The concepts of Tax Governance and Justified Trust have become a key focus area for the Australian Taxation Office (ATO) when reviewing both privately held groups and large public and multinational businesses.
In 2017, the ATO released an expanded TRM and Governance Review Guide, which was subsequently updated in April 2018. The Guide set out principles for board-level and manager-level responsibilities, and examples of evidence that entities can provide to demonstrate the design and operational effectiveness of their TRM framework. The latest iteration of the Guide also contains updated guidance for directors and public officers in terms of their responsibilities in the context of TRM, and recommended self-assessment procedures.
The Guide is an integral feature of the ATO’s overall tax corporate governance program, which includes its ‘Justified Trust’ and voluntary Tax Transparency Code (TTC) initiatives, and clearly describes what the ATO considers to be best practice for TRM and governance. The ATO expects the Board to oversee the implementation and ongoing monitoring of the TRM framework to ensure compliance with tax laws and policies.
Justified Trust applies to how the ATO engages with larger market taxpayers In particular, it involves the ATO considering if the community would be satisfied with its efforts to assure the tax paid by the taxpayer. This is also linked to the ATO’s broader domestic and global improved corporate tax transparency.
The ATO’s current expectations apply to Boards of both public and private companies, as well as Australian subsidiaries of multinational groups.
Public Officers (a company’s representative to the ATO) are also responsible for TRM. The Board are not responsible for the day-to-day management of controls and processes to ensure compliance with tax obligations - this is a responsibility of management.
However, the Board is now expected to have oversight of a tax control framework that provides guidance on how tax risks are identified and addressed.
ATO ratings system to assess tax governance
In assessing a company’s tax governance the ATO looks for evidence that a tax control framework exists, by reference to the controls set out in the Guide and applying the following staged rating system:
- Stage 1 - tax control framework exists
- Stage 2 - tax control framework is designed effectively
- Stage 3 - tax control framework is not working practice
- Red Flag - not evidenced or significant concerns
Stage 1 – Demonstrating a tax control framework exists
To achieve Stage 1 a company must be able to provide objective evidence that a tax control framework exists. This includes one or more of the following:
- Board endorsed tax policy documentation describing how the organisation identifies and manages tax risk;
- documented procedures for preparing returns; and
- a testing program to validate the operating effectiveness of the tax control framework.
Importantly, the ATO will not simply rely on things such as slide presentations, draft policies or narrative descriptions of the tax control framework, as they do not represent source documentation. In this regard, evidence in the form of actual policies and procedures demonstrating the existence of a tax control framework is required. In our view, the best way to demonstrate that a tax control framework exists is to have a documented TRM Charter that is endorsed by the Board.
Stage 2 – Demonstrating design effectiveness
Once a tax control framework has been established and implemented, the ATO will then seek objective evidence that the framework is designed effectively.
In this regard, the ATO recommend that a organisations carry out a ‘gap analysis’, by self-assessing the design of the existing framework against the ATO’s best practice detailed in the Guide. In this context, the ATO recognises entities use different governance practices based on a range of factors, including their size, ownership, complexity, industry, history and corporate culture.
Where gaps exists, organisations should describe their compensating controls and document why particular aspects of the Guide may not be applicable to their circumstances.
Many organisations may find it difficult to satisfy Stage 2 as they are unable to provide evidence of the effective design of their tax control framework. However, having a documented gap analysis with the ATO Guide will significantly assist in meeting the ATO’s evidentiary requirements.
Stage 3 – Demonstrating the framework is operating in practice
A Stage 3 rating is the highest rating for tax governance and the ATO encourages all large private and public companies to aim for this stage. Achieving Stage 3 “justified trust” means an organisation has demonstrated to the ATO that there is objective evidence that the tax control framework is operating effectively and thus supports less intense future reviews by the ATO.
In order to achieve this rating, an organisation must be able to demonstrate that its tax control framework has not only been designed effectively, but is also operating as intended. The periodic testing of tax controls can support that this stage is achieved, which can be evidenced with:
- reference to the internal tax controls testing program in the tax control framework;
- an extract of the testing program for the future (e.g. next 3-5 years), which details the:
- scope of tax controls testing;
- details of who is conducting the review; and
- description of the testing methodology to be applied.
- scope of tax controls testing;
In assessing whether Stage 3 is achieved, it will be important to demonstrate to the ATO that the independent review and testing of tax controls has been carried out and thereby provides an independent level of assurance.
Red Flag – Not evidenced or significant concerns
A ‘red flag’ will be assigned where an organisation cannot provide evidence to demonstrate a tax control framework exists or if the ATO have significant concerns with its TRM and governance.
What should you be doing?
For those with responsibility for the tax function and/or oversight of an organisation’s tax compliance, you should be asking the following questions:
- Is your Board aware of the ATO's expectations of directors in relation to TRM and Governance?|
- Are you familiar with the ATO's best practice framework outlined in the Guide and are these adopted in your company?
- Do you have a TRM Policy / Charter that is documented and approved by the Board to provide the framework for identifying and managing tax risk?
- Have you carried out a gap analysis to identify weaknesses in your existing systems, controls and documentation compared to the ATO's TRM Guide?
- Has your tax control framework been periodically tested by an independent reviewer?
If the answer to any of these is “no”, the ATO’s tax governance rating of your organisation may not be acceptable to the Board.
The TRM / Justified Trust approach will now guide how the ATO conducts its client engagement processes going forward. Establishing a TRM Policy and implementing a tax control framework is key to determining an organisation’s tax profile and overall risk rating with the ATO. Ultimately, this will:
- provide the ATO with comfort that your organisation has the requisite tax controls in place and is paying the appropriate amount of tax;
- result in confidence to the community;
- provide greater certainty for your organisation;
- focus the ATO's future engagement strategy for your organisation;
- reduce the intensity of ATO reviews over time where assurance is obtained
- ultimately, save you time, money and effort in the event of an ATO review or audit.
Nexia TRM approach
For organisations that do not have a documented TRM Policy/Charter, have not undertaken a ‘gap analysis’ or are not considering these matters, the ATO will see this as an indicator of higher risk and are more likely to ‘red flag’ the company, which will result in more detailed and intense review activities.
Nexia Perth can assist you with each stage of the tax governance assessment process. Our TRM approach is designed to mitigate risks in the event of ATO review of audit and achieve a justified trust position, by assisting you establish a TRM policy which underpins a robust tax control framework.
For more information on how Nexia Perth can assist with establishing a TRM Policy for your organisation and achieve the highest ATO tax governance rating, please contact Jason Gaudoin.