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Continuously changing environment increases tax risk for SA companies

31 January 2007 Ernst & Young

With a rapidly and continuously changing tax environment and a heightened focus on sound corporate governance, South African companies are facing the necessity of dealing effectively with corporate risk of a new sort: that of managing tax risk. This includes effective tax planning for the best benefit of the organisation to avoid lost opportunities whilst ensuring full compliance with the law in all areas of business.

According to Corlie Hazell, National Director of Tax Accounting and Risk Advisory Services at Ernst & Young Advisory Services, the 2006 global Ernst & Young Tax Risk Management survey has indicated that, for South African companies, there is a disproportionate amount of tax time invested in tax compliance. The major driver behind the focus on compliance is the increased complexity of tax legislation coupled with the presence of an efficient and effective, yet often considered to be unduly aggressive tax authority in the South African Revenue Services (SARS).

"Internationally, the introduction of new legislation for improved risk management, such as Sarbanes-Oxley, has resulted from spectacular corporate failures. This has placed tax risk on the radar screens of many organisations affected by the regulations. Whilst South Africa has not experienced failures of similar magnitude resulting in regulatory requirements similar to Sarbanes-Oxley being introduced here, audit committees and boards of directors are uneasy about tax risk in South Africa due to the fundamental changes to tax legislation and the more efficient and aggressive SARS.. This has led to the need for tax functions to report within the companys risk framework on the tax risk that the organisation is facing. In our experience, many audit committees are uncomfortable with the risk coverage from a tax perspective."

Hazell points out that failure to pro-actively assess and monitor tax risk carries with it considerable risk, in terms of both unanticipated financial consequences as well as lasting damage to the reputation of offenders. "A poor tax posture might affect financial statements disclosures, cashflow, and the company's standing with investors. The investor community has become a lot less tolerant of restatements in financial statements, ambiguities in disclosures and 'surprises' in general, post Enron" she notes.

From the survey results, it is clear that South African companies' attitude to tax planning is highly risk averse, more so than their international counterparts and they spend less time on tax planning. Timeliness of compliance was cited as the most important measure for the tax function by 35% of the South African respondents, compared to 13% globally. While opportunities may exist for companies to reduce their tax liability while remaining fully within the law, she says the typical tax function is driven by the focus on filing tax documentation in good time, with less focus on tax planning.

Meanwhile, ensuring tax accounts and disclosures in financial statements are correct was rated as most important by 24% of the South African respondents compared to 32% globally. 'Tax risk management' in general and 'effective tax internal controls' were given a joint third place by 12% of the South African respondents.

"In our view, these responses indicate that South African tax functions are still compliance-focused, resulting in a somewhat reactive approach, versus a more pro-active risk management mindset adopted by global respondents," says Hazell.

"This extensive focus of tax functions on compliance must surely be a concern for management. Experienced tax specialists are scarce and command a premium in terms of income. As such, and with more information being required by SARS, it is concerning that not more companies are investigating outsourcing their tax compliance or implementing systems which facilitate easy access to and delivery of the necessary data, automating where possible elements of risk management in the form of prevent and detect controls and tax compliance. This alleviates some of the compliance pressure of the tax function and ensures more efficient utilisation of scarce tax resources," adds Hazell.

Whilst tax functions appear to be spending a disproportionate amount of time on tax compliance, finance respondents cited tax planning and structuring as their primary expectation from the tax function. This indicates a lack of alignment of the objectives of all stakeholders of tax functions in the form of a tax strategy. Effective tax risk management depends on a strategy which takes into account the companys overall objectives, risk profile and framework.

"Few local companies report involvement of internal audit in assessing and monitoring tax risk; however, some 50% of South African respondents indicate that they will grow the involvement of this function in coming years. However, a further challenge is presented in that internal auditors are not typically trained in tax affairs. To effectively address tax risk with the limited resources in most organisations, an effective collaboration between the tax function and internal audit cannot be ignored - we believe that this is emerging best practice" says Hazell.

In our experience, many organisations do not know practically how to approach tax risk management in their organisation and how to start the collaboration between internal audit and the tax function. Further, the findings of the 2006 survey indicate that many organisations still do not understand tax risk and assessing tax risk within a structured framework. Such organisations should consider consulting external specialists who have experience in this area, as a company not focusing on tax risk may become a soft target for the aggressive approach of the SARS. By identifying tax risk and monitoring the risk within the organisation, management could potentially again focus on tax planning to reduce the tax liability, while still ensuring complete compliance with the law, says Hazell.


 

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