How to manage your tax risk

Every business owner should get their head around the very real benefits of tax risk management. By TERRY HAYES

By Terry Hayes

Every business owner should get their head around the very real benefits of tax risk management.

Tax risk management is often thought of and discussed in the context of large businesses that have a board of directors. Company boards need to manage all sorts of risks, and tax is just one of them, but in a very real sense tax risk management is just as relevant to small to medium sized businesses – it’s just on a smaller scale.

So what is tax risk management? In basic terms, it’s all about making sure a business is complying with the tax laws, meeting its tax obligations, and making sure it is aware of, and comfortable with, the tax positions it takes. For a small business, the CEO, the board and the managing director are often all roles that reside with the owner. So it’s the owner that must manage the tax risk of the business.

This year, the tax office will be expanding its coverage of income tax issues affecting SMEs including the sale of assets and investments, foreign source income, and employer obligations (including superannuation). Also this year and in 2010 the tax office will, among other things:

• Extend and enhance its analytics and risk profiling techniques to hone differentiation of taxpayers.
• Continue its debt collection focus.

These are just a few of the tax risks that must be managed by an SME.

Also, the taxman’s use of data-matching, and industry benchmarks for things like sales, cost of sales and various expenses, reveal other areas where an SME must be vigilant – all part of managing the tax risk.

The Tax Commissioner Michael D’Ascenzo says the tax office’s compliance model is based on the twin beliefs that most well-informed taxpayers will respond positively to a system they believe is both fair and transparent, and act in a self-regulatory manner that enables them “to get on with their lives and businesses”. Basically, D’Ascenzo says the model is predicated “not only on the co-operation of taxpayers but also the belief that the great bulk of taxpayers comply with tax laws”.

While many SMEs may debate the “fairness” of the tax system, the operation of self-regulation in Australia’s self-assessment tax environment provides the framework where most SMEs do comply with the tax laws. And managing their tax risks is an important ingredient of that compliance.

In a recent speech, the Tax Commissioner commented that good tax risk management requires a systematic and structured approach. That is true for all businesses. For the taxman’s part, he says the tax office undertakes risk assessment of events and their causes, and then considers the effectiveness of its controls and mitigation strategies.

In a large business context, the Commissioner says better management of risks can lead to more certainty around the achievement of business objectives, which in turn can increase returns for the organisation’s stakeholders. The same is true for SMEs. An unanticipated tax risk can adversely affect the strategic goals and objectives of the business, so better planning and management of that risk is essential.

As the tax office is not resourced to chase every tax dollar, it adopts a more holistic approach that seeks to address the causes for non-compliance with “appropriate” responses. Thus, it’s use of industry profiling, for example, to flag non-compliance.

The tax office’s compliance model is described as a regulatory pyramid that seeks to encourage as many taxpayers as possible to the base of the pyramid where there is self-regulation and high levels of voluntary compliance.

The Commissioner says the tax office concentrates on helping taxpayers operate at the base of the compliance model by identifying risks and developing appropriately tailored responses. “What this means for taxpayers who try to do the right thing is that their compliance costs are minimised,” he says.

The Commissioner related a discussion he had last year on tax risk management with the chairman of a large overseas based multinational. “His initial thought was that tax was a ‘black box’ and better delegated to the company’s tax area, rather than a consideration for the board,” D’Ascenzo says.

“He was then asked why the difference for matters on other specialised areas such as IT, industrial processes, labour management, and environmental issues, which are escalated to board or audit committee level when they are material. The chairman replied: ‘We drill where the geologist tells us to – we don’t second guess the experts.’ ‘What if then there was a chance that drilling in that spot could trigger an earthquake that could affect a nearby town – would you want to know that?’ he was asked. ‘Of course,’ was the immediate reply. After a little thought he said: ‘I’ll have to rethink my views on tax!'”

While SMEs don’t have the in-house expert resources of large companies, an important message for them is not to leave any and all tax matters solely to their accountants or advisers. The taxpayer (for example, the SME owner) has the ultimate responsibility for his or her tax affairs and they must be aware of the tax issues their business faces and how they are being dealt with. This doesn’t necessarily mean in-depth technical knowledge, but at least a true appreciation of their tax situation.

Managing tax risks (or any other risks like IT or employment relations) is all about the efficient running of the business and the adoption of good governance practices. Sounds like common sense, but common sense is not always common.

Read more on data matching and industry benchmarks

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.