By Tax Commissioner Michael D'Ascenzo
I’ve been asked for my perspective on the progress we have made since starting the journey over two years ago which raised with CEOs, company directors and Boards the consideration of tax risks as part of good corporate governance1. Anecdotal evidence suggests that companies have made good progress in ensuring that tax risk management receives due attention within their corporate governance framework. Many corporate taxpayers are treating significant tax risks as...
Speech by Tax Commissioner Michael D'Ascenzo to the PricewaterhouseCoopers Boardroom Dinner, Brisbane, Wednesday 28 June 2006.
Article from: http://www.ato.gov.au/corporate/content.asp?doc=/content/76404.htm
I’ve been asked for my perspective on the progress we have made since starting the journey over two years ago which raised with CEOs, company directors and Boards the consideration of tax risks as part of good corporate governance
1. Anecdotal evidence suggests that companies have made good progress in ensuring that tax risk management receives due attention within their corporate governance framework. Many corporate taxpayers are treating significant tax risks as they would treat other major risks to their business and reputation.
In addition, there is a growing mutual commitment to work in a more open, collaborative and consultative manner with the Tax Office (on our part for example, through our program of regular consultation at senior levels with large corporate groups). Some of the more recent initiatives we have introduced, such as forward compliance arrangements and priority private rulings, will offer further opportunities for corporate taxpayers to manage their tax risk profile, providing more certainty for those who need it.
Increased corporate regulation and responsibility
The focus on corporate risks has been to a significant extent facilitated by a greater emphasis on broader corporate compliance and corporate social responsibility in general. For example, the introduction of Sarbanes-Oxley section 404 in the US has resulted in some corporations having to restate their earnings downward by significant amounts and in at least one case, because of errors in their income-tax accounting, which were found to constitute a material weakness. These errors, one company said, were discovered in part through "rigorous reviews of financial controls as part of its Sarbanes-Oxley 404 certification process"
2. In Australia, the focus on corporate governance has taken the form of corporate law amendments (referred to as “CLERP 9”) and the Australian Stock Exchange (ASX) Corporate Governance Principles. Specifically, Principle 7 requires risk management policies to be formalised and the Board (or appropriate risk committee) to oversee the establishment and implementation of the risk management system.
In addition, the Australian Prudential Regulation Authority (APRA), which regulates companies operating in the financial services industry, recently released new prudential standards on governance for authorised deposit taking institutions and for life and general insurance companies. Furthermore, a recent international survey of tax directors conducted by KPMG showed that 80% of executives from 120 multinationals said they were “finding it of great or increasing importance to communicate with investors and shareholders about tax matters” – this is a significant increase from the previous result of 69%.
3. These developments have translated into a more rigorous approach to tax risk management within the broader focus on corporate governance. The general consensus is that tax risk management should be managed like any other business risk with reference to the corporate law, and the principles and standards referred to above.
This requires amongst other things, a rigorous analysis, consideration and communication of the tax risks within a corporate group, allowing the corporate group to consider and calibrate its appetite for tax risk. The approach to tax risk management has been varied As to be expected, we have witnessed a range of postures in relation to the level of tax risk a corporate group is prepared to bear.
At one level, through our one-on-one dialogue with the Top 100 groups, we see some groups wanting to positively engage with the Tax Office on what they are doing to manage tax risk, including frank and comprehensive discussions about their risks and their overall risk profile.
Two groups have even entered into discussions with us on forward compliance arrangements to manage their tax risks into the future. Others continue to apply for tax rulings to gain clarity on our view of the law in relation to major transactions and in recent times we have seen an increase in ruling applications.
We will continue to evaluate the reasons why private large business taxpayers are requesting private rulings on particular transactions or financial instruments, to see if there is more we can do to minimise downside risks for compliant taxpayers. For example, we might be able to issue public rulings to cover the tax position in relation to common but significant transactions. In addition, we want to create an environment where taxpayers who seek to take reasonable positions on the application of the law can feel comfortable about doing so without needing a ruling from the Tax Office.
The current law provides protection from culpability penalties if a taxpayer exercises reasonable care and has a reasonably arguable position (unless general anti-avoidance or transfer pricing provisions apply). In addition, recent legislative changes reduce the rate of interest payable for shortfalls that arise from the 2004-2005 and future income years. The design of the law is intended to minimise the downside risks for taxpayers who act reasonably.
We have also noticed that some groups continue to accept moderate to high levels of tax risk by entering into significant arrangements, undertaking valuations or calculations or shifting functions or assets between their global related parties in order to minimise or at very least manage their Australian or global tax exposures.
The tax structuring and outcomes in these cases are sufficiently problematic to require consideration by the Tax Office. Yet another response is from some groups who prefer to accept the highest level of risk by continuing to have very low or zero effective tax rates with little apparent commercial justification, continuing to pay very little tax on healthy profits, reducing their accounting profits to a very low level of taxable income or loss, converting very healthy capital gains into reduced gains or losses and exhibiting an apparent refusal to positively interact with the Tax Office and the tax system. Our response to those who choose to take this higher risk approach has been and will remain quite simple – that is, they can expect a higher degree of scrutiny from the Tax Office.
Tax Office risk management
The Tax Office is simply not resourced to do chase after every dollar, and our objective is practical compliance with the tax laws. Therefore, we must make appropriate choices as to where we can best apply our compliance resources – in a sense, we also adopt a risk management approach to our compliance activities. We target our compliance work to the highest risk areas through monitoring developments in the large business segment and the use of analysis techniques such as risk profiling.
Verification of large business compliance is relatively intensive, reflecting the nature of large business transactions and the factual and legal complexities associated with many of these arrangements. Our compliance activities are increasingly undertaken as transactions occur or as tax payments are made reflecting both the risks in the large business segment and the increasing sophistication of our intelligence and analysis tools.
For example, we are making enquiries about the nature and tax outcome of major new transactions and financial statement disclosures to the market as they come to our attention.
Understanding payments and refunds allows us to monitor both economic and compliance trends.
For example, when there is a significant boom in commodity exports or capital acquisitions, we examine tax payments or refunds at various levels to check the alignment between trade trends and tax outcomes.
We also compare tax payments by and refunds to corporate groups against previous or expected amounts, and following it up with the taxpayer where there are significant unexplained variances.
Taxpayer risk profiling Tax risk identification in the large business segment is based on taxpayer profiling. Using a range of both financial and tax-specific indicators and our knowledge of a taxpayer’s activities, we profile all large businesses, comparing their business performance with their tax outcomes.
Quantitative indicators for each group are compared with those of their market peers, along with issues identified by specialist areas within the Tax Office and intelligence gathering generally.
This analysis identifies both: across-the-board patterns, trends and risks, and specific cases in which tax outcomes seem inconsistent with business performance. Profiling involves the use of risk engine analysis that examines taxpayer-reported information, data from ASIC, our own intelligence and publicly available information as well as data on changes to consolidated groups and GST groups against risk filters to identify potential compliance risks.
The process uses established economic and financial analysis tools to understand the taxpayer’s business drivers and to identify income tax and GST outcomes that are outside the expectations for the business and its industry peers. The risk engine analysis is used to assess taxpayers to make a relative determination of risk.
This is fine tuned by taking into account: intelligence from Tax Office industry segments on the latest industry tax risks, and the compliance and tax risk management behaviour of the particular taxpayer risks arising out of the implementation of new tax law, and other relevant intelligence, including historical information on aggressive postures taken by the taxpayer’s tax adviser.
We also use data from a variety of sources including tax return disclosures, ASIC disclosures, Austrac data, information on major restructures, acquisitions and divestments, media reports, intelligence received as well as data on changes to consolidated groups.
Given the reduced periods of review following the Review of Self Assessment, we are updating our profiles more frequently so we can quickly identify and respond to emerging risks. The risk filters are also periodically reviewed for their effectiveness and changed as necessary to reflect learnings from our compliance activities. Part of our risk identification work also includes flagging which taxpayers have had large refunds.
We do this because we have detected significant tax risks in some cases where there has been a large refund. We also undertake research programs where we seek to further enhance our understanding of issues impacting on compliance in the large business segment. For example we are currently examining economic, trade and profit trends to see if they are playing out as expected in the tax system.
In particular, this is focused on establishing if the profits from the energy and resources boom are translating into consistent income tax and GST outcomes. Our research also includes a focus on whether the increase in banking profits and the increased trade with jurisdictions such as China are also translating into appropriate tax outcomes. Where our research agenda identifies taxpayers where their tax outcomes do not follow the trends in profits and trade, we flag these cases as being a potential compliance risk.
Our model is one where we run various tax performance ratios over the tax disclosures we receive from large business taxpayers. So in effect we profile each of our 1900 large businesses and compare the tax performance of large businesses over time. This enables us to understand which groups have high, medium or low effective tax rates and the trend over time. Generally speaking, if a large business has very high effective tax rates, appropriate capital gains tax on significant divestments and minimal differences between accounting profits and taxable income these taxpayers are rated as a low risk. At the other extreme, where we see low effective tax rates, low capital gains tax outcomes on profitable divestments or significant differences between accounting profits and taxable income, these taxpayers are rated a high risk.
This profiling capability also allows us to identify cases with other unusual tax outcomes. As an example, when we analysed the 2005 year lodgments, we were able to identify a number of groups, which had a significant reduction in effective tax rates over and above the previous year which in some cases appears to be an unusual outcome during a period of economic prosperity.
This profiling drives our annual compliance program and is always being updated. Increasingly, these profiles are being used to discuss tax risks with the Top 100 groups. They are also increasingly being discussed at the commencement of a risk review or audit. Compliance risks Earlier this month, the IRS Commissioner Mark Everson, testified before the US Senate Committee on Finance on compliance concerns relating to large and mid-size businesses
4. Some of his compliance concerns were in relation to the transfer of intangibles offshore and cost contribution arrangements, abusive foreign tax credit transactions, abusive hybrid instrument transactions, transfer pricing, research and development claims, tax shelters and book to tax adjustments.
Our taxpayer profiles also focus on identifying these types of tax risks which need to be considered as part of the tax risk management frameworks for large businesses. We will continue to identify cases with these tax risks for reviews and audits. The tax profile of some large businesses suggests that more attention may need to be given in tax risk management to the tax outcomes of divestments and international transactions.
Similarly, the valuations used to calculate capital gains tax outcomes on divestments remain an area that will need to withstand objective scrutiny. The transfer pricing policies and tax outcomes of businesses with significant international related party dealings and low profit or tax outcomes will also remain an area of potential scrutiny.
The journey continues
To continue on with the journey of fostering a strong culture of tax risk management in corporate Australia, we will remain open and transparent in our own risk management decisions, providing you with choices as to the risk profile you want to take. We will again be releasing our annual Compliance Program, as well as the next version of our ‘Large business and tax compliance’ booklet in August.
By publishing our intentions, providing our view of the law in public rulings and giving guidance on what constitutes practical compliance, we are deliberately seeking to influence greater voluntary compliance behaviour by publishing what will attract our attention and, by implication, how to avoid that attention.
The ‘Large business and tax compliance’ booklet will also contain updated models for the risk assessment of large businesses and for the first time, will show the steps in a review or audit so that large taxpayers can see what is expected of both of us in this process. We have been welcoming of feedback on the development of this publication and have consulted extensively with the Corporate Tax Association, the Corporate Consultative Committee and senior leaders of major accounting and legal firms.
I mentioned earlier that we have introduced forward compliance arrangements. Currently, we are working on finalising two pilot forward compliance agreements – one in the finance sector and the other in the energy sector. By entering into a forward arrangement, large businesses can reduce their risk of audit, demonstrate reasonable care, access remissions to administrative penalties (where applicable) and interest charges in the event of tax shortfalls, and have a level of confidence that tax risk has been effectively mitigated.
By developing an arrangement with features such as continuous disclosure, we aim to provide an environment less likely to produce tax surprises. However, a word of caution – entry into a forward agreement requires a significant investment from both parties, so it may not be for everyone.
Therefore, we will hasten slowly, learning from these pilots and share the results with you. In relation to our priority private rulings program, as at 14 June 2006, we have ruled on 31 significant arrangements and overall feedback about the program has been very positive. However, the success of the program requires early notification and engagement of experts from both the corporate group and the Tax Office, with all facts on the table and open discussion of the issues. An important feature is a jointly developed plan to progress the private ruling in agreed timeframes. It is helpful if we are notified of potential applications as early as possible to help us plan our work, even it is not absolutely certain that the transaction will proceed.
So far we have been able to achieve an average turnaround time of 42 days from the date we received the application. Within that timeframe we have been able to finalise the application within 16 days once all the information is received. This performance is often in the context of complex multi-million dollar transactions which often take the relevant companies many months to plan and implement. All this shows that the private (binding and reviewable) rulings system can work to provide certainty to taxpayers who choose it. Sometimes the ‘system’ is criticised because the taxpayer does not like the answer.
I think ‘working together’ requires from taxpayers a more impartial response to situations where we agree to disagree. The strength of the ‘rule of law’ approach we take to tax administration is that it promotes certainty and consistency for taxpayers. Under the rule of law taxpayers have extensive rights of objection and appeal. Ultimately, the courts are there to resolve disputes, and a strength of Australia’s private ruling regime is that it provides taxpayers with an early opportunity for this.
We will continue to enhance our understanding of business and engage in active dialogue with large taxpayers. The Tax Office has engaged a range of external experts, such as economists and valuers, on a case by case basis, to improve ATO understanding of business.
“Knowing the industry” workshops have also been introduced on a trial basis in various sites, including for example a recent workshop on the mining industry. Plans are underway for a Large Market Symposium in August. This symposium will provide a platform for a robust and productive exchange of views and informal networking, and if successful will be repeated on an annual basis.
It is another opportunity for us to better understand the needs and expectations of corporate taxpayers, and the economic and commercial drivers of activities in the large market. It is also an opportunity for large taxpayers to help us co-design our strategies for the future, and to play a role in the care and management of Australia’s tax system. We are also in the process of implementing a half a billion dollar change program which will integrate our IT systems and foster a re-engineering of our operating models to make it easier for taxpayers to deal with us.
The scale of the change is substantial. The roll out of our client relationship management system is the 5th largest in the world, and we are about to roll out the largest professional case management system in the world. The new system will eventually replace our current plethora of case management systems and will allow our people to see the total picture of a taxpayer’s dealings with us - across all tax types and in real time.
The introduction of our enterprise-wide case management system should also improve our project management of large cases. In addition, our use of analytics and data-mining will become more sophisticated, improving our ability to differentiate between those that are trying to do the right thing, and those that are game playing. Conclusion It is fair to say that tax risk management is now a familiar concept in corporate Australia.
However, the journey continues. The Tax Office is committed to consulting and collaborating with large business to co-design solutions that will contribute to an environment that fosters economic growth within the parameters of the tax law.
This includes co-designing sensible administrative approaches that facilitate practical compliance with the tax law and which reduce compliance cost for business.
It also includes bringing to the attention of Government (usually through Treasury) matters where the tax laws are not operating in accordance with their policy intent or which produce unintended consequences or unexpected and significant compliance costs. This is so whether the law in its current state benefits the revenue or taxpayers.
That is, the aim is to ensure that the tax system works in accordance with its legislative intent. These are our aspirations.
1 However, the form of the risk management system and the level of risk tolerance or aversion are strategic matters for the company decide.
2 ConAgra Foods Inc media release, `ConAgra Foods Reports Preliminary Third-Quarter Results', 24 March 2005, available at: http://investor.conagrafoods.com/phoenix.zhtml?c=97518&p=irol-newsArticlefin&ID=688663&highlight=
3 KPMG media release, June 2006, available at: http://www.kpmg.ch/library/pdf/Media_Release_multinational_Tax_trends_ENS.pdf.
4 Written testimony available at: http://www.irs.gov/newsroom/article/0,,id=158644,00.html.