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Oversight of tax risk has become an increasingly important responsibility for audit committees in recent years. In a survey conducted by KPMG’s Audit Committee Institute, nearly one-quarter of audit committee members and executives reported that tax risk is on the audit committee’s agenda at least quarterly—and for some, at every audit committee meeting.
Dennis T. Whalen (left) and Hank Gutman
This increased focus on tax risk has been prompted largely by the continued complexity of operating globally in country-specific tax regimes; the implementation of FIN 48; increased state, federal and global enforcement activities; and most recently by the prospects for business tax reform (and the related uncertainty), which is the focus of media attention on an almost daily basis. So how are audit committees carrying out their tax risk oversight responsibilities in this environment? What is the frequency of tax “deep dives”? And what are the critical items on the tax agenda? Based on what we are hearing from audit committees, we offer the following considerations:
Establish a communications protocol for management to update the audit committee on the status of its tax risk management activities. Given this tax risk environment—coupled with demands for greater transparency and disclosure by the Securities and Exchange Commission, Congress and taxing authorities throughout the world—many audit committees are taking a closer look at how they are overseeing their company’s tax risks, including the nature of their interactions with tax directors and other executives responsible for managing tax risk. Periodic meetings—annual, semi- annual or quarterly, depending on the company— between the audit committee and the tax director, as well as other managers who may play a key role in managing tax risk, are essential. 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, minimizing the possibility of future surprises.
The prospects for tax reform—and the related uncertainty it poses—are a key risk for most every company today. Consider this risk in the context of the company’s risk management processes generally, and “test” various tax risk scenarios. Proposals for tax reform are likely to affect different sectors and companies quite differently. For example, U.S. corporations have very disparate effective tax rates. While domestic retailers, service industries and defense contractors tend to have effective tax rates that are close to the statutory rate, large multinationals tend to have effective rates that are well below the statutory rate. Base-broadening proposals will affect these industries differently—creating winners and losers. Multinationals will obviously be more focused on reform of the international tax regime and the taxation of income earned outside the U.S.
Audit committees will want to ensure that their company’s tax function is fully engaged in monitoring the tax reform debate as it unfolds, and modeling potential consequences—on R&D, capital investments, cash flow, hiring, compliance and more—as well as possible remedial actions as the proposals become more specific. The serious debate over tax reform appears about to begin. What are the alternatives for tax reform? What might we expect? What will be the impact on the company? Does management understand the “realities” shaping the tax reform debate—i.e., that the fiscal situation dictates that business tax reform be revenue neutral, or even raise revenue? Scenario planning can be an important tool.
Understand how tax directors and executives deal with the company’s other significant tax risks, and how they coordinate their activities with risk management generally. Audit committees need to understand the processes management uses to identify, measure and manage the company’s other significant tax risks— such as uncertain tax positions; significant judgments and estimates; internal controls; federal, state and global enforcement activities; taxation of major transactions, etc. Because of the importance of tax risks to the company, effective management of these risks hinges on the integration of the company’s tax risk management into its overall risk management strategy and processes. Does the company employ leading risk management practices, such as scenario planning, to manage its tax risks?
Dennis T. Whalen is executive director of KPMG’s Audit Committee Institute. Hank Gutman leads KPMG’s Federal Tax Legislative and Regulatory Services and Tax Governance Institute.