Tax executives, tax administrators and tax policy-makers have perhaps never been in such agreement: converging trends have created the riskiest environment for tax controversy the world has experienced in years.
Ernst and Young's 2011–12 Tax risk and controversy survey examines how greater uncertainty is posing new financial and reputational risks for leaders of global businesses. Risks are imminent and growing in volume and complexity. Now is the time to plan a course of action to manage them.
The world has changed dramatically in the space of just a few years:
- Globalization has brought opportunities in new markets, more complex supply chains and rapid growth in the importance of intangibles, royalties, service fees, intra-group financing and intellectual property.
- The effect of the global financial crisis on tax policy has been startling, overshadowing longer-term tax trends and the convergence of accounting standards.
Companies are doing all they can to capitalize on change, including:
- Expanding market and customer reach
- Increasing their search for efficiencies, both in effective tax rate and business operations
- Altering their business models with restructuring, finance transformation, outsourcing and centralization
And tax authorities have become significantly more assertive in examining cross-border activities. The volume of tax information exchange agreements has increased by more than 1,000%.
Tax administrators and legislators acknowledge that they are committed to enforcing existing tax law and creating new enforcement mechanisms:
- Demanding more disclosure from taxpayers
- Strengthening or creating economic substance doctrines
- Imposing criminal sanctions where they believe willful tax evasion has occurred
Tax administrations around the world become more aggressive
Tax executives tell us that the harder line taken by many tax authorities is causing significant stress. 75% reported that tax audits are becoming more aggressive.
Companies: Have you experienced an increase in the number or aggressiveness of tax audits in the last two years?
Because of these changes, 77% of respondents in our 541-company survey said managing tax risk and controversy will become even more important to them in the next two years, and this figure increases to 88% for large companies. The increasing focus on managing tax and controversy is mirrored in tax directors' future appetite for risk — 92% say they will either stay the same or become more risk averse in the next two years.
But chief financial officers have a different perception and tolerance. They are expanding within fast-growing emerging markets, the same places that 73% of tax directors tell us they face increased tax risk or uncertainty.
We think this difference of opinion warrants further investigation to be sure tax is given due attention in such a rapidly-changing environment.
A new era starts
The next five years will likely be every bit as volatile and evolutionary as the last half-decade.
78% of the world's largest companies say they are already experiencing greater risk or uncertainty around legislation, and this figure increases for those in emerging markets.
Tax policy-makers foresee even more change ahead as they seek to protect the tax base and raise revenue from an evolving mix of taxes. 69% of tax policy-makers surveyed expect to generate more revenue from indirect taxes in the future. These policy changes come as revenue agencies are equipped with legislation designed to increase levels of compliance and enforcement:
- Anti-avoidance statutes
- Disclosure requirements
- Demands for greater transparency
- Increased information reporting and withholding
The enforcement landscape echoes the changes foreseen by government officials; 97% of tax administrators say they expect to increase their focus on international structures and cross-border transactions in the next few years. And 81% of corporate tax executives expect more disclosure and transparency requirements in that same time frame, with 84% of policy-makers and 76% of tax administrators concurring.
Transfer pricing remains a leading source of controversy, and indirect taxes, the migration of intangible assets and permanent establishment issues are all becoming sources of intense focus. In some countries, respondents report that tax administrations increasingly seem to be taking positions that are overly aggressive or without merit, with no treaties or dispute resolution processes (other than litigation) available.
Forging a response: how leading companies are adapting
Companies told us that they have already started responding to the new era of risk and uncertainty; they are embedding tax risk management more prominently within their corporate governance approach, opening more lines of communication with their board and audit committee and tax policy-makers and tax administrators. 72% of companies say they are pursuing a more open and collaborative relationship with a tax administrator.
Tax risk management models that were effective just five years ago may no longer provide adequate protection for companies today or in the future. Our survey indicates that companies increasingly realize this and are starting to take a more global, strategic approach to managing tax risk and controversy.
As companies improve their responses to tax disputes, they reduce the threat of unexpected assessments and penalties, achieving greater certainty and flexibility in their ability to plan. They can reduce the overall threat of reputational risk from both consumers and the tax authorities.
New sources of risk and uncertainty…
Our survey provides insight into the key drivers of tax and controversy risk reported by respondents:
- Tax administrations around the world become more aggressive and focused
- We can now more clearly identify and categorize the tax enforcement impact of the financial crisis; the speed with which the world's tax administrations have joined forces is startling. The level of information being shared among them has grown exponentially. The enforcement focus on particular taxes and issues has become clear. And companies tell that tax audits — including joint audits — have become more frequent and aggressive.
- 75% of companies say they have experienced a rise in the volume or aggressiveness of tax audits.
- 97% of tax administrators reported that they will increase their focus on tax risk related to international structures and cross-border transactions in the coming three years.
- 57% of tax administrators identified transfer pricing as being their leading tax risk focus area in the next 12 months. Transfer pricing was also the leading risk focus area for companies.
- Indirect taxes are another key risk focus, with more companies identifying indirect tax compliance as their second leading tax issue.
- 94% of tax policy-makers predict some or significant growth in general anti-avoidance rules (GAAR) and other similar measures in the next three years.
- 65% of tax administrators believe the incidence of double taxation will stay the same or increase. Only 35% believe it will decrease.
- High pace of legislative change creates more risk and uncertainty
- Alongside the clear message that “tax enforcement is becoming more aggressive,” companies tell us that the pace, volume and complexity of tax policy, tax legislation and tax administration change is a source of more risk and more uncertainty than ever before.
- 75% of tax directors in the largest companies report heightened risk or uncertainty around tax legislation. This figure rises to 78% for BRIC-based companies and 83% for US-based companies.
- While 57% of CFOs report that they feel heightened risk or uncertainty around tax legislation.
- 81% of tax policy-makers see growth in GAAR and other anti-avoidance legislation in the next three years, while 94% see new legislation in the area of disclosure and transparency.
- 76% of tax administrators see increased disclosure and transparency requirements ahead.
- Emerging markets is cited as the source of greatest risk related to legislative change.
- Growing disclosure and transparency requirements: fuel for the fire
- Around the world, the increase in tax enforcement has been accompanied by a broad range of new requirements for business taxpayers to disclose more information to the taxing authorities. And in some regards, these requirements may fuel future controversy. The objective of such requirements is clear: they drive efficiencies in tax administration, enabling the enhancement of risk assessments and targeting activities.
- 78% of companies report that they have experienced an increase in disclosure and transparency requirements made upon their company in the last two years.
- 99% of company respondents believe disclosure and transparency requirements will either stay the same or increase in the coming two-year period.
- 76% of tax administrators expect to focus on enforcing these requirements in the next three years.
- 94% of tax policy-makers expect to see some or significant growth in the area of transparency and disclosure in the coming three years.
- Expansion in emerging markets is creating tax risk and uncertainty
- Emerging markets present the ultimate dichotomy for the tax director who needs to support and enable overall business strategy while facing the thought of “entering the unknown” — with all the risk it brings. Survey respondents tell us that they feel tax authorities in the emerging markets tend to be even more aggressive overall in their enforcement efforts.
- 73% of respondents feel that entering into or operating in emerging markets significantly increases their levels of tax and tax controversy risk. But that view was shared by only 50% of CFOs.
- 92% of China-based and 62% of Brazil-based companies confirm that they have experienced a rise in the volume or aggressiveness of tax audits in the last three years.
- 85% of India-based companies and 88% of China-based companies have experienced growth in disclosure and transparency requirements in the last two years.
- 78% of BRIC-headquartered companies reported greater risk or uncertainty around legislation, compared to 67% of all companies globally.
- A new breed of tax activism emerges
- Companies now face unprecedented scrutiny and reporting of their tax affairs by advocacy groups and the news media, often hurting brand reputation and — in the worst cases — shareholder value, even when such coverage is unwarranted or inaccurate.
- 57% of tax directors surveyed reported that the threat of a negative media article about their company was somewhat or a significant concern, with 40% reporting it was not a concern.
- 58% of tax directors from the largest companies (those with annual revenues in excess of US$5b) reported that the threat of negative media was somewhat of a concern or significant concern.
- A break in the clouds: “enhanced relationship” opportunities are spreading
- The uncertainties created by the increasingly-negative backdrop take their toll on governments also. As a result, many governments have less appetite for tax litigation because of costs, time and drain on resources. Instead, many (but not all) tax authorities are now looking for new ways to open up a channel for business taxpayers to interact with them, to resolve issues before they reach controversy and also to end disputes in ways that are quicker, less costly and more efficient in the long run.
- 75% of tax administrators reported that they are reinforcing the enhanced relationship and moving their organization further in that direction.
- 21% of tax administrators told us they do not believe that taxpayers or tax authorities can achieve the enhanced relationship over the next three years.
- 48% of tax administrators report they plan to actively seek opportunities to expand their pre- and post-filing dispute resolution toolset in the next three years, while 44% say they will encourage greater use of existing tools.
…tackled in 5 steps
We recommend that you execute a five-step, enterprise-wide approach to manage your organization's tax risk and controversy:
- Adopt a global approach to tax risk and controversy management
- Tax administrators tell us that they are increasingly taking a global view of companies. Viewing risk and potential controversy from a bilateral or multilateral perspective can help companies mitigate risk and prepare to engage tax administrations who say they are looking to increase their international focus.
- Evaluate global resources, processes and systems for tax risk management
- Companies should ensure that before (or when) a tax risk or tax controversy arises, they have the right framework of systems, processes and resources in place to identify, track, report and manage the issue to minimize any resulting financial and reputational damage.
- Address tax risk and controversy at a strategic level — and execute well
- Developing wide-ranging, global tax risk and controversy management strategies — and then executing them well — can reap significant benefits for a company beyond basic financial savings. A strategic approach to tax risk and controversy management isn't just about managing active controversies. It also helps companies anticipate potential controversy issues, avoid disputes before they occur and effectively mitigate the effect of any conflicts that do arise. This reduces financial, resource and reputational risks and provides opportunities to remediate and secure the enterprise against future reoccurrences.
- Make strong corporate governance in tax a priority — it is to tax administrators, and it makes good business sense
- With financial and reputational risks running higher than ever, it's no surprise that our survey respondents indicated that improving corporate governance in tax has been a key focus in the last three years - and will continue to be so.
- Stay connected with global legislative, regulatory and tax administration change
- Companies tell us that the pace, volume and complexity of tax policy, tax legislation and tax administration change have become a larger source of risk and uncertainty than ever before. At the same time, having the ability to identify, communicate and assess the effect of these changes can provide a business with many advantages. Compliance risks can be reduced. High-quality, accurate knowledge can support tax planning activities. And the general business planning agenda can be supported with knowledge of the tax policy environment into which you may be investing.
In the full survey report, we share more insights on how tax risk and uncertainty are unfolding, how we see these leaders forging their response and how we think these global trends may develop.
Talk, talk, talk about it
What business leaders should know about tax risk and controversy
People can't stop talking about how businesses pay taxes. Negative publicity about what your company pays can reach millions via social media in the blink of an eye. How are leading companies tackling this issue to reduce both financial and reputational risk? Find out in our report