for those within the company involved in the tax process to ensure proper resourcing, both in respect of type and volume, directed to meeting the tax goals for compliance and fiscal outcomes. This is in the face of Australian and global evidence that Ernst & Young has collected which shows tax budgets within corporations have been largely static in amount, and headcounts have been falling, notwithstanding the ongoing tax reform process.
Chief financial officer
The CFO is classically seen as the ‘owner’ of tax. In this changing environment there will be greater interest in planning and budgeting for tax outcomes, establishing specific tax risk management approaches, and ensuring that reporting protocols go beyond the annual reporting requirements. CLERP 9 obligations concerning continuous disclosure provide some interesting challenges.
The situation is further complicated by a seeming mismatch between ATO assessments raised on audit activity and actual collections. The Tax Commissioner’s own data indicate a $5 billion dollar gap, with $7.6 billion assessments raised on audit activity for tax and penalties over the five years to 2001-2002, compared to collections of $2.66 billion during the same period. There are clearly many circumstances in which items in dispute on assessment are deferred pending the final determination of the substantive issue. This must remain an accessible and equitable feature of the tax landscape. However, this presents CFOs with some major dilemmas:
Disclosing liabilities
As with the determination of the disclosure of any liability in the financial statements, a two-step process is required for tax liabilities. It is first necessary to determine the existence of a liability, with the Income Tax Assessment Act providing that the issue of an assessment gives rise to a prima facie statutory liability.
The second step in the process is for the directors to determine the amount of that liability and when payment will be due.
There have been many instances when the ATO’s and the taxpayer’s view of the existence or amount of a liability do not match. Typically, these matters will be obvious to the CFO and other interested internal parties (the CEO and Board) and a specific decision will be made on whether to accept the liability and the amount of the possible final obligation when the issue has been tested.
Potential disputes
More problematic, however, are cases in which the ATO view is not yet known but some action has begun. In our experience, determining the final outcome of a contentious tax matter is a difficult and winding road. Even today, relatively recent events are being judged not by the standards in force at the time of the event but against the most recent and rapidly evolving tax law interpretations and ‘community expectations’.
Throw into this mix a body of tax law that is becoming more and more prescriptive and at the same time less based on historical principles and jurisprudence, and the opportunity for the courts to provide clear decisions based on established principles is rapidly disappearing. In such an environment there are great benefits in articulating within a corporation’s risk frameworks the guiding principles upon which management of tax matters, their reduction to financial statement outcomes and the exercise of the full rights of objection and appeal will be based.
The CFO has many layers of interest in this area. In addition, there is a tension between the ongoing commitment to full disclosure and any disadvantage to the corporation’s negotiating position with the ATO when that information is made publicly available.
Changing nature of tax items
It is also an easy mistake to think of tax only in terms of large items that arise from specific circumstances or transactions. If a well-developed risk framework exists, large items will almost certainly get the right attention and decisions will be made at appropriate times and with optimum input. However, over time we have introduced to the tax system many obligations that accrue on large volume, relatively low value transactions. The most far-reaching example is GST.
Typically, these items will have their ultimate tax outcome determined at their originating source. The transactions will be tagged so their tax outcome flows through the financial systems to IAS, BAS, income tax return or financial reports. Best practice suggests ‘one-touch’ identification of these items – indeed, this is a practical necessity, but it is here that integrity of systems, appropriate skills and information sharing are essential to achieve reliable end results.
The risk framework as a solution
The risk framework must not only identify these areas of activity but also ensure proper risk identification, establishment of control features and continued and consistent application of the system. Without these features, major unidentified risk can accumulate. Normal exception reporting is not likely to find items that are going wrong as they now represent the population of transactions. Problems are only identified by some discontinuous event such as an ATO audit. By this time, the opportunity for self-management of the issue and penalty mitigation by voluntary disclosure will almost certainly have been lost.
In reality, left unattended these risks can be the CFO’s worst nightmare. A more pro-active approach, however, is not only better business but will enable proper internal and external reporting.
Tax manager
So far we have focused on the ‘new’ stakeholders. However, the role of the in-house corporate tax manager is not immune from the influences already addressed. Technical competence remains an almost insurmountable challenge, given the enormous volume of business tax reform that Australia continues to experience.
The implications for knowledge management systems, technical resources and capable practitioners are profound. We have seen exponential growth in the complexity of the task that lies before tax managers, without an increased appreciation of the ‘value’ created by an effective tax function. The value exchange in respect of tax must be understood, having regard both to the cost of tax to the enterprise as well as its obligations.
The cost of tax management to the enterprise needs to be a holistic accounting, including not only the traditional profit and loss and cash tax charge but also the internal and external costs incurred in managing those financial statement items. Internal tax functions’ salaries, occupancy, subscription and adviser fees, and so on are easily identified. The cost of unmanaged tax risk is almost certainly not identified and it should be anticipated that it will exceed by several times those easily identified costs.
Clear performance reporting on meeting lodgement and timely payment requirements are almost universally accepted as a minimum standard for the tax function. Superior performance therefore will only be evident where the tax function is seen to have impact across the whole of the enterprise to achieve agreed tax outcomes, to achieve fully functioning tax risk frameworks, and to participate in strategy development and alignment of corporate and tax goals.
Greater visibility for tax, both across the breadth of the corporation and vertically through the management and reporting hierarchies, is a key to success.
What you can do
So, what should be done in the face of these gathering storm clouds? Our Top Ten recommendations are:
• Know your tax risk profile and your tax risk appetite;
• Build a formal tax risk framework with fully developed risk mitigation and management strategies;
• Get the ‘hygiene factors’ right – don’t be caught on tax issues that are clearly errors or non
-contentious items;
• Take a ‘whole of enterprise’/all taxes view – income tax, GST, FBT, stamp duty, PAYG, payroll tax and so on;
• Be prepared – your first interaction with the ATO is profoundly important – make it a good experience for both sides;
• Don’t despair – tax is still governed by law and many of the processes recommended are just good business;
• Maximise the benefits of cooperation, both to yourself and the ATO, but know your limits;
• Know how tax impacts your business activity and how your business activities impact your tax obligations;
• Get involved in tax policy development and ensure the tax laws work;
• Be ready and stay committed – taxes are not going to go away!
The implications of this changing environment may be seen as a further burden on an already overstretched corporate and tax sector. There is also a clear opportunity to create a new world of tax in which the corporate sector identifies and meets its obligations to the community, and manages the risk of getting things wrong to acceptable levels. If the right people commit, we may elevate tax debate to a fully developed and understood business issue.
Mick Hall is a partner with the tax and legal services division of Ernst & Young
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31 January 2006
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