Strategizing International Tax Best Practices – by Keith Brockman

Posts tagged ‘tax risk’

ERM: Tax risk

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.

 

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Tax Risk Management

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OECD: CbC-Effective tax risk assessment

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

 

Click to access 2017G_05389-171Gbl_OECD%20publishes%20two%20handbooks%20on%20Country-by-Country%20reporting.pdf

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OECD

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Tax strategies: UK transparency

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:

Click to access 2016G_00446-161Gbl_UK%20amends%20mandatory%20requirement%20for%20businesses%20to%20publish%20tax%20strategy.pdf

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.  

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Tax Risk Management

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Risk disclosures: Best Practices

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.

Click to access EY-Rising-to-the-Challenge.pdf

Our ‘acid test’

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?

Viability statement:

  • ►  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?

Business model:

  • ►  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?

Strategy:

  • ►  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 are the key metrics the board uses to measure progress against its strategic objectives?

    ► How has the company performed against these metrics and how are these linked to the remuneration of key executives?

Governance:

  • ►  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.

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Tax Risk Management

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UN: Corp. tax responsibility

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:

Click to access PRI_Tax-Guidance-2015.pdf

Key points:

  • 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.

Best Practices:

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.

 

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OECD / UN

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Global mobility & BEPS risks

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:

Click to access pwc-oecd-final-beps-package-what-does-it-mean-for-global-mobility.pdf

Key points:

  • 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.

 

 

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OECD

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New age of transparency / reputational risks

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:

Click to access ey-managing-tax-transparency-and-reputation-risk.pdf

Key observations:

  • 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.

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Tax Risk Management

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Reputation risk: are you ready?

EY’s article highlights the importance of planning a proactive risk strategy re: reputation risk.  A link to the article is provided for reference:

http://taxinsights.ey.com/archive/archive-articles/six-actions-that-help-you-mitigate-reputation-risk.aspx

Key observations:

  • Six distinct actions
    • Actively monitor the changing landscape
    • Assess readiness/desire to respond
    • Enhance communication with stakeholders
    • Drill into the details to prepare the total tax picture
    • Decide on whom communication is  to be established
    • Embed reputation risk into daily business strategy
  • Questions for self-assessment, gleaned from this topic:
    • Who monitors media coverage of the company
    • Who monitors social media channels re: the tax function
    • Who monitors new tax disclosures to assess trends and new compliance requirements
    • Is the tax structure transparent re: taxes paid by country
    • Do profits and taxes paid align?  If not, rationalize the gap
    • Who follows tax litigation in each jurisdiction
    • Is the (tax) risk officer aligned with tax strategies
    • Are Board members aware of new documentation requirements to assess tax strategy around the world
    • Has the legal team been educated on BEPS actions and related company strategies
    • Is there a metric to measure reputation risk
    • What new disclosures are taking place
    • Will the company address questions from the public
    • Should more tax information be disclosed to mitigate reputation risk
    • What information is shared with investors; does the current process need to be reviewed
    • Is tax risk an element of every new business initiative/strategy
    • What functions are aware of BEPS and the changing landscape

This article is a snapshot for an increasingly important risk: a company’s reputation.  As new tax disclosures emerge around the world, interrelated with Board awareness and acknowledgment, it is imperative that the subject of reputation risk is addressed as an immediate priority by all companies.  As soon as there is damaging press, truthful or not, it may be too late to respond.

This subject is also of importance for tax administrations: tax information is confidential and technical areas may be unclear, thus a company’s rights should be protected while an issue is raised, investigated and ultimately resolved.  The tax administration’s reputation risk is also of paramount importance, as it looks to increase trust and establish an understanding of a company’s functions, assets and risks within the relevant jurisdiction.

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Tax Risk Management

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Tax risks: Audit committee perspective

Deloitte’s Audit Committee Brief includes a summary and questions outlining Risk oversight and Tax considerations for audit committees.  A link to the publication is provided for reference:

Click to access ACBrief_NovemberDecember2014.pdf

Key observations:

  • Audit committees may have a risk committee (Will this be a continuing trend?)
  • Tone at the top is imperative for effective risk oversight
  • Insightful questions for consideration:
    • What internal controls are in place to address significant tax risks?
    • Is there a clear approach and justification for where risk issues are placed?
    • Is there a widely communicated process to quickly bring risk-related issues to the Board?
    • What issues should the audit (risk) committee be aware of when evaluating potential risks?

Risk governance is rapidly becoming the new norm, both by tax administrations to understand and rate risks of a taxpayer as well as an effective tax risk policy and framework for a multinational to identify and mitigate risks.  This trend will require additional resources to fulfill such commitments, immediately and ongoing.  

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Tax Risk Management

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Tax Risk Training: Tax Risk Framework element

As tax authorities, most recently Australia and UK, place added focus on a tax risk framework and providing evidence of diligence re: such procedures, it is critical that new financial leaders receive tax risk training upon entering an organization as well as a review on a recurring basis.  The training should also be reviewed and updated annually for new developments.

Examples of topics for discussion:

  • Beneficial ownership & disclosures (coordinated with Treasury Know Your Customer perspective)
  • Permanent Establishment (PE)
  • General Anti-Avoidance rules (GAAR)
  • Transfer pricing methodologies, internal governance procedures
  • Transfer pricing documentation process
  • BEPS governance strategies
  • Financial statement tax reserve criteria and timing
  • Interrelationship of domestic law and double tax treaties
  • Tax policy
  • Elements of tax risk framework
  • Tax audit protocol
  • Tax audit methodologies
  • Customs / Transfer pricing coordination
  • BEPS Country-by-Country report, future trends

The training generally provides additional awareness, thereby mitigating tax risk exposures and providing a win-win opportunity that cascades across the organization.

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Tax Risk Management

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Tax Transparency: Pension/Institutional focus

The referenced article provides additional evidence that tax transparency is growing more universal and attracting the interest of many interested parties.  A quote from the first portion of the article addresses interest in a taxpayer’s tax risk framework and governance procedures.

“In an exclusive interview with FTFM Local Authority Pension Fund Forum Chair Kieran Quinn has confirmed that the Forum has launched the Corporate Tax Transparency Initiative (CTTI), writing to every FTSE 100 company in late March seeking technical information via ten detailed taxation questions around tax related governance and accounting practices, taxation risk.”

management and minimisation strategies.http://www.lapfforum.org/news/lapff-seeks-tax-transparency-from-ftse-100

This article raises the question of what public tax posture, if any, companies want to exhibit to address tax authorities, individuals/companies having access to company data, individual / institutional investors, pension funds, etc.  This topic relates directly to reputational risk, and should be aligned with the Board and senior management.

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Tax Risk Management

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Tax Risks: strategic personal development objective

The subject of international tax risk for multinationals is growing exponentially every day, although there does not seem to be a significant focus on the commitment in personal development plans for the identification, assessment and / or monitoring of such risks.

Tax risk management is an integral part of all tax professionals focus, although this objective may not be identified to measure accurately and consistently.

For example, if the tax professional is communicating in an audit or appeals process, does the individual have the relevant training for interpersonal skills and understanding the negotiation process to develop a win-win opportunity for efficient resolution?

The timing for next year’s development plan has arrived, thus it might be the right time to consider tax risk with a new focus.

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Leadership

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TP Risk: Audit discussion = Framework for Ways of Working

As the OECD is developing new guidelines to address transfer pricing (TP) risk, including the Country-by-Country (CbC) template, a lack of emphasis resides in the idea that every tax audit involving cross-border issues should require an opening discussion between the taxpayer and the tax authorities of the business, its relevance in that jurisdiction apart from its global business, the functions, assets and risks for that jurisdiction upon which the arm’s length principle is based, and the rationale for the level of income/loss generated during the audit years.

Transfer pricing documentation reports, including a local country report, may be available for review.  However, such reports may not simply convey the business rationale easily to form an accurate understanding prior to embarking upon a leap into technicalities and assumptions to initiate data requests and move forward on assumptions prematurely.  For example, a company investing in a less developed country seeking long-term growth based on the domestic opportunity may have start-up losses, although such losses may be significantly offset by potential future income.

The open audit discussion should be developed into a Best Practice Ways of Working framework which is discussed and signed by the taxpayer and tax authorities.  This framework should be a simple and practical document addressing open dialogue, preliminary discussion of issues designed to produce the relevant documentation, timelines for requesting and providing information and a continuing dialogue discussing the status of open issues and requests, with a mutual effort to resolve issues efficiently.

To the extent this simple idea could be integrated consistently and uniformly around the world, it is a challenge worth addressing.

The Best Practice Ways of Working Framework could be a very effective and practical tool, supplementing the technical and legal requirements for transfer pricing.

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Transfer Pricing

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Tax Policy statement: A foundation of the Tax Risk Framework

EY has put forth a compelling article addressing the necessity of a company tax policy, stating it is not an option to delay action and hope the debate over transparency and what represents a fair share of tax will stop.  The article is referenced by the following link:

http://taxinsights.ey.com/archive/archive-articles/the-future-of-tax.aspx

Key excerpts:

So how can companies adapt to this new landscape and best address the different concerns of these very engaged stakeholders? It starts with formally and carefully defining a company’s tax policy, which gives effective guidance from the board to the group tax function on what the company’s responsibilities and required behaviors are worldwide.

This policy needs to take account of the often conflicting interests of various constituencies, such as tax authorities, investors, employees, the media and the general public. In the future, a business model must adjust to recognize that, while commercial decisions must continue to take account of tax analysis, such analysis itself needs to include wider business risks.

A company’s tax policy will also help in determining how transparent a company wishes to be with stakeholders about its tax affairs. Companies are concerned that stakeholders could misinterpret the complex nature of their tax affairs.

Any effective tax policy needs to strike a balance between clearly communicating the risk appetite and approach of the company, while also managing all costs, including opportunity costs caused by its tax approach and its consequences regarding reputation and the risk of controversy.

 

Best Practice: One of the foundations, and a good starting point for the Tax Risk Framework, is a tax policy.  The policy should be drafted with the knowledge that it is a valuable tool which the tax authorities may request to better understand, and assess, the company’s global tax risk.

 

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Tax Risk Management

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Tax risk & controversy: EY highlights

Ernst & Young (EY) have published their 10th issue of T Magazine, highlighting the topics of tax risk and controversy.  The link is attached for reference:

Click to access tmagazine10-2012-low.pdf

Key Highlights:

  • GAAR, Burden of proof: Taxpayer, Tax authority or Shared; summary of 24 countries.
  • Sustained government pressure on tax compliance means tax risk is now an issue for corporate boards, not just tax directors.
  • Clarity is now the key attribute in any message about tax that companies convey to the outside world.
  • As emerging markets become more confident and sophisticated, they are challenging commonly applied international tax standards.
  • The OECD’s “Tax Inspectors Without Borders” program (details in a prior post of 9 June 2013) seeks to match demand from countries wanting assistance with complex international tax audits with the supply of international tax experts.
  • Companies need to improve local knowledge of risk rating processes in each Asian country, including key focus areas and potential audit triggers.
  • Organizations need to show a willingness to engage with policymakers and administrators to improve policy proactively.
  • Tax authorities are increasingly adopting the OECD’s concept of the  “economic employer” to determine tax liabilities, rather than a treaty residence rule.
  • Creating a PE is the biggest tax risk companies face from sending employees on business or assignments overseas.
  • An increasing number of companies have appointed a head of tax controversy to manage tax risk and its implications.
  • Companies must be prepared to become more transparent.

Tax risk and transparency are the new challenges to be met by multinationals.  The T Magazine is a valuable resource in understanding today’s risks, and the manner in which these issues will transform current standards into leading Best Practices, tax risk policies and processes.

 

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Tax Risk Management

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