Managing Tax Risk Arising from International Assignments in
the Post-Enron Business Environment
In the wake of the Enron, Worldcom and other fiascos, multi-national corporations are increasingly on the receiving end of close scrutiny by regulators, legislators, tax authorities and the media for accountability, compliance and disclosure. In response to this, and since tax issues permeate all areas of a corporation’s business and income, shareholders, audit committees and management are also adopting an increased interest in corporate tax policy.
For assignment managers focused on planning and ensuring a hiccup-free and positively-received international assignment, this begs the question: How do international assignments affect and fit into corporate tax policy? What measures can be taken to mitigate the risks of tax exposure that are inherent to international assignments?
The Current Business Environment
Corporations are currently required to disclose detailed information about income taxes in their financial statements, and if a US Senate resolution requesting CEO signatures on filed income tax returns becomes law, even more scrutiny is likely to be directed at tax policies. The role of the internal tax department has evolved from emphasizing effective tax rate and cash flow management to being part of how a corporation approaches overall risk management. Further, tax directors’ performance is now being measured on tax risk management rather than the traditional indicators.
These factors are extending tax risk management past the focus of technical compliance to corporate reputation protection.
In addition, investors want Boards of Directors to be more accountable, and inform markets of financial and operational issues as early as possible. Shareholders want to know how the company is doing on any particular day, and this poses difficulties for Boards. Quarterly financial reports include information that has been highly filtered by management, and the financial data used to compile these reports is located in different databases within different organizations, collected in different formats and managed according to different methods. Compound this scenario for multi-national corporations operating in foreign countries. A significant amount of coordination and communication is essential to being able to disclose the required information.
Finally, complying with complicated and ever-changing tax laws requires vigilance. With foreign operations, it is necessary to become familiar with foreign tax laws, evaluate the effect on the corporation, and determine a plan to blend foreign and domestic taxation for an optimal tax position.
The nature and significance of tax risk
Non-income taxes represent one of the largest expenses in most income statements, and taxes that a company pays are embedded in nearly every aspect of business. Underpayments and overpayments of tax can have a material effect on financial statements. Underpayments can attract bad press and contribute to an unfavorable reputation.
How is an executive to know whether the corporation is paying all of the required taxes and no more? This is a critical question when taxes are also being paid in foreign jurisdictions.
Mergers and acquisitions bring about tax risks because of the blending of taxation that is required. However, similar difficulties arise with subsidiaries operating in different countries. Some exposures may be unidentified and come as a surprise; others may be identified, but are too complicated to communicate beyond the tax department. Regardless, if the information is not available, then the corporation cannot react in terms of adjusting its tax planning.
Inadequate communication is often the root cause of tax exposure. Whether the miscommunication is between foreign subsidiaries, or between departments, it can result in undetected errors in tax reporting, and missed opportunities for tax planning. In this vein, decentralization is an issue for multi-national corporations, as different time zones and cultural environments hinder communication, which is critical to coordinating tax efforts.
With tax permeating the entire corporation, the effect of a single tax exposure can multiply quickly as it appears in other areas of the business.
Mitigation of international tax risk
There is a positive side to all of this post-Enron scrutiny. It is possible to discover ways to take advantage of permissible tax exemptions, and identify ways to improve efficiency and effectiveness of tax procedures. In taking a closer look at the tax function and its related controls, corporations are in a better position to assess the appropriateness of tax provision and related financial statement disclosures.
Specific measures can be taken to mitigate international tax risk. Reserves should be set aside for potential tax exposures, compliance processes should be established to ensure that tax returns are filed accurately and on time, and legal-entity reviews should be performed to ensure that taxation is under control for each legal entity, regardless of its country of residence. Multi-national corporations need formalized, well-documented processes and related internal controls for managing tax-related activities.
Internal controls reviews of the tax function should look at tax disclosures in financial statements, accruals for tax exposures in financial statements, deferred tax accounts, tax valuation, consistency of tax returns in multiple jurisdictions, the existence of controls over non-income tax accounting and reporting, documentation of tax planning, and the existence of records retention policies. Such an approach will provide corporations, and in particular multi-nationals, the assurance that tax risk is being managed.
At CompassTAX™, we help our multi-national employer clients mitigate the risk of tax exposure for international assignments through our Assignment Tax Reviews, and the development of Assignment Tax Programs tailored specifically to the client.
An Assignment Tax Review provides the client with tax-related organization charts that demonstrate taxation relationships between the corporation, its customers, and assignees; a review of contracts (eg. consulting, employment, primary) from a tax perspective; tax appendices which clearly delineate tax reporting, withholding and remitting responsibilities between the multi-national employer, its customers and its assignees; and detailed recommendations regarding both corporate and assignee taxation issues pertaining to the corporation and its assignees. Any potential tax exposures are likely to surface during an Assignment Tax Review.
The next step is to address these concerns and mitigate the risk of future exposures through development of an Assignment Tax Program. Policies and procedures related to assignment taxation are developed to ensure compliance and to take advantage of tax savings.
Managing international tax risk with this dual approach ensures that the corporation and assignees are not overpaying or underpaying tax, that the corporation has a pro-active and organized approach to taxation, and that accurate tax information is available for public disclosure. In so doing, multi-national employers can enjoy the assurance that their taxation integrity is intact, and that their foreign ventures are proceeding without negative tax-related attention – a certain contribution to the overall success of international assignment planning.
If your corporation needs assistance or would like to discuss approaches to managing the tax risk of international assignments, contact our experienced CompassTAX™ professionals at (403) 531-2202 or www.compasstax.ca.