Chapter 2. Tax Control Framework. 6/15/13 Chapter 2 Tax Control Framework. 1. From risk management to opportunity management. 2. Tax control framework

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1 Chapter 2 Tax Control Framework Authors Robbert Hoyng [*] Sander Kloosterhof [**] Alan Macpherson [***] Latest Information This chapter is based on information available up to 1 November From risk management to opportunity management This chapter describes the key elements of a tax control framework (TCF) and how such a framework is to be built. In this respect one should realize that there is no one size fits all TCF. Each TCF needs to be custom built to the specific needs of the organization and taking into account the specific DNA of that organization. Nevertheless, when building a TCF there are a number of generic elements both in process and building blocks that apply to each TCF. In this chapter we will try to provide insight into the aspects of constructing a TCF tailored to your organization and these common elements so you can use this as a benchmark to your TCF or as a starting position for building your own TCF. The first part will provide an overview of the terms and definitions used, and a first introduction into the background of tax control. Next, the construction of a TCF will be described. This part provides an overview of the building blocks of a TCF. It provides a description on all the building blocks needed to build and construct a TCF (see 3.). The following paragraph addresses the cultural and organization context of tax control (see 4.). The last paragraph suggests how to get started with the introduction of a TCF and to get in control of tax risks (see 5.). 2. Tax control framework 2.1. Terms and definitions In this part the terms and definitions of this chapter will be described: CoCo Canadian Criteria of Control Board. Control A measure, agreed upon by those involved, to mitigate a risk, by reducing the probability of occurrence ( probability ), by reducing the impact ( impact ), or to reduce both the probability of occurrence and the impact. Control activities Control activities are the policies and procedures that help ensure that management directives are carried out. They help ensure that necessary actions are taken to address risks to achieving objectives. Control activities occur throughout the organization, at all levels, and in all functions. They include a range of activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of operating performance, security of assets, and segregation of duties. Control objective Control objectives provide specific targets against which to evaluate the effectiveness of internal control. Typically they are stated in terms that describe the nature of the risk they are designed to help manage or mitigate. COSO The Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued Internal Control Integrated Framework to help businesses and other entities assess and enhance their internal control systems. Decision table A precise yet compact way to model complicated logic. Decision tables, like if then else statements, associate conditions with actions to perform. Unlike the control structures found in traditional programming languages, decision tables can associate many independent conditions with several actions in an elegant way. Earnings per share (EPS) The portion of a company s profit allocated to each outstanding share of common stock. Earnings per share serves as an indicator of a company s profitability: (net income dividend on preferred stock) / average outstanding shares. Effective tax rate (ETR) The effective tax rate is calculated as the tax expenses divided by the income before taxes. Enterprise risk management Enterprise risk management is a process, effected by an entity s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives. Key control Key controls are those that are most important to monitor in order to support a conclusion about the internal control system s ability to manage or mitigate meaningful risks. Levers of control A control model introduced by the Harvard Scholar Robert Simon. Risk A potential event, which might have an adverse effect on the goals of an entity. This also includes a missed opportunity. Risk management process A uniform process for a structured and consistent approach to conduct risk management, with the aim to provide insight into the key risks and controls of an entity. Tax control framework (TCF) A tax control framework is a system (process) to identify, mitigate, control and report tax risks. A TCF forms part of a business control framework, which is different for every organization Building an effective, efficient and transparent tax function The most important common element in each TCF is the ultimate goal of a TCF: to build a tax function within an organization that is effective, efficient and transparent. Picture 1: Building a tax function online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 1/23

2 Effective The tax function of an organization should support and contribute to its overall strategy. There is more to tax than just making sure all the compliance deadlines are met. Especially in the area of tax planning, it is key to understand the overall strategy of an organization. Spending time on high tech tax planning is not effective if this means taking on risks without contributing to the strategic direction of the organization. In 3.1. we will address the various aspects that need to be considered when setting a tax strategy. Efficient The tax function must be organized in such a way that the goals are achieved as efficiently as possible. This means that based on the tax strategy set, the organization should consider what resources are necessary to take on the responsibilities. In this consideration, aspects such as location, outsourcing, co sourcing, budget etc. should be taken into account. Furthermore, the tax function should be managed as an integral part of the organization, and not as a stand alone function. For example, only as an integral part of the organization it is possible to implement a control framework on tax from a single audit point of view. Then the tax function can efficiently use the control measures already in place in the organization. Finally, the tax functions should address what kind of supporting tools are necessary to carry out the responsibilities. Efficiency can be achieved especially in the area of automation and integration of this into daily processes. Transparent The transparency of the tax function applies on more than one level. First, the various roles and responsibilities should be transparent. The tax function is broader than just the tax department. It should be clear to each person that has a role in the tax function, what his or her responsibilities are and how they relate to the responsibilities of the other persons. Secondly, when carrying out the tax function, each decision should be made transparent as to its effect in respect of the tax strategy not only for the desired result, but also for the impact of the other possible outcomes of that decision. Compliance A TCF focuses on, and will contribute to, the effectiveness, efficiency and transparency of a tax function. However, the more traditional role of a tax function is to organize the filings in time and in a proper way. In this chapter the compliance process in itself is seen as a resultant of the tax function processes From risk to opportunity The term tax control framework may give the impression that it is all to do with avoiding tax risks. However, being exposed to risks is a part of doing business. The key is not to take on risks that are serious threats to the strategy of your business. In this respect, there are two kinds of risks. First, there is the risk without any upside, e.g. failure to comply with administrative requirements. Generally, an organization should try to mitigate these kinds of risks to an efficient extent. The second risk is the risk that comes with pursuing an opportunity. When an organization pursues an opportunity, there is always a risk that the opportunity will not be achieved, or that additional costs are incurred to achieve that opportunity. An organization should not try to avoid these kinds of risks but make sure that when an opportunity is pursued, the opportunity (measured against the strategic objectives) outweighs the risk. In addition, appropriate measures should be taken to mitigate the negative impact of this risk. The same applies to tax risks. When it comes to the first category of risks, the organization should mitigate these risks to the extent that it is efficient. A well designed and functioning TCF will have this effect. However, a more important role for a TCF is in the relation to the combination of opportunity/risk. First, a good functioning TCF will enable an organization to spot more opportunities as the tax function will not be a staff function but embedded in the organization. Second, a TCF will enable the making of a transparent choice whether or not to pursue an opportunity, weighing the benefits against the risk. And third, because the organization has a good insight in its portfolio of opportunities and associated risks, it will be able to pursue more opportunities as it can measure the impact against the portfolio What is tax control? Before introducing the elements of a TCF, tax control should first be identified. This part provides an introductory description of a TCF and the risk areas. Description of a TCF As described above, a TCF should result in an effective, efficient and transparent tax function. In this tax function, risks that are not the counterpart of an opportunity are avoided to an efficient extent. All opportunities are made transparent as to risk and reward (taking into account the strategy of the organization) so that a reasoned decision can be made on which opportunities to pursue (and risks to take on) and which opportunities not to pursue. In a TCF for each process in an organization, the roles and responsibilities as to the tax aspects are set and procedures and tools are made available. The allocation of roles and responsibilities should be made in such a way that all opportunities and risks are spotted. Subsequently, in a TCF all of the above is properly documented and reported. Areas and risks In setting up a TCF, an organization should make clear decisions as to what the scope will be. First, the organization should decide which taxes could potentially have a material impact on the organization. When measuring this impact, an organization should not only look at the direct financial impact but also at indirect financial impact such as impact on reputation. For most organizations this will mean that corporate income tax (CIT), value added tax (VAT) and wages taxes are relevant, or in scope. However, depending on geography and industry other taxes can also be in scope. The second task is to determine in which processes the in scope taxes can play a role. This is not limited to the tax reporting processes themselves, but also includes various business processes. Especially for online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 2/23

3 transaction taxes such as VAT, these business processes are very important. In 3. this will be described in further detail Overview of the building blocks The tax function of an organization should consist of the following building blocks: Picture 2: Building blocks of a tax function This will be discussed in more detail in 3. The tax function should start with a tax strategy. This strategy should contribute to and support the overall strategy of the organization. This means that not only financial goals such as earnings per share but also non financial goals such as corporate social responsibility should be taken into account. Based on this tax strategy, the organization should formulate a framework within which it manages the opportunities and associated risks. Subsequently, it should make sure that the decisions taken and the financial effects are properly documented in the administration and reported to the stakeholders. The final step is the compliance towards the tax authorities. The accounting and reporting process should be organized in such a way that tax compliance is a seamless exercise. These four pillars can only function if they are supported by the appropriate tools and resources Overview of the roles The tax function is not just the tax department. Within an organization, more persons play a role. For example, the M&A department of an organization has a role in the tax aspects of an acquisition, even if this role is just limited to informing the tax department that an acquisition is being considered. This principle applies throughout an organization. It is a key point that an organization gets a good understanding of these roles. It is tempting to approach the TCF from the viewpoint of the tax department. However, in this approach the organization runs the risk that the perception of the roles and responsibilities of the tax department differ between the business and the tax department. If this difference in perception is not addressed, the organization runs the risks that not all relevant tax opportunities and risks are considered. In this respect it is important to note that the interpretation of the tax law is in itself seldom a source of tax risks. In most cases, the risks are triggered by either not realizing that tax may play a role in a transaction ( insight ) or that an issue although spotted is not correctly addressed. This is often the result from incorrect factual information ( analysis ) or incorrect follow up ( follow up ) on the tax technical advice given. This is illustrated in the picture below: Picture 3: Causes of potential tax risks: insight, analysis, follow up From this picture it is clear that communication is a key element to avoid risks making sure that the relevant persons understand the issue, the essential facts and what is needed to resolve the issue, and, most importantly: who takes ownership. The picture below shows a responsibility matrix for corporate income tax which can be used to facilitate the discussion on these roles and responsibilities. Picture 4: Example of a tax responsibility matrix online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 3/23

4 Based on this matrix, the parties concerned (in this example, CFO, finance department, tax department and the business) can discuss to which extent each party is involved in the respective subjects. The CFO will have an active role in setting the strategy but probably a very limited role, if any, in local tax return compliance Stakeholders There are various parties that have an interest in a good functioning TCF. In this paragraph we will briefly address the stakeholders being: (a) (b) (c) (d) (e) (f) (g) management; (supervisory) board; internal audit department; external auditors; tax authorities; public; and tax department. (a) Management The management of an organization (CEO, CFO) is ultimately responsible for the (financial) performance of the organization. Tax can have a substantial impact on this performance, both positive and negative. Generally, management does not consist of tax professionals and as a result need to get assurance that all relevant tax risks are addressed and appropriate action will be taken. Therefore, they benefit if, as result of a TCF, roles and responsibilities as to identification (and follow up) of risks are clearly set. Moreover, if the tax technicalities of these risks are translated into impact on the strategic goals of the company, they are in a position to decide on what action is needed. It is therefore essential that management is involved in building the TCF, especially where it covers strategy, operations and risks. (b) (Supervisory) board In many jurisdictions, organizations have a (supervisory) board. This board is generally not involved in the dayto day business, but has a supervisory role (e.g. on behalf of shareholders) towards management. Risk management is one of the key areas where the supervisory board plays a role. Also here, the tax position of an organization is an important element. The supervisory board should be periodically updated as to the tax risk position of the organization. Without being tax specialists themselves, members of a supervisory board will be able to understand the impact of the tax risk position to the organization, as in a TCF risks are addressed based on impact on the overall strategy of the organization. (c) Internal audit department In the governance structure of an organization the internal audit department (IAD) has an important role: having a TCF, takes tax out of the black box and makes it auditable on the processes and relating control measures which should be in place. An IAD will not audit the tax technical content of the tax position of the organization, but can audit whether appropriate persons were involved as set in the TCF. As a result, the IAD plays an important role in the operation of a TCF, because what is being measured will be done. In this respect it works both ways: the IAD can function as auditor of the tax function because of a TCF, and the TCF can be embedded in the organization through the work of the IAD. (d) External auditors Where management is ultimately responsible for the financial performance of an organization and the reflection thereof in the financial statements, the external auditor needs to make sure that these financial statements do indeed paint a fair picture of the financial position of the organization. In the audit of these financial statements, the external auditor cannot audit each and every transaction. For example, checking whether or not the organization has applied the correct VAT percentage on each invoice is too cumbersome and inefficient. For many elements, the auditor will have to rely on the internal processes and controls. In addition to auditing key transactions, the auditor will therefore have to audit these processes and controls. With respect to the example on VAT, the audit can be a check on the administrative system and authorization as to changes. If an organization has a TCF with clearly defined processes, responsibilities and controls, this facilitates the task of the auditor. online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 4/23

5 (e) Tax authorities One of the responsibilities of an organization is to meet its periodic obligations under the tax compliance. With respect to the various taxes, returns will have to be filed and payments made. In the situation of a tax authority that has the role of reviewer of these returns, a well organized tax compliance process, where all relevant information is easily accessible, is of obvious benefit to the tax authorities. In this respect tax authorities have an interest in the functioning of an organization s TCF. This is even more the case where there is a more proactive relationship between organizations and the tax authorities such as in the Netherlands. In this situation, where organizations and tax authorities have an open dialogue on the material uncertain tax positions, it is key for the tax authorities that the organization is indeed able to bring all material positions to the table and can provide the tax authorities will all relevant information. (f) Public As result of the developments around corporate social responsibility (CSR), the general public is also interested in (part of) the TCF. Many organizations already disclose information on tax and CSR in their financial statements. This tax policy, which is linked to the overall strategy, is part of the TCF. (g) Tax department Last, but not least, the tax department also benefits from a TCF. First, a TCF will facilitate the day to day operations of the tax department. It will be involved early on in important business transactions and surprises can therefore be kept to a minimum. But second, a TCF provides a common language for the tax professional in the tax department when communicating with the other stakeholders. Tax planning can be translated into impact on strategic objectives such as cash flow management, earning per share, etc. In this way the tax department can demonstrate how it adds value to the organization. Another aspect of that common language is the transparent link between tasks (strategy, operations and risks, etc.) and the need for supporting technology and resources. So when the budget meeting is being held, the head of tax department can support his budget demands by ultimately linking these to the ultimate strategy of the organization. 3. Building the tax control framework 3.1. Introduction How do we build a TCF which maximizes the benefits of tax opportunities and mitigates the risks? This question can only be answered by understanding the causes of potential risks and the business areas they originate from. In this section, where we refer to risks, a missed opportunity is also seen as a risk. Picture 5: Causes of potential tax risks As described in our earlier analysis on tax risks, the main sources are lack of tax oversight, tax analysis (both analysis of the facts and tax technical analysis) and the follow up. Effective risk management should focus on an integral approach towards tax risk management. As a start, COSO Enterprise Risk Management (COSO ERM) could be used to identify the key areas of tax risk management. Additionally, this must be embedded into an automated system and into the existing organization. This all adds up to the following key areas of the TCF approach: Tax strategy. Relating to high level goals, aligned with and supporting the entity s mission (see 3.2.). Tax operations and risk. Relating to effective and efficient use of the entity s resources (see 3.3.). Tax accounting and reporting. Relating to the reliability of the entity s reporting (see 3.4.). Tax compliance. Relating to the entity s compliance with applicable laws and regulations (see 3.5.). Automation and technology integration. Relating to the IT system of the organization (see 3.6.). Organization and resources. Relating to the resources and competences of the organization (see 3.7.). Combined, these areas form an integral approach to become, and stay in control of tax risks. This is schematically depicted in the picture below: Picture 6: Building blocks of a tax function online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 5/23

6 3.2. Tax strategy By considering the tax strategy, an organization should consider its tax activities in relation to the vision, mission and strategy of the organization. Vision articulates and legitimizes the existence of the company; it describes the reason for the company s existence (raison d être). The mission relates to what the company will do in the context of its vision. It formulates what activities the company will do. Finally, strategy is about how these activities will be executed. In this context, tax strategy is about how the tax function will contribute to the overall goals of the organization. Historically, the tax function has been a separate part of the organization which operated in a solitary manner. In that position it has always functioned on the sideline of the organization. From a financial perspective, the tax function has always been regarded as a cost centre, to deliver services to the organization at minimal costs. This is in contrast to a profit or investment centre which is measured against sales and return on investment (ROI). To make the shift from a cost, to a profit or investment centre, the fiscal department should formulate a fiscal strategy, execute effectively and clearly communicate its priorities towards other departments. By doing this, the role of the tax department changes and it becomes a business partner in the decision making process. It no longer operates as in a silo, instead it is interdisciplinary and involved with other parts of the organization, where the tax expertise offers added value for the organization. This part is dedicated to the high level goals of the organization and is the starting point of the TCF. With respect to the tax strategy, the following will be addressed: (a) (b) (c) (d) (e) goals; communication and involvement; organizational life cycle; regulation; and tax governance and social responsibility. (a) Goals In general, organizational goals can be divided in (i) qualitative and (ii) quantitative goals. Qualitative goals are topics related to continuity of operations, transparency, ability to provide information and good corporate citizenship. Quantitative goals are about earnings per share, tax cash flows and effective tax rate (ETR). (i) Qualitative goals How can the tax function contribute to the organization? A first step in the discussion on taxes is to formulate a tax strategy. Tax strategy should be an extension of the overall strategy to align tax activities with organizational goals and activities. Mainly, tax should contribute to the strategy of the organization. Continuity of operations. Continuity of operations is another topic which many companies regard as their strategy. By understanding and monitoring the tax position of the organization, pending issues with the tax authorities and fiscal disputes, the organization is able to plan ahead. Transparency. Transparency is a goal shared by many companies. In the context of tax strategy, this means the organization has an up to date awareness of its tax position. It is able to measure this by setting up a reporting structure which provides this information. By doing this, the organization is able to take informed decisions and steer actively on activities which create value after tax. Able to report and inform stakeholders in a timely manner. Another company strategy might be to be able to respond to information requests to stakeholders in a timely and appropriate manner. To be able to do this, companies should be able to generate the required information and decide on what to report. From a tax perspective, the organization should be aware of its outstanding tax issues with the authorities and be able to quantify those positions. Only then is it able to report to stakeholders in a timely manner. Good corporate citizenship. Corporate citizenship is about the social position an organization has within society. It implies a good governance and responsible behaviour of the company. Next to the strategy of profit optimization, a company is considered to have a social function and should therefore act as a reliable actor within society. In the domain of tax management and tax strategy, this implies a responsible position as a taxpaying entity towards the tax authorities. If a company identifies itself as a good corporate citizen, it should make its contribution to society by paying a decent percentage of taxes. It also implies a good, trusting relationship with the tax authorities. (ii) Quantitative goals How can the tax function add value to the organization? To visualize the added value of the tax function, one could make a value pyramid describing how tax activities contribute to quantitative goals like EPS and ETR. Building the value pyramid begins with the understanding of the overall quantitative goals of the organization. In many profit oriented organizations, this is maximizing shareholder value by maximizing EPS. EPS. An overall goal of the organization could be to maximize the EPS of the organization because it is directly related to maximizing shareholder value. This quantitative goal consists of net income attributable to shareholders and the weighted average number of shares outstanding. Building our pyramid further, the net income attributable to shareholders consists of income before taxes and tax expenses. Dividing the two gives the ETR. ETR. The ETR consists of the income before taxes and the tax expenses. Tax expenses in a year consist of the current year tax expenses, the tax expenses for previous years and the outcome of deferred tax assets and liabilities combined. The relationship between these drivers can be visualized in the following picture: Picture 7: The value drivers of earnings per share, related to the tax function online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 6/23

7 From this picture it can be seen that the tax function has three key drivers to contribute to the ultimate goal of EPS: Current year tax expense. The current year tax expense is calculated on the profit before tax adjusted for permanent items. Deferring tax expenses through timing differences has no direct impact on the ETR (see below). If EPS is an important key performance indicator (KPI) for the organization, the focus of the tax function should be on tax planning in relation to permanent items and not in relation to timing differences. Tax expenses previous years. A second element is the true up for previous tax years. A true up can have various causes. It can be a result of the fact that in the tax filing, more accurate numbers are used compared to the tax accounting process. Another possibility is the movement in the contingent tax positions as result of tax audits, statute of limitations, etc. Where the organization strives for a stable ETR, these kinds of true ups can have a negative effect. Movement in deferred tax position. The same applies to the deferred tax position. Although the timing differences in themselves do not have an impact on the ETR, rate changes can have a substantial impact on the ETR if there is a net deferred tax asset (DTA) or deferred tax liability (DTL). A reduction in statutory tax rate has an increasing effect on the ETR in the case of a net DTA position. Another element that can have a substantial impact is the (de)recognition of DTA for tax loss carry forwards. (b) Communication and involvement To work as an integrated part within the organization, all parties should change their approach in the way they involve the tax function in the primary activities. This also requires the tax department to consider its added value to the organization, bearing in mind the life phase of the organization. Considering the tax function as an integral part of the organization will help to identify tax risks at an earlier stage so that they can be taken into account during regular decision making. The tax function as an integral part of the organization is, besides involvement, about communication between departments. Communicating business issues, during commercial decision making processes, with the tax function will improve the decision making process as a whole. In many cases risks can be identified in an early stage, which otherwise could have a strong effect on the business case itself. This requires the tax function to develop as a strategic business partner in providing management with adequate information. Furthermore, the tax function should proactively suggest improvements where value could be added. By transforming itself into a strategic partner, the tax function will add more value and have a more prominent role in the organization. The tax department should organize and work from a process perspective to create a stronger connection with the rest of the organization. (c) Organizational life cycle Is lowering the ETR a smart decision? The answer to this question largely depends on the life phase the company is in. For a start up company, tax improvement programmes have less importance compared to more mature organizations. In a start up company, growth is of the essence and profit and taxes payments are relatively low. After further growth, the organization stabilizes and profit becomes more prominent. Effectively, well managed taxes become more important to the organization to create value. The further the nominal tax payments (profit before taxes multiplied by nominal tax rate) increase, the more interesting it gets to look into the tax structure of the organization. During the lifetime of a company, three main phases can be identified: the start up phase, the stabilization phase and the control phase. Phase I: Start up phase In the early phase of the company, all the energy, time and resources are focused on building the company. Revenue from operations is predominantly directly reinvested in the company to facilitate this process. Consequently the taxes paid in this phase are relatively low. Another advantage of this phase is the possibility for the company to be eligible for subsidies from the government. It could be beneficial to the organization to assess these possibilities. Phase II: Growth and stabilization After the start up phase, the company shows strong growth. Growth accelerates during this phase. The company transforms into a mature company and at the end of the phase starts to stabilize. At the end of this phase the products and/or services are better crystallized and accelerating growth comes to an end. This online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 7/23

8 provides the opportunity to the company to start paying dividends to the investors and shareholders. This increases the importance of a sound tax planning. Phase III: Control After the stabilizing phase we see the control phase. During this phase the company focuses more on cost efficiencies and allocating its resources efficiently to create value. Tax planning has become an important way to limit costs and to operate efficiently. Picture 8: Organizational life cycle phases (d) Regulation Another factor in the assessment on how a tax function could contribute to the overall strategy of the company is the intensity of regulation in its industry. There are significant differences between industries, especially when considering industries which pay high duties on their products (oil and gas, alcohol and cigarettes, etc.). In an industry where taxes form a big part of sales, it will be more likely that companies will involve the tax department in their commercial decision making process. To identify the elements which contribute to the tax position, the organization should identify the value drivers of their business and overall goals. Generally, the strategy of the company is articulated in financial terms (e.g. revenue, profit after taxes, EBITDA). The relationship between these drivers and the potential tax effects can be identified by creating a value driver pyramid. This way the interrelationship between all drivers can be identified and the tax effects visualized. (e) Tax governance and social responsibility Although tax strategy has always historically been focused on minimizing tax cash outflows, it also involves communication with its tax stakeholders. These stakeholders demand transparency on how the company will contribute to the greater good and that it will show sound corporate (tax) citizenship. Apart from minimizing the tax payments, building a good working relationship with the tax authorities has longterm benefits and should be part of an overall tax strategy. Potential disputes can be solved in a shorter time period and the organization has more clarity and assurance about its tax positions Tax operations and risk After addressing tax strategy, the execution of the tax strategy will now be described. This part will address the following: (a) (b) (c) tax operations; risk; and tax decision management. (a) Tax operations The approach taken by organizations to tax risk is constantly evolving. Historically, the way organizations dealt with tax risk was to define how risk adverse they were and list out their main areas of concern, often focusing on standard tax issues such as transfer pricing and other cross border concerns. Today, companies are approaching tax risk less in terms of money lost and instead are focusing on where there may be opportunities missed for tax optimization, and where there could be reputational damage. In measuring and reporting tax risk, transparency is key, and organizations are using a variety of tools to make tax risk more accessible to those without a tax, or indeed, a risk background. An example of such tools would be a risk register with the results displayed in a map. Such an approach is based on established risk consulting techniques that are familiar to both audit committees and the board. The methodology behind it is designed to combine the expertise of the tax director with a wider insight into the causes of risk within the wider business. Done properly, the tax risk process will look beyond specific tax technical issues and examine the activities of the organization as a whole. Leading companies regularly assess their tax risks using this risk methodology. By plotting identified risks according to the likelihood of occurrence against the potential impact of the risk being realized its significance a company can develop a view of which risks need to be prioritized. In most cases, the organization s risk appetite is determined prior to this exercise, so that an acceptable level of risk can be preplotted on the risk map, e.g. as red, amber and green lines. Risk maps which plot risks in this way can be easily adjusted in response to subsequent reassessments of the likelihood and significance of risks once they have been mitigated through remediation plans or agreed actions. The risk map is an important tool in risk management, and many organizations are using it as a clear and effective method of communicating the importance and ongoing status of tax risk to the rest of the business. An example is shown below where the horizontal axis depicts the impact of a risk and the vertical axis represents the preparedness of the organization. Picture 9: Risk map: identifying your tax risks by using a risk map online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 8/23

9 Technology is also playing a large part in demonstrating sound tax risk management and good governance. Increasingly, there is an alignment of tax and financial systems to provide standardized tax processes on a group wide level. This is complemented by the use of global data warehouses, tax dashboards (as discussed further below) that can measure KPIs and risks in real time and enhanced data analysis for tax planning. In many cases, organizations are leveraging off existing systems such as bespoke tax risk management software or business wide risk solutions, for example the governance, risk and compliance (GRC) modules within their enterprise resource planning (ERP) system (e.g. SAP or Oracle). These tools provide a structured platform for defining, maintaining and monitoring governance, risk and compliance for tax. Identifying and understanding the current position and formulating a value added strategy with key technology objectives is where many organizations currently are in their adoption of good governance and risk management. Improving tax processes as a way of managing risk A first step in improving tax processes is to undertake a current state analysis of the tax function. This often involves carrying out benchmarking and tax risk reviews to better understand the existing tax processes and determine where the tax function wants to be in the future. Organizations are establishing KPIs that will help identify gaps. These KPIs often have a clear link with the objectives of the wider business and many include ETR, cash tax, demand management, key risks, key controls, internal resources and control activities. The use of KPIs will help define an end state where the tax function wants to be in say 5 years time. Organizations that are planning ahead in this way are setting up overarching systems that benefit multiple tax processes. This requires the formalization of key objectives around how they think their tax function should operate. These tax objectives should cover every aspect of tax management. As an example, typical tax objectives could include: reducing the resources spent on compliance by 25% by 2012; cutting the tax financial close process by 1 week; more resource allocated to tax effective business planning; and improved level of standardization and consistency across tax to enhance governance across all tax processes. Many organizations are undertaking exercises to map their end to end processes and the systems that support them. Such process maps should highlight the volume and value of transactions flowing through different elements of the process and key interfaces between different processes and systems. These exercises help businesses identify areas of key tax risk and how they are currently controlled. Documentation of the process is particularly key where tax activities are undertaken by non tax specialists, either because the activity is diffused throughout the organization (as is frequently the case with indirect tax reporting) or has been moved into a shared services environment. Maintaining the quality of tax compliance in these circumstances is paramount and less reliance can be placed on the informal understanding of a closely knit tax team as perhaps was the way in the past. Tax authorities are often keen to carry out this kind of work to build their understanding of a large corporate s processes and systems, and this is particularly true where they see tax compliance activities moving into shared services centres. As a rule, many companies are uncomfortable providing this kind of access to tax authorities in the absence of a formal enquiry and so would often share their own documentation to provide the necessary assurance. The organizations which can convince their stakeholders (including tax authorities) that their tax systems and processes are robust will be able to communicate their tax risk more confidently, and will be better placed to cope in a constantly changing regulatory and risk environment through greater certainty, improved efficiencies and a stronger basis to defend tax planning and reporting. (b) Risk (i) Insight, analysis and follow up Tax risks do not only arise from an incorrect analysis of the technical facts. Many tax specialists assume that technical analysis is the main cause for errors and a potential source of risk. Considering taxes from a broader perspective reveals that many risks arise from a lack of communication. Picture 10: Causes of potential tax risks online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 9/23

10 For all tax areas, causes of potential risk are insight, analysis and follow up. In most of these cases communication between the tax function and other departments is a cause of potential risk. (ii) Business departments Tax risks arise everywhere in the organization; it is a misconception to think these risks only originate within the fiscal or finance department of the organization. Picture 11: Business departments of an organization In a case where the R&D department develops a new product, it is not common to consult the tax department about potential tax risks, altering the pricing of the product itself or changing the tax position of the entire company. This situation could very well be a cause for potential risk. For a tax department, it is valuable to be informed about important changes in the business. If potential tax risks can be identified at an early stage, small adjustments can have a strong positive effect on the overall tax exposure. This can protect a company from high potential losses. This also works for actors outside the tax department. For them it is valuable to understand how potential initiatives will translate into tax effects so that they can adjust at an early stage. Therefore, one could imagine a grid where the several departments are all analysed on tax risks in terms of insight, analysis and follow up. This is the first step towards a new model to approach tax risks in an integral way. (iii) Organizational context A common misconception is to think of a TCF as a stand alone framework. Picture 12: Integrated elements of the TCF online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 10/23

11 A TCF should be embedded in the organization together with other means to provide assurance about tax processes. The tax professional has a set of tools available to document processes and secure a way of working which provides assurance. Another means to embed the TCF in the organization is to formulate a tax strategy to support the TCF. Examples of tools which could secure the assurance on tax processes are, for example, a responsibility framework or a risk paragraph in the annual report. This all should be continuously tested with business practice. (iv) The audit cycles A TCF is an integrated framework and should build on the internal controls which already exist within the organization. In most organizations, departments already have internal controls in place based on the audit cycles of the auditor. Picture 13: Integration of business processes and the audit cycles Therefore, a central question should be: What controls do we already have? online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 11/23

12 (v) Integration and measurement All variables considered will result in an integrated approach towards risk management. The implementation of the TCF will result in a grid that includes the tax areas and potential causes for tax risks (insight, analysis and follow up), articulates the inclusion of all departments and acknowledges the organizational context in which a tax strategy and the tax organization play an important role. This is depicted in the TCF model shown below. Picture 14: TCF model: integration of all elements of a TCF (c) Tax decision management Tax decision management describes the analysis of scenarios and possible outcomes and the analysis of the likelihood of these scenarios. It builds on the identification of the value drivers described in the paragraph about tax strategy. The tax pyramid starts with the overall financial goal of the organization and breaks this goal down into several value drivers. Some are directly in the domain of tax and tax management; others have an indirect link to taxes. The value pyramid can be visualized using the technique of a pyramidal chart which links key ratios and the underlying value drivers of the business. When key variables are identified, one can use decision tables to get insight into different scenarios and the actions to be taken. Picture 15: Decision table: a structured way to make tax decisions The next example shows the link between the tax strategy and the decisions made on the various options within the strategy, using a five step approach. Example To identify the tax strategy, one should start with the overall strategy of the organization. online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 12/23

13 Step 0: Identify the corporate strategy From a financial perspective, an overall strategy could be to maximize shareholder value. More specifically we could identify EPS as the overall strategic goal of the organization. Taking a closer look, EPS depends on net income (attributable to shareholders) and the number of shares (weighted average number of shares) outstanding. Net income could be split into income before tax and the tax expenses. The combination of these two variables provides the ETR. This is schematically presented in the pyramid below. Picture 16: Effective tax rate pyramid Step 1: Define the tax strategy of the organization As a first step in making your decision you should define your objectives in this decision context and the way you measure them. Suppose that your financial objective in this decision context is to minimize the corporate tax cash outflow for the organization, measured in euros, for the current financial year (FY1) and the next 2 financial years (FY2 3). You may also have other non financial objectives, such as keeping a good relationship with the tax inspector or being a good corporate citizen, but we do not analyse these in the context of this article. Step 2: Analyse variables influencing the objectives After defining the objectives and their measurement, you analyse which (groups of) variables influence the objective(s). In this decision context, the objective is financial and is dependent on three variables, i.e. interest deduction, liquidation loss deduction and the tax rate against which the deductions, if available, can be made. This can be graphically shown in a variables objectives pyramidal model as in the picture below. Picture 17: Variables objectives pyramidal model for reduction of tax cash outflow Step 3: Analyse scenarios and possible outcomes As a next step, you analyse the scenarios for each option. It then becomes clear that accepting has just a single scenario: the corporate tax bill will be reduced by 30% to EUR 16.5 million in FY1 and with 30% to EUR 4.5 million in FY2 3 each. Hence, the total nominal reduction of tax cash outflow of the option accepting for the period of 3 years (FY1 3) would be EUR 25.5 million. Rejecting, however, provides at least four scenarios with possible outcomes ranging from zero to EUR 52.5 million, analysed in the decision table below. Picture 18: Reduction of tax cash outflow for the option rejecting online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 13/23

14 After this analysis, many decision makers have sufficient information to make a sensible decision. Suppose you do not want to accept the risk of scenario R1, in which the organization would end up with no reduction of tax cash outflow at all. It is then irrelevant what the likelihood of scenario R1 is. The option accepting then always outweighs rejecting, as the first does not have a scenario in which the organization ends up with no reduction of tax cash outflow at all. Step 4: Analyse likelihood of scenarios Before starting the probability assessment, we should first examine what new insights we gain by analysing the likelihood of each scenario. The answer is that probability quantification allows you to compare the options accepting and rejecting in terms of expected value and risk distribution. Suppose that the tax director estimates the likelihood that liquidation loss deduction will be upheld by a tax court at 70% and the likelihood of interest deduction at 60%. Decision Table 2 shows how these two estimations result in the likelihood of each possible outcome in terms of reduction of tax cash outflow, given rejecting. Picture 19: Reduction of tax cash outflow in the option rejecting with probabilities The expected monetary value of the option accepting is simply EUR 25.5 million, because it has just one possible outcome. The expected monetary value of the option rejecting is the weighted average of each possible outcome calculated to EUR 34.5 million. The risk distribution is visualized in the histogram in the following graph: Picture 20: Risk distribution for reduction of tax cash outflow The decision whether to accept or reject the tax inspector s offer may still be difficult, for example, because you may find it difficult to balance the certainty of the lower value accepting option against the higher value, but more volatile rejecting option. There may be more objectives than just the monetary implications that are relevant in this decision context, but the valuation of both options should at least have facilitated a sensible decision. Step 5: Assess the probability Now that we have discussed the use of probability assessment, we can start to examine how we should make the assessment. This step comprises two sub steps: Step 5.1: Analyse which variables influence each of the scenarios. Step 5.2: Assess the inductive and deductive uncertainties. Step 5.1: Analyse the influencing variables When focusing on the probability that the liquidation loss will be deductible, the tax director analyses the legislation and determines that loss deduction is dependent on the fulfilment of a number of conditions, i.e. that: online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 14/23

15 the liquidated company must be incorporated or resident in the European Union; the liquidating company must hold the shares in the liquidated company for 3 years or more; and the liquidated company must have completely ceased its activities. The variables objectives pyramid shows how the new information is modelled: Picture 21: Including variables for liquidation loss The following decision table analyses the rules around liquidation losses: Picture 22: Liquidation losses Step 5.2: Assess the inductive and deductive uncertainty To provide a full analysis of the inductive and deductive uncertainties extends beyond the scope of this chapter. However, we will briefly address what these uncertainties are in this perspective: Deductive uncertainty: the probability that the general rule in an analysis is correct. In a decision table, the deductive probability is the probability that the value of a certain rule (R1 or R2, etc.) is as given as an answer in that specific rule. Inductive uncertainty: the probability that the observations about a specific situation in an analysis are correct. In a decision table, the inductive probability is the probability that a given situation will arrive at a certain rule. Both uncertainties are part of problem solving by using a decision table. Tax professionals should take this into account when they solve problems using this method Tax accounting and reporting Traditionally, tax accounting issues are raised at the end of the fiscal year, and this takes place after the statutory reporting processes are finished. Because all tax accounting activities are postponed until the end of the year, the company does not have any insight into the outcome of this process and might encounter unexpected results. This part will address the following: (a) (b) tax accounting: a proactive approach; and tax reporting: the tax dashboard. (a) Tax accounting: a proactive approach A way to anticipate uncertainties at year end is to implement a system of continuous monitoring of the tax position. By monitoring the tax position throughout the year, the organization is able to take corrective actions before it is too late, and have assurance about its fiscal results at year end. During the year, commercial events take place which might also have an effect on the tax position of the company. For example, changes in the fiscal structure of the entity could have an effect on the total CIT of the organization but not be taken into account until year end. This means the information is readily available and the company could identify the changes in the CIT well before year end. The same applies to positions where the organization is eligible for VAT deduction. In the situation where the company is no longer eligible for pre allowance, it will have a direct effect on the results of the company. In theory, an organization is a non consuming entity and should therefore have no remaining VAT positions at year end. However, in practice most companies have VAT positions in their chart of accounts at year end, mainly because the organization does not have a monitoring and control system in place which covers this area. On wage taxes, many organizations do not fully utilize the available government subsidy programmes which could benefit the organization. In most of these cases the HR or tax department is not aware of existing programmes and does not have a control system which monitors this topic during this year. Once tax accounting is executed during the fiscal year, it provides two advantages to the organization. First, the organization is aware of the taxes to be paid at the end of the year. Secondly, most of the activities involved in online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 15/23

16 filing taxes are already completed. Therefore it improves the efficiency of the tax filing process at the end of the year, increases the speed of the filing process and reduces adverse effects at year end. Picture 23: The annual tax accounting process (b) Tax reporting: the tax dashboard Within the regular periodic reporting process of an organization, taxes have always played a minor role. Recently, tax specialists and specialists within the finance function of organizations have found this area to be of increased significance in the total value creation process of the organization. Efficient tax processes create value when maintained and monitored closely. The means through which the monitoring takes place is by implementation of a monitoring system. A way to monitor the tax objectives for the organization is by the use of a tax dashboard. The tax dashboard provides valuable insight to enable effective decision making and the ability to stay in control of the overall tax position. Picture 24: Tax dashboard to enable continuous tax monitoring An effective tax dashboard contains all the tax elements relevant to the organization and is largely dependent on the nature and industry of the business. For instance, a highly regulated industry with heavy taxation (e.g. liquor and tobacco) has other monitoring elements compared to a less heavily taxed industry. The final set up and configuration of the tax dashboard are largely dependent on these industry characteristics and also the overall strategy of the organization which formulates the KPIs on a tactical level. To provide insight and an overview of performance metrics widely used throughout all industry, we identified the following generic metrics: (i) Deferred and current tax positions As part of the financial statements of an organization, deferred tax liabilities, deferred tax assets and current tax assets are important elements on which the organization should steer. Because these line items are a direct part of the financial statement, they have a direct impact on the bottom line result of the organization. (ii) Effective tax rate The ETR calculates the taxes due, both current and deferred, compared to the profit before taxes. From a theoretical point of view, the ETR should be equal to the nominal tax rate, which is the corporate income tax rate of the geographic and fiscal jurisdiction in which the organization operates. In practice, however, these rates show variations over time. It is the duty of the fiscal and financial actors within the organization to provide insight into these deviations. (iii) Tax compliance Tax compliance is about filing the tax return and making the actual payments. A complete tax dashboard should include these elements for each tax area to identify whether the organization is still on track with its tax online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 16/23

17 processes. The presentation of this progress could be shown with a dashboard light in red, yellow and green. (iv) Tax risk provisioning Tax provisioning is about all outstanding tax issues which have yet to be discussed with the tax authorities, but are likely to be a point of discussion in the future. Tax provisions are measured on impact and likelihood. The product of these two factors provides the estimated amount of money to be provisioned for the tax risk. Underlying assumptions on the impact should be formulated by the fiscal department in cooperation with the financial department. The likelihood of the issue occurring should be estimated by the risk owner who has the most inside knowledge of the issue. (v) Tax litigation Similar to tax risk provisioning, tax litigation is measured on impact and likelihood, although tax litigation is about issues already under discussion with the tax authorities. (vi) Tax opportunities Tax opportunities are the ability of the organization and the tax function to create value from the existing tax structure and future tax planning proposals. It has the same elements as tax litigation and tax risk provisioning, although it solely focuses on value creation instead of the mitigation of tax destruction. (vii) Tax control The last element in the tax dashboard is about tax control. It is an overview of the key risks which are identified by the organization. It provides an overall sense of the risks which could affect the overall goals of the organization and displays the control activities action(s) taken to mitigate the risk. It provides top management with a list of priorities and the status of the counter measures taken, displayed in red, yellow and green Tax compliance: a global scope The scope of tax compliance nowadays has reached beyond borders and fiscal jurisdictions. Therefore a company should approach tax compliance with an international vision. Compliance in a global perspective means integration with accounting and reporting, automation of processes and the ability to organize tax processes around it. In this respect compliance is an integral part of a TCF. To be able to live up to those challenges, the organization should ask itself the following questions: Did we organize our tax accounting processes in an efficient and effective manner to live up to the challenges that lie ahead? Are we in control of our tax filing processes? Have we organized our tax processes in an effective manner? Are we able to comply in a timely manner with the demands of the tax authorities? Once the organization is able to construct a clear picture of its ability to be compliant with the rules and regulations which apply, it will also be aware of the areas which need additional attention and effort Automation This section will be dedicated to the automation of processes to facilitate the tax processes in an organization. This part will address the following: (a) (b) (c) (d) (e) lessons to be learned from finance transformation; new approach; transform the tax professional; start the transformation journey; and questions to ask. Introduction Ensuring underlying accounting systems are tax sensitized is an important step towards managing risk and improving efficiencies in the tax reporting and compliance processes. Many organizations review their chart of accounts and ledger codes in an attempt to ensure that the financial data they receive during the tax compliance process and for quarterly reporting is in a form that will enable them to better understand what the numbers mean and more accurately and efficiently report their tax figures. For example, the British tax authorities have indicated that companies that fail to appropriately configure their underlying systems to track tax sensitive expenditure may be regarded as having committed a deliberate error rather than being simply careless, and thus face a significant increase in penalty exposure. Probing into the underlying accounting systems such as SAP and Oracle can be disruptive, costly and require specialist help. The tax director will have to weigh up the cost benefits of doing so and determine whether a lack of granularity and quality of information being received by the tax function could risk failure of compliance with current legislation. While sometimes triggered by tax authorities some organizations are using this as a way of identifying cash flow opportunities. While some understatements will undeniably be found as part of the focus on process and systems, there will be a similar (and potentially larger) number of overstatements identified, with higher claims for relief and more rapid repayments of tax achievable. To find these, organizations will need improved access to information to improve their claims this can include, for example, better granularity of information relating to capital expenditure (to improve tax depreciation claims), and increased detail relating to certain expenses (such as legal and professional fees and client entertaining which could be classed as marketing). So how can improving technology systems in this area offer realizable cash savings? Typically, there are three barriers facing tax functions that are seeking to make claims more accurately and earlier, getting the disallowances right and reducing reliance on estimates. These are: the data required to improve claims is in the accounting system or ERP but is not easily accessible; the data is not in the accounting system or ERP but is actually maintained elsewhere in the organization and not easily accessible to the tax department; or the data does not currently exist within the organization. Overcoming these technology barriers to the underlying accounting data will allow companies to analyse, segregate and manage their assets, liabilities, income and expenditure more accurately. This will enable them to get a better tax outcome and thus the opportunity to enjoy cash savings. Understanding these issues will offer the organization the opportunity to determine the quantum of enhanced claims and whether this justifies the cost and upheaval of improvement. If such activities are undertaken at the same time as the work required to comply with the requirements of the tax authorities, these benefits can be online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 17/23

18 maximized. (a) Lessons to be learned from finance transformation Finance transformation has been a major theme for most large corporations, as well as the focus of significant investment. However, we rarely see tax included as an integral element of those change programmes. But changes in tax technology and the visibility of benefits arising from transforming the finance function mean that tax can and must become an integral part of the programme for change in the finance function. Count the cost of tax exile. When, for example, tax is not part of the scope for a major ERP implementation or finance system consolidation, major benefits are missed and the full improvement potential of a change programme is not reached. The omission of tax has a number of implications. Much tax activity is executed as manual and inefficient processes outside the core system in fact as much as 80% of tax compliance and reporting time may consist of gathering data. This creates a drag on the entire financial organization as the tax reporting and the data underpinning it are handled on a range of separate systems. Demands for accelerated reporting mean that tax needs to work with the finance function to satisfy regulators and investors. So including tax as an upfront element of a wider finance transformation is not only just possible, it is essential. Focus on the upside. Automation and standardization of processes can create a major change in the efficiency of compliance and reporting. They also open up new possibilities for how tax compliance and reporting are executed as well as where and how tax resources are organized. There is no reason, for example, why some tax resources cannot be co located in shared services centres to maximize the efficiency and improvement gains from creating centres of excellence under one (real or virtual) roof. Outsourcing, co sourcing and offshoring common practice today in the finance function are equally applicable to tax. The benefits of automation and standardization are best shown through a comparison of how many companies still operate their tax reporting and compliance today and how those adopting greater automation are achieving a more efficient, timely and effective process. For many organizations today, in country finance directors retain responsibility for preparing the local tax pack in readiness for filing a return. Typically, this is a largely manual process whereby information is extracted from financial systems and repurposed for tax locally before submission to an adviser who generates and submits the tax return. Some companies are now beginning to use shared services centres to remove some of the burden from local finance directors, reducing the complexity of what is presently a multi staged process. Others are poised to go even further. Automation is helping them drive these separate stages into a seamless process in which data flows directly from the financial system into the appropriate points in the tax return. A review ready return can then be assessed by suitably trained resources in a shared services centre before local filing. There are of course variables that drive the feasibility of this approach across an international organization. An appropriate accounting system, such as SAP or Oracle, needs to be in place which is likely at present to be restricted to a company s larger territories as well as tax return software. (b) New approach As the availability of appropriate systems continues to broaden, more and more of a company s tax requirements around the globe will be candidates for automation. We already see some companies that are embracing outsourcing options within tax realize these benefits, and more. One company is outsourcing the whole process of corporate income tax compliance and accounting over 5 years. In so doing the company expects total process cost savings of between 20% 30%, an improvement in standardization, control and visibility, and an increase in the automation of process, leading to a liberation of tax professionals in each country to focus on value adding work. We see three major areas of benefit arising from this new approach: improvement in the effectiveness and reduction in the cost of managing tax compliance and reporting on a global basis; enhanced ability to reduce the total amount of tax paid through greater visibility of the tax position and tax drivers; and release of time and resource to focus on value adding work elsewhere in the business and creating the ability to support business strategy and manage risks better. By automating tax processes, higher levels of assurance around the accuracy of direct and indirect tax source data are gained which will provide greater confidence in compliance, reporting and planning activities in the future. (c) Transform the tax professional These improvements mean that tax professionals within the organization will be able to change the way that they approach their work. They will be able to offer greater support to the business, providing insight for decision making and helping the business to make sure that it can report to the market accurately and quickly. Tax work will no longer need to be carried out in jurisdictional silos and so transferable tax skills rather than the mastery of a specific country s regulatory content will come to the fore. Just as finance professionals routinely work on a global basis, so too will tax professionals be able to focus their expertise to best serve the needs of the organization. (d) Start the transformation journey There is no need to reinvent the wheel for tax. Instead, tax should take the maximum advantage from the work already carried out in finance. Tax needs to build on those achievements, working with finance and IT to articulate what is needed and how to work together to achieve it. Tax reporting at the touch of a button may seem a distant aspiration for many, but we believe that it is a destination that tax should be travelling towards. There are some companies adopting new approaches that deliver major improvements. There is of course no single route to improvement. The degree of standardization and automation that is either desirable or possible will vary from organization to organization and will reflect the broader business strategy and environment. However, the investments that companies have made in their financial systems need to be taken up by tax so that they too can receive the benefits that the finance function has already seen. (e) Questions to ask Is the process of managing tax going to give the same benefits that we see arising in other areas of the organization? Are our tax processes as automated as they could be? Is tax an integral part of the way we collect, manage and report our financial data? Is tax executed as a workaround? Do we have tax reporting at the touch of a button? online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 18/23

19 3.7. Organization and resources This part will address the following topics: (a) (b) organizational resources; and questions to ask. (a) Organizational resources People are the cornerstone of any tax function and ensuring they have the right skills, knowledge, motivation and tools is fundamental to the management of tax and minimizing risk. The challenge for organizations is to ensure the right level and balance of resources given the available budget. To enable effective resource management, some tax departments are focusing on the following four elements to achieve the required levels of performance and quality while balancing cost constraints: Management. Tax directors need to focus on giving the right work to the right people. This will enable a balanced workload that should be consistent with the wider organization s operating strategy. Skills utilization. Allocate specific tax work to those staff that have the necessary tax technical background and skills to undertake that work. Often, tax directors fail to recognize the extent of areas where an activity requires technical skills or experience that is not tax related. Where this is the case, tax directors can benefit from contracting that work outside of the tax function. Incentivize. Tax personnel should have clear job descriptions, attainable opportunities for career progression, and a development and training plan. Of course, remuneration is also important and these attributes will ensure that the organization can attract and retain the best tax people. Motivate. Ownership and pride in the work carried out by tax personnel is important. A main risk area for the tax director is to unwittingly create a working environment which engenders monotony, career stagnation or a sense of unrewarded effort. This can readily be resolved by including staff in meetings, providing clear communication channels for feedback and discussion, providing achievable goals that challenge the individual, delegating effectively and building trust. Of course, many tax directors also look outside their immediate function for skills and resources. Equal benefits can be leveraged by alternative resourcing options such as outsourcing, use of shared services centres and external technical consultants. The important issue for the tax director however is to try and ensure there is a consistency in the skills and resources used to manage tax in the organization. Loss of knowledge and expertise of a company s tax processes and controls (especially when these may be opaque) is a significant risk. (b) Questions to ask Do we have the right tax competencies in the organization? Do we have enough skilled tax personnel in our organization? Do we have assurance on the continuity of our tax department? Do we have access to external expertise in a timely manner? Do we have enough budget to reach our tax goals, considering the tasks and responsibilities assigned to our tax department? 4. Culture This part will cover the element of culture in the organization. The following will be addressed: How can sustainable compliance be achieved without losing flexibility and creativity? (see 4.1.). Alternatives to COSO (see 4.2.). Levers of control (see 4.3.). Culture Balancing creativity and control An organization is a place where people work together and use their intellect and creativity to create output. The governance structure of an organization always has to balance the stimulation of creativity and the extent to which it is in control of this process. Too much creativity could lead to inefficient allocation of resources and losing sight of the overall goal of the organization. At the other end of the spectrum there is an organization where all processes are regulated, checks are in place, but creativity and flexibility are suppressed and underutilized. When considering this, an organization should ask the following question: 4.1. How can sustainable compliance be achieved without losing flexibility and creativity? The answer to this question is not simple. In a time where innovation and creativity are potentially the most important drivers of success, control could become a burden if applied in a dogmatic way. Too much control could pose one of the biggest risks a company faces in turbulent times because it hinders the greatest assets a company has: creativity and flexibility. These two traits could be of great value in guiding the company through turbulent times. To explore the question further, three different topics should be addressed: (a) the cost and benefits of compliance, (b) control rationalization and (c) standardization and centralization of control. These topics will be explored next. (a) The cost and benefits of compliance Considering the initial efforts made by companies to comply with the corporate governance code, many have felt as if the cost of internal control has outweighed its benefits. In the early stages, a lot of time and effort was devoted to implementing the control frameworks which included comprehensive control description, and design and testing of the internal control framework. This all laid a burden on the energy and resources of the organization. Other organizations now feel that the investments made in the early years are finally paying off. (b) Control rationalization Recently, companies have reconsidered the scope and extent of their internal control framework. During the early stages of implementing the internal control framework, many companies felt they lacked guidance and therefore over scoped their projects. Nowadays there is a clear need for lighter versions of an internal control framework which provide the same level of assurance. This can be achieved by putting more emphasis on company level controls. By improving company level controls and testing, more detailed underlying controls can be reduced significantly. The aim of company level controls is to improve control effectiveness and reduce costs. (c) Standardization and centralization of control To support an efficient management of the control environment, internal control should be more centralized online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 19/23

20 with common processes and control, and standardization. This means introducing a more centralized rulebased approach to the essential processes while balancing the need for creativity and flexibility. This asks for a change in culture as well as a change in the internal control processes; a model where people and culture are more central to the approach towards internal control Alternatives to COSO An alternative to COSO is the leading international CoCo control model from the Canadian Institute of Chartered Accountants, which was issued in It acknowledges, as does COSO, that the control environment is the foundation of internal control, but takes it one step further. The intention of CoCo is to emphasize the people and cultural aspect of control. CoCo states that effective internal control is not only enforced by segregation of duties, policies and procedures, but the model focuses on intangible factors such as leadership, shared values and mutual trust, e.g. entity level controls. It acknowledges the fact that should be obvious to management: that an organization consists not only of processes and systems, but also of people, and that people are most often the key to success or the reason for failure. So it focuses on the commitment, capability and learning of people in the organization. Moreover, the CoCo model is dynamic. It has action, and because of the implicit plan to check act cycle, the control model comes full circle and has continuous change as its basic assumption. The model is shown below. Picture 25: The CoCo model: focus on organization and culture The CoCo model identifies the mechanism of internal control based on cultural and people related elements: Purpose. First, people must understand the purpose, goals and objectives of the organization and what their role is in achieving these objectives. Commitment. The next step is to have people commit to these objectives. Capabilities. The following step should be for the people to have the capabilities which are required to achieve those goals. Having the right knowledge and skills in the organization is essential in achieving them. Monitoring and learning. To complete the model, the organization should monitor the progress and learn from previous experiences. This completes the cycle Levers of control Another model to consider besides the CoCo model is the model developed by Simon (Harvard Business School), which is called levers of control. Simon describes how managers could use innovative control systems to drive continuous strategic renewal. It describes controls (in his model the levers ) which enable the organization to stay in control while both capitalizing on the autonomy and drive present at lower levels to respond to emerging opportunities. The model seeks to empower the people in the organization and at the same time to encourage accountability. It provides a direct link from the strategy to accounting and control and taxes. In essence it is providing a bridge between top down (tax) strategy and bottom up creativity. This model is depicted below. Picture 26: Simon: levers of control online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 20/23

21 5. How to get started Tax risk management covers the identification of business risks originating from the tax position of a company and identifies ways to manage these risks. The identification, implementation and maintenance of risk management and supporting systems should be done in three phases. The first phase includes a zero measurement in which the organization identifies its key risks. The second phase includes the implementation of a TCF to mitigate these risks. The third phase is the maintenance phase in which the organization is in control of its tax risks and updates the framework when necessary. These phases will be described in more detail in the next paragraph. Apart from the execution of the tax risk management method during these phases, the organization should also consider communication and cooperation with the tax authorities. Building a good relationship with the tax authorities will speed up and improve the tax filing process in the future. Transparency about tax risks is also a way to improve good communication with the tax authorities and assures control on uncertain tax positions. The implementation of a TCF could enable insight and control of these positions Blueprint TCF A risk is the possible occurrence of an event which will negatively affect the goals of an organization. To identify the risks of an organization, the strategy and goals should also be identified. The TCF is a way to manage those risks which could potentially have a negative effect on the realization of these goals. Before the execution of this process, it is essential to make the goals quantitative to be able to measure outcomes. In many cases this involves the business goals or tax goals, which are formulated in an overall strategy of the organization. They must reflect the ambition level of the organization. Phase I: Zero measurement Based on interviews, an initial list of risks is identified. Important in this process is the explicit definition of a risk in order to create a common understanding of the risks discussed. The overview of identified risks contains all tax risks which can be identified for the organization, but not all risks can be acted upon because of time and resource constraints. Acting upon every conceivable risk is not a necessity because not all risks have the same urgency to be solved. To identify the key risks of the organization, the risks need to be rated and prioritized. The risks will be rated on impact and preparedness. These concepts will be explained next. Impact. If a risk (an event) actually occurs, what would the impact be on the organization? (This does not take the existing controls into account). Preparedness. This is the risk which remains after taking the current control measures into account. The central question is: considering our controls, are we doing enough to mitigate our risks? By assessing which risks have a high impact on the organization considering the current key controls, a risk profile can be created. This provides the organization with an insight on what risks to focus on and what risks are less urgent. Phase II: Implementation In this phase, the risk register will be introduced. In a risk register, the assessed risks from the previous phase can be documented. The risk register is a means to communicate the key risks to the management of the organization. The risk register is a central place where the identified risks are schematically presented. It contains KPIs which are relevant to the organization. A risk register, for example, consists of the following labels: number, name of the risk, risk definition, cause for the risk to occur, risk category and the risk owner. After the creation of the risk register, the identified risks must be analysed to create a plan on how to mitigate them going forward. The organization should also identify if additional (key) controls should be implemented to mitigate the risks. This analysis should be added to the risk register by formulating an action plan, evaluation of a risk profile and integration with the strategic planning process. For each risk, an assessment is made on how to approach the risk. There are four generic actions an organization could take, identified in the diagram below: Picture 27: Four ways to approach tax risks online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 21/23

22 To anticipate on the risks, an action plan should be formulated. An action plan should contain tasks and responsibilities and the ownership of risks should be appointed to individuals. This provides assurance that a risk is being monitored and that the appropriate individual with the required knowledge and competences has oversight of a specific risk. A systematic review of the causes and effects of the identified top risks provides a clear overview of the actions already taken and the actions which should be taken to optimize risk mitigation. The controls, as formulated in the action plan, aim to decrease the vulnerability to the risk. The specific set up of the controls is described in the risk action plan. Phase III: Test and use When the controls are defined by the risk owners, they should be tested in practice. A central question in this process is whether the controls are effective. This also relates directly to the control objectives. The controls are tested to prove their working and mitigating effects. In line with the risk register, the risk owners will do the testing of the appointed controls. The method of assessment of whether the control is effective is a management decision. A solution could be to carry out the physical testing of the control, but a control self assessment or similar testing is also a solution. The first step in control testing is to identify the existence of a control and how it is set up. The next step could be to test the working of the control and whether it indeed covers the related risk. The test results could be used to reconsider the approach towards existing risks. To improve transparency about the status of identified top risks and the overall risk profile, the organization could use a TCF report. The TCF report is a means to monitor the risk profile of the organization and creates the ability to manage upcoming risks or the mitigation of existing risks Conclusion In this chapter we have tried to provide you with a flavour of the common elements of a TCF. There are aspects that need to be addressed in each TCF, irrespective of the kind of organization. Although every organization is unique, every organization has a different business control framework, and therefore a different TCF, experience does show a TCF blueprint. The TCF blueprint items can be addressed along the lines of six building blocks: Picture 28: The building blocks of a tax function Ultimately, this should lead to a tax function which is embedded in the organization and which is effective, efficient and transparent. * ** *** Partner Tax Management Consulting, Deloitte, the Netherlands. Partner Tax Assurance, Deloitte, the Netherlands. Partner Tax Transformation, Risk and Co sourcing, Deloitte, United Kingdom. Citation: B. de Mik et al., Tax Risk Management: From Risk to Opportunity (IBFD 2010), Topical Analyses IBFD (accessed 15 June 2013). online.ibfd.org.tjsl.idm.oclc.org/collections/rm/html/rm_c02.html?wt.z_nav=outline&colid=4941&print=yes 22/23