Where is tax dispute resolution and controversy heading?

sarsAuthor: Johan van der Walt (KPMG) 

The tax world has changed globally (mainly OECD and G20 driven), in Africa (especially through African Tax Administration Forum initiatives) as well as locally (SARS becoming a world-class revenue authority with substantial technology and resource investment).

Sharon Katz-Perlman, KPMG’s Head of Global Tax Dispute Resolution and Controversy recently observed: “Around the world, levels of tax disputes have reached record heights, and the rise in tax controversy shows no signs of abating.”

Confirmation of the above is the fact that 73% of CFO’s are seeing a rise in the frequency of tax audits from governments across the globe (International Tax Review, March 2014).

Main drivers fuelling tax controversy

The following factors, amongst others, are some of the main drivers increasing tax disputes and controversy:

  • The fall-out from the Global Financial Crisis (“GFC”) has left many jurisdictions with fiscal deficits. Put bluntly: governments are short of revenue. There is the need to squeeze more from the existing tax base (through invasive audits and investigations), alternatively, introduce higher or new taxes (which could be politically unpalatable);
  • Taxation and morality are no longer de-linked in a world polarised because of growing inequality. The financial dimension (“tax is a cost”) used to be paramount. Suddenly, concepts like “ethical taxpaying”, “tax risk appetite” and “reputational risk” abound. Just ask Starbucks, Google and Caterpillar how the “softer” issues can damage the brand, lead to a consumer back-lash or even impact market capitalisation;
  • Worldwide growth in information-sharing, collaboration between revenue authorities and joint audits (focussing on cross-border transactions) have upped detection risk. There are more onerous disclosure requirements. Arbitraging asymmetrical tax positions on the assumption that only part of the transaction would be visible in any specific jurisdiction, is risky;
  • Civil society, non-governmental bodies and aid agencies are vociferous and shape public perceptions relating to tax behaviour and whether the multi-national taxpayer is a “good corporate citizen”. This applies to both the developed world (where austerity has caused pain) and the developing world (where strong up-skilling of revenue authorities is happening). As jurisdictions compete for their “fair share” of the tax pie, the push for country-by-country reporting is gaining momentum;
  • There is a greater emphasis on, and need for, tax certainty. This manifests itself either by having to clear out past tax defaults (e.g. by making voluntary disclosure) or by seeking clarity upfront (e.g. via a ruling application or an Advance Pricing Arrangement).

What does this mean for corporate taxpayers?

In brief: Managing tax risk, including any resultant tax dispute and controversy, is now firmly part and parcel of the new tax world faced by corporate boards and their audit committees.

The above has to be handled against the backdrop of quick-fire legislative changes going hand-in-hand with more complexity in tax policy. Furthermore, of late, tax authorities in many jurisdictions require tax risk management to be embedded as part of the overall corporate governance regime.

The tax world has changed globally (mainly OECD and G20 driven), in Africa (especially through African Tax Administration Forum initiatives) as well as locally (SARS becoming a world-class revenue authority with substantial technology and resource investment).

This demands that boards and audit committees must have a more global, pro-active and strategic regard towards tax risk and tax controversy management. This could be achieved by the board and audit committee elevating the prominence of tax risk management and by reorganising / refocussing the group tax department with attendant investment in technology solutions to enhance transparency and oversight of how tax risks are identified, managed and resolved.

How are global audit committees reacting to the rising tide of tax controversy?

The KPMG 2014 Global Audit Committee survey analysed the views of 1 500 audit committee members world-wide, covering 34 countries (not SA however).

Some of the insights:

  • Only 27% of the interviewees saw tax as a big risk for their companies;
  • The quality of tax risk information was seen as good – 47% / generally good – 43% / needing improvement 10%;
  • Just 21% of audit committee members felt their company / board could have been better prepared for tax issues that arose;
  • Understanding the company’s tax governance and tax risk profile: excellent – 26% / good – 56% / limited – 18%;
  • Tax risk as a concern in relation to international growth opportunities worried only 11% of the interviewees;
  • Only 26% wanted to receive more in-depth information from the Finance department with regard to tax;
  • Just 14% felt the internal audit function should spend more time / sharpen its focus on tax compliance, going forward.

The above could indicate audit committee members’ general comfort that they have an adequate understanding of, and handle on, their company’s tax affairs.

It would be disconcerting, however, if certain answers point to an under-estimation of the paradigm shifts that are happening in the global tax risk landscape and the looming impacts thereof?

What do revenue authorities expect? 

Following the GFC, revenue authorities have to do more, with less.

Strained resources and limited budgets are chasing steeper revenue targets. This has seen a migration to risk-oriented approaches centred on risk-profiling to identify untenable tax positions and compliance lapses.

Revenue authorities are asking questions like:

  • Does the board give clear direction with regard to tax matters, i.e. is there a proper tax risk management framework in place?
  • Does the audit committee see comprehensive tax information enabling adequate oversight, or are tax matters simply relegated to the back-office?
  • How many / often have there been compliance lapses and / or tax disputes in the past?
  • How robust is the tax risk management process and does it form part of the overall corporate governance?

As Dave Hartnett (previous HMRC Permanent Secretary for Tax, UK) put it: ”I am suggesting that you, leaders of your organisations, should have a mechanism to oversee tax risk as part of your governance process – the audit committee needs to know and influence what tax posture the tax planners are taking.”

Could there be an expectation gap? 

Whilst the KPMG Audit Committee survey could reflect some complacency in relation to the management of companies’ tax affairs, it is evident that revenue authorities want to see tax risk management elevated higher up on board and audit committee agendas.

There might well be an expectation gap.

Boards have traditionally considered the tax function purely with reference to the financial dimension, i.e. what is minimum tax amount legally payable and what was the maximum monetary benefit to be extracted from tax structuring? The dealmaker’s toolkit consisted of a calculator and a fine comb to survey the wording of the applicable tax provisions. Tax issues resided primarily with the Finance Director (overseen via the group tax department). Tax controversy only became a board problem “after the fact”, often necessitating crisis management in a reactive mode. Effectively, the board was at the end of the tax process rather than at the fore-front.

Revenue authorities are now demanding that boards should pro-actively oversee and manage the company’s tax affairs, giving high-level direction within the organisation in respect of all tax affairs. This means the board should continuously review, through the audit committee, detailed tax-related information covering e.g. the company’s compliance status, new tax risks assumed, the reputational impact of aggressive tax structuring, engagement with the revenue authority where tax controversy has arisen, etc. To do the afore-mentioned the board and audit committee should have a deep understanding of the entity’s tax risk appetite. There should also be a well-designed and detailed tax dashboard giving comprehensive oversight of the company’s tax affairs, including tax positions that might lead to tax disputes and controversy.

Pro-actively managing tax controversy now requires that, in the event of an adverse tax event culminating in a tax dispute, a board should have a predetermined strategy, whether it be in the Alternative Dispute Resolution channel, in engaging in tax litigation or in amicably settling with the revenue authority.

The Google example illustrates the changing tax landscape: Eric Schmidt initially stated that Google paid taxes “… in the legally prescribed ways” and that he was “… very proud of the structure that we set up.” Margaret Hodge (House of Commons Public Accounts Committee chairperson) responded that Schmidt’s sentiments showed arrogance, were out of touch and an insult to his customers in the UK. Fast-forward to January 2014: Tax Justice Network announced “Shareholders to get chance to vote on Google’s tax policy at AGM.” Interestingly, the last-mentioned initiative was driven by the Interfaith Center on Corporate Responsibility operating in the USA.

What does the future look like?

The following extract from a Canadian article (“Ethical taxpaying: how does a company ascertain the ‘right amount of tax’”) published during February 2014 gives a glimpse:

“This developing perception of tax as a moral or ethical obligation creates difficulty with which the existing corporate processes are not always well-equipped to cope. Historically, the only issue for a board to grapple with has been ensuring that the financial risk taken in relation to tax planning activity (to include the additional cost of implementation and compliance as well as the risk of obtaining the expected tax treatment) has merited the reduction in tax paid.

This function has largely been delegated to finance directors and tax managers as something of a numbers exercise. Now, whilst, it remains just as important to assess the financial implications of tax arrangements, the potential reputational impact of tax arrangements must also be considered. This is particularly the case where arrangements that may not only be legal, but which have previously been considered perfectly acceptable planning arrangements, may cause significant reputational harm. This must be balanced against the competitive disadvantage that would arise from a decision not to engage in tax mitigation behaviour that competitors might be undertaking.”

Some conclusions

  • A company’s tax affairs have effectively become “everybody’s business”. It is no longer feasible to manage tax solely as an internal / domestic issue. Companies are being forced into greater transparency. Already a multi-national like Vodafone is publishing its detailed “Tax risk management strategy” on the internet;
  • Tax is no longer purely a “numbers exercise”. The focus cannot solely be on navigating complex tax legislation seeking to extract maximum financial advantage. The reputational downside could decimate the financial upside seemingly achievable through aggressive structuring. (This risk is probably greater in a jurisdiction like South Africa which has one on the highest Gini coefficients in the world);
  • In future, boards and audit committees will have to pro-actively manage and oversee the total tax risk management continuum rather than to re-actively respond to already developed tax disputes and controversies. This could require a re-evaluation of the role of the audit committee, a reconfiguration of the group tax department and increasing the depth and breadth of tax-related information generated and provided;
  • A company’s board and audit committee would need to understand its own tax risk appetite and preferably also have some insight into how revenue authorities perceive its risk propensity. There might be dis-connect between the entity’s perceived internal tax conservatism and how the revenue authority regards the entity’s tax aggression. The revenue authority interface should be constructively cultivated and unwarranted perceptions should be rectified;
  • In a multiple stakeholder environment that includes shareholders, the revenue authority (could be multiple), civil society, non-governmental organisations and the market-place (think Starbucks customers in the UK) companies would need to rethink their communication strategies regarding tax and especially the manner in which tax controversy is handled;
  • And ultimately, the above would only be possible provided a company had a coherent, comprehensive tax risk management framework (including proper policies and procedures) setting out the entity’s tax risk philosophy. Boards and audit committees would need to be on top of tax positions assumed and tax structuring undertaken in their names as well as all risks (both financial and reputational) associated with same.

Tax disputes and controversies are bound to grow in number and magnitude.

As playwright Arthur Miller said: “The structure of a play is always the story of how the birds came home to roost

This article first appeared on the May/June edition of Tax Talk.