1 | P a g e
TP
DOCUMENTATION
:
THE EFFECTS OF
TRANSPARENCY MEASURES ON TAX
RELATED RISK ASSESSMENT AND THE
CONTROL ENVIRONMENT
Version: FinalStudent number S2346400
Name Hamstra, Robin
Address Metaallaan 227 9743BT Groningen Phone number +31 6 48 66 00 41 Email r.hamstra.1@student.rug.nl University of Groningen Faculty of Economics and Business
MSc Accountancy 25-6-2018
Supervisor: prof. dr. I.J.J. (Irene) Burgers Word Count: 14.878
2 | P a g e
ABSTRACT
As a response on the growing international trade, international taxation has become increasingly important. In order to effectively manage the corporate taxes payed by large multinational enterprises countries have to cooperate. One of the instruments available for tax authorities to manage cross border taxation is the TP documentation. Even though TP documentation has an extensive history in various tax jurisdictions, the OECD proposed, in its BEPS action plan of 2015, a variety of new guidelines. The Dutch tax authorities, amongst many others, used this proposal to extend their current compliance legislation with respect to TP documentation. In this research we examined whether or not and to what extend these updated laws had an impact on firms internal control framework. We interviewed four CFO’s and three Tax directors of large multinational enterprises. By interviewing these individuals we were able to collect real time data and assess the level of importance firms attach to these documentation requirements. We found that the internal control framework still has little attention for taxes, more specifically international taxation. The control environment has, for most firms, improved over the last few years. The risk assessment has not been altered, however firms do perceive an increase in risk of discussions with tax authorities as a response on the updated requirement. We found signs that firms which perceive social pressure or are intrinsically motivated to pay their share of taxes to be better organized. We also found that firms which distribute responsibilities internally in contrast to externally, experienced a larger change in the control environment.
Keywords: Transfer pricing, transfer pricing documentation, COSO, Control Environment, Risk assessment, OECD Transfer Pricing Guidelines, BEPS Action 13, Internal Control, Compliance
ACKNOWLEDGEMENT: I would like to thank Prof. I.J.J. Burgers for guiding me throughout the process of writing this MSc thesis. Secondly, I would like to thank dr. K. Linke, Mrs. A.S. van Teijen RA and peer students for providing me with the necessarily feedback. Third, I would like to thank those that prefer to stay anonymous, however helped me to great extent, by putting me in contact with the CFO’s and tax directors of multinational enterprises.
3 | P a g e
C
ONTENTS ABSTRACT ... 2 GLOSSARY ... 4 I. INTRODUCTION ... 5 II. THEORY ... 9 Legislation ... 9 Tax Risks ... 12 Internal control ... 15 Operations ... 16 Reporting on Tax ... 17 Tax Compliance ... 19 Control Environment ... 22 Risk Assessment ... 24Other Coso Components ... 26
III. METHODOLOGY & DATA ... 29
IV. RESULTS ... 33
V. DISCUSSION AND CONCLUSION ... 51
REFERENCES ... 55
APPENDIX 1 – interview guide ... 63
4 | P a g e
GLOSSARY
Chief Financial Officer CFO
Country-by-Country CbC
Internal Control IC
Local File LF
Master File MF
Multinational enterprises MNE
Tax Control Framework TCF
5 | P a g e
I. INTRODUCTION
Transfer Pricing (TP) is, since the aggressive tax planning behavior of large multinational enterprises (MNE’s) in the early 21th century an increasingly addressed topic among boards, governments and tax advisors (The Guardian, 2013; FD, 2018; Guy Sanschagrin, 2014; Zinn, Riedel, & Spengel, 2014; Kleyngeld, 2017). TP refers to the intercompany transactions of products and services and is applicable for MNE’s that share knowledge, intangibles, assets and a variety of other things across borders (OECD, 2015). Using self-established prices and compensation schemes firms may decrease their profit base in high tax countries shifting profits towards countries with lower corporate tax rates. This has enabled some firms to minimize their effective tax rate. This lead to, amongst others, proposals for increased regulation on TP (OECD, 2015). An incentive for minimizing effective tax rates has been found when tax departments are considered to be profit centers. These centers are characterized by the responsibility of managers to generate profit (Burgers & Van der Meer-Kooistra, 2015). Profit centers aim to contribute to the bottom line: profit after taxes. By decreasing tax expenses, profit after taxes is directly affected in a positive way (Robinson, Sikes, & Weaver, 2010). Another explanation for minimizing effective tax rates has been found in earnings management (Cook, Huston, & Omer, 2008). Managers use TP in order to manage earnings. These incentives are important as they are responsible for the increased demand in transparency by governments and society.
As a response the OECD, a collaboration of 35 countries focusing on the stimulation of worldwide trade, wanted to make sure that companies pay their fair share of taxes. Using globally proposed regulation and increased compliance they aim to increase transparency and affect the tax strategies of large MNE’s. The OECD report ‘Aligning TP Outcomes with Value Creation’ (2015) proposes a variety of these regulations. The increased documentation requirements Master File (MF), Local File (LF) and Country-by-Country (CbC) reporting (OECD, 2015) assist tax administrations to ensure firms are more transparent.
Governments can use the documentation requirements to assess whether they are indeed receiving their fair share of taxes. The corporate taxes payable are determined at the end of each fiscal year.
6 | P a g e
A conflict with/between tax authorities on the amount of these corporate taxes can lead to difficult situations for firms. Firms have always faced uncertainty with respect to the amount of corporate taxes. However, with the proposed changes in documentation requirements (OECD, 2015) these uncertainties may have increased and potentially cause additional risks. Increased transparency requires firms to share more information with tax authorities. Risks arise when sharing this information leads to discussions with tax authorities. In order to mitigate these risks, correct determination of transfer prices is crucial (OECD, 2015). However, due to unique products/services and competitive pressures this has proven to be a difficult assignment for management (Burgers & Van der Meer-Kooistra, 2015) (Wesdorp, 2015).
Transfer prices, the prices that legal entities within a group use for goods and services when trading with each other, should be set at “an arm’s length basis”. The “arm’s length basis” means that prices set should reflect the value added to a product or service, and should be equal or close to the price one would let a third party pay (OECD, 2015). Establishing an arm’s length price is often, due to the absence of third party prices, a difficult process. In effect it is forcing firms to benchmark their prices. This proves to be difficult. Prices are either not available or incomparable (Wesdorp, 2015). The tax positions are directly affected by the determination of transfer prices (Wesdorp, 2015). Using incorrect transfer prices directly affects the determination of taxable profit, and consequently income taxes in the respective country. Stronger regulations on regular business activities (price setting) caused the operational risks to increase (Wesdorp, 2015).
Besides the financial risk of a wrong determination of the tax position, penalties for transfer mispricing (non-compliance) (Eden, Valdez, & Dan, 2005) (McKinley & Owsley, 2013) and negative publicity also affect the firm (Bol, 2016) (FD, 2018). Nowadays, with corporate social responsibility as a hot topic, firms are required to act socially responsible; paying their fair share of taxes became part of this (OECD, 2015) (Schön, 2014). Management has to determine whether the company runs a reputational risk as this may affect the continuity of the firm (FD, 2018). The going-on concern is also of interest for the accountant (Holzmann, 2010). The determination of transfer prices plays an important role in the mitigation of these risks.
7 | P a g e
Risks can be controlled (Merchant & Otley, 2007) (Merchant & Van der Stede, 2007) (Simons R. , 1994), but in order to do so first the assessment of risks has to take place (Veldhuizen, 2015). In the risk assessment management must determine whether they find risks material or not. An Internal Control (IC) or more specifically a Tax Control Framework (TCF) can help in this process. The position of these TP risks in the IC framework is still unclear, but, due to the increased demand for transparency from governments and society, relevant for management. In his research Michaelson (2006, p. 248) argued “governments can change corporate ethics by increasing compliance, their goals will only be reached when the ethical choices underlying have been influenced”. The importance of integrating compliance into daily operations has been researched. Maclean and Behnam (2012) found firms have a hard time doing so.
As a result of increased transparency pressures, assessing and controlling for these tax related TP risks becomes increasingly important. Research found that TP risks are among the top fiscal risks in the eyes of Chief Financial Officer (CFO) (Wunder, 2009) (EY, 2016).
Research has been conducted focusing on how firms can effectively manage TP risks by incorporating TP strategies into their IC (Rossing, 2013) (Kleyngeld, 2017). Little is known about the changes in these assessments caused by the newly proposed documentation requirements (OECD, 2015). The goal of this study is to get a better understanding of the assessment of tax related TP risks for firms. This research will try to provide an answer to the following question:
How did the increased requirements, on TP documentation (OECD, 2015), affect the control environment and risk assessment?
In answering the research question the focus lies on four aspects. First, we are interested whether and if so how firms control for tax related TP risks, and whether companies use a TCF. Secondly, we will look at the risk assessment and describe which risks firms identify with respect to TP. The top fiscal risks described by PwC in 2004 will be used and described in detail later on. Thirdly, we are interested in the changes within the IC framework as a result of the updated TP documentation requirements (OECD, 2015). Fourth, we are interested in the motives that thrive these changes in the IC, and the corresponding ‘tone at the top’.
8 | P a g e
This research is a direct response on the increased documentation requirements (OECD, 2015), the demand for corporate social responsibility with respects to paying your fair share of tax (Schön, 2014) and the difficulties with respect to the incorporation of TP into the TCF (Kleyngeld, 2017). This research will focus on the behavior of firms in the Netherlands. This research will be conducted through interviews with CFO’s and tax directors from MNE’s in the Netherlands. In the next section we will elaborate further on the research question and provide the theoretical framework for this research. In section III the research methodology will be described, followed up by the results which will be examined in section IV. In section V we will formulate our conclusion and discuss the results.
9 | P a g e
II. THEORY
In order to answer the research question we will first look at the legislation and the changes that occurred from a legislative perspective. We will then define the relevant tax risks, which helps us understand what situations firms face. Thirdly, we define the IC framework used in this research and connect the relevant components and objectives with tax.
L
EGISLATIONEven though countries such as the UK and the United States already imposed TP tax regulations at the start of the 20th century (van Herwaarden, 2017) the first response of the Dutch tax authorities was in 2001 when the Verrekenprijsbesluit IFZ2001/295M was introduced. With the increase in volumes of international trade, the global relevance of TP increased on a yearly basis (van Herwaarden, 2017). On an international level the United States played an important role with respect to the formulation of regulations for TP. The OECD used some of these regulations in their later reports (van Herwaarden, 2017). TP initiatives are only effective when countries collaborate. Consequently the role of the OECD in the formulation of TP guidelines and recommended regulation became more important. One report, with respect to TP, originates from 1995 when they published the ‘OECD TP Guidelines for Multinational Enterprises and Tax Administrations’. This report – published for the first time in 1979 - provides guidelines for all countries with respect to TP and has been updated regularly (1995, 2009, 2010 and 2017). The content of these guidelines will be elaborated in this section in one of the following paragraphs. Also, the demand for simplified international information sharing policies increased (Burgers, 2017). With the introduction of the ‘Convention on Mutual Administrative Assistance in Tax Matters’ this demand has been (partially) fulfilled.
In this research we will focus on a few specific aspects of the OECD Base Erosion and Profit Shifting (BEPS) report (Action 13) as introduced in the OECD TP Guidelines report (OECD, 2017). Since the research focusses on the effects of TP documentation requirements we will explain the relevant laws, regulations and guidelines with respect to this topic. We will therefore
10 | P a g e
start with the documentation requirements posed under the Dutch Law, and explain how the Dutch Tax Authorities (DTA) share these documents with tax authorities in other countries.
The arm’s length principle has been included in the Dutch law in the year 2002 (Artikel 8b Wet Vpb 1969), and is closely related to the description given in the TP Guidelines (OECD, 2017) and art. 9, lid 1 (OESO-modelverdrag, 1992). The Dutch Secretary of State for Finance published administrative guidance on TP. The TP decree gives administrative guidance on the parts that are not clear enough, or those that may lead to discussion. The Verrekenprijsbesluit IFZ2001/295M, which has been updated in 2004 (IFZ2004/680M) was recently replaced by the Verrekenprijsbesluit IFZ2013/184M. ADD 22 April 2018. This decree focuses on how arm’s length prices should be established, which makes it less relevant for this research in terms of documentation requirements. However, paragraph 14 of the Verrekenprijsbesluit IFZ2013/184M does refer to the documentation requirements, and the corresponding obligation for firms. According to IFZ2013/184M firms should record, with respect to TP;
A motivation for the chosen method
Conditions of the transaction (including price) Comparability analysis
Thus the Verrekenprijsbesluit focusses mainly on the documentation requirements with respect to setting arm’s length prices. The recently introduced OECD TP Documentation requirements (OECD, 2015), are broader and are described in detail below. Important to notice is that the proposed OECD requirements are soft law, implicating that these are merely guidelines and do not pose binding laws for firm unless authorities choose to formalize them.
Artikel 8b (Wet op Vpb, 1969) requires firms to document relevant information with respect to the computation of arm’s length transactions. The BEPS report Action 13 (OECD, 2015) proposes more extensive documentation requirements, which were already introduced in the OECD white paper (2014). The OECD does not have any legislative power, making the report not necessarily important for Dutch firms. However, the OECD Member States generally do feel some pressure on implementing the advices given by OECD in their legislation. The Dutch legislator chose to use the OECD guidelines on documentation requirements as proposed in the BEPS (OECD, 2015)
11 | P a g e
report. In September 2015 the Dutch Secretary of Finance proposed some modifications in the ‘Wet op de Vennootschapsbelasting 1969’ for which articles 29b-29h are related to the OECD report (2015) that propose a three-tier documentation for TP. We find that firms now have the obligation to create a Master File (MF), Local File (LF) and a Country-by-Country (CbC) report based on their respective annual turnover (Artikel 29 Wet Vpb, 1969) (OECD, 2015) . The MF and LF contain, amongst others, descriptions of intra-company transactions and have to be available at request (Wet op Vpb, 1969). They display a variety of information about the firms’ background and operations. They also contain financial information including, for example, TP calculations, TP amounts and key financial figures (OECD, 2015) (Artikel 29 Wet Vpb, 1969). For larger firms (>750 million) also a CbC-report is required (OECD, 2015) (Artikel 29 Wet Vpb, 1969). These requirements (DB2015/462/m, 2015) are effective in the Netherlands as of December 2015 (i.e. profits in different tax jurisdictions, turn-over with group members and non-group members, number of employees) (Belastingdienst, 2015). The CbC-report, in contrast to the MF and LF, has to be automatically disclosed to the Dutch Tax Authorities for the first time over fiscal year 2016 (Artikel 29d Wet Vpb, 1969). The documentation requirements are not completely new. In 2005 the European Commission already proposed the Code of Conduct on TP documentation in the EU. These consisted out of a MF and country files that are very similar to those proposed in the BEPS Action 13 report (OECD, 2015). This proposition was for all European Member states thus including the Netherlands.
With the documentation requirements briefly explained we are interested in the ability of governments to share this information internationally. With TP taking place cross border receiving information from multiple tax jurisdictions is an important factor for tax authorities. Without the ability to share information, for tax authorities, their audit would be ineffective. The history of guidelines with respect to information sharing started in 2002 when the OECD published the OESO Model Tax Information Exchange Agreement (TIEA). The OECD-Model treaty was updated in 2003 to include a section more focused towards efficient information sharing with respect to cross border tax matters. The Convention on Mutual Administrative Assistance in Tax Matters and the corresponding update in 2010 allowed other countries to join in, after which the process really started to make improvements (Burgers, 2017). Over 112 countries signed the
12 | P a g e
convention halfway during 2017 (Burgers, 2017). However as mentioned before the OECD does not have any legislative power with respect to member countries, therefore the fact that the EU supports these conventions is crucial. Directive 2011/16/EU, which forces member states to share information both on request, automatic and spontaneous, the EU ensured the effectuation of the convention. In the Dutch law these conventions and guidelines have been included in the ‘Wet op de international bijstandsverlening bij de heffing van belastingen (WIB)/Act on the international assistance in levying taxes (1986)’. The WIB has, ever since its introduction in 1986, been updated regularly. The now active law mentions the 2011/16/EU directive in artikel 4 bis 34, elaborating on the Dutch obligations on sharing and receiving information from other tax jurisdictions. With respect to the CbC-report the European Union formulated a directive (2016/881) which enables member states to share the proposed third tier of the documentation requirements more efficient. The guideline requires member states to automatically share the CbC-report with other relevant countries. For the Dutch law this has been specified in Art. 29e (Wet op Vpb, 1969), using the directive 2011/16/EU and 2016/881.
Important to notice is the fact that all of the above guidelines and conventions ensure secrecy of information. Whereas government institutions are allowed to share the information with each other, they are the only stakeholders that are entitled to see the information. The proposal of the European Commission for a public CbC-report (2016/0107(COD)) presented on 12 April 2016, may change this limited distribution of the report. This possible future expansion of the law with respect to CbC-reporting originates from the proposal of the EU which requires firms to share the CbC-report not only with the governments but make it publically available. Even though this is not yet incorporated within the law, it is interesting to investigate how firms assess this proposal. Therefore this will also be subject of this research.
T
AXR
ISKSThis research focusses on tax related TP risks. In order to assess risks, categories are used. PwC identified seven categories (PwC, 2004) when assessing tax risks in general. An eight risk, which was missing in the PwC research, has also been added below. The categories given below are used in multiple tax related researches (Wunder, 2009) (Packard, 2010) (Neubig & Sangha, 2004). The
13 | P a g e
OECD (2015) acknowledges, -in their BEPS Action 8-10 Report-, there are also other categorizations possible. But as Wunder (2009) indicates, the relevance of this categorization is high because of its close relation with the COSO framework and Tax Risk Management in general.
1) Transactional risks 2) Operational risks 3) Compliance risks
4) Financial accounting risks 5) Portfolio risks
6) Management risks 7) Reputational risks
8) Legislative Risk (not from PwC research)
CFO’s describe the transactional risks as most relevant (Wunder, 2009). This risk however is mainly focusing on complex and very large individual transactions such as M&A’s and is therefore less important in this research. The same research also found that TP is perceived as the number one tax issue out of a list of six (Wunder, 2009), which in turn is supported by the survey conducted by EY (2016), thus stressing the importance of TP within the tax environment even more. Even though other categorization groups are used too (technical risks & process risks (Russo & Van Trigt, 2015)) the PwC (2004) categorization was found to be more useful for this research. In contrast to tax risks in general, we are interested in the effects of the TP documentation on the identification and quantification of risks. Therefore we are focusing on three of the above described risks: Operational, compliance, and reputational risk. Even though the other risks are important with respect to tax, we choose to exclude them in this research because of time restrains. Also the given categories allow for an objective distinction, whereas for example portfolio risk and transactional risks are more difficult to assess individually. Using a limited scope we are able to reach a higher quality.
Tax compliance refers to the obligation of firms to comply with regulation and correctly filling of tax return forms (PwC, 2004). With the introduction of the new TP documentation requirements (OECD, 2015) firms now face additional compliance legislation. Even though firms do assess TP
14 | P a g e
as number one issue (Wunder, 2009) firms seem to depend their compliance strategy generally on their previous experience with tax audits (Jost, Pfaffermayr, & Winner, 2014). Being compliant with regulations for TP is a difficult task due to the difficulty of computing transfer princes at ‘arm’s length’ (Dujsic, Goldberg, Barsalo, & Fleming, 2008). Increased transparency may lead to the conclusion that applied methods are incorrect, increasing the risk of non-compliance.
Operational risks arise through regular daily business. In a survey conducted in 2010 the risk of facing unintended consequences, because regular transactions failed to meet standards, is one of the highest ranked risks (KPMG, 2010). The difficulties with the establishment of correct transfer prices (Rossing, 2013) already cause firms a lot of operational difficulties (Burgers & Van der Meer-Kooistra, 2015). With the increased documentation requirements and the corresponding demand for transparency (OECD, 2015) these operational challenges have increased even further. Effective and efficient IC is key in this process (Rossing & Pearson, 2014).
Reputational risk is the last category under review in this research. Non-compliance can lead to a negative public opinion (Barford & Holt, 2013). Firms can vary in the amount of value they attach towards reputation, the importance of a firm’s reputation towards stakeholders such as governments and the general public, is not equal for all firms (Bebbington, Larrinaga, & Moneva, 2008). The documentation requirements now force firms to share more information in order to be transparent. This increases their vulnerability with respect to their reputation. The documentation, at this point, is only shared with governments and therefore could only affect the reputation with the Dutch Tax Authorities. However practice shows that when firms make questionable decisions this may lead to public outrage (Barford & Holt, 2013). And since the effects of a negative reputation can be significant (Eccles, Newquist, & Schatz, 2007), the assessment of this risk should take place. Increased transparency can even be beneficial in the long run when considering the potential risks of questionable management strategies (Robins, 2010) (Emerald Group, 2010). The risk assessment with respect to taxes takes place within the firm. It is found that firms assess their tax related risks ‘under control’ (Wunder, 2009), the internal control determines if a firm actually is (Merchant & Otley, 2007).
15 | P a g e
I
NTERNAL CONTROLManagement uses IC frameworks to align daily operations with corporate strategy, deficiencies in these controls with respect to tax often lead to difficult situations for management (Graham & Bedard, 2015). The importance of a control environment has been researched extensively (Merchant & Otley, 2007; Merchant & Van der Stede, 2007). For TP the importance of a proper control environment is no different. With assurance over these controls firms are able to increase the quality of their operations, reporting and compliance even further (Graham & Bedard, 2015). Even though multiple frameworks that increase management control exist (Merchant & Van der Stede, 2007; Simons, 1996), this research will be based on the COSO IC framework (COSO, 2013) as this framework is widely used (Van de Ven, 2015) and the Dutch Tax Administration in its 2008 guidelines on horizontal monitoring require a TCF based on COSO.
This widely used framework for IC originates from 1992 when the Committee of Sponsoring Organizations of the Treadway Commission (COSO) published the Internal Control Framework (COSO, 1992). This model uses various objectives and components (which will be described in detail later on) to enable firms to get in control of their operations. Figure 1 visualizes the framework. Individual components were criticized (Power, 2009) whereas the modernization of the business environment also affected the framework. As a result the model was updated to ensure a better fit in the current modernized business environment (COSO, 2013) repositioning the components, increasing the importance of the reporting objective (including internal/external financial reporting and non-financial reporting) and describing 17 derived principles that create the foundation for the framework (Janvrin, Payne, Byrnes, Schneider, & Curtis, 2012).
The Committee of Sponsoring Organizations of the Treadway Commission released another framework in 2004 (Enterprise Risk Management — Integrated Framework). This model focusses more on the risk assessment and mitigation. The COSO Enterprise Risk Management (ERM) framework was updated in 2017, focusing on a more collaborative environment and better risk assessment (Hart, 2017). This model shows great potential with respect to the identification and quantification of tax related TP risks. However, Van der Ven (2015, p. 9) states that “Tax Control
16 | P a g e
Frameworks are almost always based on the COSO framework”. Consequently, this research will focus on the IC framework (COSO, 2013).
As indicated this research will use the COSO – Integrated Internal Control Framework (2013) to assess the TP risks. Therefore the components used in this research will be explained in detail. We will start with a description of the objectives after which we will describe the components in detail.
FIGURE 1 INTERNAL CONTROL FRAMEWORK (COSO, 1992) (COSO, 2013)
OPERATIONS
On the top of the COSO (2013) cube there are three objectives, the first one relates to operations. The operational objectives ensure daily choices are made in an effective and efficient manner, and are closely related to the corporate strategy (COSO, 2013). Both financial and operational objectives are set, and combined they provide valuable borders firms can explore. Moeller (2013, p. 119) says “operational objectives are important for the overall process of enterprise-wide operational planning”, emphasizing that the goals which are set have an impact on the whole firm. When setting or changing goals, the impact throughout the firm has to be assessed. Besides budget and planning decisions, impact on IT systems and standard procedures is important (Moeller, 2013).
17 | P a g e
With the current changes in regulations, with respect to TP documentation, companies face operational difficulties (PwC, 2010). The updated regulations require firms to be transparent about their tax strategy and how this strategy is reflected in their daily operations. Whereas firms, before the documentation requirements, were able to change transfer prices easily, this process has become increasingly difficult. Flexibility decreased. Depending on the operational objectives with respect to tax, this limits the possibilities of firms to respond quickly. When firms, for example, want to introduce a product in country X that is already available and produced in country Y this transactions has to be described in detail. The “arm’s length price” has to be established, and should be benchmarked using key-value drivers Artikel 8b (Wet op Vpb, 1969). Secondly, firms have to assess whether the change in operations increases the risks related to TP (EY, 2016). The operational impact for firms is significant. How the increased transparency measures affected the current operations is still unknown, let alone the risks that are related to (changed) operations.
REPORTING ON TAX
The second objective on top of the COSO (2013) cube, focusses on reporting. This objective has been modified quite extensively, caused by the increasing importance and methods of reporting (Janvrin et al, 2012). The framework focusses on external financial, internal financial and non-financial reporting (COSO, 2013). The objectives for internal reporting are generally used to direct firms in the right direction. Using, for example, periodic reports, firms are able to monitor firm performance and respond to potential opportunities or threats (Moeller, 2013). The objectives with respect to external reporting are generally based on laws, regulations and standards or used for marketing purposes (Moeller, 2013). The quality of the external reporting is directly influenced by the quality of the internal control (Graham & Bedard, 2015). Firms include non-financial information about the quality of their internal control to increase trust in the financials (Moeller, 2013). Some of these non-financial reports are mandatory (i.e. TP documentation, and reporting over the quality of the IC (OECD, 2015) (Sarbanes-Oxley Act, 2002), for companies listed to the American stock exchange). Others are voluntarily. Below an overview is provided of the relevant reporting over tax in this research. Moreover we discuss why firms share non-financial information about TP, focusing on the mandatory disclosures.
18 | P a g e
Internal reporting with respect to tax is generally embedded within the IT environment of firms (Moeller, 2013). The goal of these internal reports is to provide management with a flow of information which they can use to effectively steer the organization. For taxes this refers to the reporting over tax positions. One of the difficult aspects with respect to tax reporting (both internal and external) is that the tax specialist does not manage or enter the data within the ERP-system (Hoyng, Andrews, & Kennedy, 2015). Effective internal reporting can help here. Internal reporting on tax positions also increases awareness over tax (COSO, 2013). Even though COSO does not specifically propose how firms should report over tax positions, making sure it is part of the internal control framework is the first step towards efficient internal reporting.
With respect to the external reporting this research will focus on the laws and regulations for TP, and on reporting requirements posed in laws and regulations and recommended in the OECD TP Guidelines for TP documentation. These have been explained extensively since they are the main focus of this research.
With respect to the reporting on non-financial information we focus on two aspects. The obligation to report TP documentation has been described. The effect of sharing this non-financial information is unknown. Aligning the documentation requirements with the actual operations is often a difficult task (Saad, 2014). Changes in business processes, and movements in price computations have to be reported. However since establishing arm’s length prices proves to be a difficult assignment (Burgers & Van der Meer-Kooistra, 2015)the quality of these reports may be questioned. The second reporting option originates from the TCF. The Dutch law advices firms to report on their tax related risks and controls. There is, however, no specific law that requires firms to use a TCF or how this TCF should be designed. The OECD recommends firms to use the COSO IC framework to design a TCF or implement tax controls within their current IC (OECD, 2015), whether and how firms actually do this remains the question. Reporting over internal control could also include this information. However since only US listed companies are required to report over their IC (SOX, 2002) and this research focusses on Dutch companies we expect zero to few firms to actually report over their IC.
19 | P a g e
TAX COMPLIANCE
The urge for firms to be compliant has increased (OECD, 2016). Being compliant refers to the extent to which firms are acting conform regulations and policies (COSO, 1992). However, due to changes in the regulatory environment (OECD, 2015), differences in tax regimes worldwide (Heinemann & Kocher, 2013) and the lack of knowledge with respect to tax regulations (Saad, 2014), firms find it difficult to actually comply with regulations (Maclean & Behnam, 2012). In order to help firms with these challenges the OECD recently published the report ‘The Changing Tax Compliance Environment and the Role of Audit’ (2017). Tax administrations use a combination of four different strategies to increase compliance, the latter two are combined due to the similarity in their characteristics:
- Reactive – responding to situations (including penalties and policy changes) - Pro-active – assisting firms up front, for example through co-operative compliance - Upstream/compliance by design – assisting firms real time or up-front
In this report the OECD (2017) also describes three categories that cause changes in compliance related activities:
- Economic changes - Technological changes
- Changes in laws and regulations
For firms especially the co-operative compliance can help increase the level of compliance (Veldhuizen, 2015). Also real time assessment of issues can lead to more certainty with respect to the achieved level of compliance. Tax administrations have changed their methods of supervision over the past years, shifting the focus from reactive towards the more ideal situation of compliance by design (OECD, 2017). Tax administrations may, according to the Slippery Slope framework (Kirchler, Hoelzl, & Wahl, 2008), use two methods to increase compliance: 1) by exercising power, or 2) by increasing trust. Both methods have proven to work. However research shows that if tax authorities choose to dynamically combine both methods the effectivity reached is highest (OECD, 2017; Kirchler, Hoelzl, & Wahl, 2008; Gangl, Hofmann, & Kirchler, 2015). More trust
20 | P a g e
leads to a lower exercising of power, stressing the importance of a trust based relationship with tax authorities. This also emphasizes the importance of co-operative compliance programs such as the Dutch horizontal monitoring program, as horizontal monitoring allows firms to increase the trust relationship with tax authorities (Veldhuizen, 2015) consequently increasing compliance. We focus on three incentives for firms to increase compliance. First, the obligation to be compliant with regulations in order to prevent penalties and minimize costs, and therefore referred to as economic incentive. The second is on the social incentives of compliance, whereas the last concerns the normative incentives. Below we will explain these incentives in detail.
In their research (Nielsen & Parker, 2012) describe these three compliance incentives (economic, social and normative). The incentives for being compliant create the basis for the identification of tax related TP risks. Even though the favored level of compliance determines to what extend firms value tax related TP risks, the motives for the assessment of risks originates from the underlying ethical choices (Michaelson, 2006). These motives look independent, but their factorial combination is crucial in actual behavior (Nielsen & Parker, 2012).
ECONOMIC MOTIVE
The economic motivation refers to the urge of managers to maximize profits and economic benefits (Nielsen & Parker, 2012). In order to do so we distinguish between two options in this research, maximizing economical gains through decreasing cost of compliance or by preventing penalties.
1) Minimizing costs of non-compliance
To maximize profits firms can minimize their costs (Robinson, Sikes, & Weaver, 2010). By calculating the minimum expenses necessary to prevent non-compliance, firms can achieve higher profits. This motive is therefore characterized as economically orientated. Research shows that costs of non-compliance can be high, especially for smaller firms (Schoonjans, Cauwenberge, Reekmans, & Simoens, 2011). The economic gains of spending large amounts of money on compliance are nearly absent (Robinson, Sikes, & Weaver, 2010), it remains the question to what extend economically driven cost motives affect the IC framework. We will try to assess the extent to which costs of compliance play a role in the IC framework.
21 | P a g e
2) Preventing penalties
Preventing penalties is described as an economic motivation as well in this research, whereas the economic motivation refers to the maximization of economic benefits penalties cause sub-optimal profits. Even though the second motivation closely relates to the first (penalties directly increase costs) for this research a clear distinction will be made, since we are interested in the extent at which managers valuate penalties as a risk. Most of the compliance related penalties are administrative fees (Levi, 2010). These administrative penalties do impose threats for firms. The economic benefit of preventing them is clear: with fewer or no penalties the firm’s profits are higher. However, preventing these penalties costs money. Taking the height of penalties into account, using a risk based approach, we are interested in whether and to what extend this affects the level of compliance costs accepted.
SOCIAL MOTIVE
In their research Nielsen & Parker (2012, p. 432) describe social motivation for compliance as “the goal of earning the approval and respect of significant others with whom an actor interacts”. The actor refers to the firm. The stakeholder theory gives us insight in the parties involved and the social pressures that stimulate the social incentive towards compliance. Even though there are approximately 600 definitions used for the term ‘stakeholder’, a universal definition is not necessarily needed as long as the stakeholders can be identified (Miles, 2017). In this research we identify governments, media and public individuals as important stakeholders. Government because they are directly connected to the firm through taxes (Dutch Tax Authorities). The media since it communicates non-compliance issues directly towards the public. A firms’ reputation is directly based on the collective public opinion, affecting the firm strongly when reputation is important for the firm. The stakeholder theory explains us that firms feel the need to satisfy their stakeholders (Freeman, 1984). Referring back to the motivation to comply with regulation this motivation is therefore described as the social pressure experienced from the indicated stakeholders to comply with regulation.
22 | P a g e
NORMATIVE MOTIVE
The normative motive closely relates to “paying your fair share of taxes”, whereas the incentive for complying is based upon the genuine motive to behave as is expected (Nielsen & Parker, 2012). Therefore it is closely related to the legitimacy theory, which states that firms agree upon the fact that their actions should be according to the norms and values of the society and therefore they should behave accordingly (Suchman, 1995). Laplume et al. (2008) argue that the stakeholder theory also has roots in the normative frameworks, such as principles of fair play (Van Buren, 2001) and organizational justice (Hosmer & Kiewitz, 2005). Normative motivations have more focus towards intrinsically wanting to comply with laws and regulations. In this case managers think it is normal to pay tax and comply with regulation. Social incentives are more caused by external motivators (Nielsen & Parker, 2012), aiming at social pressure that moves managers towards compliance. In both cases the stakeholders are equal.
Actual behavior may not correspond to the management’s intentions (Nielsen & Parker, 2012), however looking into the motivation does help understand whether certain aspects are taken into account. In respect of TP, we are mainly interested in the control environment and risk assessment, the motivation for compliance plays, especially for the control environment, an important role (Nielsen & Parker, 2012). Aligning TP goals with the corporate strategy is important when firms want to effectively use control frameworks (Michaelson, 2006).
CONTROL ENVIRONMENT
In the COSO IC (1992) cube the control environment was positioned at the bottom. However when the cube was modified and re-published in 2013 the Committee of Sponsoring Organizations of the Treadway Commission choose to position it above all other components (COSO, 2013). The corporate culture is key in this component. The effectiveness of the overall control environment is determined by management engagement. Therefore “the control environment determines if internal control is really taken serious in an organization” (Van de Ven, 2015, p. 13). The level of aggressive tax planning is directly affected by the executives in charge (Dyreng, Hanlon, & Maydew, 2010). In order to help firms practically implement the IC framework (COSO, 2013) into daily operations 17 principles have been formulated (Janvrin, Payne, Byrnes, Schneider, & Curtis,
23 | P a g e
2012). Moeller (2013) summarized the principles, defined in the COSO – Integrated Framework IC (2013) as follows:
Integrity and ethical values Role of the board of directors
The need for authority and responsibility Human resource strengths
Individual internal control responsibilities
The principles above closely relate to the belief systems of Simons (1995), focusing on management awareness, but also on the role of management in terms of setting the standards. The belief system is defined by Simons (1994, p. 170) as “the explicit set of organizational definitions that senior managers communicate formally and reinforce to provide basic values, purposes, and direction for the organization”. Using core values managers are able to get better control over the firm, the first step is defining these values (Simons R. , 1996). Even though we choose to use the COSO (2013) model for this research, the belief system as imposed by Simons (1995) closely relates to the above mentioned content of the control environment layer and complements our understanding of the effect of beliefs within an organization. Positioning the control environment layer on top of the cube is therefore a valuable improvement, “The strength of any system is in its underlying foundation” (Moeller, 2013, p. 56).
The operational goals mainly entail the created awareness among employees. Changing operational policies can have a direct impact on transfer price computations (PwC, 2010). Employees need to be aware of the effects of changes, and how regulations propose firms to deal with this. The control environment determines how the operational goals are effectuated, when management stresses the importance of being in control over TP risks this tone-at-the-top will have an immediate impact on the business. Combining the operational aspects of the COSO IC framework (2013) with the control environment will therefore indicate how and to what extend management actually created an environment in which TP is incorporated within the day-to-day business, or whether it is just a compliance obligation.
24 | P a g e
With respect to reporting the control environment is more difficult to assess. Whereas the other components show more formal controls referring to actual performed checks and balances in order to mitigate risks (Van de Ven, 2015). The control environment is more based on informal controls (Van de Ven, 2015), referring to controls that are used to mitigate risks but not formalized in procedures or checks. This directly increases the importance of individual motivations. The drivers that activate managers to pursue certain strategies should be reflected in the reporting used. However, the alignment between the goal of a report and the managers’ incentive to write the report can differ (Nielsen & Parker, 2012). Internal reporting creates more awareness amongst employees affecting the control environment. The external reporting will be mainly driven by compliance obligations. Firms that show high levels of internal reporting are more likely to have created an environment in which TP is seen as an important topic (Nielsen & Parker, 2012). The control environment does play a role in the reporting component of the IC framework. It remains to be seen to what extend it does, and what the effects are.
The tone-at-the-top contributes strongly to the effectiveness of an internal control framework (Moeller, 2013), emphasizing the importance of management motives for tax compliance. Even though compliance and legal obligations are closely related, compliance can be achieved on distinct levels. Following the spirit of the law and being compliant are not the same. The control environment determines to what extend the firms strategy strives towards compliance with the spirit of the law. Increasing documentation requirements forces firms to think twice before writing TP methods down (PwC, 2010), ultimately move firms towards following the spirit of the law by increased compliance obligations (Michaelson, 2006). The motivation for compliance with TP regulation is subject of this research because it influences the effectuation.
RISK ASSESSMENT
After firms have determined the importance of TP within their firm the next layer of the COSO cube (2013) concerns the risks that firms come across when doing business, and the corresponding risk assessment. The risk appetite of a firm refers to the extend firms are willing to accept certain risks and is closely related to the firms’ strategy (Russo & Van Trigt, 2015). This component of the COSO cube relates to the assessment of risks. And consequently deciding how to follow up on
25 | P a g e
these risks (COSO, 2013). The principles formulated in the framework on the risk assessment layer assist firms in setting up their risk assessment using four components.
Identify and assess risks Risk analysis and mitigation Assess the risk of fraud Manage changes
“Effective control hinges on the recognition of risks and following actions” (Van de Ven, 2015, p. 13), stressing the importance of the risk assessment. The recognition of risks is depending on the risk appetite of a firm. Therefore individual firms use a different identification and quantification. For this research we are looking at three out of the eight defined tax risks (PwC, 2004): operational risks, compliance risks and reputational risks. For each of these risks we will first asses theoretically if they potentially affect the components on top of the COSO (2013) cube. In our research we will look whether the risks actually are affected.
Changes in operations need to be processed through this risk assessment. Operational changes can cause both operational and compliance risks to become increasingly large, changing from insignificant to significant (PwC, 2010). With the control environment determining to what extend tax is perceived as important, the risk assessment directly follows. The operational risks arise because of the complexity that goes hand in hand with the TP computation, and the obligation for firms to document operational changes. The documentation requirements require firms to document transactions (OECD, 2015), potentially increasing the compliance risks for current or future transactions. The assessment of these risks have to take place for every intercompany transaction (PwC, 2010), increasing the complexity of regular operations. Governments gain insight in the methods used for transactions and the environment in which they take place. This may affect reputational risks.
With respect to internal and external reporting on tax related issues we look at both financial and non-financial data. Deficiencies in the internal control framework lead to mistakes in reports. These are difficult or even impossible to remediate (Graham & Bedard, 2015). Graham and Bedard
26 | P a g e
(2015) also argue that even though these control frameworks have improved over the last few periods, there are still hidden flaws in the tax reporting. Research, also indicates that MCS are directly affected by the tax strategy. With the changing tax environment, caused by increased cross border transactions and TP requirements, the risk assessment should change as well (Rossing, 2013). The first step lies at the identification of risks. The goal of the OECD (2015) has been ‘increased transparency’, however firms might face changes in the perceived TP risks on operational, reputational and compliance level. Even though it is highly unlikely that firms perceive additional risks over internal reporting, the operational, compliance and reputational risks might have been affected by the increased documentation requirements. Operational risks may occur because transactions and operations have to be reported properly and more thorough, awareness might be lacking among employees causing operational risks to increase through wrong price setting and time delays through compliance issues. Compliance risks are affected by the increased demand for external reports. The reputational risks is affected by the amount of information externally shared.
For the compliance component of the cube the risks might also have been affected. The compliance risk is important for firms, and should be assessed and quantified individually for the firm. Due to the fact that firms face penalties and inversion of the burden of proof, firms feel the need to comply. The increased documentation requirements cause firms to face more compliance tasks. Also the reputational risk may be affected since noncompliance can lead to negative reactions from stakeholders. With respect to operational risks we expect that the increased documentation requirements may lead to an increase in perceived risk. Based on the strategy and risk appetite the firms’ assessment of non-compliance determines whether countermeasures should be taken.
OTHER COSO COMPONENTS
CONTROL ACTIVITIES
“[…….] control activities should be selected and developed that effectively mitigate the risks and that they are translated into policies and procedures” (Van de Ven, 2015, p. 13). A logical consequence of the risk assessment are control activities. When risks are assessed firms are able to design controls. The controls can occur in two categories: 1) preventive, aiming to mitigate the
27 | P a g e
risk before it becomes a threat, or 2) detective, aiming at the controls that help management notice the risk when it occurs (COSO, 2013). COSO (2013) describes three principles with respect to the control activities. These principles aim towards the mitigation of assessed risks, general IT controls and design of policies that translate expected behavior towards actual behavior.
These principles try to indicate that firms should design their control activities in such a way that they effectively mitigate risks, and help translate the desired behavior into standardized processes using IT applications if possible. When control activities are designed properly they provide a valuable role within organizations in terms of, both, internal and external reporting (Moeller, 2013). It is also known that establishing arm’s length transfer prices is a difficult task (Burgers & Van der Meer-Kooistra, Control Frameworks for Cross-Border Internal Transactions: The Tax Perspective Versus The Management Control Perspective, 2015), which in turn makes estimating the corresponding risks for transfer mispricing an increasingly difficult task. Firms can use TP knowledge systems, defined as all activities performed in order to achieve better control over their transfer price related risks (Rossing & Pearson, 2014) or share TP knowledge in order to increase control (Rossing, 2013). Effective control activities trigger improvement. This element is not subject of this research.
INFORMATION &COMMUNICATION
The information and communication component of the COSO (2013) cube refers to the internal and external flows of information that allow managers and other stakeholders to rely on the other IC components. Van der Ven (2015, p. 14) states “If control activities are not performed in an effective manner recognizing control deficiencies and communicating these deficiencies in a timely manner could reduce possible negative consequences”. As mentioned in the framework, the principles reflect this description emphasizing on both internal and external communication and the collection of information with respect to the functioning of IC.
Internal reporting, for example, helps managers to be informed effectively on tax matters. This is especially important with respect to the TP documentation. When managers have updated information with respect to tax law, regulations and procedures operational, compliance and reputational risks are less likely to occur. For external reporting we refer to the documentation
28 | P a g e
requirements. As mentioned before, CbC-reports will be exchanged between tax authorities. In order to effectively report on TP firms need to include controls that ensure all aspects are taken into consideration. With respect to TP, to determine whether IC deficiencies exist, it is important that the information managers receive is of high quality (COSO, 2013).
MONITORING ACTIVITIES
The monitoring component is closely related with the information and communication component of the COSO (2013) cube. Whereas in the previous component the focus was on the generation and communication of IC deficiencies, the monitoring component focusses on the evaluation of IC. The environment firms operate in are constantly changing and in order to move along firms have to make sure their IC maintains up-to-date (COSO, 2013). “A changing environment could lead to new risks or to a different assessment of the consequences” (Van de Ven, 2015, p. 15). Therefore this complements the COSO cube in a sense that it includes continuous evaluations and the consequently necessarily improvements within the IC. This makes sure that the IC is constantly changing and improving in order to adapt with external and internal changes.
The relation between tax and IC has already been explained in the previous section, emphasizing on the importance of the communicational aspects. The importance of reporting these IC evaluations is also crucial in a changing environment such as tax. When the environment changes these changes have to be adopted within the IC. In order to do so monitoring controls have to be implemented ensuring the IC is not only evaluated, but also updated for changing documentation requirements (OECD, 2015) and moreover, corrected for deficiencies. In general the process of evaluation, which is crucial in the monitoring activities layer, is important for the overall performance of the internal control framework (COSO, 1992).
29 | P a g e
III. METHODOLOGY
&
DATA
This section indicates how the research will be conducted. A description of the research method will be provided. This section moreover contains a description on how the data will be processed. In order to answer the sub-questions semi-structured interviews have been conducted. According to Gephart & Rynes (2004) interviews enable researchers to get a descriptive overview of situations, and helps us understand how the theory is executed in practice. The semi-structured interviewing method allows us to ask all relevant questions, but in contrast to the structured interview it will also allow us to broaden our knowledge by diving deeper into certain topics that come to our attention during the interview. Using the theory section, a list of questions has been formulated (Appendix 1). Important aspects in this process vary from the assessment of risks, the control environment, and the motivations for compliance, the reporting procedures and the operational processes. The theory section provided information on how processes, using COSO, could be designed. This created the foundation of the questionnaire. The motivations for compliance were tested using the characteristics given by Nielsen & Parker (2012).
The interviews were conducted in a face-to-face environment since this will allow us to collect more reliable and extensive information (Gephart & Rynes, 2004). Prior to the interviews the interviewee has received training and feedback on his interview skills. Moreover, the question list, that has been formulated using relevant literature, has been reviewed by experienced supervisors from the University of Groningen.
These interviews will be conducted with financial specialists that are currently working for multinational firms. A crucial aspect of the selection of interviewees lies at the multinational aspect; employees that do not work with clients that operate cross border are not relevant for this research since they are not charged with TP.
The second important aspect in terms of interviewee selection, lies at the function of the individual. For this research we are interested in the control environment and the corresponding risk assessment. Management incentives for compliance will allow us to gain insight in the control environment at the highest levels of the organization, which in turn will be reflected towards the
30 | P a g e
lower levels of the organization. These managers must have the possibility to influence firms’ strategy in order to have an impact on the control environment. Either a Chief Financial Operations (CFO) or a tax manager will carry the responsibility of TP, its corresponding strategy and the risk assessment. Therefore we have chosen to interview only these high positioned individuals. These individuals will allow us to ask questions about their beliefs towards TP. Finding out whether the assessed risks match these beliefs and firm strategy is important in this research.
I collected data from firms having their head office in the Netherlands, and thus being domestic taxpayers in the Netherlands. Even though the fact that firms should be multinational enterprises does not necessarily require firms to be Dutch, the interviewee selection would be too extensive if other tax jurisdictions were chosen. Moreover in order to guarantee consistency the head office should be located in the Netherlands to ensure equal laws and guidelines, and with CFO’s and Tax Directors mostly present at the head office these circumstances are beneficial for this research. The final criteria is again related to the firm, for which the international component is important. The documentation requirements under the Dutch law require a turnover of 50 million in order to be effective. Interviewing firms that require a MF and LF is therefore a must, whereas firms that require a CbC-report (turnover >750 million) contribute even more. This is not an exclusive selection criterion due to time constraints and the low amount of firms having such a turnover. We found seven companies that were willing to participate. First it was planned to interview only five managers, however more when more candidates were available this number was expanded. When I interviewed seven managers the answers were becoming more and more similar, concluding that further expansion would not be necessarily. Each of them met the selection criteria including size and function. Company B & Company D were part of a group of companies and therefore had to hand in a CbC-report even though their sole turnover was not high enough. The manager’s responsibility with respect to TP was not affected by the fact that they were part of a larger group of companies. Table 1 shows the important data with respect to their firm. The order is based on the interview date, and transcripts use the same order and naming.
31 | P a g e
Interviewee Company Duration interview Function LF/ MF CbC-report Turnover Employees #1 Company A +/- 60 minutes Tax Director Yes No +/- 600 +/- 1350 #2 Company B +/- 70 minutes Tax Director Yes Yes +/- 600 +/- 4500 #3 Company C +/- 40 minutes CFO Yes No +/- 180 +/- 900 #4 Company D +/- 50 minutes Tax Director Yes Yes +/- 6500 +/- 13000 #5 Company E +/- 60 minutes
CFO Yes Yes +/- 350 +/- 1200
#6 Company F +/- 50 minutes CFO Yes No +/- 200 +/- 350 #7 Company G +/- 50 minutes CFO Yes No +/- 250 +/- 700
TABLE 1: INTERVIEWEE SAMPLE
Some of the data has been anonymized due to sensitive information. Prior to the interviews participants were asked to sign a consent form (Appendix 2), these have been used to guarantee the participant anonymity but also to ensure their voluntary participation. Besides the interviewed companies above, interviews have also been conducted with two tax specialists. These interviews have supported the theoretical basis of this research.
During the interviews a recorder has been used, enabling the interviewee to focus on the interview instead of writing the answers down. The duration of the interviews was approximately 1 hour on
32 | P a g e
average. After the interview transcripts were produced based on the recordings using a software tool called F5 Transcript. In order to ensure an unbiased method colleague students were asked to validate the transcripts. The selection procedure for the validation occurred random.
The transcripts were reviewed using the interpretative method. Coding was used to some extent. For this coding we used Atlas.ti. In general, we used the more traditionally qualitative method in order to process the data. “[…] interpretive methods will never meet the criteria established for quantitative methods—because each of these modes of generating understanding and claiming it as trustworthy rests on different philosophical grounding” (Schwartz-Shea & Yanow, 2015, p. 3). We are interested in these different motivational groundings. The control environment varies for all firms mapping these, and the consecutive risk assessment is a direct consequence of these beliefs. Objectively writing these beliefs and the corresponding firm response down gave us more insights in contrast to a more quantitative approach. Directly asking the interviewee their beliefs and paying attention to their (non-)verbal response was the most objective method.
Therefore the data was processed in the following way. First the transcripts were coded indicating for each answer to which sub question it provides an answer too. Secondly we checked whether this initial coding process had not led to contradicting answers within the interview. Third we examined whether different interviews have led to similar or contradicting answers for the sub questions. We present this analysis in the result section. After presenting the different views from each interview we formulated a conclusion in the final section, and discuss difficulties with conflicting views in the discussion section.
Qualitative research helps us when testing the current theory and creating new ones (Eisenhardt & Graebner, 2007), even though this research does not aim for the creation of new theories, this research does tend to provide understanding of how TP is currently positioned within the IC of firms for which the interpretive method is a suitable fit (Schwartz-Shea & Yanow, 2015).
33 | P a g e
IV. RESULTS
In order to answer our research question a series of five sub questions were formulated: 1. How does the firm control for tax related TP risks?
2. Which tax related TP risks are identified by firms?
3. How did the increased TP documentation affect the control environment? 4. How did the increased TP documentation affect the risk assessment? 5. Which incentives play a role for TP compliance?
In this section we will present the results of our interviews.
1. HOW DO FIRMS CONTROL FOR TAX RELATED TP RISKS?
Table 2 shows information collected from the interviews with respect to their internal control, after which we will elaborate on the information provided in the following paragraphs.
COMPANY IC SPECIFIC TAX CONTROLS SPECIFIC TP CONTROLS HORIZONTAAL TOEZICHT TAX STRATEGY
A COSO Yes Yes Yes Yes
B COSO Yes Yes No Yes
C None No No Yes No
D COSO Yes No No Yes
E Yes Yes No No No
F Yes Yes Yes Yes Yes
G None No No No Yes
34 | P a g e
First we notice that not all firms use COSO some firms use no internal control framework at all. This would suggest that the firms would have a hard time controlling for their tax related TP risks in general. The CFO of Company C states that even though they do not have a formal internal control framework:
“[…] we have a report from the accountant and we perform internal audits, which is essentially the basis of a good internal control”
Supported by the fact that they are participating in ‘horizontaal toezicht’ (the Dutch form of cooperative compliance) this does indicate some form of internal control. Company G previously used a formal internal control framework, which faded over time. Its CFO states that:
“[…] what is performed with respect to internal control comes from the people that work here [aims at informal control used and designed by employees]. In the past processes have been designed which include some form of controls. These processes I have been written down with the use of external consultants. Periodically these are subject of review when failures occur.”
This again indicates a form of internal control which is active but less formal.
As we are interested in the control over tax related TP risks a formal/informal internal control framework is not sufficient. As can be seen in table 2 only three out of seven firms have TP related controls. These vary from periodic reviews which should be signed off (company B), quarterly benchmark comparisons (company F) and complete process descriptions, including formal controls, that were designed using COSO and tested by the Dutch Tax Authorities (company A). From the firms that have specific tax controls only one (company A) fully adopted TP within their IC framework. This would indicate that firms either do not consider TP as important enough to be included in their IC framework, or firms have other ways of controlling for the risks.
As mentioned before Company C states that it has more informal controls, and uses audit reports, internal audits and ‘horizontal monitoring’. When asked how they control for TP related risks they indicate that their tax strategy does not require them to do so. Both Company E and G mention they use comparable searches (method used to find firms with similar characteristics) to benchmark their results for each entity. At year end they correct for any non-corresponding
