One of the critical processes in operating a business is the management of risk. Risk comes from a variety of internal and external sources, including tax policies and regulations. With the business environment’s increasing spotlight on corporate governance, management accountability, and internal controls, the traditional tax management focus on the end-of-the-line output (such as timely tax returns or aggressive tax avoidance plans) had to evolve in response. Companies have come to realize the need to approach tax operations with a more holistic and integrated view, in line with and embedded into the business’ strategic objectives.
Efficient tax management in a business is essential. It is the proactive management of various tax-related risks to ensure that the business is compliant with applicable laws and standards, operating with corporate responsibility, and maximizing shareholder value.
According to the International Tax Review, tax-related risks can be categorized as follows:
- Transactional – Risk arising from the consequences of applying tax legislation in planning and implementing specific transactions. Generally, the more unusual the transaction is, the higher the risk involved.
- Operational – Risk from actual day-to-day business operations, which could lead to unexpected fluctuations in tax charges, depending on the level of activity.
- Compliance – Risk of incurring penalties and liabilities in case of non-compliance with statutory requirements or the tax returns process
- Financial accounting – Risk of computing incorrect taxes and reporting incorrect accounts in the financial statements
- Management – Risk of failing to manage above risks due to lack of management controls, knowledge and skills
- Reputational – Risk of damaging the image of the business in case of negative publicity over questionable tax dealings or controversial tax positions
- External – Risk associated with factors outside the company’s control, such as new legislation or increased tax rates
Failure to manage those risks efficiently, effectively, and proactively could result in severe financial (penalties), reputational (negative press), and operational (license to operate) impact to the business.
Companies should conduct a wider review of their tax function and their key objectives. Management should identify and assess the risks affecting their business, determine their tax risk appetite, and map out their tax plan. Ideally, this should be documented via a tax controls framework, which flows from the company’s overall corporate objectives and embeds the strategy and policies governing tax accounting, compliance, and controls. Implementing the framework requires clear communication of policies throughout the organization, proactive monitoring of tax risks and the response to those risks, and regular reviews of risk appetite and strategy to keep the framework up to date. This could entail changing the corporate culture and behavior (tone at the top), hiring qualified tax professionals, improving business processes and procedures, and utilizing technology to increase efficiency.
Implementing a robust tax management framework enables the company to proactively:
- Manage Risks – This leads to sustainable strategic tax planning and compliance, with enhanced credibility in the eyes of fiscal authorities and the public. Increased awareness of tax risks also facilitates open dialog and better relationships with internal and external stakeholders.
- Manage Costs – Income taxes may impact working capital and cash flows, while other taxes such as wage taxes or VAT can impact operational margin and revenue. A clear tax strategy makes it easier to forecast and manage tax costs in line with the company’s commercial objectives.
- Create Value – Ultimately, improvements in the company’s effective tax rate and tax position can influence the perception of analysts and investors, thereby increasing shareholder value and share price.
Efficient tax management in a business is not about minimizing risk, but rather it’s determining what level of risk is acceptable to the company, formulating the response required, and monitoring that such response is actually being done to keep risks at the acceptable levels. At the end of the day, it is not just about trying to figure out the lowest tax liability possible, but it’s more of managing tax-related risks to support the overall business objectives, drive decision making, and create more value.