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Taxes are a big expense for most companies, profitable or not. Many larger and midsize companies must traverse a complex and constantly shifting landscape of tax rules, rates, and jurisdictions. I’ve previously written about the need for corporations to manage their taxes more intelligently, and that that may require someone in the tax department who understands both the department’s functional requirements and what information technology can do to improve those functions. Today I am going to discuss some organizational changes that are required to transform the tax department from a poorly understood, isolated and tactically driven silo into a mainstream finance function that is tightly integrated with the rest of that organization.
This transformation will depend in part on CFOs and controllers embracing three ideas: that they should have greater visibility into their future tax exposure, that they should be able to better optimize their tax exposure, and that they should actively and consistently manage their tax risk. In other words, they should apply the same basic performance management approaches used in other areas of the finance department, as well as throughout the organization, to tax processes.
Performance management is an iterative process of cycles (or sets of cycles) in which companies plan, measure and assess results, then adapt tactics, strategies and objectives that reflect the new circumstances and will optimize future results. The performance management process requires relevant metrics, effective collaborative processes, accurate and timely data and the right analytics and reporting tools. The last of these enable all the rest and for finance is what I have been educating on for a decade in what is called financial performance management. Finance must manage their own performance but also have the ability to help guide an organization.
Corporate tax departments have the same basic performance management software needs as general business users. They are:
- Planning – the ability to set baselines, determine optimal courses of action and understand the consequences these will have on a company’s income statement and cash flows. From a tax standpoint, this means streamlining and improving the accuracy of the processes used for planning and provisioning their direct (income) tax expense.
- Reporting – the ability to provide information (rather than just data) that also enlightens and alerts. For public companies, this means incorporating and managing important tax-related disclosures in their external financial statements; for U.S.-based companies, for example, these include what are called uncertain tax positions, or UTBs.
- Risk management – the ability to understand and manage the risk exposure of a company consistently and in a manner that is consistent with its risk appetite. Given the vagueness and complexity of tax rules (for example, when is a cake a cookie), corporations routinely make assumptions – some of them aggressive – that put them at risk of ultimately paying more than they have provided for in their tax returns.
- Analytics – the ability to provide measurements and insights. For taxes, this means automating tax analytics and providing an alternative to desktop spreadsheets.
- Dashboards – the ability to easily construct concise visual communications, such as charts and other graphics, that enable understanding of the information and that highlight actionable conditions.
- Scorecards – the ability to communicate quickly the performance of individuals or groups using a set of predetermined key performance indicators (KPIs).
Some specialized tax software already provides performance management capabilities that can be critical in helping an organization transform its tax department. A company can find other capabilities in its existing software; for example, business intelligence (BI) tools always include generic reporting, dashboard and scorecard functions. Bringing tax into the mainstream, however, also means that finance departments will have to tightly integrate standard processes, such as budgeting, forecasting, treasury management, financial close and so on, with the output of their tax-related processes such as planning and provisioning.
The speed with which tax goes mainstream will be influenced by tax policies and tax enforcement. When governments bite them hard enough and often enough with tax surprises, CFOs will begin to see the need to bring tax departments into the finance department mainstream. When enough CFOs are bitten, it will become a full-blown trend.
Until that time, I see three important trends in taxes that will promote the mainstreaming of tax departments. First, many governments in the developed world are experiencing financial stress and are therefore looking for ways to increase revenues. For example, state and local governments in the U.S. are looking for ways to expand their tax rolls by finding new ways to attach “nexus” (a legal presence) to companies that are not physically located in their tax jurisdiction in order to collect direct (income) or indirect (sales and use/VAT) taxes. This will put additional pressure on companies to automate tax planning and provisioning.
Second, mistakes can be costly and are likely to become even costlier. In some cases, companies could wind up paying taxes on the same item multiple times or paying fines for noncompliance when their tax departments should be spending time focused on audit defense and on optimizing their tax positions. Also, because of greater uncertainty over which tax laws ultimately will apply to whom and to what, companies will need to manage a broader set of uncertain tax positions.
Third, a great deal of political pressure is currently being exerted to simplify tax codes; many of these proposals seek to lower rates and to expand the base by eliminating exemptions and preferences. Simplification, should it happen, is likely to lessen the pressure for more tax automation and management. However, since simplification is not necessarily in the interest of either those in charge of tax laws and regulations or those who currently benefit under the tax status quo, we should all be skeptical this will happen any time soon.
I believe that what I have discussed here will come to pass. But even if only some of it does, companies still need to take a more intelligent approach to managing the processes they use to make tax decisions and to calculating and reporting their taxes. Doing so makes not just good business sense but also dollars and cents.
Over the past two decades, finance departments have increased their efficiency by embracing automation in general and technology-driven performance management in particular. They should extend this embrace to their tax departments and bring them into the mainstream of financial management.
Robert Kugel – SVP Research
To manage taxes more intelligently tax departments need to focus more on execution than compliance. I’ll confess that this observation is based on informal rather than rigorous research, so I’ll leave it up to individuals that work in these departments and in the finance function generally to consider whether this applies to their company.
Compliance is essential, to be sure, but it shouldn’t be the only objective. Tax codes the world over are extremely complex and require careful study. For this reason and because people with legal backgrounds often run tax departments, they may be more focused on the technical and enforcement aspects of what’s in the tax filing rather than the people, process, information and technology elements that produce that filing. I believe paying greater attention to enhancing the technology and data aspects of the tax function is all the more important today because technology not only can help deliver accurate and timely tax filings but can do so in a more efficient and effective fashion. If your company has 5,000 or more employees, it needs a tax technology expert, an individual who first has a strong grounding in tax but also understands how to apply information technology to this function.
The efficiency aspects of applying IT to the tax department are pretty straightforward since it’s mostly about the number of people-hours required to get to the end result of timely and accurate tax and accounting filings. Yet I believe time also can and should be invested to achieve a more effective tax function, an outcome that will be much more valuable.
Consider: Does your company apply a consistent tax risk management approach across the corporation? Are risks measured and assessed using a formal framework designed to communicate with executives? Are your tax defense efforts as effective as possible? What would it take to improve them? Does the tax department operate in a purely reactive mode or does it assess potential consequences of possible changes in depth and measure the impacts of alternative approaches?
A greater focus on the execution aspects of the tax function is necessary if corporations hope to actually achieve the kinds of operational improvements that are possible today. Unfortunately, I think there are a several key barriers standing in the way of capturing the benefits that technology can provide.
One issue is the “tone at the top,” the attitude communicated by executives running the company who know little and almost always care little about the tax function (unless it bites them on the bottom). Then there’s the attitude of those running the tax function, who by training usually are lawyers or have joint legal/accounting degrees. Understandably they are focused on the technical aspects of tax law and interpretation and much less so on how to use technology to enhance the execution of the tax function.
A second issue is the isolation of the tax function in most corporations. Our benchmark research finds that as many as half of the finance organizations we surveyed have a very limited understanding of what goes on inside their tax department. Part of this is cultural; tax is a highly technical area with its own vocabulary and conceptual frameworks, which often makes it difficult to have a dialog with the rest of the organization. And because tax matters are highly sensitive, tax people are by training, and probably inclination as well, discrete.
A third issue is that few people who understand technology appreciate how it can be harnessed to improve tax department execution. People who work in IT departments are also technically focused specialists with their own vocabulary and conceptual frameworks. Consequently, they cannot be strong advocates of the proper provisioning of ERP systems to support the tax function or a tax data warehouse of record, for example. Companies often skimp on the former because they do not realize that by failing to make their ERP systems inherently tax aware they force tax departments to do extra, unproductive manual operations. This drives greater costs than properly provisioning the ERP system. Moreover, it is often a barrier to more timely completion of tax analyses and filings. Few have adopted the latter, possibly because they do not understand how a tax data warehouse can save time and promote tax risk management, enhance tax defense capabilities and increase tax visibility. Taxing authorities worldwide are stepping up their efforts to increase collections, increasing their use of information technology to strengthen their oversight and litigate their positions. Having a central, accurate source of “as reported” tax related data enables a company to mount a more effective defense.
Having an individual with a deep understanding of what a tax department needs and what information technology can do to meet those needs is an important part of improving execution in the tax function. This person does not have to be a subject matter expert in tax law but they do have to understand the functional requirements of the people in the department as well as a knowledge of what capabilities IT systems can deliver.
Robert Kugel – SVP Research