Finally, the expected impacts on tax compliance behaviour of a large corporation adopting a tax risk management system are identified and discussed.

Transcription

1 Article Summary Managing tax risk and compliance Focus and scope The identification of tax risk management, as part of good corporate governance practices, requires directors to consider the tax risk profile that the corporation will adopt and to put in place systems and procedures that ensure the level of tax risk complies with corporate policy. Director s duties and corporate tax compliance behaviour are linked through the tax risk management policies of the corporation. In this paper, Catriona Lavermicocca discusses the impact of the corporate structure on an understanding of tax compliance behaviour, identifies the pressures on large Australian corporations to adopt a tax risk management system and considers the expected impact on corporate tax compliance behaviour. Background In an effort to improve corporate tax compliance, the Australian Taxation Office (ATO), along with other revenue authorities around the world, has emphasised that directors of large corporations (defined as corporations with annual turnover of around $100 million or more) must ensure that they are aware of the tax position taken as part of meeting their director s duties. That is, good corporate governance practices require systems to exist within a corporation to ensure directors are informed and make the final decisions with respect to acceptable tax risk. The author first introduces the topics of tax compliance behaviour, corporate governance and tax risk. This involves discussion of the impact of a corporate structure on an understanding of tax compliance behaviour, what constitutes corporate governance, what is tax risk, and the ATO compliance model as it applies to large corporations The paper then considers the pressures on large Australian corporations to include tax risk management systems in their corporate governance practices and the extent to which tax risk management practices have been adopted. This includes discussion of the views of the ATO in relation to tax risk management and tax decision making by large corporations, other pressures including the ASX Principles of Good Corporate Governance and Best Practice Recommendations, the amendments to company law made by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (Cth) (CLERP 9), continuous disclosure obligations, accounting for taxes following the adoption of International Financial Reporting Standards in Australia (AIFRS), and evidence, drawn from surveys, of tax risk management practices in large corporations. Finally, the expected impacts on tax compliance behaviour of a large corporation adopting a tax risk management system are identified and discussed. Impact The author believes that the identification of tax risk management as part of good corporate governance reflects a change in the culture and attitude of government, shareholders, directors and stakeholders towards the tax function in a large corporation. However, further research needs to be done to determine whether an improvement in large corporate tax compliance is a consequence of the identification of directors as being responsible for tax decision making and the provision by the ATO of clear guidelines concerning tax risk practices and tax decision making. It appears that, despite the adoption of a tax risk management system, large companies in Australia are devoting as much, if not more time to tax planning. Finally, UK research indicates that without a clear link between adopting a low tax risk profile and quantifiable benefits to the taxpayer it is unlikely that the identification and management of tax risks will improve corporate tax compliance behaviour. Legislation, cases, rulings discussed Corporations Act 2001 (Cth), s 180, 295, 295A, Pt 9.4AA Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (Cth) Sarbanes-Oxley Act 2002 (US), s the tax specialist Volume 13 No. 2 October 2009

2 Managing tax risk and compliance Director s duties and corporate tax compliance behaviour are linked through the tax risk management policies of a corporation. This paper discusses the impact of the corporate structure on an understanding of tax compliance behaviour, identifies the pressures on large Australian corporations to adopt a tax risk management system and the expected impact on corporate tax compliance behaviour. by Catriona Lavermicocca FTIA, Lecturer Macquarie University Introduction In an effort to improve corporate tax compliance, the Australian Taxation Office (ATO) 1 along with other revenue authorities around the world, 2 has emphasised that directors of large corporations must ensure that they are aware of the tax position taken as part of meeting their director s duties. That is, good corporate governance practices require systems to exist within a corporation to ensure directors are informed and make the final decisions with respect to acceptable tax risk. The ATO defines a large corporation as a corporation with an annual turnover of around $100 million or more. 3 Because much of the pressure on a corporation in Australia to adopt a tax risk management system derives from ATO statements and announcements, the discussion in this paper relates to Australian corporations that satisfy the ATO definition of a large corporation. The size and significance of tax revenue contributed by large corporations in Australia suggests that any improvements in the level of tax compliance of this group will have large tax revenue implications. As at April 2007, according to ATO figures, there were around 36,200 entities that constitute a large corporation, totalling 1,900 corporate groups. 4 Firstly, the topics of tax compliance behaviour, corporate governance and tax risk are introduced in this paper. The paper then considers the pressures on large Australian corporations to include tax risk management systems in their corporate governance practices and the extent to which tax risk management practices have been adopted. Finally, the expected impact on tax compliance behaviour of a large corporation adopting a tax risk management system are identified and discussed. Impact of a corporate structure on an understanding of tax compliance behaviour The factors that impact on the tax compliance behaviour of a corporation, particularly a listed corporation, in which there is a clear separation of ownership and control, are quite different from those affecting individual taxpayers. Research in relation to tax compliance behaviour has focused to date on individuals, and the models and theories that have evolved highlight economic, psychological and sociological factors that affect individual tax compliance behaviour. 5 However, one model or theory alone does not provide all the answers as research highlights a variety of factors that affect different individual taxpayers tax compliance decisions differently. 6 Economic deterrence models of tax compliance assume that the taxpayer is a utility maximiser and that decisions concerning tax compliance are based on a taxpayer s risk profile. 7 Accordingly, efforts by revenue authorities to improve tax compliance based on economic deterrence models have focused on audit and the imposition of penalties. That is, taxpayers are more likely to comply the higher the penalties and the chance of being audited. The application of economic deterrence models of tax compliance to corporate taxpayers is not straightforward, as prima facie any tax adjustment or penalty is imposed on the corporation. As the corporation is a separate legal entity, the directors and employees who make the decisions concerning tax compliance are not necessarily financially affected by the tax adjustments. The shareholder s returns are reduced by any additional taxes or penalties, yet they do not necessarily make the decisions concerning tax compliance where there is a clear separation of ownership and control. Importantly, where shareholders have diversified share portfolios, economic risks are minimised and the impact of a tax adjustment or penalty on their return cannot be assumed. 8 In addition, shareholders in a listed company are not necessarily made aware of any tax adjustment or penalty unless it is material and, as a result, there is no clear connection by the shareholders between the tax adjustment or penalty and the financial impact on them. 9 Unlike individual taxpayers, shareholders financial exposure or liability for tax adjustments or penalties imposed on the corporation is limited to their contributed share capital. Social psychology models of tax compliance look at the impact of social stimuli and interaction on individual decisionmaking and have limited application to a corporation as the corporation itself does not exhibit characteristics such as tax morale, education, perceptions of fairness, age and gender. 10 Directors decisions should ultimately be based on corporate goals and objectives as opposed to the It s essential 67

3 personal goals and objectives of a director. The extent to which the characteristics of the corporate decision makers explain corporate tax compliance behaviour has been the subject of limited research. 11 The fiscal psychology models of tax compliance behaviour are a mix of the economic deterrence and social psychology models in which economic or financial factors, as well as the social and psychological characteristics of a taxpayer, are recognised as having an impact on tax compliance decision-making or behaviour. 12 Accordingly, the limitations in applying the economic deterrence models and social psychology models to a large corporation also apply to any combination of those models. Directors and officers of a corporation are to some extent accountable for the decisions they make in relation to a corporation they manage and that includes taxation. The Corporations Act in Australia as well as common law principles, impose a duty on directors to act in good faith and in the best interests of the corporation as a whole, to maintain confidentiality, not to make secret commissions and to exercise powers for a proper purpose. Directors and officers also owe a fiduciary duty to the corporation not to individual shareholders. Section 180 of the Corporations Act applies to both directors and officers of a corporation and imposes a statutory duty to act with due care and diligence. There is no definitive standard that applies to all directors and officers as the test in s 180 is determined by considering the circumstances of the particular company and also the individual director s responsibilities within the company. Duties imposed on directors and officers under the Corporations Act and the common law do not provide workable rules and have not been used to hold corporate decision makers accountable for tax adjustments and penalties. In addition, the business judgment defence in s 180(2) provides for alternative commercial justifications for the tax decisions made. Accordingly, legislative and common law duties have to date been inadequate as a means of ensuring that the directors make the right decisions with respect to tax compliance. The uncertainty and complexity of the tax laws and the ability to rely on external advice and other commercial justifications for business decisions demonstrate that simply making directors accountable for tax adjustments is not appropriate. In many large corporations tax managers control the detailed tax information and only provide superficial information and aggregated data to the board of directors so that all board members may not be fully informed in making their decisions. 14 The recent focus on tax risk management as a duty of directors of large corporations in Australia is not based on a specific requirement within a statutory provision. Instead guidelines on good governance practices and ATO statements encourage directors of a large corporation to be informed and accountable for the tax risk profile that the corporation adopts. What is corporate governance? The topic of corporate governance has been the focus of discussion and research over the last 10 years, particularly since the corporate collapses of Enron and WorldCom in the US and HIH in Australia. At its simplest, corporate governance is concerned with the way in which companies are directed and controlled. 15 The 2004 OECD revised Principles of Corporate Governance state that, corporate governance involves a set of relationships between a company s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. 16 As corporate governance concerns the management of the company and the extent to which stakeholders interests are respected and protected, it derives very much from the separation of ownership and control in a corporate structure. Fundamental in developing corporate governance practices within a corporation there needs to be an identification of who the stakeholders are. In the Anglo-American model corporate governance focuses on the interests of the financial stakeholders, typically shareholders. In the European market model where stock markets are less liquid and cross shareholdings occur between industrial groups and banks, governance is often extended to a broader range of stakeholders, including employees and customers. Specifically, risk management has been identified globally as a corporate governance issue and tax risk has been the subject of increased attention as part of a good corporate governance approach. 17 The risk management strategy that the board of directors takes is a balancing act as reducing one set of risks may have an impact on others. By way of example, a board of directors that decides to take a more risk-averse approach to reduce the risks associated with its reputation may be accused of not taking sufficient risk to maximise tax savings. Further, the increased focus on corporate social responsibility is expected to impact on corporate governance practices as the pool of stakeholders affected by a corporation s outcomes increases. 18 The 2007 review of ASX Corporate Governance Principles (2003) 19 indicated that there was significant interest in corporate social responsibility as part of good corporate governance in Australia and highlights that in evaluating risks the directors should consider corporate social responsibility and sustainability issues. A fair contribution in the form of appropriate tax payments is an issue of corporate social responsibility and may impact on how aggressive an approach a listed corporation will take to tax planning and compliance. What is tax risk? The decisions, activities and operations of a corporation give rise to uncertainties or business risks. In a recent global survey by Ernst and Young titled Strategic Business Risk: 2008 The Top 10 Risks for Global Business, regulatory and compliance risk was ranked first in the list of strategic challenges facing leading global businesses. Tax uncertainties give rise to regulatory and compliance risk and dealing with those risks pose a significant challenge for corporations. Until recently, tax risk management and tax internal controls were rarely discussed or written about and the tax department within a corporation tended to operate in isolation from the board of directors. Tax uncertainties create tax risks and managing tax risk is about managing those uncertainties. A narrow view of tax risk would include uncertain tax positions and vulnerabilities in tax financial controls 68 the tax specialist Volume 13 No. 2 October 2009

4 and reporting. 20 In comparison, a broader definition and one that reflects the current view on risks includes, any event, action, or inaction in tax strategy, operations, financial reporting, or compliance that adversely affects either the company s tax or business operations or results in an unanticipated or unacceptable level of monetary, financial statement or reputational exposure. 21 that represent the greatest risk to the revenue. In addition, the ATO Compliance Model adopts the position that to understand the compliance of an individual or group then the ATO needs to understand the environment in which they operate. Cooperative strategies are considered first and the identification of tax risk are not legal rules but rather generally accepted guidelines and principles. Specifically, the ASX listing rules do contain Principles of Good Corporate Governance and Best Practice Recommendations which include tax risk management, however, ASX listing rules are only binding on ASX listed companies. Tax risk management is not necessarily about minimising tax risk but rather about a determination of the level of risk that is acceptable to the particular corporation and putting in place processes and procedures that ensure tax risks do not exceed acceptable levels. PricewaterhouseCoopers in their publication, Tax Risk Management outline seven broad categories of risk associated with taxes 22 including transactional, operational, compliance, financial accounting, portfolio, management and reputational risk. The ato compliance model tax risk management by large corporate taxpayers The identification of tax risk management, as part of a large corporation s governance practices and as a responsibility of the board of directors, reflects the ATO s compliance philosophy based on cooperation and described in its publication Cooperative Compliance: Working with Large Business in the New Tax System (November 2000). Responsive regulation is a fundamental characteristic of the ATO Compliance Model that derives from the Cash Economy Taskforce Review commencing in 1997 and incorporates four essential elements as follows: 1. Understanding taxpayer behaviour. 2. Building community partnerships. 3. Increased flexibility in ATO operations to encourage and support compliance. 4. More and escalating regulatory options to enforce compliance. The ATO Compliance Model is based on a risk management philosophy and compliance pyramid. 23 Compliance strategies are developed focusing on areas management practices of large corporate taxpayers by the ATO very much reflects efforts at the bottom of the compliance pyramid. In addition, the Taxpayer s Charter, first published by the ATO in 1997, documents the rights and responsibilities of taxpayers and emphasises the mutual obligations of the ATO and taxpayer in an effort to support and encourage taxpayer compliance. 24 The Commissioner, Michael D Ascenzo, has stated that the identification and targeting of risks by the ATO as part of its compliance strategy is to improve voluntary compliance using what is believed to be the least expensive and most effective approach. 25 ATO targets tax risk management The ATO expects, yet there is limited empirical evidence at this stage, that focusing on tax risk management practices will improve tax compliance by large corporations. This section of the paper highlights the views of the ATO in relation to tax risk management and tax decision making by large corporations. Since June 2003, the ATO has identified the importance of tax risk management by large corporations and the requirement that directors of a corporation be informed about tax matters, particularly the risk approach taken by the company. The Commissioner does not refer to legislation or legal rules to support the view that large corporations should adopt a tax risk management system but good corporate governance principles. As detailed later in this paper, good corporate governance principles in Australia In a leaders luncheon address on 10 June 2003, the then Australian Commissioner of Taxation, Michael Carmody, raised tax compliance as a corporate governance issue. In that speech the Commissioner stated that material tax issues require the attention of the Chief Executive Officers and board of directors and that there is a clear link between tax compliance and good corporate governance. The Commissioner identified a checklist of questions the ATO believed a Chief Executive Officer or Company Director should be asking to ensure that their corporate governance responsibilities are met. 26 The Deputy Commissioner of Taxation, Jim Killaly, also addressed the importance of good corporate governance practices with respect to taxation in large companies as well as the requirement that directors be informed about the tax position that the company takes. 27 Killaly notes that: In cases that I have recently had cause to review I have been amazed at the extent to which some boards rely on specialist tax advice, whether internal or external, without any independent scrutiny on their part. Directors need to be demonstrating that they are considering what is being put to them in a way that shows that the company took reasonable care and did not act recklessly. 28 In March 2005, the Commissioner of Taxation, Michael Carmody, again spoke of the role of corporate governance in tax at the Taxation Institute National Convention. 29 It s essential 69

5 Since raising the issue I have sought to reinforce and support more conscious tax risk management by writing directly to the Chairmen of Boards of Australian listed companies; by giving boards confidence that tax risk analysis papers prepared for them will remain confidential; and more recently by developing cooperative and time sensitive arrangements for private rulings on issues of concern to boards. 30 The ATO has made it clear that corporate taxpayers who adopt a high-risk profile will be targeted for further investigation. The governance issue for large businesses that take an aggressive stance in relation to tax avoidance is that they have to recognise that they are thereby adopting a high risk profile that may have significant financial consequences and adversely impact their reputation. On our side there is a risk to revenue and community confidence if we do not tackle such behaviour. 31 During 2006, the ATO issued information packs (2006 Large Business and Tax Compliance Booklet) to the chairpersons of large corporations regarding good governance, tax risk management and compliance, and included in that pack was 10 copies of a new one page Tax Governance Guide. The Tax Governance Guide contains two checklists taken from earlier checklists issued by the ATO concerning tax risk management. The ATO argues that they are designed to assist board members to identify the issues and characteristics that attract the ATO s attention and potential tax risks. Drawing on the Large Business Symposium organised by the ATO in August 2006, the Commissioner of Taxation wrote to the top ASX 200 in January 2007 enclosing a summary of the Large Business and Tax Compliance Booklet. The intention of the letter and summary sent by the Commissioner was to provide the company board members and directors with some suggested common sense questions which they could use for governance purposes. 32 The Commissioner advised that the feedback from this initiative was generally positive. 33 The common sense questions for directors of a large corporation to address as determined by the ATO are as follows: Is there, a sound framework in place to manage its tax risks and comply with its tax obligations? a well resourced in-house tax governance capability? reporting requirements to ensure that significant tax risks could be elevated to the board level? appropriate review and sign off procedures for material transactions? an effective tax risk mitigation capability including the company s relationship with the Tax Office, and a capacity to regularly audit tax governance systems? Most recently (May 2008), in a speech to the Corporate Tax Association Convention in Sydney titled A New Dimension the Commissioner of Taxation, Michael D Ascenzo, announced a new initiative referred to as an Annual Compliance Arrangement (ACA) in response to the large corporate taxpayers need for certainty in relation to expected tax exposures. Where an ACA is entered into, the ATO will issue the taxpayer with a sign-off letter confirming the outcomes of a joint risk assessment. Initially, the possibility of entering into an ACA will only be available to the top 50 companies based on turnover. To enter into an ACA the ATO states that the company must meet the key corporate governance guidelines set out in the 2006 Large Business and Compliance booklet and have a genuine commitment to full disclosure. 34 The recent emphasis by the ATO on large corporate taxpayers to be cooperative, transparent and work towards a constructive and cooperative relationship 35 derives very much from the ATO Compliance Model based on responsive regulation as a means of improving corporate taxpayer compliance. Other pressures on a large corporation to manage tax risks Principles of good corporate governance and best practice recommendations The Australian Securities Exchange (ASX) formed the Corporate Governance Council (made up of 21 different business, shareholder and industry groups) in August 2002 in response to a call for clear guidelines concerning governance best practice. The business community and particularly the ASX were concerned that significant corporate failures in Australia and the US, where financial problems were not identified until after the collapse, would result in a loss of confidence in the stock market. 36 The Corporate Governance Council (the Council) prepared and published Principles of Good Corporate Governance and Best Practice Recommendations in March 2003 in an effort to enhance the corporate accountability of listed companies. 37 As stated by the Council, any corporate governance regime needs to be flexible to cope with the constantly changing business environment and as a consequence the 10 core principles listed are principles not rules and each principle equally underlie good corporate governance. 38 Principle 4 of ASX Principles of Good Corporate Governance requires a board to be confident that financial reports present a true and fair view. The ability of the board of a listed company to be confident in the tax figures in its financial reports would require the development and application of policies on tax risk oversight and management. In addition, Principle 7 requires uncertainty and risk to be recognised and managed through effective oversight by the board of directors and internal controls. The board of directors must be aware of material risks, including tax risks, in complying with Principle 7. Principle 4 and Principle 7 have application to tax risks but are not compulsory and only apply to listed companies under Listing Rule Listed companies must provide a statement in their annual report in accordance with Listing Rule disclosing the extent to which they have followed the Corporate Governance Best Practice Recommendations and if they have not complied, why not. Interestingly, shortly after the publication of Principle 4 and Principle 7 in March 2003 by the Council, the Australian Commissioner of Taxation highlighted tax risk management as part of good corporate governance. As stated by the Commissioner in that speech: 70 the tax specialist Volume 13 No. 2 October 2009

6 Our expectation is that large businesses will ensure appropriate oversight and systems for management and integrity assurance relative to the importance of various tax issues. We expect close management and scrutiny of material issues. A failure to do that can have significant financial consequences for the revenue system, corporations and shareholders. 39 CLERP 9 Reflecting the theme of greater accountability for corporate decision makers, the Australian Federal Parliament passed the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9), which again was a response to corporate collapses in Australia. CLERP 9 focused on improved disclosure by listed companies. CLERP 9 amendments to the Corporations Act include the four key areas of executive remuneration, financial reporting, continuous disclosure, and shareholder participation. Importantly, these reforms increase the pressure on directors to be informed concerning tax risks, as ss 295 and 295A (applies to listed entities) of the Corporations Act requires a formal statement from directors regarding the integrity of the accounts. In addition, CLERP 9 strengthened the requirement to disclose by imposing personal liability on individuals responsible for a failure to disclose, and the Australian Securities and Investment Commission (ASIC) has the power to issue infringement notices. 40 Both the ASX Corporate Governance Principles and CLERP 9 have increased the amount of information made available to shareholders in an Australian listed corporation. It is envisaged that existing and potential shareholders in a listed corporation would have a negative reaction, possibly demonstrated in a reduction in the share price, if a listed corporation failed to comply with the ASX Corporate Governance Principles and CLERP 9. Continuous disclosure obligations Companies listed on the ASX are subject to continuous disclosure obligations (subject to some exceptions) under ASX listing rule 3.1. Listing rule 3.1 imposes an obligation to immediately disclose to the ASX information that a reasonable person would expect to have a material effect on the price or value of the entity s securities. A failure to disclose information that meets the criteria under listing rule 3.1 exposes the corporation to a civil penalty under the Corporations Act. The disclosure of tax risks identified by a listed corporation may be required in accordance with the continuous disclosure obligations and in Australia we have seen the continuous disclosure rules in operation in the disclosure to the market of the outcome of tax audits by the Commissioner in the cases of ANZ Bank, 41 Macquarie Bank 42 and Coca Cola Amatil. 43 Sarbanes-Oxley Act US of 2002 The Enron collapse in the US in 2001 put corporate governance high on the business and political agenda in the US and one of the responses of the US Federal government was to introduce tough new legislation in the form of the Sarbanes-Oxley Act of 2002 (SOX). The key objective of SOX is shareholder protection through increased regulation of the audit profession, financial disclosure and appropriate corporate governance practices by public companies listed on the US exchanges. As expected, US companies have reported significant costs in complying with SOX. Most listed US corporations have been affected by s 404 of the SOX Act that requires an annual report by management regarding internal controls, procedures for financial reporting and an attestation as to the accuracy of the internal control report by the company s auditors. Any corporation that cannot attest to the effectiveness of internal controls must report the deficiency to its audit committee. The requirements in s 404 impact on a corporation s risk management systems including tax risk management, as directors are required to attest to the internal control systems that are in place. Before SOX, accounting for income tax was handled differently to other financial statement amounts in that there was a less formal process and it was often the responsibility of one individual within a corporation. 44 The failure of the internal control systems within US listed corporations to deal with tax risk before the introduction of SOX is demonstrated in a review of the material weaknesses reported after the application of s 404: In the first year of SOX section 404 internal controls reporting, the tax function accounted for one third of all material weaknesses reported by enterprises. In the second year, the percentage of tax related material weaknesses increased slightly as external auditors focus further on this previously unconsidered area. In the third year, the trend towards 30% continues. 45 The impact of SOX has also been felt in Australia, as Australian subsidiaries of US registered reporting entities are obliged to comply with s 404 for financial years ending after 15 November Also, Australian entities issuing securities in the US must comply with s 404 after 15 July 2006 or 2007 depending on the characteristics of the securities issued. As a result of s 404 there has been a focus on internal control systems in relation to tax risk and accounting for income taxes because of the formal requirement to report material weaknesses. As previously stated, tax was one of the most common areas of internal control failure cited in adverse opinions filed after the introduction of SOX. Accounting for Tax Australian International Financial Reporting Standards (AIFRS) As a result of the adoption of International Financial Reporting Standards in Australia, AASB 112 Accounting for Tax is based on a balance sheet approach that needs regular consideration by accountants throughout the year. In the past, under Australian Generally Accepted Accounting Principles (AGAAP), the accounting entries derived primarily from the income statement and accounting for tax was relatively straightforward. In addition, the recognition criteria for deferred tax assets changed under AIFRS to probable that a future taxable profit against which the temporary differences or losses may be utilised from virtually certain under AGAAP. The balance sheet approach to accounting for taxes in AASB 112 requires accountants working in various areas of financial reporting to understand the tax treatment of a particular item, whereas in the past tax tended to be a specialist area and any tax issue that arose was referred to the tax specialist without an understanding of its impact on balance sheet items. This change in approach to accounting for income tax means that businesses must take a more integrated approach to income tax in preparing the financial statements and in evaluating risks. It s essential 71

7 There must be coordination between those responsible for accounting and reporting and those responsible for taxation in a company in an effort to comply with AASB 112 which should result in a more coordinated approach to tax risk management and evaluation within a corporation. Corporate regulation around the world has focused on the need for greater corporate responsibility with a focus on management and disclosure of risks as demonstrated by SOX in the US, ASX Corporate Governance Principles and CLERP 9 reforms of the Corporations Act in Australia. 46 This trend has had an impact on the tax function within a corporation, not just because there is a requirement to address risk management including tax, but there has been a behavioural shift in acceptable governance practices around the world. Shareholders consider the quality of a corporation s governance practices in making investment decisions and any shortcomings may have an impact on the share price. Increasingly, stakeholders including shareholders and tax authorities are looking at tax management in their evaluation of a corporation. SOX s 404, ASX Good Governance Principles and ATO announcements linking governance and tax all mean that in Australia, as in the rest of the world, a company needs to develop tax risk policies. No consensus has yet been reached concerning how companies should apply corporate governance principles to a corporation s tax function and clearly what approach is appropriate to one company will not necessarily suit another. We have seen in Australia and globally the development and application of tax risk frameworks and tax management processes in large corporations to meet reporting obligations where relevant and to satisfy local tax authorities that tax risk has been addressed by corporate decision makers. 47 The large chartered accounting firms have in recent time targeted tax risk management as an area in which they can provide services to large business. 48 The worldwide trend has been towards increased risk management, greater transparency in financial reporting and accountability of corporate decision makers, and it is anticipated that these trends have had an impact on the tax function within a corporation. To some extent the impact on the tax department in a large corporation can be gleaned from a number of surveys carried out by international chartered accounting firms that look at tax risk management practices and the activities of corporate tax departments generally. The impact of tax risk management practices on corporate tax compliance behaviour has been the subject of only limited research. Evidence of tax risk management practices in a large corporation A number of surveys by the large international chartered accounting/professional firms have considered the tax risk management practices of large corporations around the world. These firms see a market in advising on tax risk management and have published a significant amount of material on the topic. 49 KPMG and Ernst and Young have led the way in collecting information from tax executives concerning the functioning of tax departments within large companies. 50 Those surveys indicate that there is increasing pressure on tax departments to manage tax risks within a corporate governance framework. Whilst globally the majority of tax department time is still spent on tax return compliance, tax risk management was identified as an important part of a large number of respondent s corporate governance practices. Generally, the importance of tax risk management was not reflected in documented procedures or in the amount of time tax departments devoted to tax risk management. 51 During 2008 Ernst and Young surveyed over 500 tax directors and senior financial executives from large corporations in 18 countries including the United States, the United Kingdom, Canada, Germany, Australia and New Zealand concerning tax risk management practices. It was the third survey of its type carried out by Ernst and Young. 52 A report produced by Ernst and Young detailing the Australian results concerning tax risk management practices states that 64% of Australian respondents are considering or already have a broad risk assessment program for tax and that 80% of tax directors have full and timely involvement in transactions. 53 Managing tax risk was identified as an important measure of performance of tax leadership in Australian companies and tax departments in Australia are under increasing pressure to identify and deal with potential risks associated with tax planning, tax provisions and reporting. Impact of tax risk management practices on large corporate tax compliance A question arises whether the requirement that directors be informed concerning tax decision making and that a large corporation adopt a tax risk management system will necessarily result in an improvement in tax compliance. Research is required to ascertain whether directors have become more risk averse in relation to tax decision making as a result of being identified by the ATO as the individual accountable for the tax risk profile that a corporation adopts. In addition, research needs to consider whether, as a result of the identification of tax risk as a compliance risk factor by the ATO, there has been a reduction in the acceptable level of tax risk in large corporations. The results of research into the acceptable tax risk levels could be used to ascertain whether there have been any consequential improvements in tax compliance. Interestingly, participants in a symposium held by KPMG s Tax Business School (UK) in June 2007 doubted whether improved tax governance would automatically lead to an increase in tax receipts. Attending the symposium were tax professionals from major international companies, the Treasury, HMRC, major universities and personnel from KPMG. 54 The ATO expects, yet there is limited empirical evidence at this stage, that focusing on tax risk management practices will improve tax compliance by large corporations. A higher risk profile will be applied by the ATO to a large corporation that cannot demonstrate a documented tax risk management system or whose acceptable risk profile is considered too high and the ATO has advised that in those circumstances a large corporation will be targeted for further review the tax specialist Volume 13 No. 2 October 2009

8 It is anticipated that the existence of a tax risk management system would have a positive impact on a corporation s tax compliance behaviour as the tax department, directors and external auditors ensure that: a thorough analysis of the tax issues associated with the company s activities occurs; there is an improved attention to detail as decision makers are more aware of the impact of their decisions on the company s tax liability and risk rating; there is greater transparency as to the risk profile of tax positions taken; and as a result of being identified as a person accountable for tax decision making, that they are prepared to accept responsibility for the relevant tax decision. Some evidence of the impact of a large corporation adopting a tax risk management system on tax compliance behaviour can be obtained from the research detailed below. Tax risk management, tax planning and tax compliance The tax risk survey by Ernst and Young carried out in 2006 indicates that globally there was a drop in time spent on tax planning from 28% in 2004 to 20% in 2006, whilst Australian responses indicate that tax planning had increased as a priority during that time. 56 It appears inconsistent during this period, when the ATO had targeted the need for large corporations to adopt a tax risk management system and for directors to be informed concerning tax decision making, that time spent on tax planning increased rather than decreased. Perhaps directors in Australia have not taken a more conservative approach to tax planning because the identification of tax risk management obligations in Australia have primarily been a consequence of ATO announcements rather than a legislative requirement. Whilst a majority of global respondents (54%) and US respondents (60%) to the Ernst and Young tax risk survey in 2006 indicated that they had become more risk averse in relation to tax planning in the period , only 46% of Australian respondents felt that they had become more risk averse in that time. Further 62% of Australian respondents said that their attitude to tax planning would stay the same and only 27% of Australian respondents said that their attitude to tax planning would increase in caution over the period In fact, the subsequent 2008 Ernst and Young tax risk survey indicated that Australian companies have become neither more nor less averse regarding tax planning in recent years. 58 Based on Ernst and Young s research it appears that the majority of Australian corporations are not more tax risk averse despite the fact that a majority of respondent corporations indicated that they had put in place a tax risk management system and that directors were accountable for tax decision making. Development of a more tax compliant group norm in a large corporation Organisational theory suggests that to improve tax compliance in a large corporation, you need to change the tax compliance priorities of the leaders of that corporation. It is anticipated that the identification of directors as accountable for tax decision making would have a positive impact on compliance because it produces personal liability concerns for the decision makers within the corporation. In addition, the ATO tax governance guidelines and other publications giving tax decision makers clear guidelines on what they need to do to manage tax risks, provide an indication of what is acceptable and help tax decision makers avoid ethical uncertainty and reach consensus. As a result of a number of measures in the US, including an expanded tax decision making group, increased transparency, personal liability concerns and clear identification by legislators in the US of unacceptable transactions, an anti-tax shelter group norm has developed within large corporations in the US. 59 Morse argues that the success of measures in the US to reduce the involvement of large business in tax shelters demonstrates that the tax compliance behaviour of a large corporation is best developed by nurturing a group dynamic or norm within that corporation which focuses on the importance of tax compliance. 60 Research by Morse in relation to the successful reduction in the popularity of tax shelters in the US, when applied to the ATO focus on tax risk, suggests that ATO announcements concerning tax risk management practices, the requirement for directors to be informed concerning tax risks, as well as specific guidance on the issues that directors should be considering in relation to tax risk, is consistent with the development of a more tax-compliant or less tax-aggressive group norm within large corporations in Australia. 61 Evidence from UK research By way of background, as a result of the 2006 Varney Review of the relationship between the Her Majesty s Revenue and Customs (HMRC) and large business in the UK, companies within the large business sector were to be awarded a risk rating by HMRC. 62 The risk rating allocated to a company by HMRC would be used to determine the extent to which the HMRC would review the company s tax affairs, as well as the nature of the company s relationship with HMRC. The risk rating approach would allow the HMRC to direct its limited resources to the review of the higher risk corporate taxpayers and would act as an incentive for large corporate taxpayers to alter their behaviour in an effort to obtain a low risk rating. Evidence presented by Freedman, Loomer and Vella, from both a Pilot and Main Survey, indicate that the taxpayer s attitude to tax planning was central to the risk rating allocated by HMRC. 63 The views of large business in the UK regarding the application by HMRC of a risk rating were collected in a Pilot Survey in spring 2007 and in a subsequent Main Survey in spring Both the Pilot and Main Survey involved in-depth interviews with representatives of very large businesses in the UK. The Pilot Survey was small in size with only nine very large business respondents and conducted at an early stage in the implementation of the Varney Report recommendations. The Main Survey interviewed 30 corporate groups when the Risk Rating Approach was almost complete. The results of both the Pilot and Main Survey are detailed in two papers by Freedman, Loomer and Vella. 64 The results of the Pilot and Main Survey indicate a change in behaviour in terms of tax governance, transparency and It s essential 73

9 openness by respondents but identified that the attitude of respondents to tax planning had not changed as a result of the risk rating process. Respondents on the whole said that: they want to be open, transparent and have good governance in place, but they do not want to alter their tax planning behavior (which they engage in only if it is legal even though it may be aggressive in the view of HMRC). Company management ultimately applies a cost/benefit analysis to this question. If the benefit of being low risk (savings made through certainty and lighter engagement with HMRC) do not outweigh the costs (foregoing the savings made from tax planning) then companies will simply not have sufficient incentives to make the necessary changes to become low risk. 65 Evidence from the Pilot and Main Survey that the risk rating approach did not have a significant impact on the approach to tax planning by large business in the UK was also supported by the HMRC s own research. 66 Freeman, Loomer and Vella suggest that the risk rating approach has not been successful in altering attitudes to tax planning because of a failure of the HMRC to clearly demonstrate that a more conservative approach to tax planning, no matter the type or size of the corporation, would result in a low risk rating, as well as the lack of significant and clear incentives to alter tax planning behavior. 67 The Main Survey highlighted that, of the respondents that did take a conservative approach to tax planning, they did so not purely as a matter of choice but as a result of other factors such as the industry or line of business they are in, their particular legal structure, or their low corporate tax bill. 68 A greater understanding of the factors that have an impact on corporate tax compliance behaviour is required to ensure that the identification of tax risks by revenue authorities will motivate large business to adopt a less aggressive tax risk profile. Ulph s research into the affects of the risk rating approach adopted by HMRC concludes that as large business is not informed as to how the HMRC assesses risk there is no incentive for a taxpayer to adopt a conservative approach to tax risk. 69 Applying UK research, significant improvements in corporate tax compliance behaviour are unlikely to be a consequence of the identification of tax risk management as a corporate governance issue by the ATO alone. Instead clearly stated and quantifiable benefits to a corporate taxpayer of adopting a low tax risk rather than a high tax risk profile are required. After all, corporate decision makers are expected to maximise the returns to shareholders whilst operating within the legal system. A conservative approach to tax risk may be in breach of the corporate responsibility to maximise shareholder returns. Concluding remarks The identification of tax risk management as part of good corporate governance reflects a change in the culture and attitude of government, shareholders, directors and stakeholders towards the tax function in a large corporation. Recent studies indicate that a higher level of management want to be and are informed concerning general tax policies, the risks taken and any opportunities that are available. 70 Senior management increasingly has an influence on or sets tax policies in an effort to control risks. Further research needs to be done to determine if an improvement in large corporate tax compliance is a consequence of the identification of directors as being responsible for tax decision making and the provision by the ATO of clear guidelines concerning tax risk practices and tax decision making. Taxpayers may not necessarily take a more conservative low risk approach to tax decision making despite the fact that they have put in place corporate governance practices that include tax risk management. Tax compliance is not about taking a low risk position but rather ensuring that the position complies with the relevant tax laws. Announcements by the ATO identifying the directors as accountable for tax risks is consistent with the development of a tax compliance group norm within a large corporation based on organisational theory and supported by the success of measures in the US that promoted a tax compliance norm to reduce the popularity of aggressive tax schemes. However Ernst and Young tax risk surveys of Australian tax directors indicate that despite the adoption of a tax risk management system, large companies in Australia are devoting as much, if not more time to tax planning. Finally, UK research considering the effects on large corporate tax compliance behaviour of the identification and consideration of tax risk by HMRC indicates that without a clear link between adopting a low tax risk profile and quantifiable benefits to the taxpayer, it is unlikely that the identification and management of tax risks will improve corporate tax compliance behaviour. Catriona Lavermicocca FTIA, Lecturer Macquarie University The research is part of the author s doctoral studies being undertaken at Atax, UNSW. Reference notes 1 Carmody, M Commissioner of Taxation Large Business and Tax Compliance; A Corporate Governance Issue Leaders Luncheon 10 June D Ascenzo, M Commissioner of Taxation Top End Tax Risk Management The Journey Continues Speech to the PricewaterhouseCoopers Boardroom Dinner, Brisbane 28 June Killaly, J Deputy Commissioner of Taxation Large Business and International Tax Risk Governance: The Corporate and Personal Dimensions Australian Institute of Company Directors Sydney 18 July HMRC (UK) Approach to Compliance Risk Management for Large Business March Butler, D New Zealand Commissioner of Inland Revenue Corporate Insolvency Tax Risk Management at the New Zealand Law Society Taxation Conference September OECD Forum on Tax Administration Seoul Declaration Ireland Revenue Authority The Cooperative Approach to Tax Compliance Australian Taxation Statistics (ATO) Page 35 definition of a large company. 4 D Ascenzo, M Increasing certainty in uncertain times Deloitte Academy, Melbourne 16 April McKerchar, M Why do Taxpayer s Comply? Past Lessons and Future Directions in Developing a Model of Compliance Behaviour (2001) 16 (1) Australian Tax Forum Ibid 5. 7 Allingham, M & Sandmo, A Income Tax Evasion: A Theoretical Analysis (1972) 1 Journal of Public Economics Slemrod, J The Economics of Corporate Selfishness National Tax Journal Dec , Keinan, Y Corporate Governance and Professional Responsibility in Tax Law Sept/Oct (1) Journal of Taxation and Regulation of Financial Institutions 10, Fischer, CM, Wartick, M, and Mark, M Detection Probability and Taxpayer Compliance: A Review of the Literature (1992) 11 Journal of Accounting Literature Singhapakdi, A, Karande, K, Rao, CP and Vitell, SJ How Important are Ethics and Social Responsibility? A Multinational Study of Marketing Professionals (2001) 35 (1/2) European Journal of Marketing 133. Shafer, W and Simmons, R Social Responsibility, Machiavellianism and Tax Avoidance: A Study of Hong Kong Tax Professionals (2006) Department of Accountancy, Lingnan University Hong Kong. 12 Ibid 5. Hasseldine, DJ & Bebbington, KJ Blending Economic Deterrence and Fiscal Psychology Models in the Design of Responses to Tax Evasion: The New Zealand Experience (1991) 12 Journal of Economic Psychology the tax specialist Volume 13 No. 2 October 2009