Audit committees have developed a greater sensitivity to the financial reporting and reputation risks that taxes can pose for their companies today. The number of tax-related material weaknesses reported under Sarbanes-Oxley Section 404, as well as the recent implementation of the Financial Accounting Standards Board’s FIN 48, has prompted this increased attention.
These developments—coupled with demands for greater transparency and disclosure by the Securities and Exchange Commission, Congress, and taxing authorities—are causing many audit committees to take a closer look at how they oversee their company’s tax risks, including the nature of their interactions with tax directors and all others responsible for managing tax risk.
The fundamental challenge for audit committees is to understand how tax directors and executives deal with tax risks and how they coordinate their activities with risk management in general. That challenge is made more difficult by the inherently complex and technical nature of the tax laws of so many jurisdictions. To address these challenges, we offer the following suggestions:
- Consider the scope of tax risks. While the tax department may be responsible for managing most of the company’s tax risks, other departments—including marketing and sales, procurement, M&A, human resources, and compliance—may manage a variety of tax risks as well. Audit committees need to consider the tax implications of the company’s broad array of business activities in order to fully understand the scope and nature of tax risks.
- Identify, measure, and manage the portfolio of tax risks. With this broader view of the company’s tax risks, audit committees need to understand the processes management uses to identify, measure, and manage various categories of tax risk. Effective management hinges on the integration of the company’s tax risk management into the company’s overall risk-management strategy. A key question for audit committee members is who, other than the tax director, understands the company’s material tax risks.
- Set a communications protocol. Management should regularly update the audit committee on the status of its tax risk-management activities. Periodic meetings—annual, semi-annual, or quarterly—between the audit committee and the tax director, are essential if the audit committee is to keep abreast. In addition to providing updates on tax-related internal control, compliance, and disclosure issues, the meetings provide an opportunity for the committee to play a more proactive role in the company’s tax affairs and strategies, and minimize the risk of future surprises.
- Allocate appropriate resources to the tax function. The experience of the company’s tax professionals is key to managing its tax risks successfully, and audit committees can help ensure that any “gaps” are filled before a crisis occurs. Similarly, audit committees should monitor the adequacy of internal and external audit resources devoted to tax activities.
- Don’t leave the formulation of tax risk policy and strategy to the tax director alone. The audit committee, with its understanding of the level of tax risk that is acceptable to the company, should ensure that there is a clear understanding and agreement among the committee, tax director, CFO, and others, regarding the company’s tolerance for tax risk. This should be reflected in a written tax policy and strategy approved by the audit committee.
At KPMG, Harry L. Gutman is executive director of the Tax Governance Institute and Edward F. Smith is executive director of the Audit Committee Institute.