Flexibility in Tax Compliance 

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In tax compliance, a certain amount of rigidity is expected. But in tax technology, the buzzword today just may be flexibility. In this Tax Technology Corner, Tax Executive senior editor Michael Levin-Epstein interviewed two product leads at Bloomberg Tax and Accounting—Nick Frank and Adam Schrom—to find out why flexibility in this space is essential.

Michael Levin-Epstein: What are the risks for taxpayers, in terms of their provision process, of being too rigid in their approach?

Nick Frank: The provision process is the most scrutinized process in most corporate tax departments because it has visibility in the financial statements. The CFO and the CEO care about how it impacts earnings per share; they care about what that means to the actual income that the company is reporting. We want to make sure that, as tax professionals, we are managing those risks ahead of time and not being so reactive. The issue you’re going to have is that for any business process, particularly as companies grow or change, the processes need to be able to adequately address the changes in the underlying business or in the environment you’re in, whether that’s changes in tax law or changes in the actual footprint of the business that require you to comply with laws in different states or different countries. Any of those things will require some kind of corresponding changes in your tax provision process. We want to be more proactive as changes occur, so we are adapting our models and processes so that we can do the work.

An additional issue that is super common in the provision space is the time crunch. Everything is done in a very short window of time, particularly for publicly traded companies. Most people doing provision work are doing all the work just weeks after year-end, and then it goes to the external financial statement auditors for review. So, not only are you doing it quickly, not only does it have a lot of scrutiny within the organization itself, but you also have the external auditors looking at it. So, there’s a lot of pressure on this point. And if your process is very manual, and businesses change, the likelihood of getting something wrong—and having that wrong on a big stage with high scrutiny—goes up significantly. If your footprint changes and you didn’t contemplate how you were going to integrate that into your process, or if the tax laws changed very late, like they did with the Tax Cuts and Jobs Act, you will have a difficult time incorporating some of those changes into your process and meeting the deadlines that are required for reporting for those types of companies.

Adam Schrom: To key in on several things that were said . . . first, around the time crunch: this is an activity that happens at specific times during the year, and you often don’t have a lot of time to get it done. Tax is usually one of the last stakeholders in the financial close process to get this information, so they have the least time of anyone. And so, when you have a manual process, it’s hard to get all that done. Oftentimes, the tax department is forced to make trade-offs around where they’re going to spend their time on the provision. And so, if you don’t have as much time because you have a manual process—and again, you’re up against the clock to get it done—those trade-offs that you have to make lead to more risk in the calculations: risk that you’re getting them wrong or not doing enough to get them materially right. You’re leaving stones unturned, so to speak, that may otherwise result in errors that could be highly visible and lead to problems.

Keys to Flexibility

Levin-Epstein: What are some ways that taxpayers can become more flexible and dynamic in terms of the process?

Frank: There are obviously several different types of challenges that they’re trying to deal with. One is the technical challenges from a tax perspective: How do I apply the law appropriately? Another problem is, How do I apply the accounting standard ASC 740, or tax literature for accounting, appropriately? And then also: How do I mechanically do all this? A common mechanical problem is consolidation. That’s one of the most common issues we hear with larger organizations: How do I consolidate all these different calculations from different jurisdictions or different legal entities together? For that particular problem, one of the biggest solutions is implementing tax provision solutions or software, because spreadsheets—though a very powerful tool—aren’t necessarily designed to do that work in an efficient, clean, repeatable, controlled manner. So, provision solutions can do that. The other thing that gets hard to do is adherence with ASC 740 rules. There’s a set of calculations that you must do as part of the provision: You have to calculate how much you’re going to owe to each jurisdiction as your current payable, and track through all your deferred taxes from the prior year balance to the current year ending balance, whether those are temporary items, net operating losses, or credits for each jurisdiction. Because of those frameworks, there’s a set of math that goes around them. 

We also need to calculate the tax rate reconciliation at the end of the process. What is my actual rate? That’s what we’re really concerned about. All those calculations have a mechanical or logical mathematical structure to them, and a software solution can relieve you from having to manage all of that in a spreadsheet. So, instead of spending time making sure as those changes happen that you’re updating all the formulas for these calculations, you can focus on the right things and focus on the numbers: Should I have this item? Should I not? Those are the right type of questions for the tax professional—not updating spreadsheets with formulas for what are functionally defined calculations. A strong software solution can alleviate much of that.

Schrom: I think the best way I’d summarize a little bit of what Nick said is automate what you can automate. These calculations, especially in ASC 740, have a very mathematical, logical structure to them. If you can automate that structure through implementing a software, it frees you up to focus on other decisions or analyses that require more brainpower and aren’t simply representing math in a spreadsheet. You can spend your time thinking about those things, making sure you’re uncovering risks, documenting those risks and addressing them. Automate what you can. That gives you the time to focus on being flexible—responding to business changes, for example.

Measuring Flexibility

Levin-Epstein: How should taxpayers evaluate whether they are being flexible enough?

Frank: I’ve always thought one of the best ways to evaluate the effectiveness or flexibility of a process is to ask yourself a question for various elements that might need to change: What would it take for you to incorporate that change into your process? How long would it take? For example, if I have a new entity that formed this year and is operating or I acquired a new entity, how long would it take me to incorporate that entity into my process? Or if I have a new state, new foreign jurisdiction, or the tax laws were to change, how long would it take me to integrate those new things into the calculations, get comfortable that they are properly calculated and then reflected in the answer? Because what we’re always concerned about is that if something gets raised late in the process—for whatever reason it just doesn’t get filtered to the top of the priority list, or just was missed somehow—that’s the spot where the pressure is on. All eyes are on the tax department to turn that around, and as we all know, when we try to work fast, we often make mistakes. So you want to be able to test, and you can test this pretty easily. How long does it take? If I had to add a state in my existing process, is that two hours? Is that a day? Is it two days? We believe that those things in a good solution should take minutes, because [what] your focus should be on is, Do I need to be in another state? That’s a technical question that needs to be addressed. Do the facts mean I should be filing in this state? I formed a new entity; I need to be able to reflect that appropriately in the jurisdictions in which that entity owes tax. I have a new item that I need to account for; I’m claiming a new credit, for example. That needs to be reflected in how much I owe to each jurisdiction or in my rate reconciliation. Think of those types of things, and then try to estimate or even test out how long that would take to do if that was the change you had to make at the end of your structure. That will give you a good indication of how flexible and robust your process is.

Schrom: There’s probably not much to add on this one other than, similar to what Nick was suggesting, think back to an example. The Tax Cuts and Jobs Act—signed December 22, 2017, right? Nine days before the end of the year. It had a lot of people scrambling to figure out what they were going to do in their provision to reflect the results of a massive change in tax law. Fortunately, the accounting standard makers realized just how significant a change this was, so there was a little bit of relief that they gave to corporate tax departments in preparing their provisions with these changes in mind. What happens if I have that last-minute law change, like Nick was saying, or what happens if there’s this change in the business structure or entities? It’s those types of thing—maybe not at the magnitude of TCJA—that you want to be thinking about when it comes to flexibility in your provision. 

Levin-Epstein: How do you go about prioritizing what parts of the process to focus on?

Frank: I think if you’ve done that assessment, you understand how long these various things take, then you’re going to start looking at “What can I do to automate them?” Again, a software solution is going to help significantly, because you want to get the things that are repeatable and structured out of the way. You don’t want to be doing that stuff manually. So, those are the things you want to focus on automating, looking at how much time is spent on them, and then how standardized can they become. There are also technical areas where you want to think about how things in your process integrate with one another. One part of the process might be efficient, but the handoffs between components of your process may need more work. For example, once you conclude that you have an uncertain tax benefit, how hard is that to get into the process and integrated into the rate reconciliation, which is sometimes detached in a lot of people’s processes? We want to encourage tying all those provision elements together. Again, a solution can help with this significantly, but you want to make sure that the handoffs between the components of your process are extraordinarily clean or automated completely.

Schrom: This one’s interesting. There’s a tendency to conflate the tax technical calculations with the ASC 740 calculations, the tax accounting calculations, in this process. It’s also common to conflate the tax technical calculations with compliance, which I tend to think of as simply the filling and filing of the tax forms, although that’s no simple process, to be sure. That said, what this can lead to is a lack of clarity in understanding where you are struggling or what things are most important to address to make the provision process more efficient. So I think it’s really important for tax practitioners to view these processes as distinct—the tax technical calculations, the tax accounting calculations, and forms filing. Take the tax technical calculations. There’s a tool for that, right? Most of the time it’s a spreadsheet, your work papers. Those work papers are primarily where your tax technical calculations live. And then there’s ASC 740, or the tax accounting calculations, that are derived from the results of those tax technical work papers. Thinking about these two sets of calculations as distinct, looking at them in that way and then evaluating where are you struggling, what are the pieces of those distinct areas that you could improve, will help in that evaluation process and in trying to decide what solution meets a particular challenge or need that you have in the overall provision process.

Levin-Epstein: How do you see provision processes changing in the future?

Frank: There’s a focus across tax on automation, digitization, and making things more efficient. As in most areas, we’re all being asked to do more with less. But yet, at the same time, the world is actually getting more complex. Most companies that are growing are going to be adding complexity through their growth. And then, at the same time, you have tax authorities adding more and more rules and compliance issues and having more difficult technical issues that you need to deal with on the tax technical side, like Adam mentioned. With all that happening, the drive toward using tools to solve the different components of the tax experience, the whole tax journey, is going to become more and more important, because we’re going to need to make sure that we are not spending time on things that can be automated, like the consolidation question we talked about, or the various things that a provision tool can do for you. Separating the provision calculations out from those tax technical calculations—for example, the Section 163(j) interest disallowance or GILTI inclusion—I think we’re going to see more automation in that space. And we’ve started to see some of that, but I think there is going to be more automation in the tax technical calculations, in the work papers space, and then also linking all of these things together to the backbone of it all, the research; how do I know that I’m doing it technically correct? I have the rules, the regs, the Code, and the case law, and I have all that for my work papers, and I have research that I could do on ASC 740 sitting with that. So, really tying research, tax technical calculations, and the provision together in a more holistic platform.

Schrom: I think Nick nailed it. In the last question, I noted there’s this tendency to conflate the tax technical and ASC 740 calculations, which can lead to an inability to effectively identify the problems or opportunities for improvement. However, while they are distinct, you should really think about how you can address them holistically. So, this idea that Nick was talking about, how do you bring tax intelligence more directly into these processes, and also ensure your tax technical calculations flow nicely into the ASC 740 calculations, even though they are distinct sets of calculations? Look at each process discretely when you’re evaluating them and trying to identify pain points or areas of improvement. But when you’re thinking about how you address them, think holistically. 

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