The Enterprise Risk Management (ERM) process should be a coordinated process envisioning a multinational’s tax risks around the world.
The evolution with BEPS, ongoing developments re: digital taxation, multilateral instruments (MLIs) becoming effective, permanent establishment (PE) changes, and countries enacting unilateral legislation inconsistent with international norms are some examples why international tax/transfer pricing should be among the top ten risks of most multinationals.
Legacy ERM procedures may not be as effective in the current tax world as they were recently. However, have multinationals really incorporated these changes into the ERM process re: uncertainty and risk management?
Members of the Board of Directors, responsible for ultimate risk, should also be asking this question as a reminder/refresher for the ERM process. Tax executives, knowledgeable of such risks, should also be proactive in this process to educate others about recent global changes that may impact their organization.
Questions and challenges for ERM should be developed as new tax legislation is becoming more complex and uncertain in countries around the world.
OECD has published new handbooks, one of which relates to country-by-country (CbC) reports and how tax administrations can incorporate this information into their tax risk processes, inclusive of risk tools and governance processes.
Other reports/handbooks have also been issued that will be a valuable reference:
- Tax Administration 2017
- The Changing Tax Compliance Environment and the role of audit
- Shining Light on the Shadow Economy
- CbC: Handbook on effective implementation
The public transparency of a company’s tax strategies is nearing reality with the advancement of recent updates to the UK’s Finance Bill.
The UK is continuing its leadership objectives in adopting BEPS initiatives, as shown in this latest initiative.
EY’s Global Tax Alert is provided for reference:
The legislation stipulates that the published tax strategy must cover in relevant, up-to-date detail regarding the:
• Approach of the UK group to risk management and governance arrangements in relation to UK taxation
•Attitude of the group to tax planning (so far as affecting UK taxation)
•Level of risk in relation to UK taxation that the group is prepared to accept
• Approach toward dealings with HMRC
The process of developing the public UK tax strategy should be aligned with the global policy and tax risk framework, especially as other countries look to follow the UK’s lead. Transparency is the key driver that continues to drive post-BEPS legislation, with no apparent slowdown envisaged.
The EY’s linked report summarizes 2015 disclosures in Sept. 2015 annual reports; most importantly the “acid test” summary, copied herein, provides an interesting perspective for addressing risks and a framework for the Board to consider.
As we conducted this review, we found that reading risk and viability disclosures in isolation was difficult. The importance of reviewing key related and relevant narrative disclosures e.g., business model and strategy, was brought to the fore. In our September 2015 report, ‘Reflections on the past, direction for the future’, we included an ‘acid test’ — a set of key questions that preparers or reviewers should be able to answer clearly having drafted the narrative within their ARAs.
We include our acid test here again to help preparers and reviewers put all disclosures in context. We believe that investors too should view the new disclosures with these same questions in mind.
Risk management and internal control disclosures:
- ► How are the principal risks mitigated and controlled by the company’s systems of internal controls and risk management?
- ► How does the board monitor material controls on an ongoing basis to gain assurance that principal risks are being effectively managed and to take corrective action if they are not?
- ► What did the board’s review of the effectiveness of these systems encompass?
- ► Has the board identified significant failings or weaknesses?
- ► What was the basis for determining what is ‘significant’?
- ► Is it clear what actions have been or will be taken to address significant failings or weaknesses?
- ► Over what time frame has the board considered the viability of the company and why?
- ► What process did the board use to assess viability?
- ► Does the board understand which,if any, severe but plausible risks (or combination of risks) would threaten the viability of the company?
- ► What assurance did the board obtain over relevant elements (e.g., stress testing)?
- ► What assumptions did the board use in reaching their conclusion?
- ► How does the company make its money?
- ► What are the key inputs, processes and outputs in the value chain, and how are the company’s key assets (including its physical assets, IP, people, technology, etc.) engaged in the value chain?
- ► What is the company’s competitive advantage?
- ► How does the business model help deliver and sustain this over time?
Key Performance Indicators (KPI’s)
- ► What did the board and its committees actually do in the year to govern the company?
- ► What, if any, changes were made to governance arrangements during the year and why?
- ► What areas for improvement were identified from the board evaluation and what progress was made against actions from the previous evaluation?
- ► How is board composition and succession planning being managed, giving due regard to skills, experience and diversity?
- ► How did the board seek to understand the views of shareholders during the year and what, if any, action was taken as a result of feedback?
Risk transparency and Board accountability for risks are increasing exponentially in the post-BEPS era, while tax authorities are simultaneously drafting risk-based legislation. The report is worthwhile reading and should provide an impetus for new Best Practices.
Principles for Responsible Investment (PRI), a UN sponsored initiative, published a report entitled “Engagement Guidance on Corporate Tax Responsibility.” The guidance is investor oriented addressing the conduct of corporate tax responsibility, disclosure, transparency and good tax risk governance. Therefore, this report is a valuable reference to understand today’s trend of tax disclosure and transparency from an investor’s perspective, and how multinationals may be queried in the new world of international tax transparency.
A link is attached for reference:
- Earnings that rely on tax planning vs. economic activity are vulnerable to tax regulatory changes, earnings risk via strategies are increasing, and some Boards may be unaware of the effect that incentives have on tax planning.
- Corporate sustainability officers should understand tax decisions and their impact on financial results and stakeholders, with alignment between tax strategies and sustainability commitments.
- ” Companies should be able to defend how they allocate profit to each country both to tax authorities and the general public to avoid reputational risk and investor backlash.”
- Before engaging with companies on tax practices, investors should understand various strategies, including IP transfers, financing, marketing service arrangements, principal structures, tax havens, shell companies and tax incentives, that are summarily explained.
- A step plan to engage companies:
- Identify red flags, including a formula to measure tax gap
- Questions for Senior Management/Board re: tax policy, tax governance, managing tax-related risk, effective tax rate, tax planning strategies including structure and IP rights, and country-by-country (CbC) reporting.
Appendices are provided for additional reference of the OECD BEPS project, examples of good tax practices re: disclosures, summary of findings from discussions with Heads of Tax in eight multinational organisations, and a Glossary / Resources.
The report, in providing formulas and explanations, includes educational material for the investor community re: tax strategies and governance, while also providing examples of tax queries and good tax governance by many multinationals.
The report should be used as a metric to assess readiness and alignment for these important topics that may be raised by stakeholders, both internal and external. To the extent such questions have not been a primary focus, this report is an impetus to raise the priority threshold in addressing tax policies, strategies and governance in a very transparent world. Additionally, it is also worthy to review the names of multinationals cited in the report for awareness and recognition.
Global mobility will face, directly and indirectly, various challenges resulting from OECD’s BEPS proposals. PwC’s Insights provide a concise summary of these proposals, included for reference:
- Treaty changes, either bilaterally or via the Multilateral Instrument, will affect key issues and risks, including permanent establishment (PE).
- Unilateral changes, several of which have been enacted, should be reviewed with a focus on global mobility functions.
- The transparency initiative will encourage tax authorities to aggressively pursue PE and treaty based rules.
- What is the impact of the change for PE dependent/independent test.
- Responsibilities of senior executives, sales representatives and regionally based employees will need to be reviewed for the new rules.
- People functions re: controlling risk should receive separate review.
- Intercompany agreements (i.e. legal form) should be compared to practical substance responsibilities to evidence conformity, as analyses will use legal agreements as only a first step to understand the transactions and potential consequences.
Post BEPS, it is imperative that global mobility’s function and responsibilities should be reviewed, from a tax risk awareness perspective as well as internal governance controls. To the extent that global mobility is not closely collaborated with the tax function, the ways of working and reporting should be reviewed to address this new world of international tax transparency and the emphasis on multinationals paying their fair share of tax, however construed.
The latest EY tax risk and controversy survey series, entitled A new mountain to climb, provides some insights re: preparing for and proactively management tax / reputational risks. A link to the report is provided for reference:
- Media coverage of how much companies pay in tax / low effective tax rates is extensive, although engaging with the media is seen by many companies as a “no-win” situation.
- Leading companies have transformed the process of communication for tax risks and controversy to internal and external stakeholders.
- Transparency is providing information to tax authorities re: how much tax is being paid in other jurisdictions as a tool to decide if the company is paying enough tax in their jurisdiction.
- Global disclosure and transparency requirements will continue to grow in the next two years.
- Transparency readiness of companies is a significant and underestimated need.
- Direct ERP access by tax authorities represents a next phase of risk assessment.
- Transparency readiness can help mitigate reputation risk.
- Reputation risk strategy elements:
- Actively monitor the changing landscape.
- Assess readiness/desire to respond.
- Enhance communication with internal and external stakeholders.
- Gain insight into the total tax picture through the lens of public perception.
- Decide with whom the company wishes to communicate.
- Embed reputation risk thinking into core business strategy.
- Transparency is the new norm, and (media) reputation risk may be a permanent risk.
Transparency demands have created a new toolbox required by all multinational organisations.
A tax policy and reputation risk strategy should be essential tools in a comprehensive tax risk framework. The EY report is required reading for all parties interested in learning more about tax risk trends and Best Practice ideas to proactively address the new world of transparency.