Performance management is a relatively new concept for many tax departments, and a broad range of quantitative and qualitative yardsticks is still being fully developed. So what should these indicators look like?
By Fergal Byrne
Historically, many companies used their effective tax rate as the key measure of performance for the tax function. The advantage of this approach is that the effective tax rate is tangible, easy to measure and can be a good reflection of the effectiveness of a company’s tax planning.
However, the effective tax rate also has its drawbacks as a metric. For one, the overall level of the effective tax rate can depend on other factors, such as the company’s business model, that are outside of the tax department’s control. There is also a danger that a reliance on the effective tax rate can distort the risk profile of the tax function.
“Focusing on the effective tax rate tends to be one-way thinking,” says Todd Tuckner, Chief Operating Officer for UBS’s global finance function, including the UBS tax department, which he ran until his promotion earlier this year. “You can certainly reduce your effective tax rate in the short term but, very often, that leads to poorly priced long-term risks.”
Also, tax planning is only one part of what the tax function does. Tax departments need to be measured according to their performance in a host of other areas, including indirect taxes, transfer pricing, the efficiency of their processes and their interaction with the business. In some of these areas, there are fewer benchmarks in place for tax function performance.
Martin Rabenort, Ernst & Young's (EY) Tax Performance Advisory leader of Belgium and the Netherlands, believes there has been a gradual shift away from a reliance on effective tax rate within many companies. “Companies are gradually embracing a broader set of metrics that reflect the different roles of the tax function.
These might encompass compliance, risk management, supporting the business, tax reporting and, in some cases, tax policy and tax lobbying.” Despite this shift, Rabenort says many companies still tend to rely on a generic set of key performance indicators (KPIs) that can be easily measured and achieved.
This might include indicators such as the timely filing of tax returns. “These generic KPIs are all about the baseline level of performance for a tax function,” he says. “They do not challenge a tax function to be as good as it can be, so are not that useful when used for performance measurement and management purposes.”
Ambiguous metrics are another problem for many companies. “Vague KPIs, usually based on poorly defined objectives and weak leadership, are useless,” says Rabenort. He advises that companies should instead devise a set of metrics that enable historical performance to be measured alongside more proactive indicators.
“Backwards-looking metrics tend to be the most prevalent, but they don’t work so well for managing the tax function,” says Rabenort. “You need a ‘red flag’ at the moment where you can still change behavior.”
Perhaps the biggest danger of all is that companies rely upon simple measurable targets that do not tie in with the higher-level strategic role of the tax function. Tax departments therefore need to develop individual KPIs that are linked to strategic objectives yet responsive to the different dimensions of the tax service provision.
“You would have a very different set of KPIs in a business where there are ambitious objectives but poor processes and limited resources, compared with a situation where you have the same objectives but smooth processes and a clear governance model,” says Rabenort.
The qualitative approach
Tuckner emphasizes the importance of a qualitative approach to performance management. This might include measures relating to the relationship between the company and the tax authorities.
“Over time, you can keep an eye on soft factors like the relationship with tax authorities, and how transparent the tax department is in its dealings with regulators, tax authorities and even the public,” says Tuckner.
Developing the right qualitative measures requires a strong mutual understanding between the tax department and executive management. “It’s important the tax managers can articulate the tax strategy and the way they look at things,” he says.
“Otherwise, it is difficult for management to know how to measure the department. UBS has, for example, published a code of practice for tax and we’ve shared that within the organization. We also share that with tax authorities because that’s what we stand for.”
Looking forward, Tuckner believes that the qualitative approach will become more important as the tax department assumes a greater advisory- and relationship-oriented role. Greater use of shared service centers and outsourcing will accelerate this shift because the more basic activities, such as filing tax returns, will be handled outside the tax department.
“As companies seek to locate all the processing- related activities they can in lower-cost jurisdictions, the more commoditized metrics around efficiency and timeliness will become less relevant for the core tax department,” he says.
Role for internal audit
Internal audit can play an important role in helping with performance management, in line with the “three lines of defense” approach to
risk management. According to this model, the tax function is the first line of defense for the business, the second is the risk organization, and the third line is internal audit, which provides an independent perspective.
At UBS, internal audit’s role is focused primarily on processes like tax accounting and transfer pricing. “These are complex processes that are easier to measure and evaluate quantitatively than, say, providing a business with high-level consulting on a transaction,” says Tuckner.
As the role of the tax department evolves, the management of its performance needs to change accordingly. By ensuring that it has the right metrics in place to guide behavior, companies will be able to accelerate this evolution and ensure that they have a tax department that is fit for the future, rather than focused on the past.
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