Tax Impact on Decisions
This essay examines the issues surrounding corporate tax liability and the impact that corporate tax rates have on business decisions. Tax liability can be defined as the total amount of taxes that a business or corporation is required to pay as a percentage of its profits. Tax liability is a manageable expense and can vary depending upon the jurisdiction levying the tax. Allowances and deductions set forth in federal and state tax codes provide a means for corporations to reduce the amount of their gross profits and therefore reduce their tax liability. Tax directors in corporations are responsible for reducing the effective tax rate (ETR) for their organizations while ensuring high compliance standards for financial reporting. Tax directors are also tasked with defining overall tax risk strategies for their organizations; as well as with educating key organizational employees about the implications of decision-making and the effects on tax liability. Corporate business units need to partner with tax managers to insure that applicable allowances and deductions are captured to help reduce a company's ETR. This essay will also discuss the trend followed by corporations in creating overall tax management planning and risk assessment and the importance of understanding ETRs between competitors within given industries. An overview of the tax allowances available for "green business strategies" will be discussed along with the competitive nature of global tax rates as an incentive to lure corporate investment to different jurisdictions.
Keywords Codified; Corporate Social Responsibility; Corporate Tax Burden; Effective Tax Rate (ETR); Federal Tax Code; Headline; Indirect Taxes; Internal Revenue Code; Reputational Risk; Statutory Tax Rate; Strategic Tax Review; Tax Competition; Tax Planning; Tax Reform; Tax Risk Management
Accounting: Tax Impact on Decisions
There are many decisions that businesses make regarding their tax liability. Tax liability represents one of the largest, if not the largest, expense items on corporate income statements (Murray, 2006).
The Internal Revenue Code
Corporations and businesses are subject to the codes outlined in the Internal Revenue Code (IRC) which outlines the domestic tax code for U.S. companies. Most corporations pay taxes as C-corporations, but there are other designations in the tax code for non-profit companies and those operating as S-corporations. The designation of a corporation can have a big impact on the amount of taxes paid by a corporation.
The IRC refers generally to the Internal Revenue Code of 1986 which includes statutory tax law for the U.S. The IRC is organized topically, and broken into many hierarchical sections — the term that is used to describe the organization of the statutes is "codified." There have been many changes to the U.S. tax code over the years. The following timeline shows the major revisions to the code.
- 1874 — First codification of the tax code was undertaken; prior to 1874, the codes were generally unorganized acts that had been passed by Congress.
- 1939 — U.S. Tax laws first codified as an integral part of the U.S. Code.
- 1954 — IRC was greatly reorganized and expanded by Congress and replaced the 1939 code.
- 1986 — with the passage of the Tax Reform Act the IRC was renamed Internal Revenue Act of 1986. Numerous amendments to the code were added.
The Internal Revenue Code in use today is essentially the 1986 code which contained many amendments to the 1954 version. Since 1986, there have been many changes to the IRC and there are renewed calls by legislators and the public to "reform" the overly complex and onerous tax code. Since the last overhaul of the U.S. tax code there have been many amendments and additions to the code. Many critics claim that the tax code has become overly complex and unwieldy.
The topic of tax reform is discussed in the issue section of this essay and includes not only current topics regarding tax reform, but also discusses some of the topics that have come up since the last formal tax change in 1986.
Tax Risk Management
Tax risk management is a finance function and as such has been receiving increasing attention since corporate failures of the early 2000s. Along with corporate risk management, tax risk management has been given more scrutiny by corporate boards and executives. The current business climate exhibits increased shareholder interest and activism around all risk. Corporate taxpayer behavior is now a political issue in the eyes of many. Companies that don't pay their fair share of taxes are seen as lacking in integrity. Not complying with tax laws and underpaying corporate taxes can result in "reputational risk" (Johnson, 2006).
When creating a task risk management strategy, clear discussion and communication are critical. The basic components of a proactive task risk management structure include the purpose, principles, business and the group, tax authorities, government and procedures ("Creating a tax risk management strategy for a multinational," 2013).
There are a number of stakeholders that care about a company's tax liability and the associated risks. Most corporations today must manage the following groups from an overall business standpoint, and from the perspective of tax liability.
- The Public: Expects responsible, ethical behavior as part of an overall corporate social responsibility policy. A subset of this group might include customers and staff.
- The Government: Needs tax revenue and companies are good sources of revenue. Companies that make a big profit but pay little in taxes are not favored. The government might encourage public/customer/staff backlash against a company that is not paying its fair share.
- Tax Authorities: Seek to maximize the amount of tax oversight. Companies already see an increase in audit activity related to compliance. Shareholders concerned about a company's reputation might look favorable upon increased oversight as proof that their organization is paying its fair share.
Shareholders will increasingly want board involvement in tax planning. There's a definite acknowledgement that companies need to do a better job of forecasting effective tax rates. Tax management is being thought of as a more strategic function that is much more than number crunching (Johnson, 2006).
Tax Planning as a Business Strategy
U.S. corporate tax directors make sure that they always know their own corporate tax rate, that of their competitors and the average in their particular industry ("A new age of tax planning," n.d.) A review of Effective Tax Rates (ETR) by industry has revealed that various methods are used to reduce tax costs. If a tax manager researchers a given industry and finds a wide range of ETRs within that industry, this would indicate that there's an opportunity for additional tax planning as a means to reduce the ETR. Given the fact that a single % point reduction in an ETR could be worth a million dollars, there is significant incentive to reduce a company's ETR.
It is important for corporations to stay on top of their ETR to remain competitive within their industry. Companies that proactively and aggressively manage their ETR can potentially save millions of dollars in tax liability. Over the past decade, tax competition has emerged as a global trend. The United States once boasted one of the most competitive corporate tax rates in the world and corporations were attracted to set up operations in America. During the past two decades, many other countries have reduced their corporate tax rate to attract foreign companies. Today, the United States has one of the highest corporate tax rates of industrialized nations and stands to lose its advantage as the place to locate a corporation's operational headquarters. The implications of falling global corporate tax rates are discussed in more detail later in this essay.
Tax Risk Assessment
If you ask tax directors about their main current challenges, their responses always include lowering effective tax rates (ETRs) while preserving high compliance standards (“A new age of tax planning,” n.d.).
In general, risks associated with tax planning are similar to other types of corporate risk. Risks surrounding tax planning include:
- Complying with the law — not just filing correctly, but assurance that all tax laws are being followed.
- Tax reporting — Sarbanes-Oxley has only increased the awareness of having internal controls and having transparency in reporting.
- Integration of tax planning with business planning — new products, markets and business can create tax obligations resulting in missed tax planning opportunities. Tax planning cannot be a stand-alone event; it must be part of corporate decision making ("A new age of tax planning," n.d.).
- Management of taxes as a cost — taxes are a manageable cost for corporations. Most company's have some control over the ETR and could reduce their tax liability given more support. The downside here may be that when a company reduces its tax liability- the company may be seen as not paying its fair share of taxes.
- Reputational risk - corporate executives do not want to wake up and see their company’s tax planning mistakes plastered on the financial newspaper pages (“A new age of tax planning,” n.d.).
Strategic Partnership with Business
Many good tax plans have become ineffective due to minor changes in the practices of the front line operations ("A new age of tax planning," n.d.).
In corporations today, there is a deliberate effort to integrate functional business units within the overall strategic planning initiatives of the organization. Organizations have done a good...
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