Tax risk management is fast becoming an essential part of the corporate governance framework for CFOs, and while most CFOs are familiar with the core principles of a robust corporate governance framework, I still find that their challenge is in identifying and assessing the tax risk in their organisations.
This has become even more critical since the Australian Taxation Office (ATO) recently stated that it will “take a particularly close interest in your risk management and governance frameworks to mitigate tax compliance risks”.
How then do CFOs avoid the disruptive consequences of the ATO’s attention?
First, it pays to know where your business is placed in the ATO’s risk differentiation framework (see diagram below). You’ll know because the ATO will tell you if you are a high risk, or you’ll discover it from any regular interaction with them. Knowing where you’re categorised and how to move to a lower risk category is key to managing your tax risk.
Source: Australian Tax Office
More broadly, every year the ATO publishes a compliance plan that highlights the areas they are focusing on within each taxpayer category. Make sure you know the areas that are relevant for your business.
In my experience, tax issues are less likely to arise in regular day-to-day trading activities and much more likely to arise in one-off, non-“business as usual” transactions. Corporate transactions, international expansion, financing, losses and related party transactions are all examples of where a heightened tax risk can exist.
Even if a transaction has a commercial purpose and meets the various tax technical requirements, there may still be a risk of the general Part IVA anti-tax avoidance provision applying. Knowing the “red flags” to look for – such as a step in a transaction that is only explainable by its tax outcomes – is vital. Where a commercial outcome is only achievable on an after-tax basis is another. This is where good engagement with your internal or external tax advisor can pay real dividends.
How you instruct your advisor on what matters has a direct bearing on the value of their advice in the tax risk management process. On technical issues, the ATO expects that written advice be obtained. On non-technical issues (e.g. anti-avoidance) it is often better to engage the tax advisor in the overall process rather than getting a letter of advice. Position papers, private rulings and other options exist for managing tax risk.
A key role for the CFO is to bring perspective to the tax issue. For example, will the solution to the tax issue have broader commercial implications? If a riskier position is being taken, could this have a negative impact on brand or reputation? A neat test is this: if the whole arrangement ended up on the front of tomorrow’s paper, would you be comfortable? If not, it might be worth reconsidering the strategy.
A well-prepared income tax return can significantly reduce your tax risk. Your annual income tax return is your chance to tell the ATO your story, summarising your business’ financial life over the previous 12 months. But will it be a work of fiction or fact?
The ATO will want to hear a credible story. Is your story well considered and consistent? Or is your story riddled with errors? There are a whole range of checks and tests that the ATO will undertake based on your income tax return and these flow directly into your risk categorisation.
Even with the best of intentions you might face an ATO audit, which makes planning for this worst-case scenario good business practice.
Manage the disruptive impact of tax audits by having a clear set of protocols for all ATO engagement. ATO audits and reviews are not random and the ATO usually undertakes significant preparatory investigation before contacting you. The audits and reviews also tend to be undertaken in stages. Early constructive and co-operative engagement with the ATO can often limit the extent of an audit or review.
Done properly, tax risk management can mean that tax stays in the background and your focus can remain on the business. Ignored, tax issues can become all consuming. And contrary to popular opinion, it doesn’t come at the cost of higher taxes – in fact, many businesses find that a more proactive approach to tax risk identifies greater tax planning opportunities.