How Internal Audit Can Help Tame Tax Risk

Corporate tax governance arrived on CFOs' radar in a big way with the first round of Sarbanes-Oxley 404 filings, when it quickly became clear that in many companies the controls around tax accounting processes were inadequate. Erroneous accounting for income taxes was the top reason for adverse audit opinions in 2005 and 2006. Clearly, organizations needed to improve the accuracy and transparency of their tax processes. And, equally clearly, that meant that the walls separating tax management from other functions would have to come down.

Now companies are realizing that the benefits of integrating the tax function more tightly into the rest of the organization can extend far beyond improved Sarbanes-Oxley compliance. For example, teaming internal audit and tax can help businesses get a better handle on their tax risks, according to a new report from Ernst & Young.

Tax departments' view of risk historically focuses around tax return reporting and compliance requirements. But businesses need a much broader view of tax risk, one that encompasses strategic, operational, and financial exposures that might otherwise be overlooked. For instance, if a company sends a sales rep to a country where it has never operated before and HR fails to communicate with the tax department, the organization may inadvertently create a permanent establishment for tax in that country.

Internal audit's entitywide perception of risk can help the tax function identify and mitigate a much wider range of exposures. The two functions can learn from each other's skill sets, and teaming may help reduce some of the pressure on overloaded and under-resourced tax departments.

Ernst & Young describes collaboration between tax and internal audit as varying along a continuum from review and validation to competitive advantage:

1. Review and validation. At this level, internal audit provides its traditional services relating to audits of tax processes and controls, for example by reviewing and strengthening tax technology documentation, controls, and security. At the same time, internal audit works with the tax department to start to develop an enterprisewide view of tax risk and to identify any exposures that need to be addressed immediately.

2. Continuous monitoring. This enables the organization to incorporate tax within its annual enterprise risk assessment and address new risks through the internal audit report remediation plan. Activities at this stage might include, for example, monitoring post-acquisition integration tax requirements, including completion of tax elections.

3. Process improvement. This is where internal audit's expertise in best practices for processes and controls comes into play. Companies are leveraging that knowledge to standardize and automate labor-intensive tax accounting and compliance activities, freeing up tax managers to focus on key risks.

4. Competitive advantage. At this point, the tax and internal audit departments are working together to integrate tax risk processes into strategic business planning. This allows the tax function to shift from its traditional focus on short-term fixes to a long-term view of sustainability and business improvement.

Read the complete Ernst & Young report here.