There have been three fundamental, evolutionary changes in the corporate tax function over the past 20 years with respect to its mission, its alignment with corporate strategy, and its influence on organizational behavior and resource allocation.The first, in the 1980s, focused on using technology applications to improve the efficiency and effectiveness of tax preparation, with cost reduction acting as the driver for improving business processes. The second, in the 1990s, involved value creation and developing holistic approaches to sustain tax minimization, which proved that the corporate tax function could positively affect the bottom line through effective tax planning.
Now, in the post-Sarbanes-Oxley era, the role of the tax department has evolved to managing enterprise risk through improved internal controls, business processes and corporate governance. Consequently, corporate tax departments, and their leaders, have had to recreate themselves again and adapt to this increased regulatory environment.
Given all of these dynamic shifts and changes over the past two decades, top-level executives must ask themselves a fundamental question about their corporate tax departments: "What is our function?"
Is it compliance, planning, risk management, or all of these? Furthermore, is a company's tax leader a technician, a business partner, a risk manager, or all of these?
A department report card
Tax issues were involved in more than 24 percent of the material weaknesses noted among Securities and Exchange Commission-reporting companies that had revenue in excess of $500 million and that reported a material weakness in their SEC filing for 2004, the most recent data available at press time.
Of those, close to 65 percent of the tax material weaknesses were related to general accounting for income taxes, the propriety of deferred income tax balances, and the appropriateness of valuation allowances with respect to deferred tax assets and tax attributes.
The tax department report card for 2004 provides some insight as to where vice presidents and directors of tax are spending their time and deploying internal and external resources to lead and manage the enhanced requirements concerning financial statement transparency and disclosure. It seems that vice presidents/directors of tax, and the tax functions they lead, are focusing on managing risk and understanding what that means in both the context of the function itself and the enterprise as a whole.
Risk management was not absent in the pre-SOX era, but clearly the level of public scrutiny and the heightened interest of corporate boards and audit committees have elevated the need for more vibrant risk management at the corporate tax department level. More entities are now curious about the operations and results of corporate tax departments, rather than only being interested in this aspect of the business when something goes wrong.
The expanding roles and responsibilities that corporate tax departments are being asked to manage are another dynamic that has introduced an element of increased awareness around risk management. Certain business, tax and financial process streams that traditionally had been outside the purview of corporate tax are now finding their way into the function.
For example, many companies formerly relied upon accounting professionals in the corporate controller's group to prepare and review the tax provision charge - monthly, quarterly and year-end amounts - as well as related financial statement disclosures. Tax departments often served as a data point to gather and provide information to the controller's group. Today, however, companies recognize that tax expense represents one of the largest expense categories on the income statement, and one that inherently is embedded with risk.
Consequently, more companies have placed the overall tax provision process squarely on the shoulders of the corporate tax function to ensure that it gets the proper treatment for reporting purposes. The added benefit of "connecting" the tax provision process to the corporate tax function is that there is a direct correlation to the tax department's responsibility for embracing fundamentally sound corporate tax planning and the impact it has on the overall effective tax rate.
Payroll taxes, indirect taxes such as value-added tax, sales and use, real, and personal property taxes, and other transactional taxes are examples of business and tax process streams that are undergoing a greater "connectivity" to the corporate tax department. In the past, corporate tax may have served as a liaison to these above-the-line, non-income-tax areas. There now appears to be a growing interest in having the tax function involved in a more meaningful oversight role.
Because the word tax is associated with these underlying activities, there is a renewed debate as to whether or not these tax process streams should reside within or outside the purview of the corporate tax function. Again, risk management is the centerpiece of this healthy and important dialogue.
More demands, few resources
Competitive demands ask everyone to do more with less. Today's corporate tax environment is no exception. The increased regulatory demands, accompanied by added responsibilities, however, are placing a strain on existing tax resources. Because of some belt tightening, many vice presidents/directors of tax have not been able to increase their headcount to address these dynamics.
It is sadly ironic that cost containment and cost reduction may potentially lead to the very thing that tax leaders are now being asked to control and manage: increased corporate tax risk. To avoid this Catch-22, companies need to be mindful of existing tax workloads and the skill sets of their corporate tax professionals to avoid potential breakdowns in process or internal controls.
Corporate leaders may find, when analyzed in the context of potential enterprise risk, that an increase in headcount may be a small cost to pay compared with experiencing a deficiency in internal controls that may result in a material weakness.
Many companies are taking stock of their existing talent pool to better understand if they have the right resources in the right places to address all of their new tax needs: compliance, planning and risk management. The expanded roles and responsibilities, increased tax internal controls, and heightened tax risk management are placing a premium on professionals who may not have historically resided in the corporate tax function.
For example, a new role that has recently emerged in some corporate tax functions is a dedicated senior professional who possesses deep skills in accounting for income taxes and maintains a controls-oriented background. This individual reports directly to the vice president/director of tax and is responsible for the ongoing computation of the global tax provision. Additional responsibilities might include financial statement disclosure requirements, financial statement tax implications of mergers and acquisition activity, and coordinating and scrubbing global deferred tax balances.
As more transparency in tax reporting is required by regulatory authorities, this kind of internal resource could become more commonplace. But regardless of the role, title or responsibilities assumed, the message is clear: Corporate tax departments and their leaders are trying to find ways to develop, train or introduce new skill sets into the corporate tax function to better manage tax risk.
Some organizations are also re-evaluating the overall organization of the tax department, and weighing the benefits and challenges of a traditional vertical organizational model versus a more cross-functional horizontal model. Either model can accomplish the goals and objectives of senior management and the tax function. The choice will depend upon a company's particular facts and circumstances, its underlying corporate culture, and its overall business organization (centralized or decentralized). (To know when to apply each model, see the box above.)
Becoming a business partner
Since the enactment of Sarbanes-Oxley and the implementation of its Section 404, corporate tax leaders have found themselves front and center at audit committee meetings and at the table with strategic planners and business operators. This increased exposure has elevated the profile of the corporate tax executive, and as a result placed new demands on tax leadership.
As top-level executives increasingly view the corporate tax function as strategic to the business, vice presidents/directors of tax are being challenged to become business partners within their companies. As a result, the corporate tax leader will find a growing need to collaborate with other finance functions, such as treasury or the controller's group, and business operations.
One positive outcome of this interaction will be a better understanding of the underlying business strategy, which could result in new tax planning opportunities. This collaboration can also help the tax executive align the company's tax strategy and risk profile with key business imperatives.
At the same time, other members of the company's finance team will be asked to partner with the corporate tax executive. For example, when it comes to managing risk that is associated with establishing tax reserves in connection with uncertain tax positions, some companies have created a tax reserve committee that is composed of the vice president/director of tax, chief financial officer, vice president/controller and a representative from the company's legal department.
This committee periodically reviews the adequacy of the company's tax reserves (federal, state and international) and assesses the company's ongoing requirements based upon recent developments in case law, administrative pronouncements and Internal Revenue Service exams. This holistic approach to evaluating tax reserve requirements demonstrates yet another way that companies are embracing the need to manage tax risk.
So, what's the new function?
Now that we have reviewed some of the tax department's new responsibilities, we can address the earlier question, "What is its current function?" Is it compliance, planning, risk management - or all of these?
The answer, clearly, is that it is all of these. The tax function and its leader need to address the company's recurring tax compliance needs, while also implementing sound fundamental tax planning. These two pillars serve as the foundation for today's tax department.
Based upon the current environment and the regulatory and marketplace dynamics described above, risk management has become a third pillar for corporate tax departments to build themselves around. Also, the role of the vice president/director of tax has changed to where technical competencies are viewed as table stakes.
The message from the corner office is that greater emphasis is being placed on the tax leader's ability to become a business partner and risk manager. This new reality will be challenging, but it also will be replete with opportunity.
Vertical or horizontal?
A vertical model can be effective when:
* Vice president/director of tax is remote or changing
* Different location
* Frequent turnover
* Corporate structure is complex
* Tax issues
* Tax calculations
* Frequent large-scale, organizational change
* Mergers and acquisitions
* Business segments
* Places of doing business
* Key personnel are established and change-resistant
* Single point of knowledge
* Open audits
* Efficient, coordinated, cooperative, communicative
A horizontal model can be effective when:
* Vice president/director of tax leads by example
* Positions tax department as part of finance team
* Combined finance meetings
* Encourages interdepartmental cross-training
* Focuses on finance process/technology integration
* Director/manager layer embraces vision
* Sees integrated calendar
* Focuses on integrating processes and technology
* Works as team to assign and manage resources
* Staff layer embraces vision
* Welcomes broader technical role
* Sees opportunity for management experience without promotion
* Enthusiastic team players
Dmitri D. Shiry, CPA, is a partner in the Pittsburgh office of Deloitte & Touche USA LLP. Reach him at firstname.lastname@example.org. Reprinted with permission from the Pennsylvania CPA Journal.
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