You can’t tax what you can’t see

The focus of the Senate Inquiry’s Interim Report into Corporate Tax Avoidance, published last week, was very much on transparency.

Its key recommendations included making the new voluntary tax transparency code mandatory and that excerpts from the new Country-by-Country reporting requirements be published. The report also suggested there had been a change in focus of Australian Boards and management at multinationals in recent years. It argued that rather than maximising profits in Australia as a key objective of local operations, some Australian Boards and management were instead following their global parent’s instruction to do the opposite.

The report discusses and endorses the ongoing approach to transparency both locally and globally, but it does not reference emerging new guidance of best practices around tax transparency and corporate governance in Australia. Last month the ATO published its Corporate Governance Guide (the Guide), which recommends that a Board articulate its tax risk appetite for Australia as best practice. A board should also consider if testing may be appropriate to ensure its operation in practice. The Guide also suggests publication of this tax risk appetite in the company accounts, which is an interesting example of transparency guidance on how tax is managed – as opposed to what tax is paid.

It is worth noting that Australian developments are not happening in a vacuum. The UK is already consulting on whether to mandate publication of “how” type documents, including UK-specific tax risk appetites and evidence of testing. This is shining a spotlight on the role of local UK Boards in decision making around UK tax matters. As a consequence, we are actually starting to see a process of decentralising tax governance, and wrapping it into the auspices of local Boards.

The guide is the culmination of two years of consultation with the profession and the industry. It is the next step in taking tax out of its traditional ‘black box’ and effectively putting it on a par with the many developments around internal controls and enterprise risk management frameworks. Boards already have had to publicly attest that their internal controls are of high standard and are tested regularly, as part of the revised ASX Corporate Governance principles in recommendation 4.2 last year. Given the materiality of operational tax risks as well as reputational risks in the changing tax environment, many risk functions have determined tax risk to be of material magnitude to warrant its inclusion in broader risk frameworks, and as a compliance requirement of Prudential Standards including CPS & SPS 220.

Businesses should start by engaging various parts of the organisation including Finance, Risk, Tax, Internal Audit, Corporate Affairs and Human Resources to understand the business-wide operational, financial and reputational risks for tax and how best to manage them holistically across the entire business. The Tax function should also engage with the Board and Audit Committee on the changing tax environment and emerging transparency requirements. Boards are very interested in better understanding the risks and being prepared, having read the multitude of negative media and political rhetoric on the topic in recent months.

It is also reasonable to assume that the ATO will use this Guide as a high watermark for carrying out risk reviews of companies. As is already the case in other countries, and particular contracts we have seen for delivering services to the ATO, any organisation which tenders for government contracts may in time also be required to demonstrate meeting this tax benchmark to be accepted. The Senate interim report has already made some initial recommendations in this area.

In our experience, relatively few companies are as advanced on the tax governance maturity curve as their Boards and broader stakeholders might like them to be – in particular for the data gathering and recording activities which occur outside of the Tax Function with little oversight. Over the past few years KPMG has carried out continuous self-assessment surveys of Australian local and multinational companies and the approaches to tax risk management and governance. Relatively few of these companies benchmarked themselves at the high watermark outlined in the Guide.

Some of the findings among the Australian companies, which covered a range of sizes and sectors, included:

Nearly half (47 percent) of respondents replied that they were not fully confident that their internal controls were appropriate for the size and complexity of the company’s operation.

Only 7 percent had understood and documented their controls across entire tax processes

Less than one-third (31 percent) reported to Board on tax matters of any sort under a framework which had been set by the board

Our research has shown that most companies have work to do in various areas: IT controls, data integrity internal control frameworks and clarity of roles. Internal control testing is also important here – Boards need to be satisfied that the control framework is actually operating in real time to manage tax risk effectively. The ATO may ask to see evidence of this testing in the future to better understand the extent of a taxpayer’s governance. Other stakeholders, including the media and public, also expect large companies to aspire to the very best practices when it comes to tax governance and risk management, with activities in this area being increasingly spoken to in sustainability reports.

The three key questions for Boards at this stage are:

  1. How well prepared is your Tax Function in preparing for the new and changing tax environment?

  2. How does the organisation attest that it is paying the legally right amount of tax due, unless it has the core internal control foundations in place to file correct returns?

  3. How does the organisation ensure the design and operating effectiveness of these controls – in particular data integrity controls operating outside of the Tax Function e.g. across Business Units, in Finance or in Human Resources?

We regularly see examples of companies putting in amended tax returns to take account of subsequently discovered data errors. This sometimes occurs several times for a single return. The publication of this new ATO high watermark and the very public focus on transparency both locally and globally puts the onus on companies to invest in maturing their tax governance framework, or be prepared to open up as to why not.

Reputation-conscious Boards cannot take their eyes off how they pay tax since this often determines what tax is paid and where they pay it.

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