These days, enterprises operate internal policies for nearly everything. Such policies formalize rules, practices and procedures in specific areas, ranging from Human Resources to Risk Management. A Tax Policy is similar.
By putting a Tax Policy in place, an enterprise clarifies rules, practices and procedures governing the enterprise’s tax matters. This ensures that all employees know what to do when it comes to tax matters and management knows what goes on within the enterprise. It ensures risks are minimized and tax laws are complied with.
In this short article, we explain what a Tax Policy is and when you need one. We also highlight what should be included in a Tax Policy and provide tips on how to start.
What is a Tax Policy?
A Tax Policy informs internal and external stakeholders on how an enterprise deals with its tax matters. It sets out the rules, practices and procedures governing the enterprise’s tax matters, including important aspects such as:
- (i) clarification of roles and responsibilities;
- (ii) compliance with tax laws; and
- (iii) approach to tax planning.
A Tax Policy is a “blueprint” for the tax function of an enterprise. A Tax Policy is a tailor-made document that is updated periodically as the enterprise evolves. (You can imagine that a Tax Policy for an enterprise of 80 FTE with operations in one 2 countries is different than one for an enterprise of 1000 FTE with operations in 20 countries).
The Objectives of a Tax Policy
The objectives of a Tax Policy can be summarized as follows:
1. Ensure that everyone is “on the same page”
A Tax Policy ensures that everyone in the enterprise is “on the same page” when it comes to tax matters. Successful management of tax matters within an enterprise is only possible if there is awareness of the rules, procedures and practices of those involved. Let’s give a (real-life) example to make this clearer:
Tax Policy Example I:
A finance manager of a regional unit of a multinational enterprise receives a letter from the tax authorities announcing a tax audit for Financial Year (FY) 2020. The enterprise has put a Tax Policy in place that states that the Group Tax Director must be involved immediately in case of a tax audit. So the finance manager reaches out to the Group Tax Director for guidance and support in the tax audit. If there hadn’t been a Tax Policy, the finance manager might have dealt with the tax audit itself while not having the necessary knowledge and know-how. The enterprise might have ended up in a costly and time-consuming tax dispute and without the people responsible knowing about it!
2. Ensure accountability for tax matters
A Tax Policy allocates roles & responsibilities for tax matters within the enterprise. If something goes wrong, it should be clear who can be held accountable. This helps cultivate an environment where tax risks are managed and mitigated in the right way. Let’s give a (real-life) example to make this clearer:
Tax Policy Example II:
X Enterprise has a CFO and a Head of Tax, who reports to the CFO. The CFO has a finance team at his disposal that manages the Finance, Planning and Accounting of the business operations, including quarterly reporting. In the third quarter of FY 2020, the finance team notices a significant error in the financials for FY 2019, which among others affects the taxable profit and corporate tax due for FY 2019.
The finance team propose to correct this error by way of a significant prior year adjustment (PYA). Such PYA would negatively affect the Effective Tax Rate (ETR) of X Enterprise. As per the Tax Policy, the CFO is accountable for maintaining a stable ETR for X Enterprise. He cannot risk that the proposed PYA affects these financial metrics.
He, therefore, instructs his finance team to reach out to the Head of Tax and discuss solutions to mitigate the risk and a solution is found. If there hadn’t been a Tax Policy, it would have been unclear if either the CFO or the Head of Tax was responsible for the ETR and this could have resulted in the ETR risk to materialize.
3. Establish a reputation as a good corporate citizen
A Tax Policy demonstrates that an enterprise’s tax matters are being taken seriously and there is a framework to report and manage tax risks in the right way. It shows a proactive attitude toward tax matters. This is encouraged by tax authorities all around the world. It also sets an enterprise apart from the crowd as, frankly, numerous enterprises (incl. large ones) have never thought about putting a Tax Policy in place.
All of this helps to establish a reputation as “good corporate citizen” which is now more important than ever for enterprises.
Tax Policy Example II: Added Value of a Tax Policy
In case you’re not convinced that a Tax Policy adds significant value to your enterprise, please read the following example based on a real-life case:
Sunny Sunglasses is a European manufacturer of high-end sunglasses. The business in Europe is going well and the CEO wants to expand the operations to Asia. The CEO engages an M&A advisor to identify targets and decides to approach a Singapore based manufacturer (Target). As the discussion evolves, high-level due diligence is done on the Target, followed by a formal offer of USD 2m which is gladly accepted.
After Sunny Sunglasses has signed the share purchase agreement (SPA) to buy the Target, the CEO suddenly realizes that he hasn’t involved his tax director. He decides to send him the SPA and the due diligence report. The tax director is not amused. After reviewing the documents he warns the CEO that:
- The acquisition structure is sub-optimal as future dividends from the Target will be taxed at unnecessarily high rates. This would have been avoided if another group company within Sunny Sunglasses had signed the SPA.
- The transfer pricing model of Target is significantly different than the model of Sunny Sunglasses and needs to be amended. This is going to be costly.
All in all, the tax bill could amount to USD 1m; 50% of the purchase price for the Target.
This could have been avoided if Sunny Sunglasses had laid down, in a Tax Policy, that the Tax Director should be involved in ANY acquisition to be made. In that case, the CEO would have had no choice other than to involve the tax director. Perhaps the whole acquisition of the Target would have been cancelled. Unfortunately, Sunny Sunglasses is now stuck with a high tax bill.
This situation does not only happen at small or medium enterprises. We have seen it happen at the largest multinationals as well. Sometimes, large known tax bills that are coming down the pipe aren’t even accounted for!
What Needs to be Included in a Tax Policy?
It goes beyond the scope of this article to discuss in detail what needs to be included in a Tax Policy. However, in general, we advise to include the following aspects:
- Section 1 – Introduction: summarizes the goal of the policy.
- Section 2 – Compliance & Commitment: provides a general overview of how the MNE aims to comply with prevailing domestic or international law.
- Section 3 – Tax Risk Management: sets out how tax risks are met and assigns roles.
- Section 4 – Approach to Tax Planning: sets out the MNEs commitment to a prudent approach to tax planning.
- Section 5 – Relationship with the Tax Authorities: details the MNEs commitment to maintaining positive relationships with the tax authorities.
- Section 6 – Roles & Responsibilities: specifies exactly the responsibilities what each assigned role should do. Be as specific as possible.
- Section 7 – Policies & Standards: details how other policies relate to the tax authorities (we advise to make this a leading policy based on the examples given above).
- Section 8 – Media: sets out procedures on how to deal with (unwanted) media attention.
- Section 9 – Effect & Endorsement: sets out when a policy is active and how it is kept up-to-date.
How to get started with a Tax Policy?
To get started, ask yourself a few simple questions. The answers to these questions can form a basis for your Tax Policy:
- What kind of taxes do you want the policy to cover? Should it be limited to corporate tax or do you want to include all sort of taxes?
- How are you going to secure the necessary information to prepare the policy?
- Who are the internal stakeholders (e.g. finance, legal) and how can you secure their commitment?
- How prescriptive should the policy be? Do you want to write down in detail all the relevant rules and procedures or do you want to retain some flexibility?
- Who is going to sign-off on the policy?
- How are you going to ensure and monitor compliance with the policy?
Tips for creating a Tax Policy
There are many important aspects to bear in mind when preparing a Tax Policy. Based on our experience advising clients we list down three useful tips:
- Make sure that the policy aligns with actual practices and principles (i.e. reality). Material misalignment might raise questions from internal or external stakeholders. One thing is putting something on paper, another thing is doing that in practice.
- Involve important stakeholders early in the process and secure their buy-in. For example, if you need the finance department for matters such as invoicing and accounting of intercompany transactions, ensure they are aware of what is expected from them.
- Seek endorsement of the policy by internal stakeholders and formal approval from a duly authorized officer within the business. Usually, this is someone in charge of financial or tax matters.
- A policy will be most effective when specific tasks and responsibilities are assigned. Everybody should know what they have to do and when. Without this, it is just a toothless paper tiger.
A Tax Policy adds tremendous value to an enterprise. It helps to ensure that everyone within the enterprise is on the same page. It ensures accountability for tax matters. Moreover, it demonstrates that tax matters are taken seriously and there is a framework to deal with them in the right way, which helps build a reputation as a good corporate citizen.
Putting a Tax Policy in place means staying ahead of the curve. Not doing this places your, or your clients’ business at unnecessary risk.
If you wish to create a solid tax policy, check out our Tax Policy Template…