Getting on top of tax

The corporate tax landscape has seen significant change over the past two decades. Domini Stuart outlines the risks if directors fail to understand how the system works.

Poor tax governance can result in time-consuming audits, expensive disputes, serious reputational damage and, when the organisation is as newsworthy as Apple, Google or Starbucks, profit-slashing consumer backlash. If a company fails to meet its pay-as-you-go or superannuation guarantee obligations, directors can be held personally liable. And, if there is a suggestion of tax evasion, directors can be charged with a criminal offence. Yet tax frequently slips to the bottom of the risk management pile. 

“Until quite recently, tax risk management was rarely discussed and the people dealing with it had little or no contact with the board,” says Tony Katsigarakis, commercial director of CCH Corporate Reporting Solutions. “These days, no board can afford to leave responsibility for tax affairs to someone else. Directors need to understand key areas of tax exposure and the risks associated with them as well as satisfy themselves that robust governance structures are in place.”

Setting a risk profile

The first step is to set the company’s tax risk profile. This establishes the parameters that will influence future decision-making and, while it is usually the responsibility of the audit committee, it should be agreed and signed off by the full board.

“Some boards take a conservative approach, accepting little or no risk, while others are prepared to take an advantageous tax position provided it is supported by advisors and the risks are fully understood,” says Roger Penman MAICD, lead partner, tax advisory division at business advisory and accounting firm Crowe Horwath (Twitter @CroweHorwath_AU) and audit committee chairman of funeral operator InvoCare.

The Australian Taxation Office (ATO) is now doing its own assessment of tax risk in large companies by applying a risk-differentiation framework (RDF). This is divided into four broad categories – higher risk, medium risk, key taxpayer or lower risk – and where you fall on the grid will determine the ATO’s level of engagement.

“If you are considered to be a very high-risk taxpayer, the ATO will practically camp out in your finance department,” says Katsigarakis. “If you are a very low risk, they might only want the occasional conversation.”

Boards need to know where their company sits in this framework and, if it does not reflect their own risk profile, they need to know why. 

“For example, if your risk profile is conservative there would obviously be a concern if the ATO rating was high,” says Penman.

Constant change

Over the past two decades we have seen considerable change in the corporate tax landscape. 

“Twenty years ago we had no GST, annual returns and annual reporting. Now we have GST, monthly reporting and monthly payments,” says Katsigarakis. “We used to deal with the tax office, now we are dealing with revenue authorities all over the world. Organisations that used to have visible tax teams in one location now have smaller tax teams which are dispersed, often all over the world. Reporting requirements have become more onerous yet the teams have actually shrunk, which is a risk in itself.”

The most significant recent changes target companies with cross-border dealings. Last year, new transfer pricing laws were introduced which create personal risk for those signing off tax returns, and the ATO is also maintaining a sharp focus on multinational profit shifting.

“It is particularly concerned by the ability of large businesses to shift profits to jurisdictions where they are taxed more lightly, and to obtain tax benefits by selling either under or over-priced goods or services to related companies in other jurisdictions,” says John Brazzale, Melbourne managing partner of accounting and business advisory firm Pitcher Partners (Twitter @PitcherPartner) and former head of its tax consulting division.

The government recently announced a significant package of legislation designed to deal with this. The main changes relate to “thin capitalisation”, which could have a material impact on the interest deductions available to many Australian companies. And, as revenue authorities around the world are being pressed to extract their fair share of tax from non-residents, Katsigarakis predicts that major OECD initiatives currently being discussed will trigger a raft of new requirements for every company with international transactions.

“Dealing with any overseas market adds another layer of regulation and legislation, and resolving any international dispute is likely to involve considerable costs and time commitments at both ends,” says Penman. “Where groups are operating in countries with different tax laws and using a number of different advisors, there is also a danger that at least some of the decision made will be at variance with the policies of the board.”

Directors might feel hard-pressed to keep pace with seemingly relentless changes. Good advice is crucial and as the risks associated with corporate tax become more complex and specialised, even some external advisors are struggling to deal with issues beyond their capability.

“The board needs to know who is providing advice, how aggressive is it, how it is being communicated and that there is a genuine cost benefit,” Penman continues. “You also need to know whether the advice you are receiving is reliable and conclusive. Tax can never be completely definitive but it is better for your advisors to provide a clear direction than to hedge their bets with a ‘maybe, maybe not’ conclusion.”

Increasing pressure

Constant change also puts internal accounting staff under pressure. “Directors need to be sure that people within the organisation have sufficient knowledge, skills and training to do their jobs properly,” says Brazzale.

Outdated and inadequate accounting systems also pose a serious threat. “We now have computerised accounting systems which can provide all sorts of valuable management data and audit trails as well as reassurance that tax and superannuation calculations are correct,” Brazzale continues.

“Directors should keep in mind that, if there is a dispute, the onus of proof rests with the company, so poor and outdated accounting systems can jeopardise a company’s ability to defend itself. You must assume that every transaction that takes place and every position you take on a tax matter will be reviewed by the ATO, and that you will need to support and justify your decisions. If you are leaving it up to the ATO to identify an issue, or you think an issue will escape its notice, you are on very dangerous ground,” he adds.

Katsigarakis is particularly concerned that many companies still depend on spreadsheets to manage compliance and reporting. “Risks associated with this, such as key person dependency and a high incidence of errors, have been well documented,” he says. “Spreadsheets will always have a place in the system but, these days, sophisticated automated systems are needed to mitigate much of the risk.”

The ATO’s recent announcement that it plans to move to a new self-assurance model could drive taxpayers to put more robust systems in place. “At the moment, the ATO is making a call on audit activity based on their risk assessment but, in the future, it plans to automate compliance and review,” says Katsigarakis.

“The self-assurance model is a key step in that direction, so taxpayers are being incentivised to demonstrate they are getting it right.  For the first time, the ATO has acknowledged that poor systems can cause genuine mistakes, so this push for transparency is a strong motivation for organisations to review both their systems and their processes to ensure they can cope with current demands.

“Companies which are still using traditional methods could find it difficult to meet ATO standards, particularly as tax managers are being pressed to cut costs. But it is not just about the ATO – better systems will benefit them, too,” Katsigarakis adds.

Challenges for private companies

Private companies are less subject to scrutiny than public companies but this means they are under less pressure to maintain the highest levels of scrutiny and diligence. The lack of strict, regimented reporting deadlines also makes it easier to fall behind with preparing accounts and lodging tax returns. 

The directors of private companies are more likely to be removed from tax issues and, as the people who own the business are typically involved in its day-to-day affairs, there is a higher risk that personal issues will influence decision-making than in a public company, where the people running the business are quite separate from the shareholders who own it.

“There are provisions which apply only to private companies and these add to the complexity,” says Penman. “Problems can arise in areas such as private company loans, shares issued with dividend access rights, non-financial preference shares and issues related to employment taxes, which are prime targets for the ATO and other revenue authorities at the moment.

“Another serious risk is the availability of losses and determining whether these can be carried forward. If losses which are thought to be available do not satisfy the various tests and cannot be used, the company will have to deal with major adjustments.”

Brazzale advises directors of private companies to keep an eye on changes in the public sector because, sooner or later, they are likely to filter down.

“The commissioner seems particularly keen to roll RDF out into the private company market,” he says. “We also expect the reportable tax position to be rolled out to the next level of taxpayers down. This requires businesses to disclose what the ATO calls their ‘most contestable and material’ tax positions.”

In companies of all sizes, managing tax risk is fundamental to good business. “Directors need to understand that tax risk is a serious issue and that the board is ultimately responsible for the organisation’s risk management strategy,” says Penman. “It should be considered alongside other risks within the company and treated in a similar way.”