IRS Commissioner Douglas Shulman’s recent speech on the role of boards in tax risk management to the NACD corporate governance conference articulated a trend that is developing among tax administrations around the world.
The tone of his comments reflected both his own business background and the realities of the world that tax commissioners occupy–not only dealing with businesses as a major source of income, but also managing large organizations, with all that brings in terms of global competition, performance pressures, people pressures, and technology challenges.
For some it may be surprising that the issue of board engagement in tax matters has not been a high priority in U.S. business circles before now. Other countries have been exploring this path for some time. For those in the U.S. who may be wondering about his comments, it may be helpful to consider what has been happening thus far elsewhere in the world. While the context and content differ from country to country, there is a clear global trend toward more active engagement by tax administrators in understanding the tax risk management policies of their constituent taxpayers.
At KPMG, we have seen that the engagement tends to start with a robust examination of transfer pricing practices, which focus on business transactions across borders. What follows next is development of a risk assessment process at the tax authority that segments taxpayers (with a focus on large corporations as an important cluster) into categories depending on their appetite for assuming tax risk. It proceeds to encouraging risk self-assessment by companies, through positive board engagement in tax matters. It culminates in the explicit acceptance of the proposition that management of tax is a natural part of the wider corporate governance agenda.
In fact, tax administrators around the world are implementing a vision articulated by the Forum on Tax Administration (FTA) set up under the auspices of the Organisation for Economic Co-operation and Development (OECD).
The governance goal of the FTA was most recently re-affirmed in the communiqué issued after its meeting in Paris in May of this year: “We will continue to engage with business and with the agencies responsible for the development of corporate governance codes and guidelines with a view to ensuring tax compliance is included as an aspect of good governance.”
This objective has been translated into real, on-the-ground action in countries as diverse as the U.K., The Netherlands, South Africa, Spain, Chile, Australia, and China. This activity all points to a consistency of intent, even if there are different approaches to implementation.
Clear business logic is leading tax administrations to follow this approach. They are operating in a sophisticated global economy characterized by intense tax competition between countries, emerging markets which companies are eager to explore, and businesses with the ability to reorganize their supply chain to take advantage of lower cost environments almost anywhere in the world.
All these corporate decisions and activities put pressure on both the local tax base and on the resources required to administer the system and collect the taxes that are properly due. Perhaps most important, all this is happening at a time when there is a need to increase tax revenues and when the performance of government agencies is coming under increasingly acute scrutiny.
So, put simply, tax authorities realized that they need to become better at predicting taxpayer behavior and the consequent impact on tax revenue streams. They need to become better at allocating their limited resources to best effect, and they need to attract and retain a workforce with the diverse skills and abilities necessary to deal with the many different challenges that the broad spectrum of taxpayers presents. In this environment, high-quality risk assessment is seen as fundamental to the ability of tax authorities to deal effectively with these challenges.
Dialogue Can Benefit All
Shulman discussed initiating a dialogue between revenue authorities and business. So it is reasonable to ask, where might this dialogue go? We think the direction of travel is clear.
He mentioned Australia in his speech. For a number of years, the Australian Tax Office (ATO) has addressed the boards of companies, consistently urging them to take responsibility for tax risk policies, control processes, and monitoring.
The reaction of Australian corporate taxpayers has been mixed. Many do nothing extra, believing they are in control and there are few incentives to go beyond what they currently do. But there are some who see the opportunity for dialogue as potentially valuable. These companies are doing more, as the ATO puts forward an agenda, which requires the board to assume more responsibility, but balances this with recognition that there is a need for the tax authority to both communicate, and deliver on, the benefits of engagement.
This constructive engagement (or the “enhanced relationship” as it is referred to by the FTA) is an important part of the incentive for boards to look more closely at the way tax is actually managed and controlled.
If compliance costs could be lowered by minimizing unproductive tax audits, if uncertain positions could be resolved more quickly, and if assistance could be provided in negotiations with overseas tax authorities on potential double taxation, then there is a clear monetary benefit for the corporation in this process, as well as a benefits for the tax authority. Without these incentives, boards are likely to continue to rely on management assurances (including those from the tax director) that matters are under control, and no further oversight or investment is required.
The U.K. tax authority has also been at the forefront of board engagement, taking a multi-pronged approach. There has been engagement with companies to discuss risk assessments openly, to amend them as appropriate, and to establish an agreed way of operating by both sides. There have been public calls for board responsibility. There are meetings between the senior leadership of the tax authority and boards. And most recently, there is also a statutory requirement for an officer of the company to confirm the robustness of tax processes (called Senior Accounting Officer declarations). Separately, a code of conduct has been promulgated for banks. The code calls for banks to be transparent and follow the intention of the lawmakers rather than the letter of the law, although the practicalities of doing this are currently unclear.
The U.K. tax authority was closely involved with the FTA report that set out the details of the enhanced relationship outlined by the OECD, and it has clearly followed through with implementation of many of the principles outlined in the report. While a degree of skepticism remains among some business people, there are also many examples of support from companies for these measures, when they can be shown to bring benefits to the tax authority and the taxpayer. Fundamentally, it is rare that a board or senior management declines to engage with the leadership of the tax authority
Concerns Remain on Both Sides
Despite good progress in the U.K. and Australia, tensions still remain. Some companies believe this so-called engagement is simply a way for tax authorities to spot tax planning early on. They see engagement as a way for authorities to raise more money more quickly.
Tax directors worry that they are being circumvented and that untrained board members will make commitments that undermine the tax department’s ability to add value. More generally, there is a concern that the rule of law is being over-ridden by tax authorities who are dictating behaviors that suit their goal of raising tax revenues more efficiently. These are legitimate concerns that need to be recognized and dealt with.
Equally, there are concerns within the ranks of the tax authorities that it is inappropriate to have an enhanced relationship with taxpayers. Here, some see raising tax revenue as their only goal. For these people, those that stand in the way of moves to collect the “correct amount” of tax are at best obstructive and at worst disloyal to the nation. These concerns need to be addressed as well.
Early Days for the U.S.
It seems as though we are in the early days for enhanced tax relationships in the United States, and yet it was the U.S. that led the first stage in the evolution of tax authorities, by raising the bar on transfer pricing rules. Indeed the IRS has embraced taxpayer segmentation and risk assessment, including the Compliance Assurance Program (CAP).
Shulman’s speech may now signal the next stage in the evolutionary process, which is to encourage companies to self-assess their risks. The international model would suggest that what follows next is IRS engagement with boards, and, finally, tax risk management as part of the overall corporate governance agenda.
If the reactions of companies in other countries such as the U.K. and Australia are typical, his speech will raise a variety of emotions–suspicion, complacency, resentment, and resistance among them. There will also be those who see this as an invitation to engage. These people will treat the process as a business rather than an emotional issue.
If, as we have said, there is a long-term business imperative for tax authorities to take the evolutionary path, then the same business logic should apply to companies. This reality will be acknowledged by those who want to manage tax costs efficiently and who prefer their government agencies to be efficient, to understand the competitive environment business is facing, and to contribute to the growth agenda. The alternative is a long, drawn-out war of attrition, which will raise the costs of tax administration for everyone.
We believe it is appropriate for corporate governance principles to be at the heart of the debate on tax. There need to be checks and balances on the behavior of both tax authorities and corporate taxpayers, built into their operating guidelines. Clearly, the law must be the ultimate arbiter of what is correct, but we have seen that good behaviors can go beyond the minimum requirements of the law and can help assuage the needs and concerns of both sides.
The U.S. needs to find its own way on this road, but it can take valuable lessons from the experiments going on elsewhere in the world. The first and most fundamental of these is that at the heart of a changed model are better relationships, and these new relationships can only develop with better dialogue. Talking is always the first step, and Shulman is encouraging more people to take that step.
Shaun Kelly is vice chair, tax, KPMG in the U.S., and Loughlin Hickey is global head of tax, KPMG in the U.K.