Corporate tax governance for CFOs: a practical approach: CFOs don't have to be tax experts, but they do need a basic understanding of the income tax process and the corporate tax structure required to manage and report their company's global income taxes--quickly and accurately.

• Author: Norton, Bob
• Position: TAX GOVERNANCE

Accounting for income taxes was the top reason for adverse audit opinions and restatements during 2005 and 2006. It's also currently the highest risk area of financial reporting, and it's causing quite a stir within audit committees and the C-suite.

As a result, corporate governance principles specifically addressing global tax operations--"corporate tax governance" principles--are evolving. When followed, these can ensure effective tax internal controls are implemented to manage tax risk while maximizing tax savings.

Many "overseers" (CFOs, audit committee members, controllers, and other appropriate individuals) understand the frameworks for internal controls--COSO, the Committee of Sponsoring Organizations of the Treadway Commission, in the U.S.; Turnbull, in the U.K.; and CoCo, in Canada. However, they want a more practical approach to monitoring what is typically one of the largest items on their company's P&L and balance sheet, and a complex area of business operations.

To provide effective corporate tax governance, CFOs need not become international corporate tax experts. What they do need, however, is a basic understanding of the income tax process and the corporate infrastructure required to manage and report their company's global income taxes quickly and accurately.

The Tax Planning Process

The typical multinational's income tax process is cyclical and could logically start with tax planning. While tax planning has sub-categories for international, federal and state tax planning, they all come together in the company's effective tax rate, or the overall rate at which a company's consolidated pretax income gets taxed on a worldwide basis.

This includes the estimated income tax expense that will eventually be due on every country, state, province and city tax return for all companies included in the financial statements. The effective tax rate equals the total income tax expense divided by consolidated pretax income. It usually runs between 30-40 percent.

A key financial objective is to minimize the effective tax rate within the confines of the law. To do this, tax executives strive to locate profitable operations in low-tax jurisdictions.

To minimize risk of adjustment upon scrutiny by tax authorities, they need projected revenue, R&D expense, manufacturing expense, assembly expense and cost of sales by country and by legal entity.

Armed with this information, they then organize the business structure that maximizes profits in low-tax jurisdictions. They might institute intercompany charges to shift income from one jurisdiction to another (tax transfer pricing) or create a flow-through entity, the losses of which flow-through to the corporate owner to allow a current deduction or build operations in jurisdiction with tax incentives for investing and many other ways.

As a result of this tax planning, the tax executives come up with a global structure for distributing worldwide profits by legal entity that minimizes the resultant taxation without harming the underlying business operations. This includes the type of legal entity, the intercompany debt/equity structure, the...