Governments are feeling the pain of tax disputes just as highly as companies. As a result, many are focusing their enforcement efforts not only on those with day-to-day responsibility — the tax function — but also on those with strategic responsibility: the board and audit committee.

Until relatively recently, a global company’s tax function could have been described as a “black box” — you didn’t open it for fear of being overwhelmed by technical detail. Indeed, the global tax director was viewed as a purveyor of esoteric excellence who was generally left to his or her own devices so long as the effective tax rate remained competitive and the laws were followed.

This changed when the US enacted the Sarbanes-Oxley Act, which required more financial transparency for public companies, including better controls in tax matters. That push for increased transparency in tax has now accelerated massively as the globalization of business and the global financial crisis converged.

Board and audit committee increasingly engaged by government

Because of the sheer scale of the numbers involved in taxes, boards and audit committees (not to mention risk committees, where they exist) are increasingly playing a larger role in the corporate governance approach to managing tax risks.

Simultaneously, tax authorities in OECD countries in particular are also attempting to put taxation higher on the board and audit committee agenda in an effort to make sure that tax risk tolerance generally and significant tax positions specifically are understood and condoned at the highest level.

To win cooperation, tax authorities generally take a top-down, bottom-up approach. From the bottom up, they entice corporate tax functions to cooperate with hints that working more openly and collaboratively will lead to a “lighter touch” tax audit approach — while threatening a harder line for those who don’t.

From the top down, tax authorities are working hard to make their messages heard at the board and audit committee level. Evidence would suggest that their tactics have been successful.

The campaign opens

Tax administrators opened their tactics with an awareness campaign in late 2009. Douglas Shulman, Internal Revenue Service (IRS) Commissioner and Chairman of the OECD’s Forum on Tax Administration, focused on the issue in many of his speeches in 2009 and 2010 and continues to do so today.

In 2009, he said: “You, the leaders of your organizations, should have a mechanism to oversee tax risk as part of your governance process. … The audit committee needs to know and influence what tax posture the tax planners are taking.”

In early 2010, he elaborated: “The board must oversee how management manages [taxes]. And that means some level of understanding, a set of policy principles and then a control system of review and reporting that assures the board that their policy is being carried out.”

Commissioner Shulman’s words have been echoed by many of his peers in other countries.

Tax authorities move from words to action

Not long after their awareness campaign began, tax administrators moved from words to action. The UK moved to hold tax executives at companies personally responsible for business tax filings by introducing the Senior Accounting Officer (SAO) role. Even tax directors who reside in a different country could be found liable for misdeeds under the UK rule.

Both Australia and Canada deployed similar programs that consider the robustness of a corporation’s approach to corporate governance in tax. In Australia, the Australian Tax Office (ATO) assigns companies a risk rating that represents the ATO’s view of a company’s entire tax corporate governance capabilities (as opposed to targeting a specific individual).

The ATO even ranks business taxpayers by their perceived risk, applying greater scrutiny to those judged to be least compliant and cooperative. “By being transparent, accountable and engaging constructively with us, you demonstrate good corporate citizenship and lower your tax risk profile, with the benefits to reputation that follow,” states the latest edition of the ATO’s Large business and tax compliance booklet.

“Our experience with corporate governance and relationship-based products — such as our annual compliance arrangements — show that better relationships with large businesses lead to fewer audit interventions and improved certainty for both of us.”

Senior ATO officials have begun including top management of companies that receive poor ratings in their discussions about why the rating was made and what efforts need to be made in order to improve it. This approach to risk rating (and either increasing or decreasing subsequent levels of tax authority scrutiny as a result) has grown globally in the aftermath of the global financial crisis.

Indeed, the ATO may well be taking cues from the Canada Revenue Agency (CRA), which in 2011 started asking companies to attend meetings to discuss the Canadian Government’s expectations for how tax risks should be managed. One key CRA expectation was that the boardroom increases its focus on this area.

This article was first published in the Ernst & Young Talk, talk, talk about it publication which can be accessed using the link below:

• Talk, talk, talk about it, What business leaders should know about tax risk and controversy (pdf, 3.84 MB)