First there was the Enron scandal in the US, followed by the Parmalat controversy in Italy. The US responded with the introduction of the Sarbanes-Oxley Act, and similar legislation has been introduced in other countries. More and more attention is paid to the relationship between corporate governance and tax rules. Tax is the new news. One can only imagine the reputational damage that can arise from headlines suggesting your company is being investigated for tax fraud. Over the years, tax risk management has acquired its place in the boardroom.

The cynical, and those led by fear, would say the ghost of tax risk management is ever-present. This seems to suggest a sort of capitulation and that there is nothing much can be done. But this is far from the truth. The key message is that there may be millions of risks, but a company must be in control of them.


Recognising risks

The following tax risks can be identified:

– Risk of underpayment/overpayment. This usually materialises through deficiencies in financial and/or tax data, errors in the preparation of tax returns, a misunderstanding of compliance requirements, a failure to keep up to date with recent tax developments, a failure to prepare adequate custom declarations, an aggressive tax position that proves unsupportable or the lack of economic substance in relation to a tax-planning strategy.

– Risk of double taxation.

– Risk of failure to withhold. This looks at the risk of not withholding or not withholding sufficient tax on interest, dividend and royalty payments.

– Risk of non-remittance. This usually materialises through an understatement of output indirect taxes, an overstatement of input indirect taxes or a failure in the tax-withholding/remittance process whereby taxes are withheld (for example, non-resident withholding taxes) but are not remitted to tax authorities.

– Risk of interest/penalties.

The deductibility or non-deductibility of interest can also be identified as a tax risk, since a lot of countries have rules on the limitation of deduction of interest in their corporate income tax acts. In addition, anti-abuse regulation may be used to limit the deduction of interest. China, France, Germany, Japan and Mexico have a business tax, which obviously influences the effective tax rate and, in the end, the bottom line. Added to this, transfer pricing is sometimes perceived as a minefield. More and more countries implement specific transfer-pricing legislation. Meanwhile, the number of audits and disputes are rising in this field.

Different tax authorities are targeting particular industries, such as the automotive sector, consumer products, oil and gas, pharmaceuticals and financial services. This is not surprising looking at the current economic climate.

Last but not least, indirect taxes can be mentioned as an area of tax risk. In the case of a supply of goods or services, value-added tax (VAT) may be due. The rules with respect to deduction of input VAT and filing of forms for both VAT and customs duties are complex. The amounts involved with VAT, for example, are huge. A company that does not pay sufficient attention to VAT and/or customs duties issues exposes itself to significant financial risks.

Taking control

It is a complicated exercise to build and implement a tax control framework (TCF), but it is not all doom and gloom. A TCF might be helpful to control the tax risks. 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 a serious threat to a business strategy. Each company has a corporate strategy and needs to determine what this means for the tax strategy. It is important to build a tax function within the organisation that is effective, efficient and transparent.

The following building blocks of a tax function can be distinguished:

– Tax strategy – relating to high-level goals, aligned with and supporting the entity’s mission.

– Tax operations and risk – relating to effective and efficient use of the entity’s resources.

– Tax accounting and reporting – relating to the reliability of the entity’s reporting.

– Tax compliance – relating to the entity’s compliance with applicable laws and regulations.

– Automation and technology integration – relating to the IT system of the organisation.

– Organisation and resources – relating to the resources and competencies of the organisation.

In setting up a TCF, an organisation should make clear decisions as to what the scope will be. First, it should decide which taxes could potentially have a material impact. When measuring this impact, a company should not only look at the direct financial fallout but also at indirect financial impact, such as that on reputation.

The second task is to determine in which processes the 'in scope' taxes can play a role.

In a TCF, for each process in an organisation 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, all of the above must be properly documented and reported.

Click on the link below to see an overview of tax frameworks in various countries

 Anuschka Bakker is a chief editor at the International Bureau of Fiscal Documentation