Nature & Value of Tax Risk - Additional Notes to the FIN 48 in SA seminar

IFRS have issued a draft income tax statement proposing the introduction of a process to determine tax liabilities more onerous than FIN 48. Is South Africa prepared? Here are some useful tips on making preparation for future more onerous tax positions...

Nature and value of tax risk

Tax risk is something you acquire by simply doing business. You choose to be exposed to it the moment you attempt to generate income. You can of course influence the extent of the tax risk, but the final value of tax risk is ultimately determined by internal and external factors to your business. You will determine the extent by how effective and efficient your management of tax risk is.

The quality of tax risk can range between a negative monetary and bad reputational exposure, to a positive ability to identify opportunities to reduce tax exposure, increasing the ability to procure greater profits. The internal factors that influence this are:

- the quality of your tax compliance staff and/or advice;

- how well you know the facts in your business that might drive tax exposure – this is the information you access “above the ledger line” on an inverted triangle. The apex is the accurate determination of taxable income. The "ledger line" appears half way between the base and apex of the triangle – it is difficult to believe, but the size of the area between that line and the base of the triangle is 75% area of the whole triangle. The area between the line and the apex only makes up 25% of the total area. It is this part of the taxpayer’s overall tax risk that is usually accounted for in tax compliance. The other 75% goes undetected until there is an audit by a Tax Authority – or a structured tax risk management plan is put into place;

- how effectively and efficiently you manage the “above the ledger line” information (the 75% undetected or uncovered area) that may cause tax exposure.

The external factors, in summary, are:

- the regular practical processing of new tax legislation and regulations that may impact on your business;

- being targeted by a Revenue Authority for a tax audit.

Unfortunately for most businesses, they do not care to manage the “above the ledger line” information (that 75% portion), until they have been forced to do so by an adversarial Tax Authority tax audit, threatening to expose them to exorbitant back-taxes not previously provided for.

Internationally, there is an increase in targeted business tax audits by specially organized Tax Authority task teams – showing increased improvements in tax exposures by taxpayers. Why is this? Take a look at the results of a recent tax risk survey:

- 83% of survey participants (taxpayers) stated they knew they were not 100% tax compliant;

COMMENT: SARS had a 72% success rate on its 69 000 tax audits in 2008;

- 79% do not have a documented tax strategy;

- 55% tax compliance managers do not communicate with the rest of the business to double-check the accuracy of “above the ledger account” information;

- 43% did not think their tax compliance information is from a 100% reliable source;

- Between 66% - 79% had not undergone tax audits by the Tax Authority in the last 2 years;

- 43% did not know whether or not tax issues and risks are discussed at board level.

Various conclusions can be drawn from these survey results. Any Tax Authority responsible for administering tax compliance amongst these taxpayers would be virtually guaranteed of arrear taxes, penalties and interest.

Over 200 taxpayers have participated in the survey.

A properly orchestrated tax risk management plan, as advocated in the book “7 Habitual Tax Mistakes” in conjunction with the retainer program offered by www.tax-Radar.com will go a long way towards managing and controlling previously undetected and unknown tax risks in any taxpayer business.