Counting the costs
This matters more than many might think. Today, regulators, investors and the media take an increasingly hard line against companies that do not manage tax risks effectively. Tax management is no longer just a matter of compliance and minimization of the effective tax rate. Instead, it’s become a reputational issue for global businesses.
In recent years, numerous companies have made the front-page news because it is believed that they have not been paying their fair share of tax. International transfer pricing issues are particularly challenging for companies that do not properly manage charges related to their intellectual property in the various jurisdictions in which they operate or lack substance in countries to support their profits. Determining the appropriate amounts to charge for cross border use of intellectual property is difficult and subject to challenge by either taxation authority involved.
Best practice options
There are many leading practices companies can adopt to minimize their tax risk.Companies looking to reduce their transfer pricing risk between Canada and US, for example, could proactively request the CRA and the IRS to help them establish an agreement regarding reasonable fees to be charged in each country. From an internal perspective, management should also clearly establish where they would like the company to be on the tax risk spectrum (from conservative to aggressive).
Companies must also assess how to respond to rising public demands for greater transparency. Even where disclosure is not legislated, tax authorities are subjecting companies to more intense scrutiny than ever before. With reputations at stake, businesses must develop clear transparency strategies.
Governance groups, including the company’s audit committee, also play a critical role in helping to mitigate tax risk. Specifically, to fulfill their oversight responsibilities, audit committees should:
- Be fully apprised of the company’s tax strategy. To ensure the company’s tax strategy is transparent to both the audit committee and the board, a company’s governance groups may want to become involved in setting tax strategy. At the very least, they should be apprised of the tax planning strategy the company adopts, the risks involved in that strategy and the potential effects associated with the strategy from both an opportunity and cost perspective. They should also understand the company’s tax governance principles, material tax planning transactions and international tax structuring.
- Discuss tax more frequently. Given the impact the effective tax rate can have on a company’s financial statements, it makes sense to add tax to the audit committee agenda as a standing item. Whether it’s discussed regularly or periodically, audit committee members must be sure to fully understand the tax impacts of any business strategies or tax structures management plans to adopt. This includes addressing specific country-by-country reporting requirements that the OECD is currently developing.
- Consult the experts. Companies that do business in numerous countries can often benefit by having audit committee members who understand the business and tax risks related to managing global operations. Even if they don’t add tax specialists to the committee, audit committees should still consult with both internal and external experts to solicit their opinions on the company’s tax position, assess the risks related to any adopted tax strategies and use that input to ensure the company’s financial disclosures remain accurate and adequate.
To mitigate the risks associated with tax transparency and disclosures, audit committee members should consider asking some key questions, including:
- How global are we from a tax and revenue perspective? In which jurisdictions do we currently pay tax?
- Is the company expanding rapidly or entering new countries, both of which might impact our tax risk?
- How politically stable are the countries in which we operate? Is there a danger of new taxes being introduced without warning?
- Does the company currently use any aggressive or unique tax strategies?
- Is the company comfortable and prepared to defend itself against potential negative publicity? For example, does management have the facts regarding the valuable contributions the company makes to the wider economy through employment, investment and tax?
As tax matters increasingly come into the spotlight, audit committees and boards must stay abreast of developments in this area and begin to plan for a potential dialogue with all stakeholders, including the public, on the state of their tax affairs.
- John Desjardins, Business Unit Leader, Audit
- Iain MacIntosh, National Industry Leader, Tax Transparency