Triggering The Tax Advantage: Tax Tactics For The Global Financial Services Industry - Part Two

To read Part One of this article please click here

REGULATORY COMPLIANCE

How successful tax management and implementation of tax

technology can stop deficiencies from sabotaging your

Sarbanes-Oxley compliance, even with reduced tax

resources.

Auditors attribute over 30% of all reported material

control weaknesses to issues with tax accounting and year-end

processes.

The Benefits Of Increased Regulation

It has been over six years since President George W. Bush signed

the Sarbanes-Oxley Act, but only recently have organisations had

the opportunity to step back and review both the costs and benefits

of compliance. Despite widespread investment, the evidence suggests

that companies continue to find it difficult to get their books

right, with 40% of reported tax material weaknesses in the first

quarter of 2008 being by repeat offenders.

Auditors are attributing over 30% of all reported material

control weaknesses to tax, and this has unsurprisingly led to a

greater emphasis on company accountability and concerns over

potential SEC investigations. In response to this, CFOs and tax

directors are having to react to increased stakeholder scrutiny of

their tax numbers in the financial statements, as well as ensuring

greater assurance over their internal processes and controls.

Many organisations, however, are reporting the benefits of this

investment. Companies that have responded positively to the

regulatory changes are realising the benefits of their investment.

In the words of one of our clients, 'the visibility and

communication of tax has increased across the wider finance

community as a result of formalising the controls and processes

over financial reporting and tax management during adoption of

section 404.' It is our view that these organisations will be

best placed to ensure continued regulatory compliance and effective

tax management even where their tax resources are reduced as a

consequence of the economic down-turn.

What Is The Matter With tax?

Failings in tax continue to relate to problems over accounting

for tax – especially in relation to deferred tax. The

filings that reported tax material weaknesses recorded deficiencies

that included '...failing to record deferred tax balances

according to FAS109 or FAS 52,' 'inefficient review of

income tax provision calculations,' 'failures in adopting

SFAS 123R' and 'lack of expertise to determine proper tax

basis'. Other areas of weakness included those over-significant

judgements and estimates where there was 'inadequate

documentation and management review of tax exposure items'.

Process-related concerns included failures within the tax

consolidation process, with 'inadequate processes of oversight

and review,' 'inefficient review of income tax provision

calculations and related deferred income taxes' and importantly

'ineffective or inadequate IT systems'. In general, these

failures lacked policies, procedures, and resources needed to

review complex, nonroutine or nonsystematic transactions.

Some financial services companies are considering the impact of

these deficiencies as being a potential blessing in disguise and a

real opportunity to identify and implement best practices in tax

management and accounting, not just to comply with Sarbanes-Oxley,

but to benefit from enhanced operating efficiencies and precision

in tax management. This 'value-added' approach is best

exploited with an integrated solution that includes improvement

initiatives in three fundamental areas, namely, people, technology,

and processes.

Let's look at these in turn.

People

People charged with calculating the tax provision should receive

adequate training, especially in FAS 109 (Accounting for Income

Taxes under U.S. GAAP) and FIN48 (Accounting for Uncertainty in

Income Taxes). But which people in each jurisdiction are

responsible? Sometimes, the answer is not so obvious. In fact, the

'right' people can be a controller's accountants,

in-house tax personnel, or even external consultants.

The training can be delivered in a variety of ways –

live and local (which means traveling to non-U.S. jurisdictions or

bringing those people to the U.S.), Web-based, self-study, or some

combination. But no matter how it is delivered, training will be

more effective if local country preparers and reviewers are

identified early in the process and contribute to choosing new

technology or designing new processes as the institution undergoes

a larger tax 'transformation'.

Technology: Standardising For Risk Management

Having been through Sarbanes-Oxley Section 404 cycles, many

corporate tax departments are now seeing that their tax provision

technology is antiquated, that linked spreadsheets do not contain

enough controls, and that their current system is not flexible

enough to allow non-U.S. preparers to compute properly the tax

provision for their given jurisdiction. These problems lead to

others, such as the creation of several tax provision calculation

files, each customised to a specific jurisdiction. The subsequent

lack of standardisation forces the tax department to struggle

through the year-end consolidation, manually standardising items

upon receipt of the customised jurisdiction-by-jurisdiction

files.

Relatively new 'shrink-wrapped' tax provision software

and custom-designed spreadsheet/database solutions are addressing

these problems. For example, they can improve controls by including

password protection, certification, and sign-off protocols. Some

companies are choosing to enhance their homegrown technology, for

example, by standardising temporary and permanent difference

categories (including local tax calculation columns to handle all

tax jurisdictions) and building out 'return to' provision

worksheets or database tools.

This standardisation allows for an efficient and controlled

worldwide tax provision consolidation, while keeping the technology

flexible enough to handle the most difficult tax jurisdiction

computation anomalies.

Tax Balance Sheet Approach

The need for an improvement in the quality and accuracy of data

used in the determination of income tax provision calculations and

associated tax balance sheet amounts has been a key lesson learned

from reported tax deficiencies. An example of this is that many

organisations have been asked by their auditors to undertake a

thorough review of the differences between the income tax basis and

the financial reporting basis of asset and liability opening

balances. Such a validation of brought-forward balances has given

greater assurance over a company's true opening position.

Similarly, the adoption of a tax-basis balance sheet approach has

enabled organisations to better track temporary differences and

thereby provide more comfort over the completeness and accuracy of

their deferred tax balances. This in turn has saved time and

resource at year-end in substantiating figures, as well as

providing a more robust audit trail.

Process: Getting Rid Of Bad Habits

There is also much to be done in resolving a variety of

process-driven problems. Consider the 'bad habit' of

misaligning currency conversion methodologies between the tax

provision calculation and the company's financial systems.

Typically, tax provision calculations are performed quarterly or

annually in functional currency. The functional currency amounts

are often translated to U.S. dollars using the average rate for the

period in question. By contrast, tax expense may be recorded in a

company's general ledger in functional currency on a monthly

basis and translated to U.S. dollars using the average rate for the

month. These two different methodologies, under certain

circumstances, can produce materially different results. But

without transformed processes and technology, the differences can

go undetected.

Another example is the use of blended or effective tax rates to

calculate current or deferred tax expense. Most homegrown systems

include space for only one current and deferred tax rate.

This single tax rate often is applied to both the current

taxable income (to compute the current tax provision) and to gross

temporary differences (to arrive at the deferred provision). In

this case, the limitations in the technology drive a poor process.

When there are graduated rates or...