Building A More Effective Tax Function

Building a More Effective

Tax Function A report prepared by CFO Research Services in

collaboration with Hudson Financial Solutions

CFO Research Services and Hudson Financial Solutions developed the hypotheses for this research jointly. Hudson funded the research and the

publication of our findings, and we would like to acknowledge the members of the Hudson team—Andrea Gronenthal, Jack Finley, Nikki Leonardi,

and Patrick Petschel—for their contributions and support. At CFO Research Services, Celina Rogers directed the research and wrote the report.

Building a More Effective Tax Function is published by CFO Publishing Corp., 253 Summer Street, Boston, MA 02210. Please direct inquiries to Lisa

Nelson at (617) 345-9700, ext. 249 or [email protected].

CFO Research Services is the sponsored research group within CFO Publishing Corporation, which produces CFO magazine in the United States,

Europe, Asia, and China. CFO Publishing is part of The Economist Group.

October 2006

Copyright © 2006 CFO Publishing Corp., which is solely responsible for its content. All rights reserved. No part of this report may be reproduced,

stored in a retrieval system, or transmitted in any form, by any means, without written permission.

Building a More Effective Tax Function 1

© 2006 CFO PUBLISHING CORP. OCTOBER 2006

Contents

Introduction 2

About this Report 3

The State of the Tax Function 4

The Path Forward 10

Conclusion 16

Sponsor’s Perspective 17

Introduction

For Kansas City, Missouri-based tax preparer H&R Block,

few things are as critical to company performance as

maintaining credibility. This made the blow especially

hard to bear when the company announced in February,

2006 that it was restating earnings for 2004, 2005, and the

first two quarters of 2006 due to mistakes it had made in

calculating its state effective income-tax rates. H&R Block

had understated its state income tax liability by about $32

million as of the end of April 2005. These errors, said the

company, were uncovered as part of its ongoing effort to

remediate control weaknesses in the tax function.

H&R Block’s announcement—paired with a report of a 68

percent drop in third-quarter profits and lowered earnings

expectations—wreaked havoc on H&R Block stock; the

company’s share price fell almost nine percent in a single

day. More difficult to measure, however, was the effect of

the restatement on the company’s position in the market-

place: would this restatement undo the years of marketing

and advertising that had established the company as the

trusted tax preparer of millions of Americans?

The nature of H&R Block’s business no doubt made the

company exceptionally vulnerable to the embarrassment

of public restatement due to tax accounting errors. But

H&R Block has plenty of company—a long list of firms

including Kroger, Tyson Foods, Conagra, and Fortune

Brands have disclosed errors in tax accounting in the last

two years. Recent work by research firm AuditAnalytics

has made it clear that no company is immune to the risk

of exposure of tax accounting weaknesses; the firm

routinely cites tax accounting problems as the most

prevalent cause of material weaknesses reported under

section 404 of the Sarbanes Oxley Act. Mainstream

media outlets have also identified the trend: according

to newspaper reports, 183 companies identified tax

accounting errors in 2005, compared with 87 in 2004, 80

in 2003—and a mere 27 in 2002.

A recent study by shareholder advisory firm Glass, Lewis

& Co. LLC demonstrates the connection between reports

of material weakness in tax accounting and market

capitalization. According to a late 2005 letter from Glass,

Lewis to the SEC Advisory Committee on Smaller

Public Companies, companies that report material

weaknesses in tax accounting lose an average of nearly 6.8

percent in their stock price within 60 days of the

announcement. “I think it has surprised a lot of people

that accounting for income taxes has been the most

frequent reason for companies to fail in their Sarbanes-

Oxley compliance efforts,” says Charles Gilstrap, director

of tax at privately held manufacturer Dresser, Inc. “A lot

of well-known companies that did everything else right

had problems with their accounting for income taxes.

I think that’s been a kind of wake-up call for many

companies to focus more attention on these issues.”

Why has tax figured so prominently as a source for

material weaknesses? One reason, say analysts and

observers, may be the relative isolation of the tax function

from the rest of finance. In the past, tax reporting and

compliance have been considered distinct from other

financial reporting and compliance activities. Widely

accepted methods of tax accounting have, until recently,

treated many matters as subject to judgment rather than

accounting rules. And, as markets heated up in the

eighties and nineties, some companies had even shifted

the focus of their tax functions from controlling the cost

of tax liability to affirmatively extracting value by taking

aggressive tax positions.

All of this changed, however, with the massive accounting

scandals that marked the early years of the new millennium

—and with the advent of the Sarbanes Oxley Act. Sarbox

requires public companies to document and attest to

the controls of their finance processes—including tax

processes—with a high degree of precision. Many

companies, however, had never fully documented their

internal controls for tax. Accounting standards and

oversight boards also wasted little time in promulgating

new rules to place tax accounting in line with the

heightened regulatory environment. The rash of

restatements due to tax accounting errors indicates that at

least some companies are still struggling to catch up.

2 Building a More Effective Tax Function

OCTOBER 2006 © 2006 CFO PUBLISHING CORP.

Study Methodology

About this Report

In the spring of 2006, CFO Research Services launched

a study of the tax function’s priorities and challenges.

Our task? To learn how tax is meeting the challenges

posed by an increasingly complex, competitive, and

risky regulatory and business climate.

Because the traditional arrangement in which the tax

function carries on its activities at some distance from

finance appears to be coming under pressure as

regulatory reporting and tax accounting regimes

change, this study explores the priorities and challenges

companies face in tax from two perspectives—from the

point of view of tax executives, and from the point of

view of senior finance personnel. We expected to find

points of difference as well as points of alignment

between the two groups; the results of the study,

however, showed a startlingly wide gap between the

perceptions of tax professionals and their colleagues in

finance.

Broadly speaking, the study reveals that the tax func-

tion is indeed responding to a series of difficult chal-

lenges. Heightened regulatory reporting requirements

and accounting standards changes for tax have been

layered on top of increasingly aggressive state and

federal tax enforcement activity. Tax executives have

also come under pressure as their companies

undertake increasingly complicated—and increasingly

global—business activities. It’s widely understood that

effective tax planning can free up cash and reduce

future tax liabilities. In a highly competitive global

business environment, such gains are more important

than ever, and we found that tax executives are keenly

interested in pursuing them.

But while both tax executives and their peers in finance

are feeling the pressure from investors and regulators,

the results of this study show that finance underestimates

the pressure on the tax function and the urgency with

which tax seeks to meet its challenges. Because the

very nature of these challenges—including the movement

toward transparency in tax accounting and the

increased intensity of regulatory and investor scrutiny

of tax reporting—demands close collaboration between

tax executives and their colleagues elsewhere in

finance, it is important for each group to understand

and respond to the concerns of the other.

To examine executives’ views on the corporate tax function,

we executed a research program among senior finance

and tax executives, as follows:

To gauge aggregate opinion on the state of the tax function,

we surveyed senior finance and tax executives at North

American companies by invitation through an electronic

questionnaire. In total, we gathered 336 responses, 36

percent of whom are tax executives, 64 percent of whom

are finance executives outside the tax function. A majority

of responses come from public companies. Respondents

come from a broad cross section of the U.S. economy, with

particularly strong representation from the manufacturing,

financial services, and wholesale/retail industries. Nearly

two-thirds of respondents are from companies with more

than $500 million in annual revenue.

To supplement this quantitative research, we conducted a

series of interviews with senior finance executives at the

following companies:

• The Mentor Network

• Vertis Communications Inc.

• Dresser, Inc.

• The Manitowoc Company, Inc.

• Millipore Corporation

• Pratt Industries

• Square D, a Division of Schneider Electric SA

• Several other companies that asked not to be cited by

name in this report

3


The State of the Tax Function

What is the primary focus of your company’s tax

function—compliance or planning? In which areas is

your company’s tax function performing well? Where

is there room for improvement? We posed these and

other questions to senior finance and tax executives to

gauge the current state of the tax function—its strengths,

as well as its weaknesses. The portrait of the tax function

that emerged from this inquiry reveals opportunities for

improvement and increased collaboration as companies

build the tax function of the future.

Tax compliance mastery

Survey results show that tax compliance—not planning

—is the primary activity of most tax functions. Eighty-

four percent of all respondents said the tax department

at their companies devoted most of their resources to

tax compliance—activities such as preparing returns,

record keeping, and so on. Only 16 percent said their

tax departments committed most of their resources to

tax planning. See Figure 1.

Although survey results show that most resources flow

to tax compliance at many companies, the CFOs and

tax directors we interviewed were quick to point out

the critical role of tax planning at their companies,

even as they strongly emphasized the importance of

compliance with tax regulatory regimes. Both sets of

activities, interviewees agreed, had an important role

to play in helping companies reach their ultimate

goal—maximizing shareholder returns.

A well-managed balance of tax compliance activities,

tax planning, and risk management is in fact the core

work of the tax function, according to those we

interviewed. “The key drivers of what we do in the tax

area are the need to minimize the level of taxation

within the law and to do all the tax planning connected

to that—as well as the need to make sure the tax risk

environment is well within acceptable bounds,” notes

Carl Laurino, CFO of heavy equipment manufacturer

Manitowoc. “That’s the essence of our structure, and

I think that this balance has become even more

nuanced in the context of heightened regulatory

compliance.”

Survey results indicate that, in general, the tax

function performs its tax compliance activities well.

Respondents note that tax is performing particularly

well when responding to challenges to the company’s

tax positions and complying with income tax

regulations. But respondents are much less likely to

say that their tax function is performing well at less

structured general business management activities,

such as managing business risk and supporting day-to-

day business decision making. See Figure 2, next page.

It makes sense that the tax function would seek to

perfect critical tax compliance activities; these results

suggest, however, that many companies would realize

gains by expanding the scope of the tax function’s

attention to include more of these general business

management activities.



Tax compliance—not planning—is the core activity of the tax function.

The tax department at my company devotes most of its resources to ______________.(Percentage of respondents)

Compliance (e.g., preparing returns, recordkeeping, etc.)

Planning (i.e., analyzing tax consequences of business decisions)

FFiigguurree 11..

Indeed, an analysis of survey results reveals a broad tax

performance continuum. When the tax function is

called upon to perform clearly identified, assigned

duties such as routine tax compliance, it performs

extremely well. The tax function performs well—

although somewhat less well—in the role of a structured

business partner, when it provides support in relatively

circumscribed situations such as major transactions or

corporate restructuring. Performance declines further,

suggests the survey data, when tax is asked to take on

the role of an ad-hoc, unstructured business partner—

for example, by taking on a leadership role in key

business management and risk management efforts.

The less structured, familiar, and defined the activity,

the less frequently respondents say their tax functions

are “performing well”—and the more frequently

they say there is “room for improvement” in tax.

See Figure 3.

5


The tax function is doing best at core tax compliance activities.

In your opinion, does your company’s tax function perform the following activities well, or is there room for improvement in its performance? (Percentage of respondents)

0 20 40 60 80 100

Room for improvementPerforming well

Advising business management on taximplications of day-to-day business decisions

Managing exposure to business riskassociated with tax

Contributing to non-tax regulatory compliance efforts(e.g., Section 404 of the Sarbanes-Oxley Act)

Participating in deal structuring formajor transactions

Complying with non-income tax regulations

Complying with income tax regulations

Responding to tax-authority challengesto the company’s tax position(s)

FFiigguurree 22..

The performance continuum: tax function performance declines when tax is called upon to act as an ad-hoc, unstructured partner in business management.

(Percentage of respondents saying their companies are “performing well”)

0

20

40

60

80

100

Advising business management on tax implications of day-to-day business decisions

Managing exposure to business risk associated with tax

Contributing to non-tax regulatory compliance efforts (e.g., Section 404 of the Sarbanes-Oxley Act)

Actively seekingopportunities for tax reduction

Participating in deal structuring for major transactions



Responding to tax-authority challenges to the company’s tax position(s)

Routine tax compliance

Structured business partner Ad-hoc,

unstructured business partner

FFiigguurree 33..



Survey results suggest that many companies would ben

fit from a tax function that acts not just as the steward

of tax accounting and compliance, but as a true business

partner. But what would such a partnership look like—

and what is the role of tax and finance function leadership

in promoting collaboration between tax and other

functional areas of the business? At Baltimore-based

marketing communications, printing, and consulting firm,

Vertis Communications, the tax function has moved well

beyond the traditional bounds of the tax department,

says vice president of tax Myron Vansickel. “More and

more, tax directors are being tapped to develop different

business initiatives,” says Vansickel. “It’s becoming

clear that tax directors aren’t simply tax technocrats.”

This shift, Vansickel continues, is due at least in part to

heightened accounting standards and more intense

regulatory scrutiny: “I think that Sarbanes-Oxley and

the level of detail that’s now required in tax accounting is

going to force CFOs and CEOs to see that the tax director

or the VP of tax has a great deal of valuable knowledge—

information about the organization and insight into how

business issues have to be approached from a tax

perspective.”

Although he notes that the tax function’s profile has been

raised by regulatory shifts in the last few years, Vansickel

emphasizes the importance of leadership in the tax

function. A willingness to take the lead on important

management initiatives and adopt a proactive stance

with respectto business issues is, he suggests, as

important to raising tax’s profile as external forces such

as the heightened regulatory environment. And with the

tax function’s higher profile come opportunities to build

strong relationships between the tax function and other

critical business constituencies—between the tax

function and the C-suite, other functional areas in finance,

business unit heads, and even the board of directors.

The heightened regulatory environment has, for example,

contributed to greater collaboration between the tax function

and the audit committee at many companies, Vansickel notes.

“With Sarbanes-Oxley, the audit committee has become very,

very attuned to the tax department, especially with evaluating

risk,” said Vansickel. “There’s more interaction at the

audit-committee level, which means that the CFO and the

CEO need to know more—so that heightened their level of

scrutiny.” This dynamic, he notes, has begun to elevate

corporate tax functions to the highest levels of management.

“In the last several months, I’ve worked with the VP of

finance and the CFO on all major transactions,” says

Vansickel. “I have a seat at the table because they see

that I’m asking questions that need to be asked. Before

we do a transaction, we need to understand the tax

implications—the GAAP accounting changes, the after-

tax cash flow, and so forth. The tax function needs to

work with the controller and with VPs of finance to work

through these issues—to be at their level and

understand what they do and what they need.”

Vertis Communications:The tax function asbusiness partner

These results suggest that there is an opportunity for

many companies to realize substantial business bene-

fits by setting the conditions for the tax function to act

as a true partner in the business. (See sidebar, “Vertis

Communications: The tax function as business

partner,” below.)

When asked to assess their companies’ processes for

managing and complying with assorted tax regimes,

respondents were mostly likely to say their processes

for complying with federal income taxes, payroll and

benefits taxes, and state income and franchise taxes

were “excellent.” See Figure 4. But processes for

compliance with sales and use taxes, foreign tax

regimes, and excise tax ranked far behind.

Why this difference? The executives we interviewed

cited the prominence of federal enforcement efforts—

and the high stakes of non-compliance with U.S.

income tax regulations. “Federal tax is always a prior-

ity,” says Charles Gilstrap, tax director at manufacturing

company Dresser, Inc. “It’s more complex, and there

are larger dollar amounts involved—and the possible

exposure if a company is not fully in compliance is

much higher there. Other areas such as sales and use

tax are certainly important, but they often take a back

seat to federal income tax at many companies.” All the

executives we spoke with emphasized the importance

of fully complying with all applicable tax regulatory

regimes. Some of those regimes, they noted, command

more time and attention due to the nature of a

company’s business—the number of state and local

taxing jurisdictions in which a company operates, the

composition of its customer base, and so on. But as

regulatory and investor scrutiny intensify, it may well

become necessary for companies to devote as much

time and attention to areas that have historically

featured less prominently—such as sales and use tax or

foreign tax—as they currently devote to federal income

tax matters.

Performance perception gap between

tax executives and their peers in

finance

A comparison between tax executives’ evaluation of tax

function performance and that of their finance peers

reveals a substantial difference in their perceptions.

Nearly across the board, tax respondents are more

likely to say that their tax departments are performing

well than their colleagues in other functional areas

in finance. The distinction is particularly evident,

however, when respondents assessed the tax function’s

performance in business decision support, regulatory

compliance, and risk management matters. See Figure 5.

7


Companies are most confident in their compliance processes for federal income tax.

How would you characterize your company’s processes for managing and complying with each of the following items?

0 20 40 60 80 100

Excellent Unsatisfactory Satisfactory

Excise tax

Foreign tax

Sales and use taxes

Non-routine tax events (i.e., major transactions, earnings repatriation, etc.)

Real and tangible personal property taxes

State income and franchise taxes

Payroll and benefits taxes

Federal income taxes

(Percentage of respondents)

FFiigguurree 44..

Nearly across the board, tax respondents have a more positive view of tax function performance than their peers in finance.

In your opinion, does your company’s tax function perform the following activities well, or is there room for improvement in its performance? (Percentage of respondents saying the tax function is “performing well”)

0 20 40 60 80 100Finance Tax

Advising business management on tax implicationsof day-to-day business decisions

Participating in deal structuringfor major transactions


Managing exposure to businessrisk associated with tax

Actively seeking opportunities for tax reduction

Contributing to non-tax regulatory complianceefforts (e.g., Section 404 of the Sarbanes-Oxley Act)


Responding to tax-authority challenges tothe company’s tax position(s)

FFiigguurree 55..

Why this gap in perception? Because tax executives are

closer to the activities of the tax function, it would be

entirely reasonable to attribute the difference in

performance assessments to differences in knowledge

and access between the two groups. The possibility that

tax respondents have different standards from their

finance colleagues for what constitutes good

performance in decision support, compliance, and risk

management should not be overlooked, however. These

results indicate that tax executives—pressed for time,

short of resources, and responding to substantial

changes in the regulatory and business environment—

believe they are exceeding expectations. Survey results

tend to show that their colleagues in finance, however,

would benefit from more support from tax in decision

making, regulatory compliance, and business risk

management—areas traditionally viewed as outside of

tax’s purview. So, no matter what the source of the

perception gap, these results point to an area where

further discussion and increased collaboration between

tax and finance executives may yield substantial benefit.

Increased communication, say the executives we

interviewed, should be an important element of such an

effort. “We’ve been on a communication campaign

for a few years now, to raise the awareness of various

parts of the business as to the kinds of thing they could

do that would impact tax considerations,” says Kathleen

Allen, CFO of biopharmaceutical manufacturer

Millipore. “Our vice president of tax, Paul O’Connor, and

his team have proactively gone out to spend time with

senior business leaders in the company—with leaders

in manufacturing, with our R&D organization—to

educate them on how the things they do affect the tax

accounting in the organization,” Allen continues. “It’s

very healthy for them to be sensitized to the possible tax

impact of their decisions. We always want to make

business decisions for the right business reasons, but

we need to think about the financial impact of

decisions holistically—including the tax ramifications

of those decisions.”

The perception gap between tax executives and their

colleagues in finance especially pronounced when

respondents are asked to assess the impact of the most

important regulatory and market developments of the

last three years on the day-to-day activities of the tax

function. More than half of all tax respondents said that

the Sarbanes-Oxley Act had greatly impacted their

company’s tax department over the last two years. A

majority of tax respondents also said that time, budget, or

resource constraints had had a great impact on the tax

function over the last two years. Rounding out tax

respondents’ top three concerns, 30 percent of tax

respondents cited increased overseas business activities

as having a great impact—and more than a quarter of tax

executives said increased investor scrutiny had greatly

impacted their tax departments over the last two years. In

general, tax respondents indicated that broad business and

regulatory developments had affected the tax function

even more than the tax-specific developments of the last

few years, including very prominent changes such as more

aggressive enforcement of rules and regulations by taxing

authorities. See Figure 6. Their finance colleagues,

however, hold very different views on the subject.

Respondents from other functional areas in finance

perceived the tax function as relatively unaffected by

recent developments like Sarbanes-Oxley, increased

investor scrutiny of financial reporting, and changes in

their companies’ overall risk profile. Nearly half of all

finance respondents from outside the tax function said

that Sarbanes-Oxley had had “little or no impact” on

the tax function over the last two years. Fifty-five

percent of finance respondents said increased investor

scrutiny of financial reporting had had little or no

impact on the tax function, and fifty-four percent of

finance respondents said increased overseas business

activities had had little or no impact.



Survey results tend to show that the tax function’s colleagues in

finance would benefit from more support from tax in decision

making, regulatory compliance, and business risk management—

areas traditionally viewed as outside of tax’s purview.

These results reveal a critical point of difference

between the actual experience of corporate tax

directors and the perceptions of their colleagues

elsewhere in finance. A variety of forces both within tax

and in the larger business and regulatory world have

affected the tax personnel much more than many of

their peers in finance appear to realize. Tax must adapt

to these changes and address a broad array of new

challenges. But the lack of awareness within the larger

finance community of the many pressures on the tax

function point toward a question: Will tax have

adequate support for its efforts?

9


Tax executives and their counterparts in finance assess the impact of broad regulatory and business developments on the tax function very differently.

In your opinion, how much have the following items affected the day-to-day activities of your company’s tax department over the last two (2) years? (Percentage of respondents saying “great impact”)

0 10 20 30 40 50 60Finance Tax

Change in the company’s overall risk profile

More aggressive enforcement of rules andregulations from taxing authorities

Rules and standards limiting taxguidance from external auditors

Increased investor scrutiny of financial reporting

Increased overseas business activities

Time, budget, or resource constraints

Sarbanes-Oxley Act+ 34% points

+ 25% points

+ 17% points

FFiigguurree 66..

The Path Forward

External business forces and regulatory changes are

pressing the tax function to stretch beyond its traditional

bounds to participate in broad business management and

risk management initiatives. The results of this research

program indicate that many tax executives are already

moving beyond their traditional roles. But survey

responses also show that, as the tax function is called to

aid or drive decisions that extend outside its closely

circumscribed, traditional tax compliance activities, its

own assessment of its performance tends to decline.

Recent developments in the regulatory and business

environment have presented an opportunity for the tax

function to take on a more wide-ranging role in broader,

less-structured management efforts. As we shall see,

survey results show that tax is aware of the opportunity—

and even the necessity—for change. But given the wide

gap between tax and their finance colleagues’ perceptions

of the tax function, its performance, and its current state

of flux, are companies setting the conditions for the tax

function make an successful transition?

The tax function agendaWhen asked to rate the tax function’s priorities among

several broad business initiatives, we found that tax

respondents were keenly interested in risk management

activities. Indeed, tax executives’ highest priorities were

preventing public restatement of earnings projections

and financial statements, and, more generally, protecting

the company’s reputation. See Figure 7.

These results may, at first glance, seem unremarkable

given the current regulatory and business climate. But

tax executives ranked risk management priorities well

ahead of managing the company’s effective tax and

cash tax rates—even though the effective tax rate and

cash tax rate are often considered key indicators

of the tax function’s overall performance, and an

important component of many tax directors’ incentive

compensation calculations. Eighty-one percent of tax

respondents said preventing public restatement is a

high priority, and an equal number of respondents said

protecting the company’s reputation is a high priority.

But only fifty-nine percent of tax respondents said that

managing the effective or cash tax rate is a high

priority. These results confirm that the tax function

and its agenda are in a state of transition.

What is the nature of that transition? Few would

dispute that the tax function acts as the steward

of tax controls and compliance within the company.

Tax planning—including decision support, deal

structuring, and the search for both short-term and

permanent tax savings—is also an important part of

the tax agenda. Forty-three percent of respondents to

our survey said, for example, that contributing to

business decision making is a high priority; 46 percent

assessed management reporting for internal decision

making as a high priority. Tax respondents’ intense

interest in risk management priorities, however,

indicates that tax is poised to take on a broader role

within the company—if it hasn’t already. Indeed,

survey responses, taken as a whole, show that tax is



Risk management initiatives are among the tax function’s highest priorities.

In your opinion, how high a priority are the following activities within the tax function at your company? (Percentage of tax respondents)

0 20 40 60 80 100Low priorityMid-level priorityHigh priority

Contributing to a company-widerisk management effort

Contributing to business decision making

Providing useful tax estimates to companymanagement for internal decision making

Complying with non-income tax regulations(e.g., Sarbanes-Oxley)

Managing effective tax rate and/or cash tax rate

Preventing public restatement of earningsprojection and/or financial statements

Protecting the company’s reputation

FFiigguurree 77..

firing on all cylinders in almost all categories; from the

point of view of tax executives, it seems that there are

no low priorities within the tax function. But when we

queried executives from other areas in finance on tax's

priorities, a different perspective emerged.

Nearly across the board, there were striking differences

in the assessment of broad priorities in tax between tax

executives and their colleagues in finance. The gap was

widest, however, when respondents addressed priorities

like preventing public restatement, non-tax compliance,

and protecting the company’s reputation. Only

48 percent of executives from other functional areas in

finance said that preventing public restatement of

earnings projections or financial statements was a high

priority for tax at their companies—as compared with

81 percent of tax respondents. While 81 percent of tax

respondents also said that protecting the company’s

reputation was a high priority in the tax function, only

64 percent of their counterparts in finance said the

same. And while a clear majority of tax respondents—

56 percent—said complying with non-tax regulations

like Sarbanes Oxley was a high priority for the tax

function, only 25 percent of their finance counterparts

believed non-tax compliance to be a high priority for

tax. See Figure 8.

These results suggest that, broadly speaking, the

tax function’s current agenda may not be widely

understood within the larger finance function. Tax

executives indicate that risk management and financial

reporting and compliance have been layered on top of

the tax department’s traditional duties, including tax

compliance, planning, and decision and transaction

support. And, it seems, tax executives feel the pressure

of this newly expanded agenda much more keenly than

many of their colleagues in finance realize.

Responding to this expanded agenda will require a

commitment of time and resources, executives note.

“Minimizing the level of taxation within the law, doing

all the necessary tax planning attendant with that

effort, and making sure you’re in an environment of

acceptable tax risk—those are some of the key drivers

for new initiatives in tax,” says Manitowoc CFO, Carl

Laurino. “The single biggest driver of risk in the tax

area is, without question, growth in the organization,”

Laurino continues. “As a company grows, it obviously

becomes much more complex from a taxation

standpoint—and opportunities change as you bring on

new businesses in different geographies. The resources

devoted to tax need to be appropriate for the size of the

organization, and that resource issue should be

constantly reviewed as the organization changes. If

you’re not sizing the organization and the resources

you bring into it appropriately, you won’t be able to

take full advantage of opportunities to enhance

shareholder value by minimizing tax payments within

the bounds of the law.”

11


Risk management initiatives are among tax executives’ highest priorities. But their colleagues in finance underestimate the urgency with which tax is pursuing its agenda.

In your opinion, how high a priority are the following activities within the tax function at your company? (Percentage of respondents saying “high priority”)

0 20 40 60 80 100Finance Tax

Contributing to a company-wide riskmanagement effort

Contributing to business decision making

Providing useful tax estimates to companymanagementfor internal decision making

Complying with non-income tax regulations(e.g., Sarbanes-Oxley)

Managing effective tax rate and/or cash tax rate

Preventing public restatement of earningsprojections and/or financial statements

Protecting the company’s reputation+ 17% points

+ 33% points

+ 30% points

FFiigguurree 88..

Pursuing the new tax agenda—

improving management of people,

processes, and technologyTo learn more about how the tax function proposes

to realize its broader objectives, we queried executives on

their priorities among a wide array of people, process,

and technology improvement initiatives. As companies

assess the strengths and weaknesses of their tax

function—and as tax takes on a more expansive role

within the business—the results of the survey shed light

on how the tax function will choose among many

competing tax initiatives over the next two years.

Tax’s highest-priority initiatives focus on process

improvement and technology upgrades. Tax respondents

were most likely to cite process improvement for income

tax accounting and tax contingencies as a high priority;

nearly three-quarters of tax respondents listed this as a

high-priority initiative. Tax executives also showed a clear

interest in improving the quality of the information used

for tax purposes; half of tax respondents labeled

adopting new technology to improve information quality

as a high priority, and 41 percent of tax respondents said

that implementing new processes to improve the quality

of financial information used for tax purposes was a high

priority within tax. Nearly half of tax executives—

47 percent—said improving processes for routine tax

activities such as tax returns, routine filings, and

payments to taxing authorities was a high priority.

Despite a number of high-profile reports in the business

media of a shortage of qualified tax professionals,

improving talent management ranked lower on tax

executives’ list of improvement priorities. See Figure 9.

While it may seem difficult at first glance to reconcile tax

executives’ priorities for improvement—which seem, in

general, to be tightly focused on improving core tax

compliance activities—with the expanded agenda they

identify for themselves, close observation shows that

tax’s improvement priorities in fact track very closely

onto the tax function’s broader, more risk-sensitive

agenda. Process improvements for tax accounting and

contingencies, as well as information-improvement

initiatives, are direct responses to heightened accounting

standards—which require more accurate information

to support certain tax positions and more detailed

accounting treatment for tax matters—and to the

Sarbanes Oxley regime, which requires tax accounting

processes to be thoroughly documented. But a

comparison of tax executives’ views on the highest-

priority initiatives within tax with the views of their

finance counterparts reveal another wide gap in

perception between the two groups.



Process improvement for core tax activities and technology upgrades are tax executives’ highest-priority initiatives over the next two years.

Looking forward over the next two years, how would you rate the following initiatives within the tax function? (Percentage of tax respondents saying “high priority”)

0 10 20 30 40 50 60 70 80

Revising variable compensationplans for tax professionals

Improving processes for responding to taxingauthority requests and challenges

Collaborating more closely with other functionalareas in finance (e.g., internal audit)

Improving processes for non-routine tax activities(i.e., major acquisition or divestiture, repatriation

of earnings, etc.)

Improving talent management for taxprofessionals (i.e., recruiting, training, etc.)

Documenting and/or remediating tax accountingprocesses in order to comply with Sarbanes-Oxley

Implementing new processes toimprove the quality of financial information

used for tax compliance and analysis

Improving processes for routine tax activities(i.e., tax returns, regular filings and

payments to taxing authorities, etc.)

Adopting new technology to improve the quality(i.e., accuracy, reliability, and timeliness) of financial

information used for tax compliance and analysis

Improving processes for income taxaccounting and for tax contingencies

FFiigguurree 99..

Again, nearly across the board, tax executives identify

more urgent priorities within the tax function than

their colleagues in finance. The difference in the level of

priority assigned to tax executives’ highest priorities

is striking: 74 percent of tax respondents said that

improving processes for tax accounting and

contingencies is a high priority within tax—but only

26 percent of their finance counterparts said the same.

Half of all tax respondents said that adopting new

technology to improve the quality of information used for

tax purposes is a high priority; only 25 percent of their

finance colleagues said the same. And, while 47 percent of

tax respondents said improving processes for routine tax

activities is a high priority, only 24 percent of respondents

from other finance areas agreed. See Figure 10.

The differences between tax executives and their finance

colleagues are not limited, however, to process and

information technology improvement initiatives. There

are also sharp differences in the two groups’ assessment

of “people management” priorities. Tax executives, for

example, are much more interested in collaborating more

closely with other functional areas in finance than their

finance peers seem to realize. This openness may point

the way to a more collaborative approach between tax

executives and their finance colleagues as they take on

challenging improvement initiatives.

Conversations with tax and finance executives suggested

that personnel management and risk management often

go hand-in-hand. Tax personnel skilled in a variety of tax

specialties—and able to grasp the broad business implica-

tions of tax decisions—are an important part of tax risk

management efforts. “Tax is one of the areas that has—

from a talent perspective—definitely been impacted of the

new regulatory environment. Our goal, of course, is to

hire the best talent we can, and these people are in increas-

ing demand,” says Millipore CFO Allen. “People who

understand this very complex area and all the regulatory

forces at play between the various tax jurisdictions, U.S.

GAAP accounting, Sarbanes-Oxley internal control con-

siderations, and so on are very valuable resources, and

they’re getting increasinglycompetitive in the marketplace.”

Risk analysis led Manitowoc to make changes in

governance and in resource allocation, says CFO

Laurino. “Our tax people went through a risk analysis,

and some of the changes we’ve made—such as including

our director of tax on the audit committee—were

actually not specifically requested by the audit chair

until he became part of the tax risk process.” Manitowoc,

Laurino noted, has also made a significant resource

commitment to tax in recent years, adding specialized

tax staff including a head of global taxation and a

specialist in transfer pricing. “I think all of this is an

evolution reflecting not only changes in our organization

and the need to make sure we’re changing with the

organization, but also our need to make sure we’re not

leaving opportunities on the table or creating more risk

for the organization from a tax standpoint,” he says.

13


Tax executives and their counterparts in finance assess tax improvement initiatives very differently.

Looking forward over the next two years, how would you rate the following initiativeswithin the tax function? (Percentage of tax respondents)

0 10 20 30 40 50 60 70 80Finance Tax

Revising variable compensationplans for tax professionals

Improving processes for responding to taxingauthority requests and challenges

Collaborating more closely with other functionalareas in finance (e.g., internal audit)

Improving processes for non-routine tax activities(i.e., major acquisition or divestiture, repatriation

of earnings, etc.)

Improving talent management for taxprofessionals (i.e., recruiting, training, etc.)

Documenting and/or remediating tax accountingprocesses in order to comply with Sarbanes-Oxley

Implementing new processes toimprove the quality of financial information

used for tax compliance and analysis

Improving processes for routine tax activities(i.e., tax returns, regular filings and

payments to taxing authorities, etc.)

Adopting new technology to improve the quality(i.e., accuracy, reliability, and timeliness) of financial

information used for tax compliance and analysis

Improving processes for income taxaccounting and for tax contingencies

+ 48% points

+ 25% points

+ 23% points

FFiigguurree 1100..

Obstacles to changeWhat challenges does the tax function face as it

pursues a new and expanded agenda? We asked

survey respondents to identify barriers to changing

the tax function at their companies, and we found,

unsurprisingly, that time, budget, and resource

constraints rank high on tax executives’ list of

obstacles. Three quarters of tax respondents said that

time, budget, or resource constraints stand in the way

of change in their tax functions. A majority of the tax

executives we surveyed said that the tax function’s lack

of stature or influence poses a barrier—and more than

half of tax respondents said that difficulty recruiting

and retaining qualified tax personnel is an obstacle to

change. See Figure 11.

Tax respondents experience these barriers more

acutely than their finance colleagues; they are more

likely, across the board, to affirm that resource

scarcity, the tax function’s lack of stature or influence,

and recruiting and retention difficulties pose

significant obstacles. Most notable is the gap in

perception regarding tax’s stature or influence within

the company: 54 percent of tax respondents said that

the tax function’s lack of stature or influence in their

companies is a barrier to change. Only 35 percent of

their colleagues in finance perceived tax’s lack of

stature or influence as a barrier. See Figure 12. In a

separate question, 77 percent of tax respondents said

that their company’s most senior tax executive should

report directly to the CFO—but only 66 percent of

their finance counterparts agreed. These results tend

to show that tax executives are dissatisfied with

the perception of tax as less central to business

performance than other finance activities—and a

reporting structure in which the most senior tax

executive reports directly to the chief of the finance

function may well symbolize tax’s desire to move even

closer to the very center of the business.



Resource scarcity tops tax respondents’ list of obstacles to change.

Looking forward over the next two years, how would you rate the following initiatives within the tax function? (Percentage of tax respondents saying “yes”)

0 10 20 30 40 50 60 70 80

Desire to keep the tax function separatefrom the rest of the business

Lack of communication between tax andother functional areas in the business

Difficulty recruiting/retaining qualified tax personnel

Lack of stature/influence of the tax function

Time budget or resource constraints

FFiigguurree 1111..

Tax respondents experience barriers more acutely than their finance peers.

Do you perceive the following items as barriers to changing your company's tax function?(Percentage of respondents saying “yes”)

0 10 20 30 40 50 60 70 80Finance Tax

Desire to keep the tax function separatefrom the rest of the business

Lack of communication between tax andother functional areas in the business

Difficulty recruiting/retaining qualified tax personnel

Lack of stature/influence of the tax function

Time budget or resource constraints

FFiigguurree 1122..

A comparison of tax executives’ responses with those of

their peers in finance indicates that many representatives

from both groups agree that a lack of communication

between tax and other functional areas in the business

poses a barrier to change. This result tends to affirm

the notion that companies would realize substantial

business benefits if communication and collaboration

between tax and other parts of the business were

encouraged—if tax, in other words, were drawn closer

to the center of business activity.

The tax and finance executives we interviewed for this

report echo survey respondents’ concerns with respect

to obstacles to change in the tax function. “We’re

working to become even more efficient, and we’re

continuing to try to cut back on the manual component

of what happens in the tax area,” says Manitowoc’s

Laurino. “You have to think not only of what’s

appropriate for the organization at that time, but what

resources you can put into place that will fit what you

need today, that will also be beneficial to you as the

organization continues to change. That takes a little

more up-front time and planning, so that’s one

constraint. There’s often some inertia that also needs

to be overcome, but that’s natural—certainly it’s

something we work through, but it always needs to be

managed.” And, as Dresser CFO Bob Woltil points out,

it can also be fruitful to think of obstacles as challenges:

“There are a lot of competing priorities and competition

for resources, just because there’s a lot going on and

everybody is busy. We don’t think of this as a barrier;

we think of it as a series of challenges in keeping

everybody moving in the same direction and on the

same set of priorities.”

15


Conclusion

The tax function at U.S. companies has been buffeted

by a series of difficult challenges in recent years. The

combination of new regulatory scrutiny, more intense

enforcement from taxing authorities, and increasingly

complex business operations have all brought new

light and new oversight to the corporate tax function.

Pressure from taxing authorities, regulatory regimens,

accounting bodies, and external auditors has made

the core work of the tax function—balancing tax

compliance, planning, and risk management activities

—even more difficult in recent years, according to this

research program among senior tax and finance

executives at U.S. companies.

The good news, say survey respondents, is that the tax

function is performing its core tax compliance activities

effectively. And while finance and tax executives say

the tax function’s performance erodes somewhat when

tax professionals are called upon to contribute to more

general business decisions, this research identifies a

path to improved performance.

Study participants say their tax teams devote the vast

majority of their time and attention to complying with

tax regulations—completing tax returns and interacting

with taxing authorities—and to tax record keeping and

accounting. As members of the broader finance

function, tax executives are often called on to render

opinions on day-to-day operating decisions, to

participate in major transactions, and to help make

decisions to manage and mitigate business risk. It is in

these unstructured, ad hoc business partnership

activities, study respondents say, that the tax function

will likely find the most room for improvement.

It may well be that performing these unstructured

activities is fundamentally more difficult than carrying

out well-honed, well-documented processes such

as corporate tax return preparation. Indeed, the

requirements and deadlines involved with advising on

transaction structures or on operating decisions from

a tax point of view are quite different from those of

tax returns, audit responses, and so on. But the tax

function—particularly in today’s regulatory and

business environment—will be called upon to handle

all of these types of activities, and many more.

How will the tax function respond to these challenges?

Participants in this study agree that information

sharing between tax and other functional areas in

finance—and also between tax and broader business

constituencies including the C-suite, business unit

heads, and the board of directors—is critical to striking

the optimal balance between tax compliance, planning,

and risk management. But survey results show that tax

executives and their peers in finance have very

different perceptions of the tax function’s agenda,

priorities, and challenges. This marked gap in

perception between the two groups strongly points to

a strategy for improvement based on closer

collaboration between the finance and tax functions.

The difficult part, of course, is how to cultivate this

closer collaboration. This research program suggests

that the right combination of governance of the tax

function, effective talent management, and resource

commitments commensurate with a high performance

tax function will yield business benefits. Proper

governance, interview program participants note, is

less an aspiration than a necessity in light of

recent regulatory shifts. Taking an additional

governance step, however, by formalizing the tax

function’s relationship with the audit committee is one

way to encourage communication, enhance planning,

and reduce risk, according to participants in the

interview program. Recruiting and fostering tax

personnel with sophisticated tax technical skills—and

a broad perspective on business issues—is also high on

the tax function agenda. But most critical to meeting

companies’ tax challenges in coming years, say

interview program participants, is committing the

required resources—that is, the necessary time,

attention, and budget—to this effort as companies

grow, change, and respond to new business challenges.



In the current business environment, closer integration

between the tax and finance functions is more critical

than ever before. As a result, companies that synchronize

the two functions will reap significant benefits in both

areas. From the finance perspective, closer alignment will

result in better information for capital markets and other

users of the company's financial statements. From the tax

perspective, it will result in enhanced tax reporting and

compliance, as well as improved management of tax risk.

Overall, collaboration will result in more effective

financial disclosure, financial reporting, budgeting and

forecasting, and will provide companies with an effective

comprehensive risk strategy.

Historically, tax and finance have operated independently;

however, a myriad of nascent factors now point to the

need for change. Among these factors are a major shift in

the role of the tax function, changes in the regulatory

environment, increased investor scrutiny, heightened tax

compliance enforcement, evolving interpretations of tax

and accounting issues, and the growing complexity and

speed of business.

During the past several decades, there has been a

paradigm shift in the way the tax function operates. Up

until the 1980s, tax's focus was on cost efficiency and

minimization. Its responsibility has since evolved to

driving shareholder value, increasing ROI and reducing

taxes in the 1990s; to proactively managing risk posed by

external drivers such as the Sarbanes-Oxley Act today.

Because of this shift, tax must be more engaged, proactive

and nimble than in the past. It must be involved at the

front end of business and financial decisions and have an

obvious presence throughout the entire organization.

This isn't optional; it is a necessity. Organizations that

don't migrate the tax function to a more proactive and

holistic approach will carry significantly more tax risk.

Tax must be more "finance-centric," and similarly finance

must be more "tax-centric."

Our study suggests, however, that collaboration is

hindered by a large disparity between the way tax

professionals and finance professionals view the

priorities and challenges facing the tax function. The

study shows, for example, that tax executives and

finance executives have different perceptions about the

impact of recent regulatory and market developments

on the day-to-day activities of the tax function. For

instance, more than half of tax respondents said that

Sarbanes-Oxley had greatly impacted their company's

tax department over the last two years, compared to

only 21 percent of finance respondents.

While companies may recognize the importance of

alignment between tax and finance, it will not happen

automatically. For alignment to occur, senior managers

and boards of directors must communicate to both

functions that better coordination between them is

critical.

Equally important, tax must be made aware of the

company's overall risk strategy and tolerance. Risk

policy guides complex business decisions, including

how tax is evaluated for financial reporting and

disclosure. Without a coordinated risk strategy, both

tax and senior management might take actions that

could negatively impact the other.

In addition to aligning the risk policy throughout the

company, minimizing tax risk also requires developing

and documenting internal controls to ensure that

processes related to the integration of finance and tax

are carefully followed. Those processes and controls

should include a formal communication system that

spells out what information each function requires

from the other and how it should be presented.

Ultimately, the goal is for each function to provide the

other with complete, pertinent and high quality data.

17


Sponsor’s Perspective

New rules issued by the Financial Accounting Standards

Board offer an excellent example of why tax and finance

must be better integrated. Final Interpretation Number

48, Accounting for Uncertainty in Income Taxes (FIN

48), represents a sweeping change in the accounting and

reporting model for income taxes. It lays out detailed

rules that standardize how income taxes must be

disclosed in company financial statements. The rules

also will affect reporting of key financial measures,

budgeting, and how companies communicate with

financial markets. For the tax function to meet the

demands of FIN 48, it has to rely on finance for

information. Similarly, finance needs information from

tax to produce more accurate financial statements. The

functions will need to be more interdependent and

proactive to achieve high quality results.

Creating bridges between tax and finance will require

both functions to do things differently. External help is

available to integrate the activities of the two areas or to

conduct finance and tax activities during the process.

Organizations such as Hudson Financial Solutions that

offer tax risk management and tax advisory services can

help companies make a smoother transition to a more

coordinated model.

18 Sponsor’s Perspective


For additional information on Hudson Financial Solutions,

contact Andrea Gronenthal at [email protected]

or 312-416-8663.

Building A More Effective Tax Function

Documents

Transcript of Building A More Effective Tax Function