Wage taxes in Dutch internationally operating charities

Wage taxes in Dutch internationally operating charities

Building a tax control framework to mitigate wage tax risks

J.F. Kerseborn S3257568

Groningen, August 2018

University of Groningen

MSc. BA - Organizational & Management Control Faculty of Economics and Business

Supervisor: Prof. dr. I.J.J. Burgers Co-assessor: dr. K. Linke

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Abstract

Tax risk management has increase the international community’s awareness after financial scandals in the United states and other countries. Not only the for-profit sector is interested in tax risk management. Also charities become interested because it cannot only contribute to the financial wellbeing of an organisation, but also to the reputation of an organisation, which could be very important for charities as they are operating in an environment with growing competition for donors and grants. In the Netherlands, a charity can be exempt from corporate income taxes, which makes wage taxes the biggest tax obligation of charities. This study tries to develop a tax control framework (TCF) for wage taxes and mitigate wage tax risks within Dutch internationally operating charities by using the existing literature on wage tax, tax risk management and performing in-depth interviews. This TCF is based on the internal control components of the COSO Internal Control – Integrated framework as of 2013. The results of this study show that there is enough commitment and awareness within the organisation for a TCF. Nevertheless, the current TCF does not provide enough ‘control’ to mitigate wage tax risks within the organisation. These risks can be mitigated by conducting regular training sessions for the staff involved with wage tax administration and managers must regularly contact local tax authorities. In addition, documenting wage tax issues, developing an intranet site for wage taxes within the organisation, and documenting responsibilities can enhance ‘control’ within the organisation. Finally, extra staff at the audit and control department is needed in order to provide all manager with feedback concerning their TCF.

Keywords

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1. Introduction

The financial scandals in the United states (Enron and Worldcom) and other countries (Maxwell pension) have increased the international community’s awareness of the importance of risk management and internal controls (Wunder, 2009). As reaction on these scandals, the European Union (EU) approved a law for companies, which pertains to the approval of auditors in EU member states (Wyman, 2006). In the Netherlands, the government introduced ‘horizontal monitoring’ in order to manage taxes (Visser, 2008). Horizontal monitoring consists of checking ‘in control’ systems (also called; Tax Control Framework) beforehand instead of checking tax returns afterwards, and therefore can lead to savings for both companies and the government (Visser, 2008). Not only the for-profit sector is interested in these control systems. Also the non-profit sector became interested because it cannot only contribute to the financial wellbeing of an organisation, but also to the reputation of an organisation (Benjamin and Mohamed, 2014), which could be very important for the non-profit sector as they are operating in an environment with growing competition for donors and grants (Weerawardena and Mort, 2008). However, the Dutch non-profit sector is too large to cover in one study. Therefore, this study focuses on the aspect of Dutch internationally operating chairties. A Tax Control Framework (TCF) is an instrument of internal control specifically focused on the tax function within an organisation (Belastingdienst, 2008). A TCF can help to manage existing and potential tax risks within an organization (Rabenort, 2007). The aim of a TCF is to control all taxes within an organisation, for example; corporate income tax, sales tax, wage tax, and all other taxes an organisation may encounter (Belastingdienst, 2008). The existence of an sound framework is essential to the financial, reputation and business well-being of any organisation, especially those with public accountability like charities (Benjamin and Mohamed, 2014).

4 If an organization operates internationally, it must deal with different tax laws in different countries. For instance, these organisations may have to pay wage taxes in more than one country, which could lead to double taxation for expatriates. These double taxation issues for internationally operating organisations combined with rules and regulations that change from periodically make it difficult to manage wage taxes, which could result in a lack of compliance (van den Enden, de Groot, and van der Stroom, 2010). These risks can result in an additional claim and adjustments from the tax authorities and therefore must be managed.

Although there are numerous models available for risk management and internal control, in most studies and publications with regard to tax risk management, the authors refer to the framework of COSO (Goodman, 2004; PriceWaterhouseCoopers, 2004; Benjamin and Mohamed, 2014), as do countries and international organisations (Netherlands Tax and Customs Administration, 2008; OECD, 2016).

Prior research has described how the COSO integrated framework can function as guidance to manage tax risks with internal controls. For example, Benjamin and Mohamed (2014) primarily address categories of the COSO framework, namely, legal and compliance risk, whereas Goodman (2004) addresses tax risks in terms of the three internal control objectives specified in the COSO integrated framework: 1) effectiveness and efficiency of operations, 2) reliability of financial reporting, and 3) compliance with laws and regulations. He identifies tax-related risks associated with each of the three COSO objectives in order to control them.

However, as far as I could trace all other studies on TCFs regarding wage taxes have described the use of the COSO integrated framework within for-profit organisations. The current literature does not provide substantial information about TCFs and tax risk management in charity organisations, despite the fact that a sound TCF can contribute to the financial wellbeing of an organisation and also to the reputation of an organisation (Benjamin and Mohamed, 2014), which could be very important for the non-profit sector as they are operating in an environment with growing competition for donors and grants (Weerawardena and Mort, 2008).

To provide greater insight into controlling wage taxes in Dutch internationally operating charity organisations the following research question has been developed; “How can Dutch internationally operating charity organisations gain control of the wage tax process?”. By answering this research question, this study aims to contribute to the literature on TCFs with respect to wage taxes within Charities.

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2. Literature review

A wide-web of rules and regulation exist concerning wage taxes in every country in the world. Furthermore, we must address international taxation and extra-territorial regulation. Thus, tax risk management is highly important not only to financial well-being but also the reputation of an organisation (Benjamin and Mohamed, 2014). For charities in particular, reputation is important so as to remain competitive in attracting donors and grants (Weerawardena and Mort, 2008).

This chapter provides the theoretical background on wage taxes from a Dutch perspective. This chapter begins with a short introduction to charities. Thereafter, wage taxes levied in the Netherlands, wage taxes for internationally operating organisations, rules and regulation regarding the double taxation of expatriates, and tax risk management with respect to wage tax are covered. The second part of this chapter provides a framework for wage tax risk management based on the principles of the COSO framework as of 2013.

2.1 Charities

In the Netherlands, charity organisations differ from for-profit organisations as they are prohibited from distributing net profit to individuals such as officers, directors, or other members who exercise control over the organisation (article 2:285 lid 3 BW). A charity is not prohibited from deriving a profit, and in fact, many charities show substantial annual net earnings. However, all net earnings must flow back into financing the goods or services that the charity was formed to provide

(Hansmann, 1981). A charity can also be distinguished from a for-profit organisations with respect to tax obligations, as a charity can be exempt from income taxes if it meets the requirements of Article 4 of the Uitvoeringsbesluit Vennootschapsbelasting 1971 (Corporate Tax Implementation Decree 1971) for non-profit organisations. However, this tax exemption does not apply wage taxes.

Sometimes the board of charities do not realise that wage tax may carry big risks (VWGNijhof, 2016). The next section covers the general features of wage tax levied in the Netherlands.

2.1.2 General features of wage tax levied in the Netherlands

7 these levies and the payment to the tax authorities via the periodical payroll taxes return (Belastingdienst, 2018). However, this study focusses primarily on wage taxes.

The withholding agent or employer is the one who withholds wage taxes of the employees and then submits the tax periodically. In the Netherlands, every employee has a withholding agent (art. 2 lid 1 Wet LB), but the withholding agent can also be independently taxable (art. 1 Wet LB 1964). In that case, the wage tax is levied directly from the withholding agent and not from an employee’s income (as is discussed in more detail at the end of this sub-section).

According to art. 2 lid 1 Wet op de Loonbelasting 1964, an employee is an individual who is, 1)‘a subject in employment; a ‘regular’ employee, or benefits wage from an earlier employment of himself (a retired employee), or 2) someone else (as a widow or orphan), or 3) derives wage from an earlier employment of someone else like a child of an employee who receives a study allowance from the employer of one of his parents.

Besides ‘common employees’, charities and other non-profit organisations may have volunteers working in their organisation, in contrast to for-profit organisations. A volunteer is someone who performs work without making it his profession or is not subject to the authority of a board of an organisation, or both (Bresser et al., 2017). Generally, this person may receive a cost allowance but not a wage. For those volunteers who do receive more than simply a cost allowance, the volunteers scheme could apply (art. 2 lid 6 Wet LB 1964). In this case, this person is not seen as an employee, provided that he or she receives solely reimbursements or benefits with a maximum joint value of €150 per month or €1500 per year. This volunteer scheme does not apply when one of the maximum amounts is exceeded.

8 which the tax due is not paid and the employer received an additional assessment, private use of a company car (in the event that this car is used by two or more employees), and benefits in terms of the Work-Related Expense Scheme.

The Work-Related Expense Scheme, or in Dutch the ‘Werkkostenregeling’ (‘WKR’), was introduced as part of the Dutch wage tax legislation on 1 January 2011. The WKR provides a mechanism with which to determine the taxable element of cost reimbursements, fringe benefits, and other costs related to personnel. Instead of an itemised division of taxable and non-taxable elements per employee, the WKR provides for a maximum amount of tax fee aggregate personnel costs stated as a fixed percentage of total salary sum.

The Work-Related Expense Scheme includes all work-related allowances and benefits provided by the employer up to a maximum of 1.2% of the total amount of wage per year. The amount that exceeds the 1.2% will be taxable with an 80% tax rate. The employer may determine which allowances and benefits are included (art. 31 lid 1 onderdeel f Wet LB 1964). Examples of allowances or benefits which may not be included are monthly wages, holiday fees, and bonuses of a disproportionate size. The employer can also grant employees a fixed amount of remuneration for work-related costs (art. 31a lid 3 Wet LB 1964), for example, 19 eurocents per kilometre for travel expenses related to work. In this case, the employer is obliged to investigate the actual costs made. As mentioned before, the Work-Related Expense Scheme only applies to employees who are taxable in the Netherlands (Horlings, 2017). Internationally operating organisations, however, must also deal with rules and regulations in other countries concerning wage taxes. The next paragraph provides background information on wage taxes in other countries.

2.1.3 Wage taxes: the international perspective

9 only applies to employees taxable in the Netherlands (Horlings, 2017). In most other countries, additional work-related allowances or benefits in cash or kind are part of the taxable wage of an individual (Ernst & Young, 2017; KPMG International, 2018).

The remainder of this section covers the aspects of double taxation and extraterritorial costs for expatriates.

2.1.4 Methods preventing double taxation

When no arrangements are made regarding wage taxes between countries, double taxation could occur for employees working abroad. This means that organisations face the risk of not paying enough or paying too much wage tax, which can result in an organisation not being in control of wage taxes. Tax treaties and other arrangements are established to prevent employees (and companies) from double taxation. If internationally operating organisations operate in more than one country, then wage taxes must be paid in the country of residence of the employee, but under certain circumstances also in the country of source, that is, the country in which the employee performs his or her activities for the employer. Thus, organisations must focus on the different circumstances concerning double taxation, that is, tax treaties. In the absence of such treaties, unilateral rules can prevent double taxation (in the Netherlands; ‘Besluit dubbele belasting 2001’; Decree for the prevention of double taxation, 2001). In general, unilateral rules preventing double taxation prescribe that countries do not apply their national tax laws, and tax treaties instead allocate taxation rights (Belastingdienst, 2018).

10 If these three conditions are not met, then the state in which the employee works is entitled to levy tax. In addition, the ‘183-day rule’ does not apply to directors and supervisory directors of companies, professional athletes, artists, professors, teachers, and civil servants. Tax treaties prevent not only double taxation by countries but also abuse of the law and aggressive tax-planning (OECD, 2016). These rules generally do not concern wage taxes, given that as it is a withholding tax, the employer is not interested in tax-planning structures. Therefore, tax-planning is not discussed in this thesis.

Double taxation can also be prevented by means of unilateral rules, provided that no tax treaty is in force between the employee’s country of residence and the country of source in which the employee performs his or her activities. Based on these rules ,double taxation can be prevented when 1) the employee works fewer than 30 consecutive days in the non-treaty country and can demonstrate that he or she pays wage tax in the country in which the employee works or 2) the employee works for 30 consecutive days or longer in the non-treaty country and makes plausible that the country of employment levies wage tax. In this case, the employee does not need to prove that he or she pays wage tax. If the period is longer than 3 consecutive months, then it is plausible that the country of employment levies wage tax (Belastingdienst, 2018).

2.1.5 Extraterritorial costs and the 30% rule

Employees who are send by their employer to the Netherlands or abroad on a temporary basis may receive reimbursement for the additional costs incurred during the stay, namely, the extraterritorial costs. If these costs are administered incorrectly, then the organisation is not in control of its wage taxes. The employer may choose to reimburse these costs based on the actual extraterritorial costs or else to apply the ‘30% rule’.

When the employer uses the actual extraterritorial costs method, then the employer is obligated to make these reasonably made costs plausible. In addition, the costs and reimbursement per employee must be registered in the wage administration of the employer (Belastingdienst, 2018).

11 Furthermore, when employees are suspended or made non-active but still receive wage, then the 30% rule may not be employed during this period.

The next paragraph describes the risks with respect to wage tax and how to manage and mitigate wage tax risks.

2.1.6 Tax risk management

With changing rules and regulations, wage taxes can be difficult to manage, which can result in a lack of compliance (van der Enden, de Groot and van der Stroom, 2010). The literature provides several definitions of tax risks. For example, Neubig and Sangha (2004) define tax risks in a broad sense as ‘all sources of risks that may create an unexpected outcome from a tax position’. Erle (2008), meanwhile, defines a wage tax risk as ‘the risk of overpaying taxes or of paying less tax than legally required’. According to Erle (2008) tax risks

thus consist primarily of compliance risks, transactional risks, reputational risks, and operational risks. Keeping up-to-date with changing rules and regulations is vital to mitigating wage tax risks, as the alternative can result in additional claims and adjustments from tax authorities and moreover could lead to both reputational and financial damage (Benjamin and Mohamed, 2014). Some examples of wage tax risks in the Netherlands include reimbursements to employees of expenses paid without taking taxes into account, payments made to freelancers without deducting wage tax, and the risks for expatriates for whom no or insufficient wage tax is paid (De Boer et al., 2010). To manage these risks, organisations must remain ‘in control’ of their wage taxes.

Several models and frameworks are available for risk management. The most common models used are the ‘levers of control model’ of Simons (1995), the Enterprise Risk Management– Integrated Framework of the COSO of the Treadway Commission, and the Internal Control – Integrated Framework of COSO (Netherlands Tax and Customs Administration, 2008). In most studies and publications with regard to tax risk management, the authors refer to the two frameworks of COSO (Goodman, 2004; PriceWaterhouseCoopers, 2004; Benjamin and Mohamed, 2014), as do countries and international organisations (Netherlands Tax and Customs Administration, 2008; OECD, 2016). Despite the fact that both COSO frameworks have much in common, they are not identical. The Enterprise Risk Management – Integrated Framework of COSO (2004, 2017) focusses more on enterprise-wide risks (including strategic risks), whereas the Internal control – Integrated Framework of COSO (2013) focusses more on the internal control risks and developing guidance on internal

12 controls (Graham, 2015). In this study, we use the Internal Control – Integrated Framework of 2013, because we focus on the internal controls procedures in charities.

2.1.7 The COSO Internal Control – Integrated Framework 2013

The COSO Internal Control – Integrated Framework of 2013 (hereafter, the COSO framework) enables organisations to effectively and efficiently develop systems of internal control that adapt to changing business and operating environments, mitigate risks to acceptable levels, and support sound decision-making and governance of the organisation (COSO, 2013).

The COSO framework assists management, boards of directors, external stakeholders, and others interacting with the entity in their respective duties regarding internal control without being overly prescriptive (COSO, 2013). The COSO framework can help management and boards of directors, for example, to identify and analyse risks and develop and manage appropriate responses to risks within acceptable levels and with greater focus on anti-fraud. The framework can also be beneficial for external stakeholders of an entity or others who interact with the entity (COSO, 2013). If applied appropriately, the result can be greater confidence in the board of directors and the organisation’s ability to identify, analyse, and respond to risks and changes in the business and operating environments. Moreover, greater confidence regarding the achievement of entity objectives may be the result (COSO, 2013).

As seen in Figure 1, the upper side of the COSO cube provides three categories of objectives, which allows organisations to focus on different aspects of internal control. The front side of the COSO cube provides the internal control components which are required to achieve the objectives. The internal control components have 17 principles which must be met in order to create decent internal control components and are covered in the next paragraph. The right side of the COSO cube distinguishes different levels within the organisation.

13 2.2 COSO and wage taxes

In this part, we provide a detailed overview of the five internal control components and 17 related principles of the COSO framework of 2013. The knowledge of wage tax and the rules and regulations concerning wage tax (provided in the first part of the literature review) are integrated into the COSO framework in order to develop a framework which can help Dutch internationally operating charities to become and remain in control of their wage taxes. However, this framework may not be used as a standard framework because every organisation is different and requires a specific framework to solve its specific issues (Netherlands Tax and Customs Administration, 2008).

2.2.1 Control environment

The control environment is the set of standards, processes, and structures that provide the basis for exercising internal control across the organisation (COSO, 2013). The board and senior managers emphasise the importance of internal controls at the top and establishes structures, reporting lines, and appropriate authorities and responsibilities in the pursuit of objectives (COSO, 2013). This internal control component consist of five principles which must be met in order to create a decent basis for internal control: the component must 1) demonstrate commitment to integrity and ethical values, 2) exercise oversight responsibility, 3) establish structure, authority, and responsibility, 4) demonstrate commitment to competence, and 5) enforce accountability (COSO, 2013).

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2.2.2 Risk assessment

Risk assessment involves a dynamic and iterative process of identifying and assessing risks to achieving objectives. The establishment of specific objectives is necessary in this process of risk assessment in order to identify and analyse the risks entailed by those objectives (COSO, 2013). In addition, changes to the internal and external environment should also be taken into account (COSO, 2013). This internal control component consists of four principles which build upon those enumerated in the previous sub-section: it must 6) specify suitable objectives, 7) identify and analyse risk, 8) assess fraud risk, and 9) identify and analyse significant change (COSO, 2013).

The first step in the process of risk assessment is setting objectives. Paying wage taxes involves processing large amounts of data with great financial interest. Minor errors in this process can lead to additional assessments, which may cause financial damage (PricewaterhouseCoopers, 2009). Therefore, organisations are advised to pursue an (extremely) low risk tolerance with respect to wage taxes (PricewaterhouseCoopers, 2009).

After the objective is set, the risks can be identified and analysed. The aspects of wage tax described in the previous section of this literature review are used to identify and analyse risks with respect to wage tax. De Boer et al. (2010) mentioned several common wage tax risks in the Netherlands, namely, 1) reimbursements to employees of expenses paid without taking taxes into account, 2) payments made to freelancers without deducting wage tax, 3) the risks for expatriates for whom no or insufficient wage tax is paid, and 4) benefits in kind not being taken into account for wage tax purposes.

Aside from these specific wage tax risks, some general risks are associated with wage tax. According to PricewaterhouseCoopers (2009), entering the correct data into the system constitutes a common risk. Rabenort (2007) emphasised communication risks within the organisation. Internationally operating organisations face risks in situations in which the organisation must determine the country in which an employee is taxable. In addition, PricewaterhouseCoopers (2004) mentioned compliance risks, that is, the risks of applying the correct rules and regulations.

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2.2.3 Control activities

Control activities are the actions established through policies and procedures in order to ensure that risks to the achievement of objectives are mitigated to acceptable levels. These activities could be automated or manual, such as authorisations and approvals (COSO, 2013). After the risks are identified and analysed, control activities are implemented. This internal control component consists of three principles: it 10) selects and develops control activities, 11) selects and develops general controls over technology, and 12) deploys by means of policies and procedures. The control activities are then developed based on these principles. By selecting and developing control activities, the risks mentioned in the previous subchapter can be mitigated. This is based on the general risks, which are listed below along with the mitigating activities.

 Entering the correct data into the system.

An organisation can mitigate this risk by assigning responsibility to appropriate members of the organisation’s staff, the management instituting a policy with different levels of authority (e.g., who has to review what), and establishing the ground rules for people performing tasks in which no review procedures are in place (PricewaterhouseCoopers, 2004). In addition, COSO (2013) suggests mitigating this risk by incorporating some manual and automated activities such as authorisations and approvals, as well as the segregation of duties.

 Communication.

Clear communication within the organisations can mitigate wage tax risks which may occur when the organisation decides whether an employee is taxable in a specific country. PricewaterhouseCoopers (2004) suggests storing wage-tax-related information in an organisation’s intranet site (or something similar) or in documents such as policy manuals. This information must be available for all staff involved with wage taxes within the organisation. As previously mentioned, responsibilities of individuals should also be communicated throughout the organisation, because this provides the opportunity for staff to contact these individuals should they face any ambiguities.

 Compliance.

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2.2.4 Information and communication

Organisations must obtain and use the relevant information from both internal and external sources to support the functioning of internal controls. The dissemination of information throughout the organisation is extremely important, as it enables management to communicate the importance of the control responsibilities. This internal control component consists of three principles: it 13) uses relevant information, 14) communicates internally, and 15) communicates externally.

Information must flow up, down, and across the organisation to ensure that detailed control policies and procedures are communicated to and known by those responsible for acting upon them (PricewaterhouseCoopers, 2004). For wage tax, this involves the issues of whether employees are taxable in a specific country and whether the correct rules and regulations are applied in a given country in which the organisation operates. To communicate control activities and responsibilities, they must be stored and managed in some central repository (PricewaterhouseCoopers, 2004).

2.2.5 Monitor activities

When all internal controls are implemented, monitoring is important in order to check whether those components are present, functioning, and relevant. The organisation evaluates and communicates deficiencies in a timely manner to those responsible for taking corrective action (COSO, 2013). This internal control component consists of two principles: it 16) conducts ongoing or separate evaluations and 17) evaluates and communicates deficiencies.

The tax control framework of an organisation is never finished because the environment in which the organisation operates is constantly changing (Belastingdienst, 2008; Veldhuizen and Kamerling, 2009; Benjamin and Mohamed, 2014). The rules and regulations with respect to wage taxes are constantly changing (PricewaterhouseCoopers, 2009), and therefore, each stage in the framework must be constantly reviewed to determine whether every single aspect of that stage is working properly and the risk management process is adequate (Benjamin and Mohamed, 2014). Identifying new risks and changes in rules and regulations related to wage tax must be checked periodically in order to keep the organisation up-to-date. Findings are evaluated, and deficiencies are communicated to

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3. Methodology

The aim of this research is to study wage tax risks in Dutch internationally operating charity organisations, as well as how a tax control framework can mitigate these wage tax risks. Qualitative research is the most appropriate approach for this topic, since the underlying relationships and explanations regarding wage tax risks in Dutch internationally operating charities must be understood in order to develop a tax control framework (Eisenhardt, 1989).

A single case study company is selected rather than multiple case study companies in order to deeply understand a single and unique setting (Lee & Lings, 2008). Therefore, a single case study approach appears to be the most suitable strategy for this research (Eisenhardt, 1989). The site of this case study is a Dutch internationally operating charity organisation with its headquarters in the Hague. The size of the charity organisation and the possibilities of collecting data from this organisations renders it a suitable case study company.

3.1 Case study setting

The case study company selected for this research is a Dutch organisation established in 1965 as a governmental organisation within the Ministry of Foreign Affairs and therefore completely subsidised by the Netherlands government. As the core business of this organisation is to provide development aid in the areas of water and sanitation, hygiene, renewable energy, and agriculture in more than 30 countries around the world. This organisation also functions as a knowledge centre in the field of development aid.

In 2006, the Dutch government announced that they intended to privatise the organisation within nine years, meaning that the organisation was required to redesign its financial structure from a completely subsidised organisation with many political influences and significant monitoring to an NGO which is responsible for its own grants and financial structure. Gaining market knowledge regarding how to receive grants and donations was crucial to this transition.

In 2015, the organisation officially became an international operating charity with offices in 27 countries and its headquarters in the Hague.

3.2 Data collection

18 (Kenya, Laos, Bangladesh, and Ethiopia) and other managers from the headquarters who were involved with wage tax within the organisation. The interviews were held in the interest of understanding how different country offices within the organisation control their wage taxes and how they are able to comply with rules and regulation. In addition, I held semi-structured interviews with an independent tax adviser and the controller of another charity to obtain a clearer insight and knowledge of this topic from a different angle and in a different organisation. This study conducted a total of nine interviews and employed the semi-structured format in order to target specific subjects of interest and explanation (Yin, 2013).

To enhance the quality of this research, I incorporate measurements for validity and reliability (Yin, 2017). With respect to reliability, demonstrating the operations of the study, such as the data collection procedure, is necessary so that the study can be repeated with the same results. First, to guide the execution of the semi-structured interviews, the study developed an interview protocol, with another person supervising the coding process of the interview output (Yin, 2013). Secondly, interviewing employees both from a charity organisation and an independent tax advisors provided me insight and answers from different angles (Yin, 2013). Third, I use triangulation to collect data from different instruments (Yin, 2013).

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Interviewee Position Case study site Time Date

Manager A Country Finance Manager Ethiopia Charity A 01:19 4-5-2018

Manager B Country Finance Manager Kenya Charity A 01:09 4-5-2018

Manager C Country Finance Manager Bangladesh Charity A 01:35 15-5-2018

Manager D Country Finance Manager Laos Charity A 01:21 23-5-2018

Manager E Manager Global Business Development Charity A 01:08 3-5-2018

Manager F Global Accounting Support Charity A 01:13 9-5-2018

CFO Chief Financial Officer Charity A 02:12 8-5-2018

Controller A Controller at another charity Charity B 01:05 17-5-2018 Independent

Tax Advisor

Tax Advisor - 01:16 24-5-2018

Table 1: Overview interviews

3.3 Data analysis

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4. Results

This chapter provides an overview of the results of this study. This chapter retrieves information from the interviews with the managers from the case study company (Charity A), the independent tax advisor, and the manager from another organisation (Charity B). The structure of this chapter is based on the five components of the COSO framework that are described in the second part of Chapter 2.

4.1 Control Environment

PricewaterhouseCoopers (2004) described the importance of commitment and awareness in the organisation for successfully implementing an internal control framework for taxes. Within Charity A, managers demonstrate a positive attitude towards a control framework.

Yes, definitely because, you know, it can make the difference between whether or not you can operate in a country. And, um, to be honest I think that’s something that – yeah, I think that’s a good thing that we need to probably improve on, is to make sure that it’s clear. (Country Finance Manager Laos, Charity A)

The board of Charity A also shows commitment and support for a framework. Several years prior to this study, Charity A decided to redesign its organisational structure by deleting its regional management teams. Every country in which Charity A performs its activities has its own country finance manager and country manager who are responsible for all financial matters in that country, including wage tax. Before Charity A changed its organisational structure, the regional management teams were the overarching management teams for a specific group of countries in, for example, Asia and also included one regional controller. Due to this ‘proximity to the business’, Charity A was able to control and experience how the country offices managed and carried out their controls to a greater extent. To centralise these controls, Charity A implemented a global ERP-system several years prior to this study. With respect to wage taxes, Charity A wants to be able to monitor and review whether the country offices are compliant and in control from a central location (the headquarters).

Well, of course it is not the case that we can execute all compliance matters for all countries from headquarters, but we want to be able to monitor whether the countries are compliant. Because, we cannot do the tax-fillings for all countries at our headquarters in the Netherlands, for example. (Chief Financial Officer, Charity A)

21 with respect to wage tax. For example, Charity A encountered an issue with personal income tax for expatriates in Indonesia. Headquarters discovered several long-term accounts regarding personal income tax which were not paid in time. The country finance manager and country manager of Indonesia failed both to control their taxes and to report this in the self-assessment form. At headquarters, they discovered this mistake too late because the control department was understaffed and lacked the time to review the tax payment (the self-assessment process is discussed in more detail in Section 4.5). After headquarters discovered the oversight, Charity A was required to make an arrangement with the government in Indonesia to resolve the issue. This tax issue also had consequences for the country finance manager and country manager of Charity A in Indonesia.

This could of course have consequences in terms of dismissal, but it also has an effect on the assessment of especially the country finance manager. Because he needs to manage it and also the country manager needs to ensure that their balance sheet is clean. (Chief Financial Officer, Charity A)

This comment emphasises that Charity A wishes to ensure that they are 100% compliant with local rules and regulations with respect to taxes, and they thus strive to retain competent individuals who are able to contribute to achieving the objectives of the charity. If such tax issues become public, Charity A may suffer reputational damage which could negatively influence (potential) donors.

At the time, we face an additional tax claim and it would appear in the newspaper that we [the charity] do not comply with local tax obligations or evade taxes in a certain country, I wouldn’t be responsible for that. Moreover, we will not benefit from this because in the end we will charge our donors for the total costs of the project, including taxes. (Chief Financial Officer, Charity A)

4.2 Risk Assessment

Risk assessment involves a dynamic and iterative process of identifying and assessing risks to the achievement of objectives (COSO, 2013).

22 The objective mentioned previously implies that the risk tolerance within Charity A with respect to wage tax is extremely low. Nevertheless, wage tax risks exist within Charity A. At headquarters, in the Netherlands, the Global Accounting support of Charity A mentioned a reporting risk regarding wage taxes. The risks of inappropriate reporting of salaries and taxes is considered to be the principal challenge. The manager Global Business Development of Charity A noted a communication risk.

If we would get an invitation from a donor to submit a proposal in Country X in Africa, for example, we would immediately be in touch with the country team, so not just working on the technical proposal for which we have a technical team, but also on taxes, the financial and other legal and administrative developments, which my team handles. So then we have to make sure that we include all that or take account of all that in our final proposal and budgets of course. If we don't get everything in there, if we miss up in that, that becomes our liability. (Manager Global Business Development, Charity A)

Other countries in which Charity A does business emphasised the compliance risk regarding wage taxes.

We emphasise the compliance risk because the government in Ethiopia has big penalties for not being compliant with rules and regulation. Although the mistakes concern a small amount of money, the penalties are huge, and Charity A doesn’t have any budget at all for these penalties. We simply cannot use money from donors for these penalties. (Country Finance Manager Ethiopia, Charity A)

Every country has its own rules and regulations, and therefore, all country managers have their own means of remaining appraised of local rules and regulation. Predominantly, the government is the party that can initiate changes which could seriously affect Charity A with respect to wage tax.

As much as possible we try to follow all changes regarding taxes in Ethiopia made by the government. We buy the latest changes and adjustments regarding taxes bundled in a paper from a printing company of the government. We also stay in contact with people from other companies in this field to keep each other up-to-date about these changes and adjustments. (Country Finance Manager Ethiopia, Charity A)

23 So the government issued every year, every financial year, government has declared employment tax rates and VAT rate, eh, yeah, that is very clear and concrete. And if you want to buy these sort of things, you know the VAT rate and employment tax rate, ok? So, when the government declares VAT and employment tax rates – these will apply next year, and we follow that prescribed rate. (Country Finance Manager Bangladesh, Charity A)

I get updates from KMPG whether Laos tax laws have changed. It seems to me that the audit firms here probably have more interaction with the tax office here than anyone and they probably know who to talk to. (Country Finance Manager Laos, Charity A)

By contrast, Charity B also described a situation pertaining to countries in which rules and regulations are not clear. In this situation, such as one in which the government is less stable or rules and regulation change frequently, Charity B sends its own legal advisors to this country (in contrast to Charity A) to ensure that its complies with local rules and regulation.

4.3 Control Activities

Control activities are the actions established through policies and procedures that help ensure that the directives of management intended to mitigate risks to the achievement of objectives are in fact carried out (COSO, 2013).

Several years prior to this study, Charity A implemented a new ERP system on a global level designed to enable the headquarters of Charity A to gain greater insight into the activities of all the country offices. With respect to wage tax, this system is less oriented toward African and Asian countries which force countries in these parts of the world to manage their wage taxes using other software, which is less easy to control because this manner of wage tax administration does not follow a standard process.

Within every country, the country director is the one who is responsible in the end. So, first the HR department administrates all the taxes concerning wage tax. After this, the country finance manager and the country director check the numbers before these are implemented in the ERP system. In the end, the controller at headquarter checks it for all countries sample-wise. (Global Accounting Support, Charity A)

24 The employment tax administration is mainly the processes of who prepares, who reviews, who verifies, and who approves. So that’s a procedure we have. It’s, uh, preparation done by separate person, review by separate person, verified by a different person and approved by a different person. So that way there is segregation of duties. (Country Finance Manager Kenya, Charity A)

Almost all country finance managers emphasised that this process consumes a great deal of time and could easily lead to small errors. All country finance managers suggested it would be better to integrate this wage tax or employment tax administration into the ERP system already in place.

That would help us a lot! This because, although it sounds quite easy to adjust some figures at the balance sheet, it is very complicated to adjust this in the system. Incorporating both systems could help to record the right numbers directly from one system to the other. (Country Finance Manager Ethiopia, Charity A)

However, the CFO disagreed with this idea owing to the cost.

It is not always cost-effective to integrate everything into one system. Most of the time it is less costly to hire an external party to administrate all salaries. This external party sends us the journal-entries which we only need to upload in our system. (Chief Financial Officer, Charity A)

The process of wage tax administration for national staff, as described above, is highly personnel-dependent and involves significant manual control. For volunteers, the process functions identically. In essence, volunteers do not exist within Charity A because everyone receives decent pay, including the interns, since the organisation believes that everyone should receive appropriate pay for his or her activities. Moreover, paying everyone for his or her activities ensures a mutual commitment between Charity A and its staff, which ensures Charity A that its staff complete their activities. For consultants, this process differs from the process for national staff. Charity A ensures that it withholds taxes from the consultants. Via standardised contracts signed before any project, the organisation informs the consultants about its tax policy to avoid any surprises.

25 In general, headquarters advises country managers to consult their local tax advisor, while in other cases, country managers from different countries consult each other regarding specific tax-related issues. The latter practice, however, does not extend throughout the entire organisation. In addition, tax risks are also not documented by all country offices within Charity A.

At the moment, it is very people-dependent, which means that if I’m not around and someone else needs to do these checks, they have to contact me all the time. So, it would be better to document those procedures somehow. (Country Finance Manager Ethiopia, Charity A)

To increase the level of communication within Charity A, country managers advised to implement some kind of a tax platform with which to share common tax related issues.

Control activities regarding the compliance risk differ per country office within Charity A. To remain up-to-date with changes in rules and regulations, most country offices check whether they comply with local rules and regulations on a frequent base. However, no standard procedure exists for all country offices to check whether they remain compliant. In addition, every six months, the mid-year-reviews of all countries are sent to the headquarters, where the control department checks these mid-year-figures sample-wise. However, these current controls do not prevent incidents regarding wage tax.

26 are taxable in the country as part of the total salary. Expatriates (only if they are taxable in the Netherlands) and staff at the headquarters can also benefit from the Work-Related Expense Scheme. Aside from the fact that the budget for these Work-related Expense have been reduced in the last years, the interviewees could provide little more information on these costs and how the organisation controls them.

Charity B controls its activities concerning wage tax differently than Charity A. First, Charity B integrated the wage administration in their ERP system. Secondly, Charity B only acts after the government in a specific country has informed them to check whether they are compliant with local rules and regulations. Charity B emphasises that it aims for full compliance according to the local rules and regulations, but if they are not provided with any indications that they are not compliant, they just ‘wait and see’ what happens. Charity B is sometimes required to pay an additional amount of money afterwards, and sometimes the money is remitted. Charity B can afford to maintain this strategy because it does not rely solely on project funding. Charity B also receives significant amounts of money from private donations, which enables them to finance these additional expenses if necessary.

4.4 Information and communication

Management obtains or generates and uses relevant and quality information from both internal and external sources to support the functioning of other components of internal control. Both internal and external communication support the functioning of these components as well (COSO, 2013). The most crucial information concerning wage taxes is derived from the government or tax consultants in each country. The country finance manager and the country manager are both responsible for keeping this information current. This information is also relevant for headquarters and sometimes for other countries; for example, when a donor wishes to invest in a project, the manager of Global Business Development prepares a proposal detailing the relevant costs for that project. Information regarding wage taxes (and other taxes) becomes important for calculating the appropriate amounts. Of course, not all information concerning wage taxes is also relevant for other countries given that this information is country-dependent. However, information regarding wage tax issues can help other countries, for instance, to identify their tax issues in a timely manner or generate ideas to address the issues.

27 between countries to much. It’s about getting ideas as well. (Country Finance Manager Laos, Charity A)

Several countries do communicate specific information with other countries concerning taxes, however, this does not occur on a regular basis and sometimes happens only once. Meanwhile, headquarters is not always aware of such information sharing between country offices because this communication is not part of some global procedure or policy.

We only shared information once with another country, when we started the process after Charity A became an NGO in 2011. (Country Finance Manager Ethiopia, Charity A)

Last month I have experienced I'm going to hire a new consultant from USA, okay. It is from the Bill Gates deposit. That time, eh, my concern was that the specific country is responsible for the deduction of VAT and other taxes at source, okay. Then, for hiring the international consultant, who will take the risk? Who will ensure the VAT and employment tax? So, it is actually the country. Back then I asked the consultant to give us their Tax-ID number, tax number from your country, VAT number from your country so that it is ensured that when I send the total money to that country, they will ensure deduction from the bank as well. But, sometimes the international consultant, they do not agree to share with us these documents. So, in such cases, I share this with other countries, that if you want to hire a consultant, how to follow the rules when you face any problem. If you follow your own country rules or whether you follow the rules of Charity A. Sometimes we share this kind of issues. (Country Finance Manager Bangladesh, Charity A)

In addition, some finance managers are not even aware of whom to contact at headquarter if they have any tax-related questions.

You don’t know who to contact, there’s no tax person, you know, there is no one that I know – there’s is no central person that I’m aware of, there’s no communication about that – there might be someone, but I don’t know who it is. (Country Finance Manager Laos, Charity A) The independent tax advisor emphasised that communication of information is crucial. The information concerning wage taxes must be available to everyone involved with wage taxes in his or her activities across the entire organisation, at any place and at any moment.

28 information in these two files? They couldn’t ensure us that everybody was up-to-date at the administration department . . . . (Independent Tax Advisor)

4.5 Monitor activities

Ongoing evaluations, separate evaluations, or some combination of the two are used to ascertain whether each of the five components of internal control, including controls intended to affect the principles with each component, is present and functioning (COSO, 2013).

Every year, each country office is required to conduct a self-assessment regarding its internal control framework and fill in a checklist of finance-related questions including tax information. Some country offices must also report to their governments that they comply with the rules and regulations concerning taxes and other administrative matters. These self-assessments are reviewed by the controller at headquarters to check whether such internal control frameworks remain sufficient. To determine whether the answers reflect the actual situation in a certain country, the controller can check and verify the numbers with the mid-year reviews and other information generated from the ERP system. However, the returned self-assessment forms do differ from each other in terms of quality and the level seriousness with which various country offices approached the assessment.

We mainly fill in the self-assessment checklist we give to headquarters and answer their basic questions with respect to taxes. For example, do you withhold taxes? Do you pay taxes on time? Do you follow the requirements set by the government? The answers are always yes. Sometimes they ask for a document to verify the answers of the questions mentioned before. (Country Finance Manager Ethiopia, Charity A)

Yeah, so for instance we submit the internal control framework, but then I never heard anything back about whether or not . . . . I submitted it and then it probably went to the piles of head office. So I never heard feedback as to “oh you guys are going okay, you know, you’ve met 80% of what our framework is saying you should be doing.” So you know, of course nobody is going to be perfect with this, you know their processes and stuff, but there was no feedback from anyone as to say. All they said was you need to talk about this with your country management team and then you need to work a plan going forward, but there was no particular feedback from anyone, it just sort of went to the black hole of emails. (Country Finance Manager Laos, Charity A)

29 countries, but not annually because this is simply not possible due to a limited amount of time available.

The control on the self-assessment needs to get better. In the past, only samples were taken due to an understaffed audit and control department and there were not enough samples checked. But the review of the self-assessments will take place more thoroughly. The reason for this is that our auditor will also rely more on our internal control. (Chief Financial Officer, Charity A)

30

5. Discussion

The previous chapter explains how Charity A designs the internal controls of the COSO framework with respect to wage taxes. This chapter explains how these internal controls in Charity A differ from the theory explained in Chapter 2 and how this can affect the ability of Charity A to control its wage taxes. The findings of this research reveal that Charity A fails to meet all the guidelines for internal controls as described in the literature regarding the COSO framework.

31 The control activities described by COSO (2013) are implemented to a certain extent. Several years prior to this study, Charity A began implementing a new ERP system on global level, but this implementation has not yet been completed in all countries of operation. Wage taxes are not processed using the global ERP system, which makes the wage taxes difficult to control. Only the journal entries can be checked regarding wage taxes in this system. The country finance managers emphasised that they would save significant time and effort were wage taxes integrated into the ERP system, but the CFO claims that this improvement is too costly and instead suggested hiring an external party to administer all salaries. At the country offices interviewed, most of the control activities consist of manual controls such as various checks by different officers (segregation of duties) before the numbers are entered into the ERP system, as described in the literature. Charity A does not address the communication risk within the company well, the literature also describes. Within the organisation, managers are unaware of whom to contact for tax-related issues, and not every country manager documents wage tax risks. In addition, within Charity A, country managers have no regular moments of contact with each other. Control activities intended to keep managers up-to-date with local rules and regulations differ per country. Standard control procedures are not present on a global level, which making control from a central location difficult. The only way Charity A controls the activities of all countries is with the self-assessment forms and mid-year-reviews which are submitted once a year. The controls implemented for the compliance risk are quite limited compared to those outlined as ideal in the literature, which hinders controlling the wage tax process in these different countries from a central location for Charity A. By contrast, Charity B has integrated the salary administration in their ERP-system and addressed the compliance risks, as previously mentioned. They ‘wait and see’ until the government of that country provides an indication that they do not comply. Sometimes, Charity B is required to pay an additional amount of money afterwards, and other times money remitted. Charity B can afford this practice because it does not rely solely on project funding.

32 be seen as less important or not be taken seriously by the individual country managers within Charity A (COSO, 2013).

33

6. Conclusion

The case study conducted in this paper has made clear that the Dutch charity (Charity A) in this research lacks an appropriate internal control framework regarding wage taxes. The biggest risk that Charity A encounters is a compliance risk, particularly in countries in which the government fails to clearly communicate local rules and regulations. Charity A lacks sufficient communication of information regarding wage taxes (and other taxes) throughout the organisation, and headquarters fails to provide monitoring and feedback. The research question to be answered in this study is as follows: ‘How can Dutch internationally operating charity organisations gain control of the wage tax process?’ The biggest general risks mentioned by the managers of Charity A are the compliance riks and communication risk. The compliance risk can be mitigated by conducting regular training sessions for the staff involved with wage tax administration. In addition, country managers must regularly contact local tax authorities or else contact local tax advisors. Support from the board is required in order to succeed in these matters. The communication problem can be solved by documenting wage tax issues, developing an intranet site for wage taxes within the organisation, and documenting responsibilities in the event that an individual encounters any ambiguities and must consult someone. The monitoring problem can be solved with extra staff at the audit and control department in order to regularly review all control frameworks and self-assessment forms from every country, providing feedback if necessary.

6.1 Theoretical and managerial implications

34 6.2 Limitations and further research

35

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7.1 Laws

art. 2 lid 1 Wet LB art. 1 Wet LB 1964

art. 2 lid 1 Wet op de Loonbelasting 1964 art. 2 lid 6 Wet LB 1964

art. 27 lid 2 en 3 Wet LB 1964

art. 19 Algemene wet inzake rijksbelastingen (AWR) art. 28a lid 1 en 2 Wet LB 1964

art. 20 AWR

art. 31 lid 1 Wet LB 1964

art.31 lid 1 onderdeel f Wet LB 1964 art. 31a lid 3 Wet LB 1964

38

Appendix A

1. Introduction of the study

A short introduction of my study background, my research topic with and a short description why I think the interviewee can contribute to this study. I also ask whether it is okay to record this interview.

2. Background information of the interviewee.  Can you introduce yourself?

- What is your age?

- What is your study background?

 How long are you working for Organisation X? - What is your function at the moment? - What are your tasks and responsibilities?

 Do you have any experiences at other companies?

3. Introduction questions about wage tax

 How would you describe wage tax within your organisation? (describe the process)

 How are you as a manager involved with wage taxes? (examples)

 Do you have any tax (wage tax) related experience?

 Who are responsible for wage taxes within your country? (e.g. paying the right amount etc.)

4. Questions about internal control Control environment

 Do you know the attitude of the top management related to tax risks, especially wage tax? - How is their vision communicated throughout the organisation?

- What is the desired behavior related to wage taxes?

 Was this attitude the same before Organisation X became an NGO?

39 - How does the management communicate the responsibilities per country?

Risk assessment

 What are the objectives with respect to wage tax? - Can you explain these objective(s)?

- How does this objective influence the activities concerning wage tax in your country?

 Do you think wage taxes can cause risks to achieve the objectives within the organisation? - Why?

- Can you give an example?

 Have you ever face any problems concerning wage taxes as a manager? (e.g. Work related expense scheme, expatriates, etc.)

- Can you explain this situation if applicable? - How did you manage this situation?

 How do you identify any wage tax risks that could affect the achievement of the objectives in a negative way?

- Can you give me examples?

- Do you expect any kind of tax risks or changes related to wage tax in the future which could have an impact on Organisation X? Please explain if necessary?

 Changing regulation, how do you deal with this?

- Your CFO described a situation in a country in Africa where expats from Organisation X were no longer excluded from wage taxes due to a change in legislation. Organisation X became a NGO and therefore wage taxes must be paid by Organisation X. This could have serious consequences for the project when this issue was not known before the project started. How do you deal with these issues?

Control activities

 Can you explain the process for wage taxes in your country?

 What kind of internal control measures do you use for this process? - Do you think this is the best way to control this process? - Have you ever faced any problems? (e.g. fraud)

 How do you deal with non-cash benefits which are part of the wage? E.g. housing, cars, educational fees etc.