Release date: February 15, 2011
Guest: John Gotts
Running time: 10:44 minutes
Organizations face a wide variety of tax risks. PwC Tax partner John Gotts provides the background, noting that early involvement of the tax department in business decisions increases the opportunity to mitigate risk. Tax risk management has become a topic of increasing interest, with the potential for long-term paybacks to those who implement appropriate programs and processes.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Gerry Lewandowski: Here with us today is John Gotts, a partner with PwC’s Tax Management and Accounting Services group based in Toronto and the National leader of PwC Canada’s Tax Function Effectiveness practice. John has been with PwC for a number of years and has worked with many Canadian businesses in delivering various solutions for improving the governance and administration of the tax function. John is with us today to discuss the evolving world of tax risk.
John, to those of us who are not tax experts, the term tax risk is not only a tongue twister, it’s also a bit mysterious. Can you start us off with a simple explanation?
John: Sure. Many of us are familiar with Benjamin Franklin’s comment:
"In this world, nothing can be said to be certain except death and taxes."
Actually, even with the best advice and intentions, many aspects of tax are not certain. It is these uncertainties that give rise to tax risk. For example, even a well-thought-out tax plan can get upset by surprising results in a court case.
Tax risk can derive from every type of tax and in each jurisdiction in which an organization operates. When you consider all the types of taxes – not just income tax – and then when you add more and more jurisdictions where companies do business – not just Canadian provinces and U.S. states, but countries all around the globe, the risks become numerous and more complex.
Gerry: So, tax risk can arise from income and a few other taxes. Is that really a big deal?
John: Well, I wouldn’t say a few, Gerry. PwC’s Total Tax Contribution report for 2009 identified almost 300 potential sources of tax in Canada, even though we often think mainly of income tax. Add to that the potential sources of tax in one or more foreign countries, and you have plenty of opportunities for tax risk. Granted, many of these may not be significant but it’s important to identify them and assign responsibility and accountability to address them. Although these taxing points can result in tax risk, many of these taxes are administered by individuals outside of the tax function. Identifying all of the taxes for a particular company is a critical step. And yes, tax is potentially a big deal.
Gerry: Can you explain how companies can minimize tax risk?
John: Actually, no. Minimizing risk is rarely the right approach. The idea is to optimize risk.
Gerry: I’m not certain that I follow you. Risk can be good?
John: Absolutely! Businesses make profit by taking risk, and each business has its own strategy towards managing risk. Like other business risks, there’s a trade off between tax risk and value created. Businesses must find the appropriate balance between the risk taken and the value achieved. This is optimal when tax risk is aligned with the broader corporate strategy. For instance, the instability of corporate tax law in a developing country may cause much uncertainty and result in increased tax risk. However, the potential value to the business of expanding into that jurisdiction may far outweigh the risk. Without a clear understanding of both perspectives, it may not be possible to reach the optimal solution.
Gerry: Interesting. Can you provide more detail about specific tax risks?
John: Sure. Tax audits about as concrete as it gets. In effect, this often is where rubber meets the road for tax risk. Tax authorities conduct audit procedures and challenge the tax positions taken by a business.
The Canada Revenue Agency recently announced that it’s changing the way they select files for audit. The CRA has stated that they will use a risk assessment approach and will be focusing on the companies they consider most likely to fail to comply. We encourage Canadian businesses to consider what their risk profile may look like. Similar approaches have been announced, or are being used in other countries and other countries are talking to each other and sharing information. Many businesses and tax advisors have noted that tax authorities have become more aggressive and globalization has increased the focus on protecting the domestic tax base.
For businesses, the key risk is being audited and getting an unexpected bad result.
Would it help if I provide some broad headings around types of tax risk?
Gerry: Please do.
John: We’ll generally classify tax risks under four headings:
First, strategic and transaction risks. These relate to the application of tax rules to business transactions. As you’d expect, routine transactions normally generate much less risk than one-offs, like buying or selling a business.
The key with strategic and transactional risks is to identify and optimize them – taking into account the potential business outcome. Identified risks can be managed to align with the organization’s risk profile. For example, controls can be put in place to ensure that tax implications are considered for all significant transactions. Some organizations may choose to seek a tax ruling to provide greater certainty before completing a significant transaction.
Second, we have operational risks. This is the everyday situation of applying rules to the normal ongoing business. Different types of operation will result in different levels of tax risk. For instance, increasing globalization leads to higher operational risk as businesses work to navigate tax rules in foreign jurisdictions. Most businesses are well aware, for example, that tax authorities like to scrutinize cross-border transactions with a corporate group.
Gerry: If I have this right, the first two categories cover non-routine and routine business transactions. What’s left for the other two risk categories?
John: There’s plenty left! We still have compliance risk and financial accounting risk.
Compliance risk relates specifically to things like preparing returns – of all types and in all relevant jurisdictions. Compliance risk also covers the process of supporting filing positions with tax authorities.
The fourth category is financial accounting risk and is the category of risk that I believe has evolved the most in the past decade. Accounting standards around the world have or are changing and more attention is being paid to tax accounts. This environment has left many tax directors feeling pressure to avoid risk, which may result in business opportunities being missed.
Gerry: John, from what you have said I understand that there are potentially numerous taxes that have risks associated them, and that the types of risks that can arise fit more or less into four categories. You also said that minimizing tax risk isn’t usually the right approach…
John: That’s right – optimizing tax risk is what matters. Aligning tax risk with the overall corporate strategy.
Gerry: Right. But with all this complexity, how can corporations deal with the risks? It seems a bit overwhelming.
John: Well, that’s true. It isn’t easy. The key is to develop a systematic approach so that tax risks get identified, discussed, quantified and assessed. What works best will vary widely from one organization to another, and may change as a company changes. What is consistent is that the early identification of tax risks greatly improves your opportunity to manage them effectively. I mentioned before an example of a business expansion into a new jurisdiction with a developing tax system. The tax department could help to identify the risks and structure the expansion to mitigate, if they are involved early in the process. The opportunity to manage risk decreases, however, if the tax department learns of the expansion many months, or years, after the operations are underway. While this may appear to be fundamental, I have spoken with many tax directors who have learned important facts far too late.
At PwC, we have a range of tools and expertise that we can use to help you better understand, quantify and manage tax risk in a way that is appropriate for your business.
One example is our Tax Controversy and Dispute Resolution network that helps our clients gain a better understanding of their company’s risks and exposures as well as, if necessary, manage their tax disputes and audits. Our team in Canada includes ex CRA officials.
Gerry: OK, so there is no easy answer, but where might be a good place to start?
John: Well, PwC has developed a proprietary tool, the “Tax Risk Profiler” which provides a tax risk assessment which is a preventative measure to create awareness of the tax risks a company is assuming and to assist in avoiding a tax dispute.
The tool is user-friendly and cost-effective. For a small fixed fee, we meet with the company for about 30 minutes to go through a questionnaire.
We take the information and compile a report, which provides a risk rating under categories discussed above. We also highlight the key activities that drive the assessed level of risk. The assessment allows management to understand some of the key drivers of tax risk, and can be used to develop a systematic approach to understanding the tax risk assumed by an organization - and what, if any, adjustments need to be made to realign tax risk to correspond to corporate strategy.
Gerry: Thank you, John.
We have been speaking with John Gotts. For additional information on Tax Risk Management, please visit our PwC Tax Management and Accounting Services webpage at www.pwc.com/ca/tmas.
Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.