The key factors that influence and shape the current tax environment are transparency, tax compliance enforcement and corporate governance.

Tax compliance and enforcement
In the 2004 Winter Edition of Tax Talk, we discussed various worldwide initiatives that have been introduced to promote transparency and combat tax leakage.

These initiatives have intensified over the last 12 months. A very good example is Transfer Pricing. Transfer pricing laws generally prescribe that international related party transactions be undertaken on a commercially justifiable “arm’s length” basis in order not to shift profits from one jurisdiction to another. Within the Asia Pacific region a number of countries, including China, India, Malaysia, Australia and Japan have either introduced or enhanced the legislation governing transfer pricing, increased the number of audits and investigations into transfer pricing, or clarified aspects of their transfer pricing legislation, thereby indicating that transfer pricing is a target area.

Corporate governance
The US Sarbanes-Oxley Act of 2002 has had a profound impact on corporate governance. The Act requires the management of a company to report on the effectiveness of the company’s internal control over financial reporting. This has led to similar legislation being introduced in other countries around the world.

In 2004 public companies and their auditors in the US identified accounting for taxes as one of the primary areas of weakness in internal controls over financial reporting.

Managing risk
Every company should review their own internal control systems for taxation. This would include evaluating compliance, considering how key estimates are developed and recorded, reviewing how tax positions and planning strategies are developed, evaluated and approved, and evaluating how key conclusions and decisions are documented.

Tax compliance
Companies should ensure that their tax compliance function has adequate internal controls at an operational and group level. In the past, all too often management in each country has been left to deal with compliance, often with little or no resources. Even if this function is outsourced to a professional firm at an operational level, there is still a need for internal controls locally, and for someone to have overall responsibility at a group level.

One possible approach that has been successful in helping deal with the compliance process on a multinational level has been to use a professional firm who controls the compliance process on a multinational level. This enables management at a group level to monitor and review the compliance process on a multinational basis.

In addition to helping in controlling the compliance function, this can also help in identifying planning opportunities and save on professional fees.

Transfer pricing
Transfer Pricing has consistently been a major concern for CFOs around the world. If you ever talk to someone who has been through the pain of a transfer pricing audit or investigation you will understand why.

Companies should consider their transfer pricing practices and policies as part of any risk review analysis given that adjustments, when coupled with penalties and interest, can be material.

An alternative approach and one which has been successfully implemented is to look more strategically at the business from a supply chain management perspective. As well as leading to savings from a business perspective, this approach can also lead to the identification of tax planning opportunities.

Planning
Many corporate structures and tax planning strategies have evolved over time, with little or no regard for the current tax environment, with the result that:

What is needed is a complete review of the structure and current planning strategies in order to identify areas of weakness. Of course, this can also help identify opportunities.

Internal controls
For the future, companies should be implementing and documenting internal controls over the tax function, including:

Conclusion
Tax risks are inherent; what is essential is to understand and manage those risks. The starting point is to take a step back and assess your current practices and procedures and strategically look at your tax arrangements in the context of the business as a whole.

gary.james@gthk.com.hk