Favorable Effective Tax Rates Follow Boards' Active Engagement in Oversight of their Companies' Tax Risks

New research finds that boards of directors who play an active role in the risk management of their companies’ tax functions, and who know which questions to ask and when, are often rewarded with more favorable effective tax rates for their companies, lower tax uncertainty, and less risk to their companies’ reputations.^[i]

BDO Tax Partners Richard Bayer and Daniel Newton recently spoke with one of the  study co-authors, Nathan Goldman, assistant professor of accounting at North Carolina State University’s Poole College of Management, to gain greater insight into the findings of the study.
The researchers evaluated proxy disclosures for 665 non-financial, non-regulated U.S. publicly traded companies belonging to the Russell 1000 index to understand the level of each board’s involvement in risk management. The researchers also analyzed the financial reporting for income taxes to better understand the level of tax planning each company undertook.

“Our study would say that they [the board] should be getting more involved,” noted Goldman. He goes on to say that “we estimate that companies with the highest level of risk oversight have 31% lower tax uncertainty and 13.2% lower tax burden, as compared to companies with the lowest level of risk oversight.”

To achieve these results, tax initiatives that companies take would focus more on achieving permanent tax savings, instead of temporary savings that would result in cash tax benefits being paid back in future years. The cash generated from these permanent tax savings can be invested back into the business to spur further growth and expansion opportunities that ultimately should favorably impact a company’s bottom line and investor sentiment.

 

It’s Execution of the Strategy, Not Just the Strategy

Oftentimes, companies find that a well-designed strategy doesn’t achieve the expected results. In searching for the reason why, all too often poor results come down to poor execution of the strategy. Tax planning is an area where board risk oversight would play a vital role in ensuring the company is pursuing appropriately risk-balanced tax reduction strategies and setting the right tone from the top.

Companies with greater board oversight in taxes are “not doing things that the IRS is going to fight them on for the next four years but rather they’re doing things that are going to logically lower their tax rates in a safe and secure manner,” says Goldman about increased board involvement in understanding the company’s tax profile.

The study notes that more aggressive and risky tax-planning strategies may result in several unanticipated negative consequences for a company, notably increased future cash tax outflows and potential reputational damage. To counter this, Goldman notes that “when you have legitimate operations, not only does it fall into the OECD BEPS implementation plans, it really falls into a logical business process that should be earning a lower tax rate.”

 

Room for Enhancement – Not All Board Members Are Equal Regarding Taxes

While it is clear from the study that there should be greater involvement by boards of directors in understanding the company’s tax profile and strategy, recent studies conducted by BDO find that not all board members have a clear understanding of their company’s tax strategy.

BDO’s Center for Corporate Governance and Financial Reporting conducts a survey of board members each year on various topics that boards are currently facing. In the 2018 and 2019 surveys, board members were asked “What level of understanding do you have of the total tax liability of your business and its impact on your corporate tax strategy?”

The 2018 study showed that 95% of respondents had a strong to moderate understanding of their company’s tax strategy. However, the results for 2019 showed a marked decrease in board members’ understanding of the corporate tax strategy, where only 65% responded that they have a strong or moderate understanding. One factor that could explain the decrease is that the 2018 survey was conducted shortly after tax reform was enacted in the United States. As the Tax Cuts and Jobs Act is the most significant piece of tax legislation to be enacted since the Tax Reform Act of 1986, it would be expected that boards would increase their oversight at that time.

2018 BDO Board Survey: