World-Class Tax Capabilities
Imagine youre the CFO of a successful company who can communicate financial
information to the markets in a timely manner, certain of every number you present.
With particular confidence, you are able to articulate the tax impact on the
numbers despite the many acquisitions and disposals, as well as complex restructurings,
that your company has recently undertaken.
Imagine that within one day of the quarters close, the tax provision is completed and presented to the central finance function, and that the tax liability in each company is estimated with the same detail applied to the actual tax return. Also imagine that youre able to determine the favorable tax treatment parameters in certain jurisdictions in real time.
Finally, imagine that all this information is presented to key tax and finance stakeholders within the organization through an integrated tax portal providing a single version of the truth.
Thats the situation Accenture has observed in world-class organizations, where tax resources have been used to make the greatest impact on a companys overall value. No longer a separate activity, tax planning is fully integrated into the strategic planning process, giving CFOs one of their largest opportunities to drive bottom-line results.
With taxes representing 20 to 30 percent of a companys cash outflow, a restructured tax function can generate significant savings. Recognizing this opportunity, world-class companies are focusing highly knowledgeable tax resources on adding value to the company. A key step in this process is to integrate the tax planning process with the overall strategic planning process.
Tax functions have access to numerous tax planning ideas. These ideas range from long-term strategic tax planning to short-term, tactical decision-making. Many of these ideas are not new and are accessible from a range of tax resources. In considering the tax planning ideas, world-class tax functions adopt a consistent approach to assessing their potential. The tax professional must have the data and information to assess the idea, and the capabilities to develop the tax planning idea.
Capabilities include the design, implementation, monitoring, and finally defending the strategy. Most companies are great at design but typically falter at the implementation, never monitor effectively, and finally try to recover during the defending component.
Getting It Right
Compensation and incentives to management have been traditionally figured on the basis of pretax performance. Some companies have started to address this by measuring economic value added. Irrespective of the terminology adopted by the analysts, however, true shareholder value should be considered in the context of post-tax performance. The tax charge is a manageable component contributing to the overall value of the company.
The tax function can add true value to the company by long-term planning, such as devising strategies for moving capital across the global organization and generating the optimum post-tax return for the company.
Medium-term planning and forecasting is also key. The ability to predict statutory profit in subsidiaries must take into account the companys transfer pricing approach, the profit repatriation policy, the withholding tax regimes, the effects of double taxation relief and the taxation on repatriated dividends.
Managing the tax charge also requires monitoring the tax structures already in place to defend value already delivered by the tax function. Understanding the derivation of the local tax return, schedule of payments (the impacts on cash flow), and tax leaks through lack of data also help to build the short-term view.
Having the right tools and capabilities enables the tax function to integrate and streamline its planning activities and thus contribute to the overall financial position of the company.
Extending planning capabilities beyond the traditional accounting and central finance function into areas such as tax and treasury extends the value creation chain, while leveraging existing internal assets.
Tax Planning Approach
Successful tax planning strategies focus on minimizing taxation across a companys value chain, from:
- Tax-efficient profit generation — Generating the trading income (earn income in the jurisdictions with the lowest tax rate);
- Movement of pretax profit — Optimizing intercompany flows to obtain the maximum after-tax profits for the company;
- Use of capital to generate post-tax return — Eliminating double taxation caused by overlapping taxation principles in two or more jurisdictions;
- Restructuring opportunities — Structuring companies to defer tax affects earnings repatriation; fund overseas operations;
- Capital distribution to shareholders — Enhancing shareholder value (through dividends or capital distribution) and maintaining company value; and
- Mitigating tax risk — Ensuring that the companys tax structures are able to withstand the scrutiny of tax authorities.
The framework highlights the need to focus resources on every component of the tax planning process. Typically, the business delivers the numbers under tax-efficient profit generation; the other components are considered and often neglected, except in best-in-class companies (see Figure 1).
Figure 1: Typical Tax Planning Framework
The tax function has a crucial role in developing, maintaining, and defending the structures created through the tax planning process. It is important to understand the evolution of the tax function in the organizations value chain before considering the value creation opportunities.
Facing Challenges
Companies are still required to file tax returns. The tax compliance process can absorb the entire resources of the tax function and may involve business resources that supply data to support the filing process. Minimizing the compliance effort allows a value-added tax function to dedicate resources to strategic tax planning and effective business support.
The tax and treasury functions need access to data along legal entity reporting structures, yet businesses today transcend national (and therefore legal entity) boundaries. Local and consolidated accounting systems report on a management basis and are typically developed with minimal consideration for tax and regulatory reporting, yet legal entity reporting is the basis by which the tax charge is managed.
The ability to obtain tax-sensitive information at the account level and thus allow the tax function to prepare and defend tax returns is often limited by the lack of involvement of the tax function in the design of accounting systems. The benefits of a systems resource dedicated to addressing the tax agenda cannot be underestimated.
The tax function still spends a significant amount of time manually gathering and processing information, relying on the trusty spreadsheet to manipulate data.1 Because the average U.S. consolidated return has more than 100 entities, the effort required is excessive. While there may be improvements in the quality of the data, the ability to extract, manipulate, and interpret data in a streamlined process is still elusive for tax functions that do not have a technology agenda. For the companies that have been technology enabled, the focus is most often on supporting the compliance process. Companies that dedicate resources to the strategic planning process generally continue to use spreadsheets.
Traditionally, the tax function is seen as a cost center attributing to overhead costs, a necessary obligation for commerce, but not adding value. The resources within a tax function are typically highly qualified professionals relative to the average finance and accounting professional, but have spent most of their time in tax-compliance activities.
A value-added tax function is able to shift its resource allocation from compliance management and low value-added data processing to value-adding activities such as planning and business support. As Hackett Best Practices notes, World-class companies devote 56 percent more managerial resources proportionately to value-added decision support than average companies.2
In recent times, there has been a trend toward outsourcing tax compliance activities so that internal resources can be dedicated to other activities. While the merits of this may vary, the focus on freeing up highly skilled tax resources to more appropriate activities is recognized as being crucial to creating a world-class tax organization.
The Right Stuff
In our work with world-class companies, weve seen: increased allocation of resources to planning and risk-support activities; recruitment of project management and technology expertise to support the tax function; increased focus of the tax function in planning activities and business strategy; and trends toward compliance outsourcing (both direct and indirect taxes).
Resources in world-class companies spend twice as much time on planning and analysis as average companies. The trend toward channeling resources to value-added activities is only possible when highly skilled tax resources are used for their knowledge and are released from mundane compliance activities, and technologies are leveraged to create capabilities that help the tax professional analyze and interpret information aimed at enhancing tax value.
However, freeing up resources and developing new capabilities is only part of the equation in world-class tax functions. A tax function must be:
- Supported by senior management: The CFO must communicate the considerable
degree to which the tax function adds value to the bottom line;
- Proactive: Freeing up resources creates capacity, but this must be supported
by a desire to create value. Proactive rather than reactive planning is essential;
- Value adding: The basis of every decision should be value driven;
- Grounded in business purpose: Tax planning ideas exist in support of business
purpose and because of it;
- Connected to the business: A tax function must work together with the business
and not in hindsight.
- A supportive environment: The culture of the tax function must be flexible
and team-oriented; and
- Adaptable: The tax function must be able to change in line with the direction of the business.
Taking the shareholder value creation one step further requires companies to focus on tax, the key performance indicator often forgotten by the financial community. The tax jurisdiction is only one factor in driving a companys effective tax rate. Other factors include profit distribution policies, utilization of prior-year losses, and intercompany debt flows. Priorities and allocation of resources to tax management differ across companies.
To assess the impact of tax in a company, one must understand how it integrates with the overall business model at every level. Deriving the tax charge from the statutory tax rate and the profit-before-tax figure should be consigned to history.
Planning and Forecasting Applications
Commercially available modeling solutions deliver enablers to the tax function previously not possible. Despite the advances in ERP and other software solutions, applications to the tax function have been limited (see Figure 2).
Figure 2: Attributes of Commercial Planning Software
Taking advantage of new features enables the tax function to deliver tax solutions across the company, building on general process re-engineering principles and placing tax sensitivity analysis in the core of business process support.
Developing solutions helps the tax function understand the business, which benefits the organization. As with any planning and forecasting process, ownership of the numbers is key, and participation in the process is essential to accepting ownership.
Using planning models to assess and understand discrete tax processes will be a step toward value-added planning.
| Example: Capital Repatriation |
| Issues: A multinational company wishes to identify where it generates excess capital in its subsidiaries and model the effects of capital repatriation on the global tax charge. The company does not readily have access to the local statutory accounts of its subsidiaries. Solution: A corporate planning solution is used to:
|
What-If Analysis
Traditional planning and forecasting processes have been berated for their archaic approach to supporting the strategic vision. Best practice suggests that models, not chart of accounts forecasts, should be built to explain business performance. Forecasts and plans should be iterated upon to determine the optimum performance parameters.
The ability to perform what-if analysis, scenario modeling, and/or performance simulations is central to helping the company understand the key performance parameters in its planning process.
| Example: Access to Statutory Information |
|
Issues: The tax function of a multinational company is not able
to obtain financial data on a legal entity basis to support its
quarterly tax forecasting process. Access to local subsidiary accounting
information is only possible via the central consolidation system
that reports on a management entity basis.
Results: The tax function spends less time reviewing the numbers for consistency and is able to dedicate time to help the business understand its tax position rather than spend time developing the forecast. |
Examples
- 1. What product mix is appropriate to maintain tax compliance parameters
for monitoring income sources?
2. What is the impact on profits if the tax treatment of applied research and development (R&D) changes in future tax years?
3. What would be the impact on past and future profits arising from challenges to how R&D expenditure has been recognized?
A world-class tax function organizes its activities around its processes, including strategic tax planning, local business support, tax compliance, finance and accounting, and audit and risk (see Figure 3).
Figure 3: Organization of a World-Class Fax Function
Applying commercially available planning and forecasting applications to these tax processes allows the creation of capabilities that have never been considered before and elevates tax planning into the mainstream of business performance support.
| Example: Assessing Tax Impacts on Sales Opportunities |
|
Issues: A professional services provider wishes to estimate its tax liabilities for utilizing overseas resources on client engagements and the associated cost of compliance in addition to other tax liabilities (such as U.S. compensatory costs, state income taxes, etc.). Previously, this activity was executed manually on request. Solution: An Internet-enabled, self-service estimating model was developed to allow engagement teams to calculate tax costs associated with sales opportunities that crossed tax jurisdictions, based on the location of the engagement and the originating jurisdiction of the resources. Results: The ability to perform sensitivity analysis to determine the extent to which compensatory costs applied was one of the key drivers in determining the profitability of the engagement. |
Strategic Planning
Large corporations will typically have a shareholding base predominately located in one tax jurisdiction, and thus a need to repatriate cash from abroad to pay dividends and fund new opportunities. The objective of the tax function is to repatriate the capital while keeping incremental taxes to a minimum.
The tax department needs to identify an optimal means to repatriate the cash from abroad. The value creation opportunity for the company lies in the tax functions ability to identify the surplus retained earnings in a proactive manner and apply techniques to determine the options available to repatriate the cash.
Data collection and modeling tools may be applied to capture the data that identifies the opportunity (i.e., the surplus cash) and to model the flow of cash across the company (and the various tax jurisdictions). There is a need to be able to model the companys dividend policy and the long-term strategic requirements.
The power of the capability lies in the ability of the tax function to identify the opportunity through a consistent process (not in an informal, ad hoc manner), and to be able to forecast the impact of any transaction relative to the overall strategy of the organization.
The company may then take a long-term view to restructure its operations abroad in a more tax-efficient manner and thus reduce the worldwide tax burden over time.
| Example: Transfer Pricing |
|
Issues: A company has a transfer pricing benchmark that indicates
an operating profit margin of X percent for a given functional
composition. The company has more than Solution: The company has developed a model to upload data from the subsidiaries’ financial systems to monitor the margins against the comparables. Information from external sources is fed into the model. The solution identifies deviations from policy and issues adjustment postings to maintain the policy. Results: Tax resources are freed
from data collection and manipulation activities. The ability
to perform the analysis allows the tax function to actively manage
the transfer pricing component of the company’s risk profile. |
Local Business Support
The impact of moving resources across tax jurisdictions can be difficult to assess without access to a tax professional. The after-tax effects on a sales opportunity need to be understood to appreciate the true profitability of a transaction. The size of the salesforce relative to the tax function may be overwhelming.
One solution used at Accenture was to provide the salesforce with a tax-estimating model to access and thus accurately determine the tax costs and thereby more accurately determine the economic value added of the opportunity.
| Example: Protecting Tax Structures |
|
Issues: A producer of goods wishes to take advantage of the tax savings available in a low-taxation regime in which it has a manufacturing and sales operation. The subsidiary reports on a management entity basis, and its legal entity alignment is blurred. The information must show a clear distinction between trading and financial activities. Trading activities must distinguish between differing types of trade activities. This can be interpreted as a breakdown of the various product lines. Solution: Data must be assimilated from various sources, cleansed,
and reinterpreted before required analysis can be obtained. The
company develops a model to capture the data from these data sources
and maps the tax-sensitive data elements into the required tax
reporting structures. |
Statutory Accounts
The task of taking the numbers to the market leaves behind a litany of inefficient processes under pressure to generate the correct numbers. Corporate reporting under the groups Generally Accepted Accounting Principles (GAAP) drives the overall reporting process to the detriment of the regulatory requirement to report and file accounts and tax returns under local GAAP in jurisdictions of the subsidiaries.
There is typically no central view of accounting information under local GAAP standards, the prerequisite of all tax and treasury planning activities. To exacerbate this issue, the ability to produce statutory accounts on a more-than-once-a-year basis is limited.
In the major tax jurisdictions of the world, such as the United States and the United Kingdom, companies are under obligation to generate statutory accounts more frequently to determine taxable profits for tax payments to the authorities.
However, there is lack of focus on generating this information outside of the tax organization. Examples of items attributing to the issue of statutory accounts preparation include: shared cost allocations, transfer pricing adjustments, and infrequent reconciliation of intercompany transactions.
The tax function must therefore lead the requirements for statutory basis accounts in the implementation of accounting systems. The process of generating management-to-statutory-to-tax accounts can take considerable time. Automating the rules and principles that drive this process is central to improving the tax planning process. This information can then be used to feed the local tax provisions process and integrate with the overall forecast for the organization.
Transfer Pricing
Transfer pricing concerns the price at which goods and services are transferred to a related party. The Organization for Economic Cooperation and Development states that Taxpayers should themselves apply the arms-length principle when they calculate their taxable profits on their tax returns.
Companies must undertake detailed functional and comparability analyses as part of the exercise to ensure that it meets the transfer pricing legislation in every country. The arms-length principle means that companies must adjust the profits if necessary to reflect a fair transfer price.
Inefficient data collection and processing processes mean that companies are not able to do this effectively. For example, costs from the global supply chain or shared service operations cannot be allocated to the entity receiving the benefit. Consequently, the statutory profit position may not be known in the desired timeframe, thus impacting downstream accounting processes (i.e., forecasting of quarterly tax payments).
Companies that are able to model the effects of transfer pricing policy, without the need for pulling data from multiple sources and inputting these into cumbersome spreadsheets, can more efficiently derive a forecast statutory position and file periodic tax provisions and estimated payments with improved accuracy.
Audit and Risk
Companies are increasingly being managed along global functions rather than country divisions. There is a trend toward redesigning processes — for example, using toll, contract manufacturing, and commissionaire arrangements. The tax function is able to add value by understanding and modeling the tax impacts on a companywide basis to derive optimal tax savings. To do this, the tax function must be able to have access to current business data, understand the new processes, and factor in the tax effects.
Business operations that have been redesigned to be tax-efficient will require monitoring to ensure that the parameters resulting in the favorable tax treatment are not compromised. Self-assessment regimes thus impose the necessity for a company to carefully monitor these parameters.
The tax function will appreciate the importance of the parameters, but the source of data resides within the business, typically transcending many functional boundaries.
Integrated Tax Planning
The examples given indicate how a planning solution can be applied to discrete applications in the tax process. However, the overall tax position can only be truly assessed when the discrete models are integrated.
Emphasis on integrating individual tax planning applications into the overall strategic planning model helps the company truly comprehend its tax position. Real benefits are derived from integrating the tax planning processes in line with other planning activities in the company. The ability of the tax function to support the overall business strategy by accurately forecasting the tax changes arising from trading performance and financial transactions is key to its credibility in being a successful business partner.
Back to Reality
Discrete projects and investment decisions are subject to net present value and economic value added metrics, but companies still reward management on the basis of volume or revenue numbers, all of which are pretax-profit performance metrics.
After-tax performance reporting is recognized as a key metric but is seldom considered. Only when a company addresses this can tax be considered part of the shareholder-value creation agenda.
Companies may not appreciate the benefits of dedicating resources to planning activities when faced with the pressures of across-the-board cost reductions. However, recognizing the value that tax resources can bring is essential in driving after-tax value.
