The Answer for Reduced Completeness and Accuracy Checks During Tax Audits

Warren Buffett once said that risk comes from not knowing what you are doing. We believe that this quote can also be applied to the current business environment, wherein Tax Assurance is the method by which a company can assess its tax risks, manage them, as well as mitigate these risks to an acceptable level (Tax Risk Management). Furthermore, the presence, monitoring and testing of the tax internal control framework, including the accounting organization and the measures of internal control (hereinafter: AO/IC) are globally being presumed as an indispensable part of the tax risk assessment performed by the tax auditor.

AUTHORS JEANISE JOB, MEIJBURG & CO. CARIBBEAN AND JEANNITZA FELIX, MEIJBURG & CO. CARIBBEAN

Tax Assurance is not only assurance on the tax position in the financial statements, but concerns everything related to the process of tax aspects in a company, such as Tax Risk Management, AO/IC, management control, corporate governance, tax policy, relationship with the tax authorities, etc.. In this article we will elaborate on how Tax Assurance, specifically Tax Risk Management and an effectively working AO/IC, including internal monitoring activities can lead to a reduction of the completeness, respectively the accuracy checks during a tax audit. If the aforementioned is present and is working effectively, the tax auditor may take the work performed by the external auditor into consideration, and solely review and discuss their dossiers, since both the external auditor and the tax auditor rely on the same information related to the company’s AO/IC.

Tax audit
The tax audit is the process in which the tax auditor checks and accesses the audit object on a basis of criteria, and forms an opinion that provides the taxpayer with a certain degree of assurance. Moreover, the tax audit is required to be effective and efficient and therefore the tax auditor needs to gather sufficient audit evidence to achieve reasonable assurance, which is necessary to complete the tax audit assignment. On the other hand, Tax Assurance enables the company’s management to obtain assurance regarding the concerned tax events or tax processes in an earlier stadium. Before a tax audit, the company would be aware of the tax implications of certain transactions and can implement internal control measures to mitigate these consequences to an acceptable level. Should the company have implemented an appropriate, well-designed and effectively working internal control framework, the tax auditor would shift to a review-based tax audit approach, which is based on a risk analysis and consists of an analysis of the AO/IC (reduction of the completeness and accuracy checks).

Tax Risk Management
All decisions, business operations and activities that a company undertakes give rise to numerous uncertainties. These uncertainties are considered as the business risks and some of these risks will be tax related. The tax uncertainties can be a result of – amongst others – the application of tax law and the tax implications of certain facts or uncertainties within the company. Taking the aforementioned into account, it can be concluded that tax risk management is about managing tax related uncertainties, understanding where tax risks may arise and making conscious decisions on how to deal with these tax risks. Tax risk management is not only about minimalizing the tax risks but also about setting an internal control framework and scale for the company’s risk appetite.

When the company has implemented tax risk management, it has a set of risk response and internal control activities in place. The degree to which the company should implement risk-mitigating actions depends on the likelihood and the impact of the assessed tax risk in relation to the company’s risk appetite. The company should determine which risks are acceptable, which risk causing activities should be discontinued, and which should be transferred to third parties i.e. insurance companies. Additionally, risk control measures (AO/IC including internal monitoring activities), should be implemented and continuously submitted to testing and monitoring.

In addition, the company could seek a Tax Assurance Report, in which its current and future tax risks and the effectiveness of the implemented AO/IC and are assessed and tested, including an overall opinion about the company’s internal (tax) control framework. Additionally, the Tax Assurance Report could contain information regarding internal control measures to mitigate the risks and measures for monitoring and testing the effectiveness of the tax function continuously.

Reduction of completeness and accuracy checks
The second phase of the tax audit is the preliminary risk analysis, which includes the completeness checks respectively the accuracy checks. Prior to the completeness checks the tax auditor determines the administrative context and analyses the design of the AO/IC. In this phase the tax auditor analyzes the critical processes related to the AO/IC, because of its impact on the tax return. In the following, the role of the positive advance information on reduction of the completeness and the accuracy checks will be discussed in detail.

Positive advance information
An adequate and effectively working AO/ IC may, under certain circumstances, lead to reduced tax audit procedures. Therefore, the tax auditor would perform test of controls to assure the effectiveness of the tax related internal key controls, whereas monitoring is viewed as the most important part of a fully, well-designed and accordingly implemented internal control framework. Since monitoring activities are set up to ensure adequate and effective performance of the measures of internal control, the tax auditor would – in case duly functioning monitoring activities are in place – only review the performed monitoring activities instead of performing all the tests of controls himself, (i.e. a more review-based auditing approach). The aforementioned confirms that it is of utmost importance that entrepreneurs identify their tax risks and are aware of them, and moreover, that they are in control of their tax risks.

Subsequently, the tax audit activities would include reconciliation checks and analysis of preliminary account adjustments, because of the possibility for the management to adjust the figures. Accordingly, he will perform a review of the monitoring activities, repeat a couple of the monitoring tests already performed and reduce the completeness checks to a minimum.

Reduced completeness and accuracy checks
When the tax auditor determines that the internal controls work effectively and are sufficient to mitigate and manage tax risks, positive advance information could be deemed present. In such cases the tax auditor can choose to perform reduced completeness and accuracy checks. The tax audit would then be subject to the ‘dual purpose-test’ , which is a combination of compliance tests and substantive tests. The ‘dual purpose-test’ implies that the correctness and the administrative procedures regarding certain controls would be tested. However, if inaccuracies or mistakes are discovered during the reduced completeness and accuracy checks, the advance information would be deemed to be incorrect having the result that all controls have to be tested. It is common practice that tax auditors search for as much as possible positive advance information in order to reduce the extent of the completeness and accuracy checks. Well-functioning tax risk control measures are therefore of utmost importance since this is one of the main sources tax auditors reach to when trying to obtain positive advance information. Furthermore, positive advance information can also be obtained from the absence of specific inherent risks, the quality of the internal control measures and other controls performed by third parties.

Degree of reduction
The more the tax auditor can rely on the positive advance information regarding the tax control measures of a company, the less the degree of uncertainty will be. This could subsequently result in a reduction of the completeness and accuracy checks.

The weight of the different types of positive advance information and the effects this would have on the degree of reduction are set out below:

• If a specific inherent risk is identified but there are insufficient tax control measures in place, no reduction will be applicable. In such situation the company would be subject to a comprehensive completeness and accuracy check.

• If the tax auditor does not identify any inherent tax risks, the accuracy checks could be reduced by approximately 20%. In this regard please be informed that the tax auditor should be able to justify his statement/finding on the absence of inherent tax risks.

• If the AO/IC is appropriate, well designed and implemented, and is expected to work effectively, the accuracy checks could be reduced by 75%.

• If there are additional internal control measures present (such as internal monitoring activities), the accuracy checks could be reduced by 85%. This reduction is only applicable if 10 to 30 ‘dual purpose-tests’ are applied and no mistakes were identified during the process.

• If there are additional external controls in place, a 100% reduction on the accuracy checks could be possible. In such cases the tax authorities mainly use file reviews.

A reduction of the completeness and accuracy checks has advantages for both the tax authorities and the taxpayer. The tax authorities would be able to focus their resources on targeting the non-compliant or less compliant taxpayers whereas the compliant taxpayers have more certainty upfront and are less exposed to significant corrections after a tax audit.

Conclusion
In general, the tax auditors access whether or not the taxable events and items are properly and fully accounted for. Furthermore, they are responsible for determining whether or not the interpretation of the legal facts in the concerned tax return is acceptable for tax purposes. This is generally done through a tax audit in which completeness and accuracy of the controls are tested extensively. A combination of tax risk management, an effective accounting organization and measures of internal control could lead to a reduction of the completeness respectively the accuracy checks during a tax audit. The degree of reduction in this respect is highly dependent on the degree of positive advance information available and the results of the ‘dual purpose-tests’.

When a tax auditor can rely on the positive advance information regarding tax control measures of a company, he will perform less completeness and accuracy checks. Meijburg & Co Caribbean could perform a tax risk analysis for your company in which the current relevant tax risks are assessed, including a review of the effectiveness of the implemented AO/IC. In addition, we identify possible future tax risks and propose internal control measures to be implemented in order to duly mitigate these risks. Subsequently, we could design a control mix that can be implemented in your company to help continuously monitor and test the effectiveness of the tax functions, which enables you to be effectively in control of your tax risks and how these are dealt with. Such a Tax Assurance Report could serve as positive advance information and may lead to a reduction of the completeness and accuracy checks during a tax audit. This would provide you with more certainty upfront and less exposure to significant corrections during and after a tax audit.