Weighing Up The Risks

WHEN I WORKED in tax departments of accountancy firms, more years ago than I care to remember, very few people would have understood the concept of 'assessing the business risk' involved. It was before the days of mass computerisation, certainly before the days of ambulance-chasing litigation, and people just got on with the job of completing tax returns and filling out forms 930 by hand (that should have dated me pretty accurately for those old enough to remember). The nearest you got to risk management was a fledgling compliance manual which set out a few standard procedures.

Things have changed. Talking to those responsible for managing tax departments now, it is clear that the management of risk is increasingly important for many of them. Unfortunately, it is also an area where firms are not always particularly keen to be quoted by name. This article is therefore based on what I have been told by practitioners, even though no details are given. It looks mainly at personal tax departments, although similar principles apply to corporate tax.

What is risk?

The Concise Oxford English Dictionary offers the following definition of risk: 'hazard, chance of ... bad consequences, exposure to mischance'. Risk therefore involves an element of chance or uncertainty, probability and consequence. The outcome of risk-taking could be harmful. The converse must also be true: if successful, the outcome of risk could be beneficial or result in an opportunity — the greater the risk, the greater the degree of success or failure.

Every day business life involves a considerable number of risks. To seek to avoid risk is to stagnate. A successful business is not one that studiously avoids risk or takes risks on casually. Rather, it is the business which assesses the probabilities in advance and takes steps to manage the outcomes.

Risk in the modern tax department

For the modern tax department, as for the practice as a whole, risk presents itself in a number of ways and cannot be avoided as long as there are clients. Tax practitioners should, like all good business people, embrace properly managed risk for the benefits it can bring to the practice: good client relations, enhanced reputation, resulting in an increased quality client base, a more profitable business.

However, the accountancy (and hence tax) profession is widely regarded as ultra-conservative and therefore risk averse and that, perhaps, is why it is all too easy for tax practitioners to disregard the whole question of risk management.

Unfortunately, the consequences for the practice of poorly managed risk can be disastrous: loss of reputation (with both the Inland Revenue and clients), Inland Revenue enquiries, negligence claims and litigation, loss of clients, reduction in profits.

But what are the risks for today's tax practice? Have they changed over the years or is the profession simply more aware of them? Certainly, the most worrying day-to-day area of risk for the tax professional must be that associated with compliance. Gone are those lazy, hazy days of Inland Revenue driven assessments, appeal and postponement and eventual determination, often some years after the accounting period.

Despite the failings of today's Inland Revenue, tax deadlines under self assessment are tighter and more inflexible, with automatic penalties and surcharges. The onus has shifted: practitioners can no longer luxuriate in lengthy exchanges of correspondence with the taxman.

They are now called upon to interpret the client's actions according to ever more complex legislation, for presentation within the confining parameters of the self-assessment return. Many practitioners feel that the Inland Revenue is itself becoming more aggressive, and that the risks are greater and the pressure to get it right higher than in the days prior to self assessment.

Area of risk in compliance

The move to self assessment has led to a more process driven environment and the associated risks are different from pre-self assessment days. Even a moderately large tax department must adopt a 'production line' type approach for personal tax return preparation, involving tighter controls of process and clients to manage the flow of returns as evenly as possible throughout the ten months of the tax return period. The risks inherent in operating a process driven compliance function arising from this change of emphasis include the following.

Tax practitioners operate in a service occupation, where the ability to create and maintain client and partner relationships is paramount. But the human element conflicts with the need to be process aware.

Reduction of client interaction and service appear inevitable in a process-driven operation, where the focus shifts from clients to form completion and attainment of targets, especially if staff are measured by compliance statistics. The paradox lies in the fact that, although, ultimately, the client receives the completed tax return within the time limit, there has been a sacrifice of client understanding and knowledge to achieve it.

The associated risk of reduced client confidence can also be enhanced if a tax department adopts an inflexible 'compliance by numbers' system of standard letters. The benefit of these to the practice, it is suggested, lies in the satisfying of professional indemnity insurance criteria, not that of client service.

Lack of ownership is another direct result of the process-driven environment: there is a requirement for management to distribute work evenly across the workforce. This may be commercially acceptable and achieve the targets, but leads to fragmentation of approach and lack of knowledge of the client's affairs. Of course, staff movement, increase in experience and promotion all add to complicate this issue.

Incomplete or late provided information is another problem for the process-driven operation, which may grind to a halt as a result. There can be a tendency to push the return out of the door (no questions asked, process now, without checking later), especially during January.

Risk exposure is then to loss of accuracy, through incorrect returns, or the use of estimates or provisional returns, to Inland Revenue enquiry (interest and penalties), with its resultant loss of client confidence. Tax involves attention to detail and the concept of materiality is, as CIOT Professional Conduct Guidelines remind us, not officially recognised by the tax authorities.

The need to understand in depth the consequences of any action taken by the client is paramount to the completion of tax returns and this can be sacrificed when there is inconsistency in the use of staff, or where low cost, inexperienced staff are used because of fee and time cost pressures. Tax staff may become demotivated by the process environment and, if the process is too tightly controlled, may feel that they do not have the opportunity to know the client. Eventual loss of staff will exacerbate many of the issues described above.

Effective management of risk

The areas of risk identified in this article are centred around risks involving clients and staff, which lead to Inland Revenue exposure. Consequently, management of them centres around these groups of people. The greatest risk is probably around the people involved in the process, but preconceptions need to be challenged in all areas.

Although there is a view that it is impossible to 'train the client', some practitioners do have experience of their successful management, with some clients knocking on their door as soon as the tax return hits the doormat. Ideally, clients should be managed to provide their information in full, with supporting paperwork early enough in the season for a proper review to be made and advice given. Clients will appreciate the benefits of knowing their tax liabilities well in advance of Christmas and of receiving appropriate advice, based on a considered review of their tax affairs. The benefits also include the reduction in incomplete or incorrect returns, in the use of estimates and in the need for provisional returns.

As for managing the Revenue: 'Is this possible', do I hear you ask? Perhaps not, but it is possible to use the white space, 'additional information' area. Some managers suggest that there is too little advantage taken of the opportunity — not given pre-self assessment — to explain and justify return entries, not only where further detail is desirable or required because of recent legislation, but anywhere that further information could prevent a Revenue enquiry.

Staff education in the use of judgment and in the application of client knowledge and specialist tax skills is vital. Management must balance the level of staff knowledge and experience and the need to challenge and motivate staff against the potential profitability of the return, bearing in mind the client's needs and his importance to the firm.

Staff are the key to driving the process forward. Standard 6 April checklists and reminder letters are, for some clients, just junk mail until New Year's Day, when tax return completion appears as a deadline in their diaries. Successful management by staff of their clients and workloads will bring the benefits of increased ownership and motivation and a happier team.

When the inevitable does happen, and January dawns to reveal the list of 'usual suspects' to be rounded up, management by staff of their clients should mean that these names come as no surprise and, in the final week of January, if a firm is forced to 'prepare now' it should take a leaf from the Revenue's book and 'check later': in February, after the dust has settled, staff should re-evaluate the return and make any amendments immediately.

Finally, having acknowledged that self-assessment requires process awareness, the process itself needs to be managed. This involves the necessary use of statistics and, it is believed, a review process involving the eyes of another over the contents and meaning of the completed return. In reviewing, the emphasis should reflect what the review procedure sets out to achieve, namely accuracy and completeness, but with an overview of the importance of the return contents to the client and any exposure to the Inland Revenue.

Proper and consistent risk management for the self-assessment compliance function is essential to ensure that the process operates like a 'well oiled machine'; the manager's role then becomes that of the maintenance engineer, keeping an eye on the moving parts and preventing them from breaking down or coming to a halt. Then, when the machine is humming quietly away, you can think about adding value to those compliance clients — a few bells and whistles will, after all, not overburden the machinery.

Issue: 3990 / Categories: Comment & Analysis