Tax Risk Management From Risk To Opportunity

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Chapter 2

Tax Control Framework

Robbert Hoyng,* Sander Kloosterhof** and Alan Macpherson***

This chapter is based on information available up to 1 November 2009.

1. From risk management to opportunity management

This chapter describes the key elements of a tax control framework (TCF)and how such a framework is to be built. In this respect one should realizethat there is no “one size fits all” TCF. Each TCF needs to be custom builtto the specific needs of the organization and taking into account the specif-ic DNA of that organization. Nevertheless, when building a TCF there area number of generic elements both in process and building blocks that ap-ply to each TCF.

In this chapter we will try to provide insight into the aspects of construct-ing a TCF tailored to your organization and these “common elements” soyou can use this as a benchmark to your TCF or as a starting position forbuilding your own TCF. The first part will provide an overview of theterms and definitions used, and a first introduction into the background oftax control. Next, the construction of a TCF will be described. This partprovides an overview of the building blocks of a TCF. It provides a de-scription on all the building blocks needed to build and construct a TCF(see 3.). The following paragraph addresses the cultural and organizationcontext of tax control (see 4.). The last paragraph suggests how to getstarted with the introduction of a TCF and to get in control of tax risks (see5.).

* Partner Tax Management Consulting, Deloitte, the Netherlands.** Partner Tax Assurance, Deloitte, the Netherlands.*** Partner Tax Transformation, Risk and Co-sourcing, Deloitte, United Kingdom.

Bestand: {3b2}IBFD/Boeken/2010/Tax Risk Management(TRM)/opmaak/binnenwerk/07_TRM_c02.3d – Pagina 19<19>72 [totaal: 54]

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2. Tax control framework

2.1. Terms and definitions

In this part the terms and definitions of this chapter will be described:

CoCo – Canadian Criteria of Control Board.

Control – A measure, agreed upon by those involved, to mitigate a risk, byreducing the probability of occurrence (“probability”), by reducing the im-pact (“impact”), or to reduce both the probability of occurrence and the im-pact.

Control activities – Control activities are the policies and procedures thathelp ensure that management directives are carried out. They help ensurethat necessary actions are taken to address risks to achieving objectives.Control activities occur throughout the organization, at all levels, and in allfunctions. They include a range of activities as diverse as approvals, au-thorizations, verifications, reconciliations, reviews of operating perform-ance, security of assets, and segregation of duties.

Control objective – Control objectives provide specific targets againstwhich to evaluate the effectiveness of internal control. Typically they arestated in terms that describe the nature of the risk they are designed to helpmanage or mitigate.

COSO – The Committee of Sponsoring Organizations of the TreadwayCommission (COSO) issued Internal Control – Integrated Framework tohelp businesses and other entities assess and enhance their internal controlsystems.

Decision table – A precise yet compact way to model complicated logic.Decision tables, like if-then-else statements, associate conditions with ac-tions to perform. Unlike the control structures found in traditional pro-gramming languages, decision tables can associate many independent con-ditions with several actions in an elegant way.

Earnings per share (EPS) – The portion of a company’s profit allocated toeach outstanding share of common stock. Earnings per share serves as anindicator of a company’s profitability: (net income – dividend on preferredstock) / average outstanding shares.



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Effective tax rate (ETR) – The effective tax rate is calculated as the tax ex-penses divided by the income before taxes.

Enterprise risk management – Enterprise risk management is a process, ef-fected by an entity’s board of directors, management and other personnel,applied in strategy setting and across the enterprise, designed to identifypotential events that may affect the entity, and manage risk to be within itsrisk appetite, to provide reasonable assurance regarding the achievement ofentity objectives.

Key control – Key controls are those that are most important to monitor inorder to support a conclusion about the internal control system’s ability tomanage or mitigate meaningful risks.

Levers of control – A control model introduced by the Harvard ScholarRobert Simon.

Risk – A potential event, which might have an adverse effect on the goalsof an entity. This also includes a missed opportunity.

Risk management process – A uniform process for a structured and consis-tent approach to conduct risk management, with the aim to provide insightinto the key risks and controls of an entity.

Tax control framework (TCF) – A tax control framework is a system(process) to identify, mitigate, control and report tax risks. A TCF formspart of a business control framework, which is different for every organiza-tion.

2.2. Building an effective, efficient and transparent taxfunction

The most important common element in each TCF is the ultimate goal of aTCF: to build a tax function within an organization that is effective, effi-cient and transparent.



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Picture 1: Building a tax function

Effective

The tax function of an organization should support and contribute to itsoverall strategy. There is more to tax than just making sure all the compli-ance deadlines are met. Especially in the area of tax planning, it is key tounderstand the overall strategy of an organization. Spending time on high-tech tax planning is not effective if this means taking on risks without con-tributing to the strategic direction of the organization. In 3.1. we will ad-dress the various aspects that need to be considered when setting a taxstrategy.

Efficient

The tax function must be organized in such a way that the goals areachieved as efficiently as possible. This means that based on the tax strat-egy set, the organization should consider what resources are necessary totake on the responsibilities. In this consideration, aspects such as location,outsourcing, co-sourcing, budget etc. should be taken into account. Fur-thermore, the tax function should be managed as an integral part of the or-ganization, and not as a stand-alone function. For example, only as an inte-gral part of the organization it is possible to implement a controlframework on tax from a single-audit point of view. Then the tax functioncan efficiently use the control measures already in place in the organiza-tion. Finally, the tax functions should address what kind of supportingtools are necessary to carry out the responsibilities. Efficiency can beachieved especially in the area of automation and integration of this intodaily processes.

Transparent

The transparency of the tax function applies on more than one level. First,the various roles and responsibilities should be transparent. The tax func-tion is broader than just the tax department. It should be clear to each per-son that has a role in the tax function, what his or her responsibilities are




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and how they relate to the responsibilities of the other persons. Secondly,when carrying out the tax function, each decision should be made transpar-ent as to its effect in respect of the tax strategy – not only for the desired re-sult, but also for the impact of the other possible outcomes of that decision.

Compliance

A TCF focuses on, and will contribute to, the effectiveness, efficiency andtransparency of a tax function. However, the more traditional role of a taxfunction is to organize the filings in time and in a proper way. In this chap-ter the compliance process in itself is seen as a resultant of the tax functionprocesses.

2.3. From risk to opportunity

The term “tax control framework” may give the impression that it is all todo with avoiding tax risks. However, being exposed to risks is a part ofdoing business. The key is not to take on risks that are serious threats tothe strategy of your business. In this respect, there are two kinds of risks.First, there is the risk without any upside, e.g. failure to comply with ad-ministrative requirements. Generally, an organization should try to mitigatethese kinds of risks to an efficient extent. The second risk is the risk thatcomes with pursuing an opportunity. When an organization pursues an op-portunity, there is always a risk that the opportunity will not be achieved,or that additional costs are incurred to achieve that opportunity. An organi-zation should not try to avoid these kinds of risks but make sure that whenan opportunity is pursued, the opportunity (measured against the strategicobjectives) outweighs the risk. In addition, appropriate measures should betaken to mitigate the negative impact of this risk.

The same applies to tax risks. When it comes to the first category of risks,the organization should mitigate these risks to the extent that it is efficient.A well designed and functioning TCF will have this effect. However, amore important role for a TCF is in the relation to the combination of op-portunity/risk. First, a good functioning TCF will enable an organization tospot more opportunities as the tax function will not be a staff function butembedded in the organization. Second, a TCF will enable the making of atransparent choice whether or not to pursue an opportunity, weighing thebenefits against the risk. And third, because the organization has a good in-sight in its portfolio of opportunities and associated risks, it will be able to




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pursue more opportunities as it can measure the impact against the portfo-lio.

2.4. What is tax control?

Before introducing the elements of a TCF, tax control should first be iden-tified. This part provides an introductory description of a TCF and the riskareas.

Description of a TCF

As described above, a TCF should result in an effective, efficient and trans-parent tax function. In this tax function, risks that are not the counterpartof an opportunity are avoided to an efficient extent. All opportunities aremade transparent as to risk and reward (taking into account the strategy ofthe organization) so that a reasoned decision can be made on which oppor-tunities to pursue (and risks to take on) and which opportunities not to pur-sue. In a TCF for each process in an organization, the roles and responsi-bilities as to the tax aspects are set and procedures and tools are madeavailable. The allocation of roles and responsibilities should be made insuch a way that all opportunities and risks are spotted. Subsequently, in aTCF all of the above is properly documented and reported.

Areas and risks

In setting up a TCF, an organization should make clear decisions as towhat the scope will be. First, the organization should decide which taxescould potentially have a material impact on the organization. When meas-uring this impact, an organization should not only look at the direct finan-cial impact but also at indirect financial impact such as impact on reputa-tion. For most organizations this will mean that corporate income tax(CIT), value added tax (VAT) and wages taxes are relevant, or “in scope”.However, depending on geography and industry other taxes can also be inscope.

The second task is to determine in which processes the “in scope” taxescan play a role. This is not limited to the tax reporting processes them-selves, but also includes various business processes. Especially for transac-tion taxes such as VAT, these business processes are very important. In 3.this will be described in further detail.




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2.5. Overview of the building blocks

The tax function of an organization should consist of the following build-ing blocks:

Picture 2: Building blocks of a tax function

This will be discussed in more detail in 3. The tax function should startwith a tax strategy. This strategy should contribute to and support the over-all strategy of the organization. This means that not only financial goalssuch as earnings per share but also non-financial goals such as corporatesocial responsibility should be taken into account. Based on this tax strat-egy, the organization should formulate a framework within which it man-ages the opportunities and associated risks. Subsequently, it should makesure that the decisions taken and the financial effects are properly docu-mented in the administration and reported to the stakeholders. The finalstep is the compliance towards the tax authorities. The accounting and re-porting process should be organized in such a way that tax compliance is aseamless exercise. These four pillars can only function if they are sup-ported by the appropriate tools and resources.

2.6. Overview of the roles

The tax function is not just the tax department. Within an organization,more persons play a role. For example, the M&A department of an organi-zation has a role in the tax aspects of an acquisition, even if this role is justlimited to informing the tax department that an acquisition is being consid-ered. This principle applies throughout an organization. It is a key pointthat an organization gets a good understanding of these roles. It is temptingto approach the TCF from the viewpoint of the tax department. However,in this approach the organization runs the risk that the perception of theroles and responsibilities of the tax department differ between the business




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and the tax department. If this difference in perception is not addressed,the organization runs the risks that not all relevant tax opportunities andrisks are considered. In this respect it is important to note that the interpre-tation of the tax law is in itself seldom a source of tax risks. In most cases,the risks are triggered by either not realizing that tax may play a role in atransaction (“insight”) or that an issue although spotted is not correctly ad-dressed. This is often the result from incorrect factual information (“analy-sis”) or incorrect follow-up (“follow-up”) on the tax technical advicegiven. This is illustrated in the picture below:

Picture 3: Causes of potential tax risks: insight, analysis, follow-up

From this picture it is clear that communication is a key element to avoidrisks – making sure that the relevant persons understand the issue, the es-sential facts and what is needed to resolve the issue, and, most importantly:who takes ownership.

The picture below shows a responsibility matrix for corporate income taxwhich can be used to facilitate the discussion on these roles and responsi-bilities.




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Picture 4: Example of a tax responsibility matrix

Based on this matrix, the parties concerned (in this example, CFO, financedepartment, tax department and the business) can discuss to which extenteach party is involved in the respective subjects. The CFO will have an ac-tive role in setting the strategy but probably a very limited role, if any, inlocal tax return compliance.

2.7. Stakeholders

There are various parties that have an interest in a good functioning TCF.In this paragraph we will briefly address the “stakeholders” being:(a) management;(b) (supervisory) board;(c) internal audit department;(d) external auditors;(e) tax authorities;(f) public; and(g) tax department.

(a) Management

The management of an organization (CEO, CFO) is ultimately responsiblefor the (financial) performance of the organization. Tax can have a substan-




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tial impact on this performance, both positive and negative. Generally,management does not consist of tax professionals and as a result need toget assurance that all relevant tax risks are addressed and appropriate ac-tion will be taken. Therefore, they benefit if, as result of a TCF, roles andresponsibilities as to identification (and follow-up) of risks are clearly set.Moreover, if the tax technicalities of these risks are “translated” into im-pact on the strategic goals of the company, they are in a position to decideon what action is needed. It is therefore essential that management is in-volved in building the TCF, especially where it covers strategy, operationsand risks.

(b) (Supervisory) board

In many jurisdictions, organizations have a (supervisory) board. This boardis generally not involved in the day-to-day business, but has a supervisoryrole (e.g. on behalf of shareholders) towards management. Risk manage-ment is one of the key areas where the supervisory board plays a role. Alsohere, the tax position of an organization is an important element. Thesupervisory board should be periodically updated as to the tax risk positionof the organization. Without being tax specialists themselves, members ofa supervisory board will be able to understand the impact of the tax riskposition to the organization, as in a TCF risks are addressed based on im-pact on the overall strategy of the organization.

(c) Internal audit department

In the governance structure of an organization the internal audit department(IAD) has an important role: having a TCF, takes tax out of the “blackbox” and makes it auditable on the processes and relating control measureswhich should be in place. An IAD will not audit the tax technical contentof the tax position of the organization, but can audit whether appropriatepersons were involved as set in the TCF. As a result, the IAD plays an im-portant role in the operation of a TCF, because “what is being measuredwill be done”. In this respect it works both ways: the IAD can function asauditor of the tax function because of a TCF, and the TCF can be em-bedded in the organization through the work of the IAD.

(d) External auditors

Where management is ultimately responsible for the financial performanceof an organization and the reflection thereof in the financial statements, theexternal auditor needs to make sure that these financial statements do in-deed paint a fair picture of the financial position of the organization. In theaudit of these financial statements, the external auditor cannot audit each




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and every transaction. For example, checking whether or not the organiza-tion has applied the correct VAT percentage on each invoice is too cum-bersome and inefficient. For many elements, the auditor will have to relyon the internal processes and controls. In addition to auditing key transac-tions, the auditor will therefore have to audit these processes and controls.With respect to the example on VAT, the audit can be a check on the ad-ministrative system and authorization as to changes. If an organization hasa TCF with clearly defined processes, responsibilities and controls, this fa-cilitates the task of the auditor.

(e) Tax authorities

One of the responsibilities of an organization is to meet its periodic obliga-tions under the tax compliance. With respect to the various taxes, returnswill have to be filed and payments made. In the situation of a tax authoritythat has the role of reviewer of these returns, a well organized tax compli-ance process, where all relevant information is easily accessible, is of ob-vious benefit to the tax authorities. In this respect tax authorities have aninterest in the functioning of an organization’s TCF. This is even more thecase where there is a more proactive relationship between organizationsand the tax authorities such as in the Netherlands. In this situation, whereorganizations and tax authorities have an open dialogue on the material un-certain tax positions, it is key for the tax authorities that the organization isindeed able to bring all material positions to the table and can provide thetax authorities will all relevant information.

(f) Public

As result of the developments around corporate social responsibility(CSR), the general public is also interested in (part of) the TCF. Many or-ganizations already disclose information on tax and CSR in their financialstatements. This tax policy, which is linked to the overall strategy, is partof the TCF.

(g) Tax department

Last, but not least, the tax department also benefits from a TCF. First, aTCF will facilitate the day-to-day operations of the tax department. It willbe involved early on in important business transactions and surprises cantherefore be kept to a minimum. But second, a TCF provides a commonlanguage for the tax professional in the tax department when communicat-ing with the other stakeholders. Tax planning can be translated into impacton strategic objectives such as cash flow management, earning per share,etc. In this way the tax department can demonstrate how it adds value to




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the organization. Another aspect of that common language is the transpar-ent link between tasks (strategy, operations and risks, etc.) and the need forsupporting technology and resources. So when the budget meeting is beingheld, the head of tax department can support his budget demands by ulti-mately linking these to the ultimate strategy of the organization.

3. Building the tax control framework

3.1. Introduction

How do we build a TCF which maximizes the benefits of tax opportunitiesand mitigates the risks? This question can only be answered by under-standing the causes of potential risks and the business areas they originatefrom. In this section, where we refer to risks, a missed opportunity is alsoseen as a risk.

Picture 5: Causes of potential tax risks

As described in our earlier analysis on tax risks, the main sources are lackof tax oversight, tax analysis (both analysis of the facts and tax technicalanalysis) and the follow-up.

Effective risk management should focus on an integral approach towardstax risk management. As a start, COSO Enterprise Risk Management(COSO ERM) could be used to identify the key areas of tax risk manage-ment.




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Additionally, this must be embedded into an automated system and intothe existing organization. This all adds up to the following key areas of theTCF approach:

– Tax strategy. Relating to high-level goals, aligned with and supportingthe entity’s mission (see 3.2.).

– Tax operations and risk. Relating to effective and efficient use of theentity’s resources (see 3.3.).

– Tax accounting and reporting. Relating to the reliability of the entity’sreporting (see 3.4.).

– Tax compliance. Relating to the entity’s compliance with applicablelaws and regulations (see 3.5.).

– Automation and technology integration. Relating to the IT system ofthe organization (see 3.6.).

– Organization and resources. Relating to the resources and competen-ces of the organization (see 3.7.).

Combined, these areas form an integral approach to become, and stay incontrol of tax risks. This is schematically depicted in the picture below:

Picture 6: Building blocks of a tax function

3.2. Tax strategy

By considering the tax strategy, an organization should consider its tax ac-tivities in relation to the vision, mission and strategy of the organization.Vision articulates and legitimizes the existence of the company; it de-



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scribes the reason for the company’s existence (raison d’être). The missionrelates to what the company will do in the context of its vision. It formu-lates what activities the company will do. Finally, strategy is about howthese activities will be executed. In this context, tax strategy is about howthe tax function will contribute to the overall goals of the organization.

Historically, the tax function has been a separate part of the organizationwhich operated in a solitary manner. In that position it has always func-tioned on the sideline of the organization. From a financial perspective, thetax function has always been regarded as a cost centre, to deliver servicesto the organization at minimal costs. This is in contrast to a profit or invest-ment centre which is measured against sales and return on investment(ROI). To make the shift from a cost, to a profit or investment centre, thefiscal department should formulate a fiscal strategy, execute effectivelyand clearly communicate its priorities towards other departments. By doingthis, the role of the tax department changes and it becomes a business part-ner in the decision making process. It no longer operates as in a silo, in-stead it is interdisciplinary and involved with other parts of the organiza-tion, where the tax expertise offers added value for the organization.

This part is dedicated to the high-level goals of the organization and is thestarting point of the TCF. With respect to the tax strategy, the followingwill be addressed:(a) goals;(b) communication and involvement;(c) organizational life cycle;(d) regulation; and(e) tax governance and social responsibility.

(a) Goals

In general, organizational goals can be divided in (i) qualitative and (ii)quantitative goals. Qualitative goals are topics related to continuity of op-erations, transparency, ability to provide information and good corporatecitizenship. Quantitative goals are about earnings per share, tax cash flowsand effective tax rate (ETR).

(i) Qualitative goals

How can the tax function contribute to the organization?

A first step in the discussion on taxes is to formulate a tax strategy. Taxstrategy should be an extension of the overall strategy to align tax activities




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with organizational goals and activities. Mainly, tax should contribute tothe strategy of the organization.

Continuity of operations. Continuity of operations is another topic whichmany companies regard as their strategy. By understanding and monitoringthe tax position of the organization, pending issues with the tax authoritiesand fiscal disputes, the organization is able to plan ahead.

Transparency. Transparency is a goal shared by many companies. In thecontext of tax strategy, this means the organization has an up-to-dateawareness of its tax position. It is able to measure this by setting up a re-porting structure which provides this information. By doing this, the organ-ization is able to take informed decisions and steer actively on activitieswhich create value after tax.

Able to report and inform stakeholders in a timely manner. Another com-pany strategy might be to be able to respond to information requests tostakeholders in a timely and appropriate manner. To be able to do this,companies should be able to generate the required information and decideon what to report. From a tax perspective, the organization should beaware of its outstanding tax issues with the authorities and be able to quan-tify those positions. Only then is it able to report to stakeholders in a timelymanner.

Good corporate citizenship. Corporate citizenship is about the social posi-tion an organization has within society. It implies a good governance andresponsible behaviour of the company. Next to the strategy of profit opti-mization, a company is considered to have a social function and shouldtherefore act as a reliable actor within society. In the domain of tax man-agement and tax strategy, this implies a responsible position as a taxpayingentity towards the tax authorities. If a company identifies itself as a goodcorporate citizen, it should make its contribution to society by paying a de-cent percentage of taxes. It also implies a good, trusting relationship withthe tax authorities.

(ii) Quantitative goals

How can the tax function add value to the organization?

To visualize the added value of the tax function, one could make a valuepyramid describing how tax activities contribute to quantitative goals likeEPS and ETR.




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Building the value pyramid begins with the understanding of the overallquantitative goals of the organization. In many profit oriented organiza-tions, this is maximizing shareholder value by maximizing EPS.

EPS. An overall goal of the organization could be to maximize the EPS ofthe organization because it is directly related to maximizing shareholdervalue. This quantitative goal consists of net income attributable to share-holders and the weighted average number of shares outstanding. Buildingour pyramid further, the net income attributable to shareholders consists ofincome before taxes and tax expenses. Dividing the two gives the ETR.

ETR. The ETR consists of the income before taxes and the tax expenses.Tax expenses in a year consist of the current year tax expenses, the tax ex-penses for previous years and the outcome of deferred tax assets and liabil-ities combined.

The relationship between these drivers can be visualized in the followingpicture:

Picture 7: The value drivers of earnings per share, related to the tax function

From this picture it can be seen that the tax function has three key driversto contribute to the ultimate goal of EPS:

– Current year tax expense. The current year tax expense is calculatedon the profit before tax adjusted for permanent items. Deferring tax ex-penses through timing differences has no direct impact on the ETR




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(see below). If EPS is an important key performance indicator (KPI)for the organization, the focus of the tax function should be on taxplanning in relation to permanent items and not in relation to timingdifferences.

– Tax expenses previous years. A second element is the “true-up” forprevious tax years. A true-up can have various causes. It can be a re-sult of the fact that in the tax filing, more accurate numbers are usedcompared to the tax accounting process. Another possibility is themovement in the contingent tax positions as result of tax audits, statuteof limitations, etc. Where the organization strives for a stable ETR,these kinds of true-ups can have a negative effect.

– Movement in deferred tax position. The same applies to the deferredtax position. Although the timing differences in themselves do nothave an impact on the ETR, rate changes can have a substantial impacton the ETR if there is a net deferred tax asset (DTA) or deferred tax li-ability (DTL). A reduction in statutory tax rate has an increasing effecton the ETR in the case of a net DTA position. Another element thatcan have a substantial impact is the (de)recognition of DTA for taxloss carry-forwards.

(b) Communication and involvement

To work as an integrated part within the organization, all parties shouldchange their approach in the way they involve the tax function in the pri-mary activities. This also requires the tax department to consider its addedvalue to the organization, bearing in mind the life phase of the organiza-tion.

Considering the tax function as an integral part of the organization willhelp to identify tax risks at an earlier stage so that they can be taken intoaccount during regular decision making. The tax function as an integralpart of the organization is, besides involvement, about communication be-tween departments. Communicating business issues, during commercialdecision making processes, with the tax function will improve the decisionmaking process as a whole. In many cases risks can be identified in anearly stage, which otherwise could have a strong effect on the businesscase itself. This requires the tax function to develop as a strategic businesspartner in providing management with adequate information. Furthermore,the tax function should proactively suggest improvements where valuecould be added. By transforming itself into a strategic partner, the tax func-




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tion will add more value and have a more prominent role in the organiza-tion.

The tax department should organize and work from a process perspectiveto create a stronger connection with the rest of the organization.

(c) Organizational life cycle

Is lowering the ETR a smart decision?

The answer to this question largely depends on the life phase the companyis in. For a start-up company, tax improvement programmes have less im-portance compared to more mature organizations. In a start-up company,growth is of the essence and profit and taxes payments are relatively low.After further growth, the organization stabilizes and profit becomes moreprominent. Effectively, well managed taxes become more important to theorganization to create value. The further the nominal tax payments (profitbefore taxes multiplied by nominal tax rate) increase, the more interestingit gets to look into the tax structure of the organization.

During the lifetime of a company, three main phases can be identified: thestart-up phase, the stabilization phase and the control phase.

Phase I: Start-up phase

In the early phase of the company, all the energy, time and resources arefocused on building the company. Revenue from operations is predomi-nantly directly reinvested in the company to facilitate this process. Conse-quently the taxes paid in this phase are relatively low. Another advantageof this phase is the possibility for the company to be eligible for subsidiesfrom the government. It could be beneficial to the organization to assessthese possibilities.

Phase II: Growth and stabilization

After the start-up phase, the company shows strong growth. Growth accel-erates during this phase. The company transforms into a mature companyand at the end of the phase starts to stabilize. At the end of this phase theproducts and/or services are better crystallized and accelerating growthcomes to an end. This provides the opportunity to the company to startpaying dividends to the investors and shareholders. This increases the im-portance of a sound tax planning.




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Phase III: Control

After the stabilizing phase we see the control phase. During this phase thecompany focuses more on cost efficiencies and allocating its resources effi-ciently to create value. Tax planning has become an important way to limitcosts and to operate efficiently.

Picture 8: Organizational life cycle phases

(d) Regulation

Another factor in the assessment on how a tax function could contribute tothe overall strategy of the company is the intensity of regulation in its in-dustry. There are significant differences between industries, especiallywhen considering industries which pay high duties on their products (oiland gas, alcohol and cigarettes, etc.). In an industry where taxes form a bigpart of sales, it will be more likely that companies will involve the tax de-partment in their commercial decision making process.

To identify the elements which contribute to the tax position, the organiza-tion should identify the value drivers of their business and overall goals.Generally, the strategy of the company is articulated in financial terms(e.g. revenue, profit after taxes, EBITDA). The relationship between thesedrivers and the potential tax effects can be identified by creating a valuedriver pyramid. This way the interrelationship between all drivers can beidentified and the tax effects visualized.




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(e) Tax governance and social responsibility

Although tax strategy has always historically been focused on minimizingtax cash outflows, it also involves communication with its tax stakeholders.These stakeholders demand transparency on how the company will con-tribute to the greater good and that it will show sound corporate (tax) citi-zenship.

Apart from minimizing the tax payments, building a good working rela-tionship with the tax authorities has long-term benefits and should be partof an overall tax strategy. Potential disputes can be solved in a shorter timeperiod and the organization has more clarity and assurance about its tax po-sitions.

3.3. Tax operations and risk

After addressing tax strategy, the execution of the tax strategy will now bedescribed. This part will address the following:(a) tax operations;(b) risk; and(c) tax decision management.

(a) Tax operations

The approach taken by organizations to tax risk is constantly evolving.Historically, the way organizations dealt with tax risk was to define howrisk adverse they were and list out their main areas of concern, often focus-ing on standard tax issues such as transfer pricing and other cross-borderconcerns. Today, companies are approaching tax risk less in terms of mon-ey lost and instead are focusing on where there may be opportunitiesmissed for tax optimization, and where there could be reputational dam-age.

In measuring and reporting tax risk, transparency is key, and organizationsare using a variety of tools to make tax risk more accessible to those with-out a tax, or indeed, a risk background. An example of such tools would bea risk register with the results displayed in a “map”. Such an approach isbased on established risk consulting techniques that are familiar to bothaudit committees and the board. The methodology behind it is designed tocombine the expertise of the tax director with a wider insight into thecauses of risk within the wider business. Done properly, the tax risk pro-




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cess will look beyond specific tax technical issues and examine the activ-ities of the organization as a whole.

Leading companies regularly assess their tax risks using this risk method-ology. By plotting identified risks according to the likelihood of occur-rence against the potential impact of the risk being realized – its signifi-cance – a company can develop a view of which risks need to beprioritized. In most cases, the organization’s risk appetite is determinedprior to this exercise, so that an acceptable level of risk can be pre-plottedon the risk map, e.g. as red, amber and green lines.

Risk maps which plot risks in this way can be easily adjusted in responseto subsequent reassessments of the likelihood and significance of risksonce they have been mitigated through remediation plans or agreed ac-tions. The risk map is an important tool in risk management, and many or-ganizations are using it as a clear and effective method of communicatingthe importance and ongoing status of tax risk to the rest of the business.An example is shown below where the horizontal axis depicts the impactof a risk and the vertical axis represents the preparedness of the organiza-tion.

Picture 9: Risk map: identifying your tax risks by using a risk map

Technology is also playing a large part in demonstrating sound tax riskmanagement and good governance. Increasingly, there is an alignment oftax and financial systems to provide standardized tax processes on a group-




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wide level. This is complemented by the use of global data warehouses,tax “dashboards” (as discussed further below) – that can measure KPIs andrisks in real time – and enhanced data analysis for tax planning. In manycases, organizations are leveraging off existing systems such as bespoketax risk management software or business-wide risk solutions, for examplethe governance, risk and compliance (GRC) modules within their enter-prise resource planning (ERP) system (e.g. SAP or Oracle). These toolsprovide a structured platform for defining, maintaining and monitoringgovernance, risk and compliance for tax. Identifying and understandingthe current position and formulating a value added strategy with key tech-nology objectives is where many organizations currently are in their adop-tion of good governance and risk management.

Improving tax processes as a way of managing risk

A first step in improving tax processes is to undertake a current state analy-sis of the tax function. This often involves carrying out benchmarking andtax risk reviews to better understand the existing tax processes and deter-mine where the tax function wants to be in the future. Organizations are es-tablishing KPIs that will help identify gaps. These KPIs often have a clearlink with the objectives of the wider business and many include ETR, cashtax, demand management, key risks, key controls, internal resources andcontrol activities.

The use of KPIs will help define an end-state – where the tax functionwants to be in say 5 years time. Organizations that are planning ahead inthis way are setting up overarching systems that benefit multiple tax proc-esses. This requires the formalization of key objectives around how theythink their tax function should operate. These tax objectives should coverevery aspect of tax management. As an example, typical tax objectivescould include:– reducing the resources spent on compliance by 25% by 2012;– cutting the tax financial close process by 1 week;– more resource allocated to tax-effective business planning; and– improved level of standardization and consistency across tax to en-

hance governance across all tax processes.

Many organizations are undertaking exercises to map their end-to-endprocesses and the systems that support them. Such process maps shouldhighlight the volume and value of transactions flowing through differentelements of the process and key interfaces between different processes andsystems. These exercises help businesses identify areas of key tax risk and




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how they are currently controlled. Documentation of the process is particu-larly key where tax activities are undertaken by non-tax specialists, eitherbecause the activity is diffused throughout the organization (as is fre-quently the case with indirect tax reporting) or has been moved into ashared services environment. Maintaining the quality of tax compliance inthese circumstances is paramount and less reliance can be placed on the in-formal understanding of a closely knit tax team as perhaps was the way inthe past. Tax authorities are often keen to carry out this kind of work tobuild their understanding of a large corporate’s processes and systems, andthis is particularly true where they see tax compliance activities movinginto shared services centres. As a rule, many companies are uncomfortableproviding this kind of access to tax authorities in the absence of a formalenquiry and so would often share their own documentation to provide thenecessary assurance.

The organizations which can convince their stakeholders (including tax au-thorities) that their tax systems and processes are robust will be able tocommunicate their tax risk more confidently, and will be better placed tocope in a constantly changing regulatory and risk environment throughgreater certainty, improved efficiencies and a stronger basis to defend taxplanning and reporting.

(b) Risk

(i) Insight, analysis and follow-up

Tax risks do not only arise from an incorrect analysis of the technical facts.Many tax specialists assume that technical analysis is the main cause forerrors and a potential source of risk. Considering taxes from a broader per-spective reveals that many risks arise from a lack of communication.




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Picture 10: Causes of potential tax risks

For all tax areas, causes of potential risk are insight, analysis and follow-up. In most of these cases communication between the tax function andother departments is a cause of potential risk.

(ii) Business departments

Tax risks arise everywhere in the organization; it is a misconception tothink these risks only originate within the fiscal or finance department ofthe organization.

Picture 11: Business departments of an organization

In a case where the R&D department develops a new product, it is notcommon to consult the tax department about potential tax risks, alteringthe pricing of the product itself or changing the tax position of the entirecompany. This situation could very well be a cause for potential risk.




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For a tax department, it is valuable to be informed about important changesin the business. If potential tax risks can be identified at an early stage,small adjustments can have a strong positive effect on the overall tax expo-sure. This can protect a company from high potential losses. This alsoworks for actors outside the tax department. For them it is valuable tounderstand how potential initiatives will translate into tax effects so thatthey can adjust at an early stage.

Therefore, one could imagine a grid where the several departments are allanalysed on tax risks in terms of insight, analysis and follow-up. This isthe first step towards a new model to approach tax risks in an integral way.

(iii) Organizational context

A common misconception is to think of a TCF as a stand-alone frame-work.

Picture 12: Integrated elements of the TCF

A TCF should be embedded in the organization together with other meansto provide assurance about tax processes. The tax professional has a set oftools available to document processes and secure a way of working whichprovides assurance. Another means to embed the TCF in the organizationis to formulate a tax strategy to support the TCF. Examples of tools whichcould secure the assurance on tax processes are, for example, a responsibil-




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ity framework or a risk paragraph in the annual report. This all should becontinuously tested with business practice.

(iv) The audit cycles

A TCF is an integrated framework and should build on the internal con-trols which already exist within the organization. In most organizations,departments already have internal controls in place based on the auditcycles of the auditor.

Picture 13: Integration of business processes and the audit cycles

Therefore, a central question should be: What controls do we alreadyhave?

(v) Integration and measurement

All variables considered will result in an integrated approach towards riskmanagement. The implementation of the TCF will result in a grid that in-cludes the tax areas and potential causes for tax risks (insight, analysis andfollow-up), articulates the inclusion of all departments and acknowledgesthe organizational context in which a tax strategy and the tax organizationplay an important role. This is depicted in the TCF model shown below.




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Picture 14: TCF model: integration of all elements of a TCF




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(c) Tax decision management

Tax decision management describes the analysis of scenarios and possibleoutcomes and the analysis of the likelihood of these scenarios. It builds onthe identification of the value drivers described in the paragraph about taxstrategy.

The tax pyramid starts with the overall financial goal of the organizationand breaks this goal down into several value drivers. Some are directly inthe domain of tax and tax management; others have an indirect link totaxes. The value pyramid can be visualized using the technique of a pyra-midal chart which links key ratios and the underlying value drivers of thebusiness. When key variables are identified, one can use decision tables toget insight into different scenarios and the actions to be taken.

Picture 15: Decision table: a structured way to make tax decisions

The next example shows the link between the tax strategy and the deci-sions made on the various options within the strategy, using a five-step ap-proach.

Example

To identify the tax strategy, one should start with the overall strategy of the or-ganization.

Step 0: Identify the corporate strategy

From a financial perspective, an overall strategy could be “to maximize share-holder value”. More specifically we could identify EPS as the overall strategicgoal of the organization. Taking a closer look, EPS depends on net income (at-tributable to shareholders) and the number of shares (weighted average num-ber of shares) outstanding. Net income could be split into income before taxand the tax expenses. The combination of these two variables provides theETR. This is schematically presented in the pyramid below.




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Picture 16: Effective tax rate pyramid

Step 1: Define the tax strategy of the organization

As a first step in making your decision you should define your objectives in thisdecision context and the way you measure them. Suppose that your financialobjective in this decision context is to minimize the corporate tax cash outflowfor the organization, measured in euros, for the current financial year (FY1) andthe next 2 financial years (FY2-3). You may also have other non-financial objec-tives, such as “keeping a good relationship with the tax inspector” or “being agood corporate citizen”, but we do not analyse these in the context of this ar-ticle.

Step 2: Analyse variables influencing the objectives

After defining the objectives and their measurement, you analyse which (groupsof) variables influence the objective(s). In this decision context, the objective isfinancial and is dependent on three variables, i.e. interest deduction, liquidationloss deduction and the tax rate against which the deductions, if available, canbe made. This can be graphically shown in a variables-objectives pyramidalmodel as in the picture below.




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Picture 17: Variables-objectives pyramidal model for reduction of tax cashoutflow

Step 3: Analyse scenarios and possible outcomes

As a next step, you analyse the scenarios for each option. It then becomesclear that “accepting” has just a single scenario: the corporate tax bill will be re-duced by 30% to EUR 16.5 million in FY1 and with 30% to EUR 4.5 million inFY2-3 each. Hence, the total nominal reduction of tax cash outflow of the option“accepting” for the period of 3 years (FY1-3) would be EUR 25.5 million. “Re-jecting”, however, provides at least four scenarios with possible outcomesranging from zero to EUR 52.5 million, analysed in the decision table below.

Picture 18: Reduction of tax cash outflow for the option “rejecting”

After this analysis, many decision makers have sufficient information to make asensible decision. Suppose you do not want to accept the risk of scenario R1,in which the organization would end up with no reduction of tax cash outflow atall. It is then irrelevant what the likelihood of scenario R1 is. The option “accept-ing” then always outweighs “rejecting”, as the first does not have a scenario inwhich the organization ends up with no reduction of tax cash outflow at all.

Step 4: Analyse likelihood of scenarios

Before starting the probability assessment, we should first examine what newinsights we gain by analysing the likelihood of each scenario. The answer isthat probability quantification allows you to compare the options “accepting”and “rejecting” in terms of expected value and risk distribution. Suppose thatthe tax director estimates the likelihood that liquidation loss deduction will beupheld by a tax court at 70% and the likelihood of interest deduction at 60%.




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Decision Table 2 shows how these two estimations result in the likelihood ofeach possible outcome in terms of reduction of tax cash outflow, given “reject-ing”.

Picture 19: Reduction of tax cash outflow in the option “rejecting” withprobabilities

The expected monetary value of the option “accepting” is simply EUR 25.5 mil-lion, because it has just one possible outcome. The expected monetary value ofthe option “rejecting’ is the weighted average of each possible outcome calcu-lated to EUR 34.5 million. The risk distribution is visualized in the histogram inthe following graph:

Picture 20: Risk distribution for reduction of tax cash outflow

The decision whether to accept or reject the tax inspector’s offer may still be dif-ficult, for example, because you may find it difficult to balance the certainty ofthe lower value “accepting” option against the higher value, but more volatile“rejecting” option. There may be more objectives than just the monetary impli-cations that are relevant in this decision context, but the valuation of both op-tions should at least have facilitated a sensible decision.




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Step 5: Assess the probability

Now that we have discussed the use of probability assessment, we can start toexamine how we should make the assessment. This step comprises two sub-steps:

– Step 5.1: Analyse which variables influence each of the scenarios.

– Step 5.2: Assess the inductive and deductive uncertainties.

Step 5.1: Analyse the influencing variables

When focusing on the probability that the liquidation loss will be deductible, thetax director analyses the legislation and determines that loss deduction is de-pendent on the fulfilment of a number of conditions, i.e. that:– the liquidated company must be incorporated or resident in the European

Union;– the liquidating company must hold the shares in the liquidated company

for 3 years or more; and– the liquidated company must have completely ceased its activities.

The variables-objectives pyramid shows how the new information is modelled:

Picture 21: Including variables for liquidation loss

The following decision table analyses the rules around liquidation losses:




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Picture 22: Liquidation losses

Step 5.2: Assess the inductive and deductive uncertainty

To provide a full analysis of the inductive and deductive uncertainties extendsbeyond the scope of this chapter. However, we will briefly address what theseuncertainties are in this perspective:

– Deductive uncertainty: the probability that the general rule in an analysis iscorrect. In a decision table, the deductive probability is the probability thatthe value of a certain rule (R1 or R2, etc.) is as given as an answer in thatspecific rule.

– Inductive uncertainty: the probability that the observations about a specificsituation in an analysis are correct. In a decision table, the inductive proba-bility is the probability that a given situation will arrive at a certain rule.

Both uncertainties are part of problem solving by using a decision table. Taxprofessionals should take this into account when they solve problems using thismethod.

3.4. Tax accounting and reporting

Traditionally, tax accounting issues are raised at the end of the fiscal year,and this takes place after the statutory reporting processes are finished. Be-cause all tax accounting activities are postponed until the end of the year,the company does not have any insight into the outcome of this processand might encounter unexpected results. This part will address the follow-ing:(a) tax accounting: a proactive approach; and(b) tax reporting: the tax dashboard.

(a) Tax accounting: a proactive approach

A way to anticipate uncertainties at year-end is to implement a system ofcontinuous monitoring of the tax position. By monitoring the tax positionthroughout the year, the organization is able to take corrective actions be-fore it is too late, and have assurance about its fiscal results at year-end.




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During the year, commercial events take place which might also have aneffect on the tax position of the company. For example, changes in the fis-cal structure of the entity could have an effect on the total CIT of the or-ganization but not be taken into account until year-end. This means the in-formation is readily available and the company could identify the changesin the CIT well before year-end.

The same applies to positions where the organization is eligible for VATdeduction. In the situation where the company is no longer eligible for pre-allowance, it will have a direct effect on the results of the company. Intheory, an organization is a non-consuming entity and should thereforehave no remaining VAT positions at year-end. However, in practice mostcompanies have VAT positions in their chart of accounts at year-end,mainly because the organization does not have a monitoring and controlsystem in place which covers this area.

On wage taxes, many organizations do not fully utilize the available gov-ernment subsidy programmes which could benefit the organization. Inmost of these cases the HR or tax department is not aware of existing pro-grammes and does not have a control system which monitors this topicduring this year.

Once tax accounting is executed during the fiscal year, it provides two ad-vantages to the organization. First, the organization is aware of the taxes tobe paid at the end of the year. Secondly, most of the activities involved infiling taxes are already completed. Therefore it improves the efficiency ofthe tax filing process at the end of the year, increases the speed of the filingprocess and reduces adverse effects at year-end.




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Picture 23: The annual tax accounting process

(b) Tax reporting: the tax dashboard

Within the regular periodic reporting process of an organization, taxeshave always played a minor role. Recently, tax specialists and specialistswithin the finance function of organizations have found this area to be ofincreased significance in the total value creation process of the organiza-tion. Efficient tax processes create value when maintained and monitoredclosely. The means through which the monitoring takes place is by imple-mentation of a monitoring system. A way to monitor the tax objectives forthe organization is by the use of a tax dashboard. The tax dashboard pro-vides valuable insight to enable effective decision making and the abilityto stay “in control” of the overall tax position.




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Picture 24: Tax dashboard to enable continuous tax monitoring




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An effective tax dashboard contains all the tax elements relevant to the or-ganization and is largely dependent on the nature and industry of the busi-ness. For instance, a highly regulated industry with heavy taxation (e.g.liquor and tobacco) has other monitoring elements compared to a lessheavily taxed industry. The final set-up and configuration of the tax dash-board are largely dependent on these industry characteristics and also theoverall strategy of the organization which formulates the KPIs on a tacticallevel. To provide insight and an overview of performance metrics widelyused throughout all industry, we identified the following generic metrics:

(i) Deferred and current tax positions

As part of the financial statements of an organization, deferred tax liabil-ities, deferred tax assets and current tax assets are important elements onwhich the organization should steer. Because these line items are a directpart of the financial statement, they have a direct impact on the bottom lineresult of the organization.

(ii) Effective tax rate

The ETR calculates the taxes due, both current and deferred, compared tothe profit before taxes. From a theoretical point of view, the ETR shouldbe equal to the nominal tax rate, which is the corporate income tax rate ofthe geographic and fiscal jurisdiction in which the organization operates.In practice, however, these rates show variations over time. It is the duty ofthe fiscal and financial actors within the organization to provide insightinto these deviations.

(iii) Tax compliance

Tax compliance is about filing the tax return and making the actual pay-ments. A complete tax dashboard should include these elements for eachtax area to identify whether the organization is still on track with its taxprocesses. The presentation of this progress could be shown with a dash-board light in red, yellow and green.

(iv) Tax risk provisioning

Tax provisioning is about all outstanding tax issues which have yet to bediscussed with the tax authorities, but are likely to be a point of discussionin the future. Tax provisions are measured on impact and likelihood. Theproduct of these two factors provides the estimated amount of money to beprovisioned for the tax risk. Underlying assumptions on the impact shouldbe formulated by the fiscal department in cooperation with the financial de-




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partment. The likelihood of the issue occurring should be estimated by therisk owner who has the most inside knowledge of the issue.

(v) Tax litigation

Similar to tax risk provisioning, tax litigation is measured on impact andlikelihood, although tax litigation is about issues already under discussionwith the tax authorities.

(vi) Tax opportunities

Tax opportunities are the ability of the organization and the tax function tocreate value from the existing tax structure and future tax planning pro-posals. It has the same elements as tax litigation and tax risk provisioning,although it solely focuses on value creation instead of the mitigation of taxdestruction.

(vii) Tax control

The last element in the tax dashboard is about tax control. It is an overviewof the key risks which are identified by the organization. It provides anoverall sense of the risks which could affect the overall goals of the organi-zation and displays the control activities action(s) taken to mitigate therisk. It provides top management with a list of priorities and the status ofthe counter measures taken, displayed in red, yellow and green.

3.5. Tax compliance: a global scope

The scope of tax compliance nowadays has reached beyond borders andfiscal jurisdictions. Therefore a company should approach tax compliancewith an international vision.

Compliance in a global perspective means integration with accounting andreporting, automation of processes and the ability to organize tax processesaround it. In this respect compliance is an integral part of a TCF. To beable to live up to those challenges, the organization should ask itself thefollowing questions:

– Did we organize our tax accounting processes in an efficient and effec-tive manner to live up to the challenges that lie ahead?

– Are we in control of our tax filing processes?




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– Have we organized our tax processes in an effective manner?

– Are we able to comply in a timely manner with the demands of the taxauthorities?

Once the organization is able to construct a clear picture of its ability to becompliant with the rules and regulations which apply, it will also be awareof the areas which need additional attention and effort.

3.6. Automation

This section will be dedicated to the automation of processes to facilitatethe tax processes in an organization. This part will address the following:(a) lessons to be learned from finance transformation;(b) new approach;(c) transform the tax professional;(d) start the transformation journey; and(e) questions to ask.

Introduction

Ensuring underlying accounting systems are tax sensitized is an importantstep towards managing risk and improving efficiencies in the tax reportingand compliance processes. Many organizations review their chart of ac-counts and ledger codes in an attempt to ensure that the financial data theyreceive during the tax compliance process and for quarterly reporting is ina form that will enable them to better understand what the numbers meanand more accurately and efficiently report their tax figures.

For example, the British tax authorities have indicated that companies thatfail to appropriately configure their underlying systems to track tax sensi-tive expenditure may be regarded as having committed a deliberate errorrather than being simply careless, and thus face a significant increase inpenalty exposure.

Probing into the underlying accounting systems such as SAP and Oraclecan be disruptive, costly and require specialist help. The tax director willhave to weigh up the cost benefits of doing so and determine whether alack of granularity and quality of information being received by the taxfunction could risk failure of compliance with current legislation.




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While sometimes triggered by tax authorities some organizations are usingthis as a way of identifying cash flow opportunities. While some under-statements will undeniably be found as part of the focus on process andsystems, there will be a similar (and potentially larger) number of over-statements identified, with higher claims for relief and more rapid repay-ments of tax achievable. To find these, organizations will need improvedaccess to information to improve their claims – this can include, for exam-ple, better granularity of information relating to capital expenditure (to im-prove tax depreciation claims), and increased detail relating to certain ex-penses (such as legal and professional fees and client entertaining whichcould be classed as marketing).

So how can improving technology systems in this area offer realizablecash savings? Typically, there are three barriers facing tax functions thatare seeking to make claims more accurately and earlier, getting the disal-lowances right and reducing reliance on estimates. These are:– the data required to improve claims is in the accounting system or

ERP but is not easily accessible;– the data is not in the accounting system or ERP but is actually main-

tained elsewhere in the organization and not easily accessible to thetax department; or

– the data does not currently exist within the organization.

Overcoming these technology barriers to the underlying accounting datawill allow companies to analyse, segregate and manage their assets, liabil-ities, income and expenditure more accurately. This will enable them toget a better tax outcome and thus the opportunity to enjoy cash savings.

Understanding these issues will offer the organization the opportunity todetermine the quantum of enhanced claims and whether this justifies thecost and upheaval of improvement. If such activities are undertaken at thesame time as the work required to comply with the requirements of the taxauthorities, these benefits can be maximized.

(a) Lessons to be learned from finance transformation

Finance transformation has been a major theme for most large corpora-tions, as well as the focus of significant investment. However, we rarelysee tax included as an integral element of those change programmes. Butchanges in tax technology and the visibility of benefits arising from trans-forming the finance function mean that tax can and must become an inte-gral part of the programme for change in the finance function.




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Count the cost of tax exile. When, for example, tax is not part of the scopefor a major ERP implementation or finance system consolidation, majorbenefits are missed and the full improvement potential of a change pro-gramme is not reached. The omission of tax has a number of implications.Much tax activity is executed as manual and inefficient processes outsidethe core system – in fact as much as 80% of tax compliance and reportingtime may consist of gathering data. This creates a drag on the entire finan-cial organization as the tax reporting – and the data underpinning it – arehandled on a range of separate systems. Demands for accelerated reportingmean that tax needs to work with the finance function to satisfy regulatorsand investors. So including tax as an upfront element of a wider financetransformation is not only just possible, it is essential.

Focus on the upside. Automation and standardization of processes can cre-ate a major change in the efficiency of compliance and reporting. Theyalso open up new possibilities for how tax compliance and reporting areexecuted as well as where and how tax resources are organized. There isno reason, for example, why some tax resources cannot be co-located inshared services centres to maximize the efficiency and improvement gainsfrom creating centres of excellence under one (real or virtual) roof. Out-sourcing, co-sourcing and offshoring – common practice today in the fi-nance function – are equally applicable to tax.

The benefits of automation and standardization are best shown through acomparison of how many companies still operate their tax reporting andcompliance today and how those adopting greater automation are achiev-ing a more efficient, timely and effective process. For many organizationstoday, in–country finance directors retain responsibility for preparing thelocal tax pack in readiness for filing a return. Typically, this is a largelymanual process whereby information is extracted from financial systemsand repurposed for tax locally before submission to an adviser who gener-ates and submits the tax return. Some companies are now beginning to useshared services centres to remove some of the burden from local financedirectors, reducing the complexity of what is presently a multi-staged pro-cess. Others are poised to go even further. Automation is helping themdrive these separate stages into a seamless process in which data flows di-rectly from the financial system into the appropriate points in the tax re-turn. A “review-ready” return can then be assessed by suitably trained re-sources in a shared services centre before local filing.

There are of course variables that drive the feasibility of this approachacross an international organization. An appropriate accounting system,




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such as SAP or Oracle, needs to be in place – which is likely at present tobe restricted to a company’s larger territories – as well as tax return soft-ware.

(b) New approach

As the availability of appropriate systems continues to broaden, more andmore of a company’s tax requirements around the globe will be candidatesfor automation.

We already see some companies that are embracing outsourcing optionswithin tax realize these benefits, and more. One company is outsourcingthe whole process of corporate income tax compliance and accountingover 5 years. In so doing the company expects total process cost savings ofbetween 20%-30%, an improvement in standardization, control and visibil-ity, and an increase in the automation of process, leading to a liberation oftax professionals in each country to focus on value adding work.

We see three major areas of benefit arising from this new approach:– improvement in the effectiveness and reduction in the cost of man-

aging tax compliance and reporting on a global basis;– enhanced ability to reduce the total amount of tax paid through greater

visibility of the tax position and tax drivers; and– release of time and resource to focus on value adding work elsewhere

in the business and creating the ability to support business strategy andmanage risks better.

By automating tax processes, higher levels of assurance around the accu-racy of direct and indirect tax source data are gained which will providegreater confidence in compliance, reporting and planning activities in thefuture.

(c) Transform the tax professional

These improvements mean that tax professionals within the organizationwill be able to change the way that they approach their work. They will beable to offer greater support to the business, providing insight for decisionmaking and helping the business to make sure that it can report to the mar-ket accurately and quickly. Tax work will no longer need to be carried outin jurisdictional silos and so “transferable” tax skills – rather than the mas-tery of a specific country’s regulatory content – will come to the fore. Justas finance professionals routinely work on a global basis, so too will tax




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professionals be able to focus their expertise to best serve the needs of theorganization.

(d) Start the transformation journey

There is no need to reinvent the wheel for tax. Instead, tax should take themaximum advantage from the work already carried out in finance. Taxneeds to build on those achievements, working with finance and IT to artic-ulate what is needed and how to work together to achieve it.

Tax reporting “at the touch of a button” may seem a distant aspiration formany, but we believe that it is a destination that tax should be travelling to-wards. There are some companies adopting new approaches that delivermajor improvements.

There is of course no single route to improvement. The degree of standard-ization and automation that is either desirable or possible will vary fromorganization to organization and will reflect the broader business strategyand environment. However, the investments that companies have made intheir financial systems need to be taken up by tax so that they too can re-ceive the benefits that the finance function has already seen.

(e) Questions to ask

– Is the process of managing tax going to give the same benefits that wesee arising in other areas of the organization?

– Are our tax processes as automated as they could be?

– Is tax an integral part of the way we collect, manage and report our fi-nancial data?

– Is tax executed as a workaround?

– Do we have tax reporting at the touch of a button?

3.7. Organization and resources

This part will address the following topics:(a) organizational resources; and(b) questions to ask.




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(a) Organizational resources

People are the cornerstone of any tax function and ensuring they have theright skills, knowledge, motivation and tools is fundamental to the man-agement of tax and minimizing risk.

The challenge for organizations is to ensure the right level and balance ofresources given the available budget. To enable effective resource manage-ment, some tax departments are focusing on the following four elements toachieve the required levels of performance and quality while balancingcost constraints:

– Management. Tax directors need to focus on giving the right work tothe right people. This will enable a balanced workload that should beconsistent with the wider organization’s operating strategy.

– Skills utilization. Allocate specific tax work to those staff that have thenecessary tax technical background and skills to undertake that work.Often, tax directors fail to recognize the extent of areas where an activ-ity requires technical skills or experience that is not tax-related. Wherethis is the case, tax directors can benefit from contracting that workoutside of the tax function.

– Incentivize. Tax personnel should have clear job descriptions, attain-able opportunities for career progression, and a development and train-ing plan. Of course, remuneration is also important and these attributeswill ensure that the organization can attract and retain the best tax peo-ple.

– Motivate. Ownership and pride in the work carried out by tax person-nel is important. A main risk area for the tax director is to unwittinglycreate a working environment which engenders monotony, career stag-nation or a sense of unrewarded effort. This can readily be resolved byincluding staff in meetings, providing clear communication channelsfor feedback and discussion, providing achievable goals that challengethe individual, delegating effectively and building trust.

Of course, many tax directors also look outside their immediate functionfor skills and resources. Equal benefits can be leveraged by alternative re-sourcing options such as outsourcing, use of shared services centres andexternal technical consultants.




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The important issue for the tax director however is to try and ensure thereis a consistency in the skills and resources used to manage tax in the organ-ization. Loss of knowledge and expertise of a company’s tax processes andcontrols (especially when these may be opaque) is a significant risk.

(b) Questions to ask

– Do we have the right tax competencies in the organization?

– Do we have enough skilled tax personnel in our organization?

– Do we have assurance on the continuity of our tax department?

– Do we have access to external expertise in a timely manner?

– Do we have enough budget to reach our tax goals, considering thetasks and responsibilities assigned to our tax department?

4. Culture

This part will cover the element of culture in the organization. The follow-ing will be addressed:

– How can sustainable compliance be achieved without losing flexibilityand creativity? (see 4.1.).

– Alternatives to COSO (see 4.2.).

– Levers of control (see 4.3.).

Culture – “Balancing creativity and control”

An organization is a place where people work together and use their intel-lect and creativity to create output. The governance structure of an organi-zation always has to balance the stimulation of creativity and the extent towhich it is in control of this process. Too much creativity could lead to in-efficient allocation of resources and losing sight of the overall goal of theorganization.

At the other end of the spectrum there is an organization where all pro-cesses are regulated, checks are in place, but creativity and flexibility are



Culture

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suppressed and underutilized. When considering this, an organizationshould ask the following question:

4.1. How can sustainable compliance be achieved withoutlosing flexibility and creativity?

The answer to this question is not simple. In a time where innovation andcreativity are potentially the most important drivers of success, controlcould become a burden if applied in a dogmatic way. Too much controlcould pose one of the biggest risks a company faces in turbulent times be-cause it hinders the greatest assets a company has: creativity and flexibility.These two traits could be of great value in guiding the company throughturbulent times. To explore the question further, three different topicsshould be addressed: (a) the cost and benefits of compliance, (b) control ra-tionalization and (c) standardization and centralization of control. Thesetopics will be explored next.

(a) The cost and benefits of compliance

Considering the initial efforts made by companies to comply with the cor-porate governance code, many have felt as if the cost of internal controlhas outweighed its benefits. In the early stages, a lot of time and effort wasdevoted to implementing the control frameworks which included compre-hensive control description, and design and testing of the internal controlframework. This all laid a burden on the energy and resources of the organ-ization. Other organizations now feel that the investments made in theearly years are finally paying off.

(b) Control rationalization

Recently, companies have reconsidered the scope and extent of their inter-nal control framework. During the early stages of implementing the inter-nal control framework, many companies felt they lacked guidance andtherefore “over-scoped” their projects. Nowadays there is a clear need for“lighter versions” of an internal control framework which provide thesame level of assurance. This can be achieved by putting more emphasison company level controls. By improving company level controls and test-ing, more detailed underlying controls can be reduced significantly. Theaim of company level controls is to improve control effectiveness and re-duce costs.




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(c) Standardization and centralization of control

To support an efficient management of the control environment, internalcontrol should be more centralized with common processes and control,and standardization. This means introducing a more centralized rule-basedapproach to the essential processes while balancing the need for creativityand flexibility. This asks for a change in culture as well as a change in theinternal control processes; a model where people and culture are more cen-tral to the approach towards internal control.

4.2. Alternatives to COSO

An alternative to COSO is the leading international CoCo control modelfrom the Canadian Institute of Chartered Accountants, which was issued in1995. It acknowledges, as does COSO, that the control environment is thefoundation of internal control, but takes it one step further. The intentionof CoCo is to emphasize the people and cultural aspect of control.

CoCo states that effective internal control is not only enforced by segrega-tion of duties, policies and procedures, but the model focuses on intangiblefactors such as leadership, shared values and mutual trust, e.g. entity levelcontrols. It acknowledges the fact that should be obvious to management:that an organization consists not only of processes and systems, but also ofpeople, and that people are most often the key to success or the reason forfailure. So it focuses on the commitment, capability and learning of peoplein the organization.

Moreover, the CoCo model is dynamic. It has action, and because of theimplicit “plan-to-check-act” cycle, the control model comes full circle andhas continuous change as its basic assumption. The model is shown below.



Culture

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Picture 25: The CoCo model: focus on organization and culture

The CoCo model identifies the mechanism of internal control based on cul-tural and people-related elements:

– Purpose. First, people must understand the purpose, goals and objec-tives of the organization and what their role is in achieving these ob-jectives.

– Commitment. The next step is to have people commit to these objec-tives.

– Capabilities. The following step should be for the people to have thecapabilities which are required to achieve those goals. Having the rightknowledge and skills in the organization is essential in achievingthem.

– Monitoring and learning. To complete the model, the organizationshould monitor the progress and learn from previous experiences. Thiscompletes the cycle.

4.3. Levers of control

Another model to consider besides the CoCo model is the model devel-oped by Simon (Harvard Business School), which is called “levers of con-trol”. Simon describes how managers could use innovative control systems




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to drive continuous strategic renewal. It describes controls (in his modelthe “levers”) which enable the organization to stay in control while bothcapitalizing on the autonomy and drive present at lower levels to respondto emerging opportunities. The model seeks to empower the people in theorganization and at the same time to encourage accountability. It providesa direct link from the strategy to accounting and control and taxes. In es-sence it is providing a bridge between top-down (tax) strategy and bottom-up creativity. This model is depicted below.

Picture 26: Simon: levers of control

5. How to get started

Tax risk management covers the identification of business risks originatingfrom the tax position of a company and identifies ways to manage theserisks. The identification, implementation and maintenance of risk manage-ment and supporting systems should be done in three phases. The firstphase includes a zero measurement in which the organization identifies itskey risks. The second phase includes the implementation of a TCF to miti-



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gate these risks. The third phase is the maintenance phase in which the or-ganization is in control of its tax risks and updates the framework whennecessary. These phases will be described in more detail in the next para-graph.

Apart from the execution of the tax risk management method during thesephases, the organization should also consider communication and coopera-tion with the tax authorities. Building a good relationship with the tax au-thorities will speed up and improve the tax filing process in the future.Transparency about tax risks is also a way to improve good communica-tion with the tax authorities and assures control on uncertain tax positions.The implementation of a TCF could enable insight and control of these po-sitions.

5.1. Blueprint TCF

A risk is the possible occurrence of an event which will negatively affectthe goals of an organization. To identify the risks of an organization, thestrategy and goals should also be identified. The TCF is a way to managethose risks which could potentially have a negative effect on the realizationof these goals. Before the execution of this process, it is essential to makethe goals quantitative to be able to measure outcomes. In many cases thisinvolves the business goals or tax goals, which are formulated in an overallstrategy of the organization. They must reflect the ambition level of the or-ganization.

Phase I: Zero measurement

Based on interviews, an initial list of risks is identified. Important in thisprocess is the explicit definition of a risk in order to create a commonunderstanding of the risks discussed. The overview of identified risks con-tains all tax risks which can be identified for the organization, but not allrisks can be acted upon because of time and resource constraints. Actingupon every conceivable risk is not a necessity because not all risks havethe same urgency to be solved. To identify the key risks of the organiza-tion, the risks need to be rated and prioritized. The risks will be rated on“impact” and “preparedness”. These concepts will be explained next.

– Impact. If a risk (an event) actually occurs, what would the impact beon the organization? (This does not take the existing controls into ac-count).




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– Preparedness. This is the risk which remains after taking the currentcontrol measures into account. The central question is: considering ourcontrols, are we doing enough to mitigate our risks?

By assessing which risks have a high impact on the organization consider-ing the current key controls, a risk profile can be created. This provides theorganization with an insight on what risks to focus on and what risks areless urgent.

Phase II: Implementation

In this phase, the risk register will be introduced. In a risk register, the as-sessed risks from the previous phase can be documented. The risk registeris a means to communicate the key risks to the management of the organi-zation.

The risk register is a central place where the identified risks are schemati-cally presented. It contains KPIs which are relevant to the organization. Arisk register, for example, consists of the following labels: number, nameof the risk, risk definition, cause for the risk to occur, risk category and therisk owner.

After the creation of the risk register, the identified risks must be analysedto create a plan on how to mitigate them going forward. The organizationshould also identify if additional (key) controls should be implemented tomitigate the risks. This analysis should be added to the risk register by for-mulating an action plan, evaluation of a risk profile and integration withthe strategic planning process.

For each risk, an assessment is made on how to approach the risk. Thereare four generic actions an organization could take, identified in the dia-gram below:



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Picture 27: Four ways to approach tax risks

To anticipate on the risks, an action plan should be formulated. An actionplan should contain tasks and responsibilities and the ownership of risksshould be appointed to individuals. This provides assurance that a risk isbeing monitored and that the appropriate individual with the requiredknowledge and competences has oversight of a specific risk.

A systematic review of the causes and effects of the identified top risksprovides a clear overview of the actions already taken and the actionswhich should be taken to optimize risk mitigation. The controls, as formu-lated in the action plan, aim to decrease the vulnerability to the risk. Thespecific set-up of the controls is described in the risk action plan.

Phase III: Test and use

When the controls are defined by the risk owners, they should be tested inpractice. A central question in this process is whether the controls are ef-fective. This also relates directly to the control objectives. The controls aretested to prove their working and mitigating effects.

In line with the risk register, the risk owners will do the testing of the ap-pointed controls. The method of assessment of whether the control is effec-tive is a management decision. A solution could be to carry out the physi-cal testing of the control, but a control self-assessment or similar testing isalso a solution.




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The first step in control testing is to identify the existence of a control andhow it is set up. The next step could be to test the working of the controland whether it indeed covers the related risk. The test results could be usedto reconsider the approach towards existing risks.

To improve transparency about the status of identified top risks and theoverall risk profile, the organization could use a TCF report. The TCF re-port is a means to monitor the risk profile of the organization and createsthe ability to manage upcoming risks or the mitigation of existing risks.

5.2. Conclusion

In this chapter we have tried to provide you with a flavour of the commonelements of a TCF. There are aspects that need to be addressed in eachTCF, irrespective of the kind of organization. Although every organizationis unique, every organization has a different business control framework,and therefore a different TCF, experience does show a TCF blueprint. TheTCF blueprint items can be addressed along the lines of six buildingblocks:

Picture 28: The building blocks of a tax function

Ultimately, this should lead to a tax function which is embedded in the or-ganization and which is effective, efficient and transparent.



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Tax Risk Management From Risk To Opportunity

Documents

tax control framework2

control model

control structures

tax control framework

control of tax risks

background oftax control

key control key controls

risk management process