Take a closer look at the relationship between corporate level risk and tax risk, using some helpful business scenarios.
How do we get from corporate level risk to a tax risk?
We start by looking at the company’s principle risks. A principle risk is an uncertainty that alone or combined with interrelated risks would impact the corporation negatively absent existing mitigating controls.
We then evaluate how tax impacts these principle risks. Let’s use the example of a retailer with its long list of principle risks as identified from its strategic plan:
- Business continuity,
- Consumer lending practices,
- Financial markets as a source of capital,
- Financial reporting, and
- The ability to execute the growth plan.
So where is the tax risk? Tax risk is obviously in the financial reporting but also in the execution of the corporate strategy as tax is going to be embedded in new product development, off shore purchasing and sales, geographic expansion, acquisitions and divestitures, and many more areas.
Each principle risk can therefore be broken into segments such as operational, financial, and reputational risks which can further be segmented into routine and non-routine risks.
- Routine risk is an uncertainty that arises due to normal or routine processes – in tax this would be filing the monthly HST returns.
- Non-routine risks arise when the event does not occur often such as addressing the HST issues related to acquiring another business or company.
So let’s drill down from the principle risk to a tax risk to see how they are linked using an exaggerated example:
- ABC Company is expanding into Country B and is going to support the expansion by issuing Euro denominated debt. If the debt cannot be raised, the expansion will not proceed or will need to be scaled back.
- The principle risk is the inability to execute its expansion strategy. Not executing the plan will impact the shareholders’ growth and value in the company (real or perceived) and the Board may lose faith in management abilities.
- There are operational, financial and reputational risks to not executing the plan. Supply logistics may be frustrated without the expansion. Revenue may not hit target expectations and cash flow restricted. Equity analysts may downgrade stock if they don’t believe management can grow the company. The embedded tax risk running through the contemplated financing structure may be challenged by domestic or foreign tax authorities. And if the structure needs to be changed it will affect the financing cost and the potential viability of the expansion.
- Finally, the risk would be non-routine assuming global expansions are not common place for ABC.
(With excerpts from the book, Tax Risk in the 21st Century: How to Manage Tax Risk like a Big Company Without the Big Expense by Ana Sainz of Claret Partners)
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