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Post Crisis Bank Losses Prompt Call for Better Tax Governance 

According to the OECD, the world’s banks suffered write-downs and losses of US$1.3 trillion up to January 2010 due to the 2008 financial crisis. The OECD Forum of Tax Administrators (FTA) fears that the scale of these losses, and the potential regulatory capital, profit and cash-flow benefits for banks able to convert them into cash, create potential tax compliance risks from aggressive tax planning involving losses.
Author:

Carmela Pallotto, Partner, Tax

  

To address fears of inappropriate tax planning, the Canada Revenue Agency (CRA) and its FTA colleagues are reaching out to banks and other large corporations to create new relationships based on mutual transparency and trust. By positioning tax risk management as a corporate governance issue, the world’s tax authorities are seeking to expand their dealings beyond tax departments to engage company directors and C-level executives and promote better tax compliance.

 

While Canadian banks fared better than most during the recent crisis, stakeholder confidence in all financial institutions has been eroded. Today’s financial institutions need to respond to the new focus on tax governance while complying with ever more complex tax laws and managing the impact of tax on their bottom lines. To strike the right balance and gain the CRA’s confidence and trust, financial institutions can benefit from putting in place a solid framework for governing their tax risk.

 

Tax risk focus zeroes in on banks

 

Over the past several years, the FTA has raised concerns about the risk to tax systems posed by the extent that banks use, facilitate, or promote tax planning schemes. Even before the financial crisis, the FTA had begun to zero in on global financial institutions and commissioned a study to understand banks’ involvement in aggressive tax planning both on their own behalf and for clients. The OECD released the study entitled Building Transparent Tax Compliance by Banks early in 2009 and it was swiftly followed by a consultation document, A Code of Practice on Taxation for Banks, issued by HM Revenue and Customs in the UK. A 2010 FTA report details the tax compliance risks arising from the huge losses suffered by banks due to the 2008 financial crisis.

 

The FTA says banks can help reduce these tax compliance risks by:

  • Being open and transparent with tax authorities in their planning involving losses (whether or not tax-motivated.
  • Ensuring appropriate corporate governance and tax risk management processes are in place.
  • Helping tax authorities identify and address areas of uncertainty in the operation of their country’s loss recognition and loss relief rules.
  • Adopting, as part of their business strategies, the pursuit of an enhanced relationship with the tax authorities, so they can benefit from early certainty, reduced compliance costs and reduced reputation risk.

 

A suggested code of conduct for banks accompanied the FTA’s report. The code emphasizes that banks should not enter into aggressive tax planning on their own behalf or in their capacity as tax intermediaries. The code also stresses that banks should ensure they have adequate governance to control the types of transactions they enter into and the associated tax risks. Banks should document their tax risk management strategy and governance processes within a formal policy. They should maintain processes (e.g., product approval committees) to ensure the tax policy is taken into account in making business decisions.

 

Rising demands for tax transparency and disclosure

 

Spurred by the FTA’s emphasis on corporate governance and tax risk, the tax authorities are influencing governments to adopt legislation requiring greater transparency and disclosure of possibly inappropriate tax plans. Here in Canada, Quebec introduced a regime in 2009 requiring companies to disclose “aggressive tax planning” transactions, while the federal government is developing rules to establish a similar regime nationally. Meanwhile, the CRA has embarked on a project to evaluate the risk profile of large corporate taxpayers based on their tax governance structure and history of cooperation with the CRA.

 

A framework for tax governance

 

In this environment, financial institutions need to be able to show that they have a solid tax management foundation in place. The framework should extend to all parts of the business, including those involved in the design and sale of financial products. Once in place, such a framework can help deliver day-to-day compliance and reporting effectively and efficiently while focusing on the right balance between managing tax risk and creating value. In addition, a strong tax governance framework will increase the confidence of customers, shareholders, and other stakeholders, such as the tax authorities, that the financial institution is well-run and responsible.

 

 

Seven Building Blocks of Effective Tax Risk Management

A sound tax governance framework comprises seven building blocks to help the tax function of financial institutions and other large organizations manage tax risk while adding value. Below we describe the qualities of these building blocks in leading organizations in the tax governance area, and we present some action items for putting these building blocks in place.

1. COMMON PURPOSE

Leading practice


    The strategic goals and objectivesof the tax functions are aligned with those of the wider organization.

    Action item

    Hold a workshop with your organization’s key executive stakeholders to ensure the tax strategy is aligned with your overall business strategy.

    2. HIGH-PERFORMING TEAMS

    Leading practice

    Your tax function comprises the right number of tax professionals with the right mix of training, skills, and experience.

    Action item

    Develop a high-level vision of your organization’s optimal tax team; assess your existing group’s current skills, knowledge, and abilities; and train or hire tax professionals as needed.

    3.  EMBEDDED PROCESSES

    Leading practice

    Your tax management strategy is implemented across the organization through embedded processes and controls, and with clarity over accountability and responsibility between the tax function and the organization’s other business units.

    Action item

    Develop a common methodology and approach to tax process management that standardizes, harmonizes and automates the processes and controls across the organization to manage tax risk and inspire confidence in the underlying tax numbers.

    4. TIMELY AND ACCURATE INFORMATION

    Leading practice

    Required financial and tax reporting data is produced, shared and distributed data to the right people, at the right time, and in the right format.

    Action item

    Perform a detailed analysis of current data flow and processes to determine what data is needed and by whom, where the numbers are coming from, and who is responsible for their accuracy.

    5. ENABLING TECHNOLOGIES

    Leading practice

    Labour-intensive processes that consume resources and increase risk are automated through the use of enabling technologies (e.g., Enterprise Resource Planning systems, tax software); IT systems are linked to tax management software to create an end-to-end tax information system that supports automation, creates a clear audit trail, and produces accurate entity-based financial data.

    Action item

    Review your organization’s current IT systems and, based on this review, design and implement new systems (if necessary), integrate disparate systems, and standardize and automate where possible.

    6. ONE VIEW OF PERFORMANCE.

    Leading practice

    The effectiveness of your tax risk management is monitored and measured by reference to commonly understood requirements and agreed key performance indicators (KPIs).

    Action item

    Conduct interviews with organizational stakeholders to determine their needs and assess how well the tax function is meeting them; then develop relevant KPIs that are aligned with those of the entire organization.

    7. INFLUENCING STAKEHOLDERS

    Leading practice

    Your tax function understands the goals and constraints of stakeholders and communicating with them effectively to help achieve their goals.

    Action item

    Create an enterprise-wide communication plan to channel tax compliance, planning, and business information between the tax function and internal and external stakeholders.

     

     

    Does your financial institution have a strong tax governance framework in place? If so, the bank’s board members, executives, tax directors and other stakeholders should be able to answer “yes” to the following questions with confidence:

     

    • Are you aware of the key pressures and challenges facing companies’ tax departments?
    • Do you know how to successfully achieve balance between managing tax risk and creating value, within significant resource constraints?
    • Do you know that standardization in tax processes, structures and reporting lines is crucial for achieving a risk-value balance?
    • Are you aware of the leading practices in implementing efficient and effective tax management processes?
    • Are you aware of the building blocks that you need to put in place to achieve a risk-value balance?
    • Have you ever formally evaluated and/or benchmarked your company’s tax function and tax risk management philosophy against peer organizations?