Preparing for Tax Compliance in 2023 - Michael Rasmussen & Impero
As organizations settle in for a big 2023, what should be on the mind of finance teams?
We’ve teamed up with Michael Rasmussen, an internationally-recognized pundit on governance, risk management, and compliance (GRC) with specific expertise on the topics of enterprise GRC, GRC technology, corporate compliance, and policy management.
Known as the “Father of GRC”, Michael has penned some thoughts on how to prepare for tax compliance in 2023 with practical tips and insights your finance team can use today.
The modern organization is a complex array of transactions, processes, and relationships.
This is challenging to manage within a single jurisdiction, but becomes even more complex, bridging on the word chaotic, when the organization deals with an interconnected mess of subsidiaries, divisions, relationships, and cross-border transactions.
Even a small organization faces a complex web of transactions that span geographic and jurisdictional boundaries as money is moved, services rendered, and products are produced. Complexity grows as these interconnected transactions and processes nest themselves in intricacy.
In this context, organizations operating across jurisdictions (whether country or state/province) face a challenge in managing risk and complying with tax laws as they enter 2023.
Within each jurisdiction is a government aimed to maximize tax owed to it while the organization aims to minimize tax it pays across all jurisdictions. Governments around the world are working to provide coordinated global policing and monitoring of corporate tax planning, ESG in a tax context, minimum corporation tax, and address taxing crypto currency and digital goods. The increased focus on tax compliance will result in more conservative positions being taken by external auditors when evaluating their clients’ financial statement tax accruals.
Standard corporate transfer pricing agreements recognize that legal entities of the organization in different tax jurisdictions contribute in varying amounts to the organization’s value chain and the revenues, costs and profits need to be appropriately allocated.
Aggressive tax planning builds a perception that the organization is undergoing a tax avoidance strategy as it shifts profits from jurisdictions with high tax rates to “tax haven” jurisdictions with low or no taxes through “transfer mispricing” between organizational subsidiaries in different jurisdictions.
Governments around the world are cracking down on this perceived organization tax avoidance.
There is an ongoing focus specific to transfer pricing tax compliance through demonstrating substance.
Substance is the ability to ensure that profits match economic value where that value is created in the organizations value chain. Organizations need to be able to define what drives business value and performance in context of structured accounting for transfer pricing tax compliance. This involves the ability to demonstrate which processes and activities are critical to the business and map back to where they took place (e.g., jurisdiction). This requires that organizations have a performance management framework with robust documentation and controls that can stand up to inquiry.
There also is increased focus and scrutiny on effective tax rates and the upcoming minimum corporate tax that result in greater scrutiny by auditors, tax authorities, and public opinion. This is driving the importance of clearly and defensibly proving tax compliance in 2023, particularly as organizations brace for increased tax pressures in subsequent years with the 15% corporate minimum tax globally. Organizations not effective in supporting their internal controls related to tax compliance will see increased risks to:
Reputation and brand
The court of public opinion will be against the organization as a perception of tax avoidance builds and the organization not being able to defend substance and the proper context for effective tax rates where value is created.
There will be an increase in the volume and complexity of requests, interactions, and disputes with government tax authorities and the organizations will see an escalating cost of defending their position.
External auditors anticipating the likelihood of reputation risk and tax disputes, will require increased documentation of substance and potentially require additional tax reserves.
The goal is to make organizations transparent and accountable while facilitating fair tax compensation within a jurisdiction but also across jurisdictions.
Auditors, in addition to government tax regulators, are expected to drive further action, like they did for Sarbanes Oxley. An inability to timely produce evidence of tax compliance and internal controls will receive increased scrutiny from the board of directors and potentially increased reserves for tax liabilities.
In this context, organizations struggle to identify and govern tax compliance. There is a growing awareness that risk and regulation are increasing in this area.
An organization can face reputation and economic risk by establishing or maintaining the wrong tax policies, or by allowing performance to sour because of weak governance of tax compliance. Governance issues often stem from the tax department not having visibility to, or not understanding, the organization’s processes and transactions of where value is created that creates taxable transactions. Alternatively, the tax department could have established good tax governance but the organization itself doesn’t comply with approved policies.
Tax problems directly impact the brand and reputation while increasing exposure to risk and compliance matters. When questions of business practice, ethics, tax, and internal controls arise, the organization is held accountable, and it must ensure that tax compliance is dealt with appropriately.
Failure in tax compliance comes about when organizations have:
- Growing risk and regulatory concerns with inadequate resources
Organizations are facing a barrage of growing regulatory tax requirements and expanding risks around the world. The organization is encumbered with inadequate resources to monitor tax compliance and ensure controls are in place.
- Interconnected processes and transactions
The organization’s processes and relationships across jurisdictions are growing increasingly interconnected and it becomes difficult to define where value is created and thus taxable. An exposure in one area may seem minor but when factored into other exposures can become significant. The organization lacks a complete record or understanding of internal controls and tax compliance that is material to the organization.
- Silos of oversight
Allowing different parts of the organization to go about managing tax compliance, such as substance and transfer pricing, in different ways without any coordination, collaboration, and control. This is exacerbated when the organization fails to define responsibilities for oversight of tax compliance which leads to the unfortunate situation of the organization having no end-to-end visibility of value creation, substance, transfer pricing, international transactions, and tax compliance.
- Document and email centric approaches
When organizations govern internal controls for tax compliance in a maze of documents, spreadsheets, emails, and file shares it is easy for things to get overlooked and buries the organization in mountains of data that is difficult to maintain, aggregate, and report on. There is no single source of truth, and it becomes difficult to impossible to get a comprehensive, accurate, and current analysis in value creation and tax owed. To accomplish this requires a tremendous amount of staff time and resources to consolidate information, analyze, and report on value, substance, and transfer pricing information.
- Scattered and non-integrated technologies
When different parts of the organization use different solutions and processes for tax compliance, transfer pricing, and managing controls, the organization never sees the big picture. This leads to a significant amount of redundancy and inefficiency, impacts effectiveness, while encumbering the organization when it needs to be agile.
- Inadequate processes to manage change
Governing tax compliance is cumbersome in the context of constantly changing regulations, transactions, processes, strategy, and more. Organizations are in a constant state of flux. The organization must monitor the span of regulatory, geo-political, commodity, economic, and operational risks across the globe in context of international tax compliance requirements and transfer pricing.
Managing tax compliance in disconnected silos of documents, spreadsheets, and emails, managed inconsistently in different legal jurisdictions, leads the organization to inevitable failure. Without a coordinated strategy the organization and its various departments never see the big picture and fail to put tax compliance in the context of business strategy, objectives, and performance, resulting in complexity, redundancy, and failure. An ad hoc approach results in poor visibility across the organization because there is no framework for managing tax compliance as a part of understanding value creation in the organization and performance management.
However, there is value to the organization as this can be seen as more than just a tax department issue, but also as an economic and business validation for the organization to understand how value is created throughout the organization supported by documentation and evidence. Finance departments are facing greater regulatory pressure from many directions. International tax compliance and substance management is just the most recent in a series of ongoing pressure on organizations to have strong and aligned GRC processes with a robust system of internal controls.
In other areas, the finance department is seeing increased pressure over internal controls over financial reporting (ICFR), ensure ethics and integrity in finance and accounting processes, automate controls, and monitor for fraud continuously. Particularly, the finance department regulators and auditors are increasing scrutiny in the use of end user computing applications such as spreadsheets in accounting processes that lack controls to validate integrity and appropriate use.
To address the range of risk and regulatory pressures bearing down on the finance department the organization is best served to think through a holistic strategy of finance and accounting processes and controls and build a foundation of tax compliance strategy and processes on an agile information and technology architecture that manages an integrated risk and control management perspective.