Tax-risk management was not in the forefront of the minds of most U.S. directors prior to IRS Commissioner Douglas Shulman’s speech at the NACD conference in Washington, D.C., last fall. Since then, the professional service firms have conducted webcasts and written articles highlighting how tax administrators in other countries are addressing this issue, suggesting specific tax issues with which directors should be familiar, and providing questions to ask regarding policies and procedures–all good and valuable information.
Pamela Packard
Despite the recent attention, many directors view tax-risk management and tax governance as tedious topics best left to accountants and attorneys or delegated to the audit committee. No doubt there are other directors who view the IRS’s campaign to promote tax risk management as integral to good corporate governance as a faintly veiled attempt to increase tax revenue. Here is another view.
Good tax-risk management and governance requires the board be able to discuss, debate and influence the corporation’s overall tax risk posture within the realm of its oversight role. “One size does not fit all” is popular in corporate governance circles today and certainly applies here. Valid business reasons may exist for a company to choose to have a conservative, moderate, or even an aggressive, albeit complaint, overall tax-risk posture. Importantly, boards must understand the consequences of each approach. A company could choose to take conservative tax positions in hopes of reducing compliance costs associated with tax examinations. This could also serve as a counterbalance for companies with significant risks inherent in their core business strategies. At the other end of the spectrum, companies that choose to take aggressive tax positions must expect resources will be spent defending the positions taken and expect that the potential for creation of increased long-term shareholder value outweighs the risks. Best practices in tax governance ultimately may evolve into willingness for transparency but will not require agreement with the IRS on all matters.
IRS Commissioner Doug Shulman’s statement, “…the general public has little tolerance for overly aggressive tax planning that can be viewed as corporations playing tax games,” is undoubtedly an accurate reflection of current sentiment. Contrast that statement with a well- known quote attributed to Judge Learned Hand, “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Does one expect sufficient alignment could ever exist among the competing views of the myriad stakeholders and various public policy considerations to allow a company’s tax-risk posture to be decided purely from a single public policy point of view?
The impact of adverse publicity regarding tax matters varies with the circumstances and is certainly different when a corporation lobbies for company or industry favorable legislation, litigates and loses a well thought out tax position, or violates tax-compliance rules. Risk to reputation over tax matters could be critical for corporations holding themselves out as leaders in good corporate governance practices and certainly is critical for those providing tax, governance or government related services.
As publicity increases around this issue, shareholders are unlikely to be silent. One might expect activist shareholder action for failing to enhance shareholder value if the tax risk posture of a company is significantly more conservative than is typical for its peer group, particularly if the company follows the IRS’s position on issues that other taxpayers fight and win. Alternatively, would shareholder actions arise if a company undertakes costly tax litigation, which ultimately is unsuccessful? How will rating agencies and proxy advisory firms view these issues?
The IRS has indicated it will measure a company’s overall appetite for risk as a possible predictor of the company’s tax-risk appetite (and allocate its audit resources accordingly.) While risk appetite may be consistent across an organization, it is as probable that it is not. For example, significant willingness to take risks for strategic initiatives and revenue enhancement opportunities may coexist with zero willingness for risk in regulatory and reputational matters. Where in this spectrum would tax risk be?
Certainly management will make its recommendation. Will the board review and either accept or reject the recommendation, or will the board consider and debate the alternatives – as evolving best practices might suggest? The practicality of this depends in part on whether tax risk in a particular corporation is viewed as a business management risk, an enterprise risk, a governance risk or a “top ten” risk.
Given the breath and potential magnitude of these issues, an ancillary governance question arises: “Does the board possess sufficient knowledge of tax to appreciate the inherent risks and make informed decisions in this area?”
One looks at the evolution of skills in the boardroom and remembers: boards used to rely on the auditors with respect to the financial statements, now audit committees are required to have a designated financial expert; boards used to rely on the compensation consultants engaged by management, now many boards hire independent compensation consultants and choose board members with compensation expertise. The list of examples goes on.
Will boards hire independent tax firms to advise them directly? This was among the suggestions made by Shulman. While not specifically addressing tax risks, the recent NACD report on Risk Governance acknowledges the potential value consultants may bring and yet suggests “…the use of independent consultants should not be a tool of first resort. Boards should seek to possess expertise that matches the company’s needs. When the required skills are absent, boards should look to their own composition and make adjustments to meet company demands.” Another governance question arises: “Will tax be added to the skills matrix used by nominating committees to identify and recruit new directors?”
Clearly, the IRS’s goal is to improve corporate tax compliance and increase tax revenues. Shulman has chosen the route of appealing to best practices in corporate governance and risk management to obtain allies in the boardroom. In the current political and business environment, one wonders whether his suggestions foretell a future regulatory mandate if the vast majority of boards fail to embrace this initiative. At a minimum, a warning bell has rung – tax risk governance is yet another area where boards’ oversight will be subject to scrutiny.
Pamela Packard is a corporate director and a former vice chairman and National Business Line Leader of Tax at the public accounting and consulting firm, BDO Seidman, LLP.
The views expressed in this article are those of the author and do not represent the views of any organization with which she is or has been associated.
What a terrific article. It addresses not only tax risk, but highlights the issue as yet another area of expertise that a board must have access to at some level. Great job.