Code of Corporate Governance (CCG) has become an integral part of limited companies listed on the registered stock exchanges in Pakistan and across the globe conservatively. CCG has come out from the mere box ticking approach to compliance with the CCG statement being an essential element of Financial Statements of listed companies.
The concept of CCG has come out from its infancy stage and has now become a grown up concept, which may be subject to changes in the near future. Such changes may occur owing to the activities of the Pakistan Institute of Corporate Governance or the result of the recent survey conducted by the Association of Chartered Certified Accountants (ACCA) in Pakistan, in close liaison with the International Financial Corporation (IFC), Securities and Exchange Commission of Pakistan and Pakistan Institute of Corporate Governance.
It has long been felt that committees and agenda of meetings lack the most important figure appearing between the two headings, that is, profit before tax and profit after tax, missing on the face of profit and loss statement is - Tax. This article is an endeavour to highlight the importance of Tax in the board of directors meetings and the CCG committee meetings, apart from ascertaining the root cause of this inclusion.
IMPORTANCE OF TAX MANAGEMENT:
The most important question one may ask at this point is that does tax pose any risk which needs to be tackled at the board of directors and code of corporate governance level. As we all know that the major component of a profit and loss statement includes Manufacturing costs, selling costs, administration costs, finance costs and tax costs. It is ironical that except for tax all the components are represented and monitored at the board level. Consequently, tax is considered as part of the finance department being part of the financial nomenclature.
In reality tax is a mixture of legal and financial knowledge. Nevertheless, the imams of taxation are either professionally qualified accountants who turned out to be goods advocates, but never vice versa. The question of importance of tax is more appropriately answered by Loughlin G. Hickey - Global Managing Tax Partner KPMG as follows.
Tax has changed dramatically in recent years. Its public profile has become much more conspicuous, it has acquired moral, ethical and social dimensions that have never been discussed before and, for reasons, the business management issues associated with tax have become more complicated, more subtle, more steeped in risk and much more challenging.
Reactions in the tax world and the wider business community to these changes have been varied. No consensus has yet emerged about how companies and their tax functions can or should accommodate the unfamiliar ethical and social issues now associated with tax.
On thing seem clear. Tax cannot remain in splendid isolation in which its technical nature and its perceived independence from business mainstream have historically placed it. An attitude of benign assumption that tax is under control cannot provide the transparency demanded in these times of heightened sensitivity to corporate governance and responsibility issues.
Conversely, lack of systemic review of tax could also deny companies access to the potential benefits of incentives created by tax competition between countries designed to attract and retain corporate investment.
Tax is embedded in the fabric of the capital markets in which wealth is created and companies compete. A company's policies for tax and its risks need to be as sophisticated, coherent and transparent as its policies in all other areas involving multiple stakeholders, such as suppliers, customers, staff and investors -(Loughlin G. Hickey [Global Managing Partner KPMG Tax])
TAX RISKS:
Imagine, in case the tax authorities categorises your tax planning as an Tax Avoidance Scheme, which appears on the front page of a newspaper or the Earning per share ratio is down just because of unprecedented tax demand after an amended assessment which appears as the real cause in the financial analysis of a leading newspaper! Both situations raise doubts about reputation and governance aspects.
It is immaterial that such accusations are justified or not but the most important aspect is tax lies at the heart of such accusations and may result in either decline of share prices or tarnishing the image of reputation before stakeholders, including the Tax Authorities. The core reason is that Tax Authorities always assess a taxpayer's income with a preconceived mindset that taxable income is not a true reflection of accounting income owing to innovatively devising, implementing and concealing aggressive tax avoidance schemes.
Agreeing over the point that Tax is important one needs to understand the risks associated with tax. Tax risk can be categorised as Generic or Transactional. Generic Tax Risks relates to compliance, planning and accounting. Compliance has increased considerably in the recent future, consequently the compliance cost has also increased. However, this generic compliance tax risk term is comprised of several factors. Similarly, the tax risk planning is also comprised of various factors, while the accounting tax risk involves inadequate provision for tax.
GENERIC TAX RISK:
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TYPE NATURE
Compliance 1. Technical or factual inaccuracies
2. Miscoding of expenditure
3. Late submission of returns
4. Later payment of tax
5. Poor presentation of tax planning
Planning 1.Failure to plan
2.Technical imperfections in planning
3.Excessive aggression in the planning
4.Failure to implement planning correctly
Accounting 1. Incorrect recognition of tax liability
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On the other side, the Transactional Tax Risk involves the ascertainment of tax risks at the micro accounting level, that is, transaction.
TRANSACTIONAL TAX RISK:
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TYPE NATURE
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Technical The technical basis of the tax treatment
is successfully challenged
Accounting The tax analysis is dependent on an accounting
treatment which is not accepted.
Change of Law A change of law affects the transactions
before maturity, and the break even
point or the required return is met.
Inconsistency The treatment adopted and the argument
to support one transaction is prejudice to
arguments in another transaction
Concentration Multiple transactions fall as a result
of a single technical failure
Implementation The risk that the transaction will not be
implemented as required so that it
falls on a question of fact
Administrative The ongoing administration of the transaction
is not correctly recorded in the accounts, or
the tax return. Elections are not made or
there is some operational failure
Reputation The transaction or approach significantly
prejudices the relationship with the fiscal
authority Publicity concerning the transaction
adversely affects standing with shareholders,
counterparties, policyholders, and other customers
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KPMG conducted a survey, reported in 2004, to assess risk appetites of tax executives which are reproduced hereunder.
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S. No Approach Description Choice
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1. Very Conservative Nothing will knowingly be done that might
a few provoke the tax authorities
2 Conservative Planning subject to rigorous 50%
technical review, legal opinion
must give 70 to 90% Comfort, no
reputation risk tolerated, the
company would not go to court to
defend Tax planning decisions
3 Company would 70 - 90% comfort, no reputation risk 25%
be prepared to
defend planning
in the courts
4 Company would 51 - 70% comfort 25%
be prepared to
defend planning
in the courts
5 Company would No reputation risk 0%
be prepared to
defend planning
in the courts
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The above survey is a reflection of the fact that companies are not inclined towards tax planning activities which are viewed as aggressive because it stimulates high risk censor of tax authorities or presented by the press as engaging in unethical tax behaviour. In any case, companies should take the initiative as the tax risk increases.
AFTER TAX PERFORMANCE MEASUREMENT:
After assessing the tax risks one may conclude that performance measurement should be associated with tax. As we all know that companies normally provide various kinds of services enter into various kinds of contracts and launch various types of products. All these transactions have one common aspect - Tax. The tax implications of all these transactions are analysed and sometimes advices were taken in advanced and a more conservative approach lead to advance rulings in certain cases.
However, the most important aspect of performance measurement is the post tax analysis which was normally missing in all these transactions owing to several reasons.
1. It is unfair to measure business line performance on cost line managers who have no control over it.
2. Companies have tax managers in their business, consequently there is no need for post tax performance analysis.
3. Post tax performance analysis encourages wide of the mark behaviour
4. Focusing too much on post tax performance could send the wrong kind of signal to the local tax authorities and so increase tax risk.
5. Tax efficiency is directly related to the tax department; hence, the bonus of efficient successful planning must be attributed to them.
Consequently, it is important to have a good post tax analysis which would reveal very interesting deviations such as preconceived implications and post implementation scenarios. Nowadays, companies watch more closely the potential downside of a decision for the implementation of tax planning ideas. However, all this is not done at the board level!
TAX RISK MANAGEMENT:
Tax risk management is no more confined to conventional tax planning. A good tax philosophy should lead to a tax strategy to cover compliance and planning owing to the fact that various shapes and forms of tax risk might prevent the achievement of the company's strategy. Consequently, tax management would become its integral part. Hence, growing tax risks makes it important that boards should take a closer interest than they have in the past in overseeing the management of tax risk.
Normally, the tax department has been equipped with the goal to maximise after tax profits or to maintain a set of effective tax rates and its approach to achieving its goal determines the level of tax risk. In achieving its goal, the tax department may adopt an aggressive approach, which may satisfy shareholders but may increase the risk of tax audit. The isolation of tax departments has meant that decisions about what is an acceptable level of tax risk have often been made without the board's knowledge or approval and should no longer be acceptable! A suggestive tax philosophy model is reproduced hereunder.
TAX PHILOSOPHY:
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INHERENT OVERT CONTROL ENVIRONMENT
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Alignment 1 Data Integrity Risk 1 Coordinated with overall
2 Internal and assessment risk management procedure
External Relationships Tools 2 Aligned with commercial goals
Responsibilities 1 Staff quality and quantity Portfolio 1 Defined areas of authority
2 Training Programs analysis of tax risks 2 Define reporting lines
Formal Control 1 Reporting Documentation 1 Defined by policies
Systems Protocols 2 Policed and enforced
2 use of Technology 3 Procedure for dealing with
control failures
Third Party Review 1 Profile Communication 1 Internal Audit
2 Covera ge protocols, eg 2 External Auditors
regular reports 3 External Advisors
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TAX GOVERNANCE:
In the current age, the tax department normally reports to the Chief Financial Officer (CFO). Consequently, the department was not monitored at a strategic level in line with other business functions of similar importance. As a result, tax risks may have received only cursory attention outside the finance function in many companies.
In this regard, following are the KPMG's preferred practice indicators.
KPMG'S TAX PREFERRED PRACTICE INDICATORS:
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Aspects of management Tax Preferred Practice Indicators
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Strategy 1 Tax strategy derived from and aligned
with business strategy
2 Tax strategy understood, agreed and
supported by the board
3 Documented, communicated and understood
policies around key strategies and risks.
4 Strategies in place to address
stakeholder expectations with suitable
controls around them
Relationship and 1 Tax department seen as a business partner
Communication with relationships and clear points of
(Internal and External) the business contact across
2 Tax department reporting to the board and
located close to the CFO, as the first point
of contact for tax related issues.
3 Tax department goals and strategies drivers
are understood by the business as a whole
4 Tax department stakeholders identified (for
instance finance, legal, fiscal authorities etc)
and relationship managed
Staff 1 Tax team to understand role in achieving business
strategy and frame service delivery with
this in mind
2 Clear roles and responsibilities around
management of tax, including adequate
support of internal clients
3 Use of appropriately qualified staff with
defined areas of responsibility
4 Training programs for suppliers of tax
information and tax team
Process and Technology 1 Tax process coordinated with management of
taxation to help improve efficiency and accuracy
2 Tax technology systems coordinated
with accounting system
3 Tax relevant information built into coding
process and accounting system
Risk Management and Control 1 Tax risk policy aligned with
business risk policy
2 Control environment established by board
3 Risk identification and control
processes in place and subject to checks
Accounting 1 Forecast and report activities coordinated
with finance function
2 Controls to confirm accuracy of provisions in
place, eg adequate audit trails
3 Accounting consequence of any tax
planning fully considered
Coverage 1 Taxation on board room agenda
2 Adequate coverage of all taxes
3 Formal process to raise awareness of
tax within the business
Planning 1 Tax department proactively involved at
the strategic level
2 Tax department to have an easy access to
management information and decision makers
3 Tax department procedures aligned with
risk policies
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The above stated preferred practice indicators gives shape and substance to a company's tax management style and strategy and needs to be supported with appropriate behaviour patterns, apart from their promotion and exemplification by the board.
-- An established tone from the top - The Tax Philosophy
-- Clear attitude towards deviations from procedures
-- Active oversight of tax strategy, including risk strategy
-- Ability to ask perceptive questions of tax management
-- What is our tax risk, how significant is it, who manages it and how?
-- How do we do our tax planning, how is it monitored?
-- Is our tax strategy acceptable to investors and non-owning stakeholders?
-- What is the total amount of all the taxes we pay, what percentage of our profit is that?
-- Do we know who is responsible for each of the various types of taxes in our organisation and do they know they are responsible?
-- How accurate is the tax information provided for financial and tax reporting obligations?
-- Are we being too prudent, are we overpaying taxes?
-- How do we compare with our peers?
-- How does tax talk to the business, including the board?
-- Insightful and timely reporting to board on material tax issues
-- Appropriate reporting lines and access for the tax function
-- Clear definition of responsibilities/delegation of authority
-- Appropriate staffing of the tax function
-- Independent reviews of the tax function
CHIEF TAX OFFICER:
However, in the modern world, tax is not the sole domain of the CFO but it has gained significant voice through the post of tax directors, called as Chief Tax Officer (CTO) in the near future, in the board room. In the industry, the tax departments normally operates in isolation from boards and business units, apart from the fact that they operates ethically, in accordance with the applicable laws without any bearing of facing the challenge for its advices. It concludes with the help of tax advisors owing to over sightedness.
CONCLUSION:
Tax is the most significant figure in the Profit and Loss account of any company and in the Balance Sheet. The changing role of the CFO's is turning them into consultants cum managers. However, the pre-requisite technical knowledge of tax is felt missing in the CFO's which requires a combination of Legal Tax and Accounting knowledge. It is expected that the most important figure appearing in the Financial Statement may find its place in the Code of Corporate Governance and discussions of the Board of Directors.
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