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Sunday, 14th April 2024
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'Is tax on your board’s agenda?' part 2: potential tax risks for finance professionals Back  
In a follow up to his December article 'Is tax on your board’s agenda?' Liam Lynch takes a practical look at the potential tax risks for which Irish tax and finance personnel may be responsible.
With the increasing focus which corporate governance in relation to tax matters has attracted in recent years, it is hardly surprising that the number of tax professionals employed in tax functions within industry globally is on the increase. Ireland is no exception.

Where the tax function is not represented locally, Irish finance teams will probably have seen an increase in reporting required of them by Group Tax.

If you are a tax or finance professional whose role involves any degree of reporting in relation to tax matters, it is important that you have an understanding of the bigger picture – Who is setting your group’s tax risk policy? What is the policy? What risks need to be managed? Which of these risks apply to your jurisdiction/business segment? Who has ‘ownership’ of these risks? What is your role or responsibility or have you confirmed that you do not have any?

In a perfect world, a tax risk policy document would set out these risks, responsibilities and reporting lines.

The reality is that the pace at which focus on tax matters has increased has not usually been matched by an increase in tax department budget and staff resources. Therefore such a detailed mapping of tax risks, and their ownership and responsibilities in relation to their management has not always yet taken place in practice.

Ideal tax governance framework
It is generally accepted that the Board of Directors should set tax policy. This involves deciding the group’s approach to tax risk and its management usually on the basis of advice or draft policies prepared by the tax department.

The Board may delegate some of its functions to the Audit Committee – occasionally tax risk policy decisions but, more frequently, monitoring and reviewing responsibilities to ensure the appropriate control framework is in place.

The policy should set out, at a high level, the group’s attitude to tax and the management of associated risk. However, no policy should be based to any extent on ‘detection risk’, i.e. it should always be assumed that the tax authority in question will review the issue concerned. Therefore the focus should be on issues, such as, whether correct procedures are in place to ensure compliance or, on a technical matter, what is the likelihood is of the position taken being agreed.
No surprises please!

At a practical level, due in some part to various corporate scandals and collapses which were as much of a shock to internal senior management as to external stakeholders, the desire for ‘no surprises’ has become very central to most risk policies and tax is no exception.

Analysts tend to infer better governance from stable effective tax rates than from fluctuating ones and US GAAP requires more disclosure of tax uncertainties to ensure no surprises to the market.

Equally, internally, the focus is on ensuring senior management are, at the very least, aware of any potential ‘blow-ups’ which might arise. Generally, if there is a risk you are aware of with potentially serious consequences, however remote the likelihood of it materialising, you will not be thanked if senior management have not been informed.

So, what are the risks for which you might be responsible?
The components of tax risk are many and vary from organisation to organisation. However the following broad categories encompass most of the elements:

Compliance risk
The basic function of the tax department has always been to ensure the organisation’s tax compliance obligations are met, i.e. that the tax returns are accurately prepared, reviewed appropriately and submitted to the tax authorities on time and ultimately agreed in a satisfactory manner.

There are usually well established procedures to ensure that corporate tax compliance is taken care of for operating subsidiaries, either by Group Tax directly or by the relevant local finance function in conjunction with external tax advisors. Nonetheless misunderstandings can arise as to responsibilities, in particular in relation to less active or less prominent entities and other taxes such as payroll taxes, VAT, stamp duties etc.

If you have some tax responsibility, has it been confirmed to you which entities and which taxes you are responsible for? If yes, is it clear how and to whom you report? If not, is it possible that senior management is assuming you are responsible for some taxes in relation to any entities in your jurisdiction which you do not look after?

It should be noted that the person said to ‘own’ a risk and the person expected to carry out the daily tasks to deal with the risk may not be the same. For example, a country tax manager may have responsibility for all tax matters including stamp duty for an Irish based brokerage entity. Yet operations personnel may carry out the daily accounting for stamp duty and make payments and returns to the Revenue Commissioners. Lack of agreed and documented responsibilities can be problematic if things
go wrong.

Financial reporting risk:
If you have a responsibility for conducting any tax compliance functions you need to have confidence in the underlying accounting information on which the returns are based and the timeliness with which it
is available.

If you are responsible for the financial reporting of tax figures, as well as ensuring that basic current and deferred tax amounts are accounted for correctly in the financial statements, you may have other considerations such as accounting for items over which there is uncertainty.

For groups operating under US GAAP, FIN 48 deals with accounting for ‘uncertain income tax’ matters. It establishes a threshold for recognition of tax benefits in relation to positions not certain to be sustained by the taxing authority and prescribes a measurement methodology for positions meeting the threshold. While IFRS does not currently have such specific requirements, the IASB and US GAAP convergence project may bring the positions closer.

If you work for a subsidiary of an SEC listed group, you will probably have had to deal with increased demands for reporting to the US in respect of internal controls in relation to various tax risks and tax accounts. Section 404 of the US Sarbanes-Oxley Act regulates internal controls for reducing risk of fraud or errors in financial reporting and requires detailed documentation of the design and operational effectiveness of risk management policies and controls, including those related to tax.

Transactional Risk:
There are tax risks associated with all transactions. The more straightforward, frequent transactions should be dealt with by general procedures. One-off transactions tend to entail more risk due to their unusual nature and their tendency to be larger in size than normal transactions.

If you have a role in the approval of transactions, you will need to spend time considering such matters as the strength of the technical tax analysis; the accounting treatment and its correct implementation; the risk of a change of tax law; consistency with previous sign-offs; how to enforce sign-off conditions; ensuring proper completion of relevant documentation etc.

- Operational Risk:
This refers to the general risks associated with complying with tax requirements in relation to normal, ongoing business operations.

There are usually procedures whereby those who transact business are obliged to raise any new aspect of their activity for consideration by the tax department or some central department for new initiatives. In reality, cases will occasionally arise where it will not occur to someone in the front line eager to conduct new business, that what they perceive as a standard trade they are about to clinch might give rise to a whole new set of tax implications for the company, e.g. if the client has moved jurisdiction, the product has changed slightly or there has been a legislative change impacting the product’s tax treatment.
Continuous education of business lines in tax matters through regular dialogue on their activities and an ear to the ground are critical for those with operational tax responsibility.

- Reputational Risk:
Boards are becoming increasingly aware that while certain transactions or tax strategies may comply with relevant law and regulations and may contribute to the bottom line, they may have the potential to adversely impact shareholder value in the long term if a company’s reputation suffers, be it in the eyes of tax authorities, shareholders, customers or the general public. This could arise through factors outside the company’s control such as inaccurate media reporting etc.

Some large groups are developing reputational risk committees of one type or another to opine centrally on whether certain transactions or planning initiatives fit within the group’s acceptable risk profile.

Whether such formal processes exist within your organisation or not, if you are responsible for providing local sign-off on a transaction and you are aware of local factors at play, such as adverse media coverage of similar structures, which may give rise to reputational risk, there would normally be an expectation that you should escalate such matters.

Tax Authority Expectations
Different tax authorities have differing expectations in terms of companies’ tax risk management and different rules in terms of what types of transactions need to be specifically disclosed to them. This can be challenging for groups implementing a policy across several jurisdictions.

In Ireland we have had general anti-avoidance legislation for some time now whereby the Revenue may challenge a ‘tax avoidance transaction’ (‘Section 811 regime’). In recent years a form of disclosure regime was appended to it. 2008 legislation expands the ‘carrot and stick’ approach, by introducing more penal provisions in relation to such transactions. However, if a taxpayer files a protective notification in relation to a transaction, these provisions can be mitigated.

While legitimate tax planning continues to be necessary and appropriate, Irish operations must take on board this new legislation and explain it to overseas tax management where relevant.

Mind the gap!
If you have tax responsibility and the above prompts questions as to the extent of your duties, it may be wise to make time to take stock. List your current responsibilities and reporting lines and clarify with tax management whether your understanding is in accordance with their expectations. If there are gaps, you will need to assess whether such gaps can reasonably be filled with current resources, or indeed the appropriateness of additional resources in a commercial context.

The above provides only a flavour of the different types of tax risks which will be relevant to varying degrees in different organisations. However, hopefully it provides some food for thought for those with accountability for any tax matters to ensure there is no expectation gap which may have serious repercussions if things go wrong.

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