Tax Risk Management - An Introduction

Risk comes from not knowing what you’re doing. - Warren Buffet

A risk illustration

Imagine you enter your office one morning and are surprised to find a few officers from the service tax department. They are speaking with your Accounts Manager in a very tough tone. You are told this visit is due to a default of service tax on payment made by your company to service vendors. Though service tax has been paid on the payments received by your company for services rendered, the tax remained unpaid on payments to some service vendors.

One thing is perplexing. You ask your Accounts Manager "why we are liable to service tax when we receive service from vendors and we are not a service provider." It takes some time for your accountant to explain that these are the exceptional situations. For some defined services the liability to pay service tax gets shifted to the recipient. He calls this "reverse charge mechanism".

You then discover that transactions and payments to service vendors are through the ERP, but the service tax payable on a "reverse charge" basis on "accrual basis" is tracked off-line by your staff using excel spread sheets. All along you your impression was that all accounts and tax processes were automated. You ask the Accounts Manager to investigate and report on the lapse and what can be done to prevent recurrence.

Does it really end there? Should it really end there? How could you be confident that there aren't other similar gaps in processes which are latent and waiting to explode? How do you protect the Company from such risks?

Such risks are not unusual in the world of Indian taxes.  In taxes, risks arise from myriad sources. The consequences of unmitigated risks may range from life threatening to trivial. There could be operational risks arising from a critical consignment required to start production getting stuck in customs. It could be a sudden surprise demand by the authorities alleging incorrect claim of an ineligible exemption going back several years.  There could be a survey or raid by the tax authorities on your company and this news may find its way into the media denting the company’s reputation.

Whatever be the nature of the tax risk, the consequences are invariably dreadful. It’s necessary to know what you are doing… it’s necessary to know what  the tax laws require you to do … and finally it’s necessary to do a due diligence periodically to ensure that your tax processes are robust and adequate to meet the legal requirements.

We shall be dealing with this aspect of tax management in future articles and posts. Watch this space.