The modern business environment has been described as volatile, uncertain, complex, and ambiguous (VUCA). Agility and adaptability have become catchy buzzwords in corporate management. Technology is evolving faster than humans can adapt, governments’ appetite for revenue is bursting beyond sustainable levels, job cuts and corporate reorganization have become the order of the day. We have no future because the present is too volatile. Only one option remains; Risk management.
Upon this realization, Risk management is evolving as a critical function in all organizations. Amongst the components of corporate operation that requires special attention in risk management is taxation. Tax is definitely among the largest expenditure items to any person or organization. The payment dates are fixed by law, non-compliance is subject to penalties and further punitive measures. To complicate it further tax is law and that exposes the taxpayer to the risk of misinterpretation. Amidst these challenges posed by the very nature of taxation, the accountant has to reconcile the interest of the taxpayer operating in a very dynamic environment and a government agency keen on revenue targets.
In finance Risk is defined as variability of returns, simply put, getting unexpected returns whether positive or negative. This definition puts tax risk management into perspective. Risk management in taxation has two faces, the adverse consequences that may befall an organization due to non-compliance, and the other face is the opportunities that may be foregone due to poor tax planning decisions. Should be understood that tax risk exposure does not arise at the point of remittance, nearly all transactions have tax implications. That is to say, tax risk management needs to be integrated into all business processes and the spirit of tax conscious decision making must be inculcated in all cadres of staff. To appreciate the weight of tax risk management processes, the following categories of risk need to be considered.
Operational risk- This refers to exposures linked to the application of tax laws to routine business activities. For example, misclassifying the tariff heading for an item subject to excise duty and consequently paying more or less taxes over a very long period. Another example to cite is staff benefits especially the petty allowances here and there, it’s an operational issue that needs to be aligned with the tax laws. These operational affairs being routine may involve very little amounts per transaction but cumulatively resulting in humongous figures. Moreover, doing the wrong thing over and over may make it look right, but a million wrongs do not make a right.
Transactional risk– This touches on non-routine or one-off transactions such as mergers and acquisitions and all other forms of corporate reorganization. Transactions of this magnitude are usually unique, likely to have no precedence, and even there might be no specific tax provision giving express guidance. The level of risk exposure in these activities is usually high.
Compliance risk– Compliance covers the dealings with the Revenue authority; the process of filing returns, responding to any inquiries in the process reaching an agreed position with the revenue officers. Minimizing exposure in compliance risk requires up to date knowledge of the tax laws, infallible accounting information system, and seamless integration of the accounting system with the tax system, Itax in this case.
Financial accounting risk- relates to exposure touching on the integrity of the financial reports, the underlying internal controls, and corporate governance issues. To understand how financial reporting poses risk to the tax position of an entity, try to imagine a scenario whereby the auditors issue a qualified opinion, you would expect the taxman to search through the books with a fine tooth-comb.
Liquidity risk– One aspect of liquidity risk in taxation is failing to meet tax obligations when they fall due or doing so at a cost like having to borrow money to pay taxes. The other aspect to it is being in a poor cash flow shape after paying the taxes such that an organization struggles with the rest of the obligations.
Reputational risk– this refers to suffering negative publicity, being labeled as a tax evader due to adverse dealings with the revenue authority. It is usually the outcome of going through court processes to settle a tax matter. Whether guilty or innocent of a tax case, the organization’s name is left in the public gallery. In this era of information technology all decided tax cases are all over the internet.
The risk management process
Risk Management context- The initial step in handling tax risk for any organization is contextualizing the risk. That involves considering the nature of the organization by size and type of operations. The context helps in establishing the tax obligations that the organization would be liable to. The obligations of a non-governmental organization are different from the obligations of a manufacturing entity. The risk exposure for a multinational company is different from a locally based company. At this stage, it’s also important to establish the tax history of the organization. Organizational culture matters as well, some have a lax, carefree culture, others operate in complete oblivion of the law while others have systems and structures.
Risk identification- This stage involves gathering real facts of the tax exposure of the entity. The risk assessor has to dig through historical data and records, conduct interviews, and brainstorming sessions. Risk identification in tax consultancy practice is commonly known as a tax health check. A typical tax health check involves going through the tax ledgers of a taxpayer, establishing the obligations registered for and the tax compliance under those obligations. This extends further to assessing the adequacy of the system of recording and accounting for transactions. At this stage, it’s also important to assess the capacity of the tax handlers within the organization.
Risk analysis – A tool by the name of risk matrix is commonly used to measure the risk value.
| Item/Transaction/Activity | Impact | Likelihood | ||
| Low(1) | Medium(2) | High (3) | ||
| High (3) | = 3 | = 9 | ||
| Medium (2) | = 4 | |||
| Low (1) | = 1 | = 3 | ||
Risk value is the product of impact and likelihood. The risk assessor assigns values for impact and likelihood, for simplicity sake, values 1,2,3 are used in this illustration but a more comprehensive matrix may be created with more values. The red zone in the matrix is a danger zone in terms of risk where the likelihood of an occurrence is high and if it occurs the impact would be severe.
Risk evaluation- This involves considering the risk level from risk analysis and determining the right treatment. The actions to take are depended on the risk level.
| Risk Level | Description | Action |
|
Low
|
|
Stick to procedures keep it low |
| Medium |
|
Keep the transactions in watch
Alert senior finance officers Engage consultants Read widely |
| High |
|
Report to the senior management e.g CFO, risk committee
Consult with experts Obtain a private ruling over the matter from the revenue authority |
Risk treatment – There are four options available in standard risk management practice.
- Accepting or tolerating the risk which is an option where the risk is very low and the amount involved is little
- Avoiding risk which in tax may entail avoiding some transactions because of their tax implication. for instance, in designing remuneration policy some petty benefits that require to be accounted for on monthly basis can be withdrawn.
- Risk mitigation- These are the measures taken to reduce the adverse impacts of an imminent event. it like an umbrella, it does not stop the rains but it helps. In taxation, mitigation may take the form of negotiation with the revenue authority for a relaxed payment plan. In case of a tax dispute, the alternative dispute resolution mechanism comes in handy in eliminating the litigation and also in warding off reputational risk.
- Transferring risk- The available option in risk transfer is securing a private ruling which binds the Revenue authority
Conclusion
As the discipline of risk management continues to evolve and getting more pronounced in a corporate setup, it is important to appreciate the dynamism of tax practice. Tax is not a certain bill issued on a given date for payment, it is a complex affair involving significant amounts of cash flows and the risk exposure is high. Ownership of tax risk cuts across all levels of the organization and thus an integral part of the corporate risk management strategy.