Effective tax risk management using a tax control framework
Effective tax risk management using a tax control framework
All organisations need practical and effective ways to improve ensure that tax risks are well managed. The main goal is to ensure tax processes are efficient, transparent and well-controlled across a business to reduce tax authority challenge (and the ongoing burden that can create) and avoid increased tax costs/leakage.
We believe effective tax risk management doesn't need to be complex. A straightforward and holistic approach can significantly improve the identification, assessment, and management of tax risk.
A global focus on tax risk
As our world becomes more complex and governments and tax authorities push for increasing self-accountability and self-regulation, both internal and external stakeholders expect strong governance, tax controls and tax reporting frameworks to ensure transparency and a culture of no surprises when managing tax risk.
No business wants to be on the receiving end of the unexpected financial burden of correcting a tax issue. Equally, the impact of tax mistakes or perceived unethical behaviours on stakeholders can be significant:
- A drop in investor confidence can lower share prices
- Damaged relationships with tax authorities may result in greater compliance burdens
- Ineffective internal guidelines or data management can increase the amount of tax that is paid
- Businesses may experience problems with regulators or in maintaining government contracts
- Customers or clients could turn to competitors
There are also a number of trends in the global tax environment that make a strong tax control framework an important tool:
- Global tax transparency through both legislation (CbC reporting, tax strategy requirements) and the rise of ESG agendas
- Tax authority collaboration globally (Exchange of Information Agreements, ICAP international tax reviews) and in the UK with HMRC working in a more joined up way. There are also the new Pillar 2 requirements which have been adopted in more than 140 countries
- Failure to prevent the facilitation of tax evasion legislation (where there is some level of UK nexus) means businesses are accountable for the actions of associated persons, including those in their supply chains
- Media interest in tax-related stories
- Remote working and changed businesses processes have contributed to increased fraud and evasion as well as forcing businesses to review their tax policies
The cost of non-compliance can very high and very public – ignoring tax risk is no longer an option.
A Tax Control Framework
The OECD defines a Tax Control Framework simply as ‘the part of the system of internal control that assures the accuracy and completeness of the tax returns and disclosures’.
This sounds simple and obvious, but many businesses are complex or have a very wide base of operations across many territories. They often fail to have in place the right mechanisms or procedures to assure their filings, and many more do not have visibility of where, or how their framework is lacking, sometime only realising there is an issue when a penalty is raised by a tax authority (for example because of a complete lack of any submissions being made for a number of years).
This is often the case because many businesses operate without specialist tax teams, or those teams are spread thin and hence fulfilling tax accounting, tax return preparation and tax filing obligations are left to finance operations or outsourced to third parties who have a limited remit, or do not have a sufficiently full picture of the circumstance to advise appropriately. Whether you operate only within a single territory or across many, understanding your current state, and then implementing change where risks are identified to enhance and better control your tax operations is critical.
The top 4 attributes to creating an effective tax control framework
1) Tax Policy – Setting an expectation
Develop an overarching tax policy which sets out your approach to tax, how compliance should be managed, the reporting and management of tax audits, escalation points and a reporting framework. This needs to be sensitive to the way that the business operates and what will work for it
2) Understanding relevant tax filing obligations and who manages these
This usually requires a walkthrough of the tax landscape and identification of who is Responsible(R), Accountable(A), Consulted(C), and Informed (I) (or a RACI) around your key tax characteristics and processes
3) Ensuring there is an understanding of the existing control environment
Identify the processes and systems that support the preparation of tax calculations and tax filings and capture and assess the existing control environment – This will provide the data to prepare an initial register of (risks) and controls (a Risk and Controls Matrix or a RACM). It also allows for the quality of the control environment to be assessed.
4) Build your mechanism for reporting/visibility
Once you have a defined policy which sets your approach and requirements for tax, assessed how tax is managed, and how it is controlled then the final piece is to build a feedback loop of reporting and visibility to allow for senior management to have access to relevant Key Performance Indicators and management information in real time.
Complications in creating an effective tax control framework
There are of course complications to creating an effective tax control framework, and they are mainly driven by the fact that no two businesses are the same. What will work for one business will be very different to what will work for another.
Some businesses operate a command-and-control approach to tax (with everything guided from the centre), whereas others allow for tax filings and governance to be very much handled locally. Both approaches have their own set of tax “complications”.
Some businesses have very limited resource and budget whereas others have teams available to support. There are so many variables to consider, including the need to get “buy-in” from non-tax teams that they are part of the wider tax organisation.
The review and creation of an effective tax control framework needs to be carefully managed, which is why so often we find ourselves as advisers, supporting the review, right sizing the control environment and sympathetically implementing “light touch” change to enhance and support better outcomes.
There is also the point that the creation of a structured tax control framework is likely to identify unmanaged risks, inefficiencies and opportunities to enhance the way tax elements are managed. There is a real opportunity to better manage your tax obligations, perhaps reduce your risk rating in the UK with HMRC, reduce risks more widely, ensure that you are not overpaying tax, eliminate where you are non-compliant (which can lead to penalties or repeated challenges), and be better prepared for tax audits.
Where to start
Before you get to any of this, the key is to understand the current state, and that is where some kind of maturity assessment is of huge value. Often those with the ultimate accountability for tax have a sense of where there may be gaps, issues, or unmanaged risks, but regardless of this, undertaking a current state assessment of the maturity of your tax operating model or tax control framework is invaluable, providing documented certainty and a standardised way of assessing one part of the business against another.
This knowledge allows an assessment to be formed as to whether tax controls and operations are not working, working at a basic level, working in a systemised, structured and integrated fashion, or somewhere in between. Knowledge is power, and having assurance regarding your current state allows you to make informed choices about where you want to be on that maturity scale.
It also invariably leads to the identification of areas for improvement or alignment, be they “quick wins”, medium term enhancements, or longer-term transformational change.
The maturity assessment is the starting point for understanding what needs to be done, be that control enhancement, transformational change or alignment. Ultimately the aim is often to create an appropriate level of consistency, assurance, control and oversight.
Examples of tax risk
Tax risk can arise in many situations.
Tax Compliance Risk
In the UK HMRC has allocated significant time and resource to clamping down on the facilitators and enablers of non-compliance. You should ensure that your business is fully compliant and that you have an adequate control environment in place.
Tax compliance risk arises for various reasons, including insufficient resource or technical skills, system change, data integrity issues, legislative changes, lack of management, etc.
Using technology to reduce tax risks and automate where possible using tax technology tools that work effectively together can make a significant difference to an organisation's tax risk.
Operational risk
There is a well-known mantra that says that a significant proportion of tax risk doesn’t arise within tax or finance functions, but from the rest of the business. Everyday operations, from HR decisions to procurement arrangements, implementation of new billing systems to technology developments can create tax exposures. The tax and finance team need to understand these ‘known unknowns’ and be involved in all significant business decisions to ensure that tax risks are identified and controlled.
Transaction Risk
Commercial and financing transactions, mergers and disposals can all give rise to tax risk, and it is now imperative for these types of transactions to involve the tax team as early as possible. At the same time the ESG agenda and pressure from governments and tax authorities has driven many away from undertaking transactions purely to gain a tax advantage.
Tax Reputational Risk
Recent high-profile tax cases and the resulting media backlash have driven a public expectation that businesses should be paying ‘the right amount of tax’. Today’s challenge for CFOs and Tax Directors is to ensure Tax is aligned to the wider business’s ESG messaging and determine how much they are at risk from a review of their tax profile and how best to respond if challenged. Developing an approach to tax, tax transparency and responsible tax behaviours that aligns to their ESG agenda will enhance their corporate reputation.
Subject Matter Expert advice on Tax Operating Models and Tax Control Frameworks
Perhaps you are a new Tax Director or CFO. Perhaps you have concerns over the number of tax authority challenges you have received of late, or perhaps you are cognisant that you don’t have full visibility or control of your tax operations.
We are here to support you on your journey, be that discussing what good or best practice looks like for you, assessing your current tax controls and risk framework, or helping you take the first steps towards the implementation of effective tax risk controls.
In our work with businesses of all sizes and across all industries, we have seen immediate value for our clients in benchmarking the maturity of their tax operations through our Tax Operations Maturity Model and assessing their current tax risk profile. This helps them to understand where they are, and what the opportunities are to improve. This could start the process for their development of a robust tax control framework that will go a long way towards ensuring they don’t experience any nasty tax surprises.
If you would like to understand more about tax risk governance and strategy, contact James Egert on +44 (0)7920 591 553 or Jason Land on +44 (0) 7738 310 434