SME risk management: taxation

This document highlights the key tax risks that small and medium-sized enterprises (SMEs) and their advisors could face and provides some practical guidance on how these risks can be identified, managed and mitigated. It includes customisable proforma checklists covering common areas of tax risk and which should be adapted to reflect local tax law and tax risks.

Read the full paper or view the summary below.

Introduction: why tax risk management matters for SMEs

For many companies, dealing with the complexities of the tax system is one of the most challenging aspects of doing business. Taxation is a highly technical area, subject to frequent changes, and failure to properly deal with tax compliance obligations can result in significant financial consequences.

These challenges are particularly acute for SMEs. Tax compliance costs for micro entities (representing around 90% of all European businesses) have been estimated to be in relative terms more than five times greater than for large businesses.

It is, therefore, unsurprising that SMEs are more likely to outsource their tax compliance obligations than larger businesses – with smaller or firms professional accountants often being the professionals that the SME turns to for help.

While outsourcing tax functions is an effective form of risk management for SMEs, it also means that the professional accountant in a small or practices (SMP) assumes a share of their clients’ tax risks.

Consequently, it is advisable that both the SME and their professional advisor take active steps to manage tax risks.

Key tax risks facing SMEs

SMEs are exposed to a wide variety of tax risks, which fall into the following categories:

• Lifecycle tax risks: tax risks that arise at particular points in the business’ life, such as on start-up, when the business expands or when owners wish to retire
• Structural risks: these are risks inherent to the business, such as poor accounting records, inadequate management resources or knowledge
• Opportunity risks: these are risks that arise from failing to optimise the business’ tax affairs, which could lead to excessive tax being paid and reducing the funds available for investment

Tax risks facing SMPs

Apart from the element of tax risk that the SME is placing on the SMP by outsourcing its tax compliance and optimisation functions, the SMP faces additional specific risks arising from:

• Not having the full picture of the SMEs business model, its long term plans or its appetite for tax risk
• Failing to take into account changing client circumstances and how they impact tax and the client’s appetite for tax risk
• Deliberate acts by the client that amount to tax evasion and / or fraud

There is also the risk for the advisor when they are asked by their clients to deal with aspects of the tax system where they have had little or no previous experience, which are technically complex or result from new legislation. Failure to address this risk may not only result in financial costs for the SMP but could also put them in breach of a fundamental principle of the IESBA Code of Ethics for Professional Accountants.

Consequences of failing to address tax risks

For both SMEs and their advisors, inadequate tax risk management could lead to:

• Financial risks, including interest or penalties charged on underdeclared tax
• Reputational risks, both resulting in a worsening in the relationship with the tax authorities but also potentially wider if made public
• Loss of freedom, where non-compliance is so severe that the sanction is imprisonment. This in turn could lead to the failure of the business

Practical approaches to mitigating tax risks

The first stage of risk mitigation is to identify the risks that impact the business or the engagement.

Several tax authorities have produced documents that indicate those areas where they encounter the greatest number of errors and mistakes – for example, the lack of proper accounting records is frequently highlighted as a key cause of tax risk.

Using these examples, this document provides practical tax risk designed to help SMEs and their advisors identify potential exposure areas. However, no two national tax systems are the same so the SME and / or their advisor must tailor these checklists to account for local tax law and custom.

Also highlighted are measures that some tax authorities have taken to try to improve relationships with taxpayers and their advisors, including advice on how to approach tax authorities in a transparent matter. Additionally, links are provided to Accountancy Europe’s previous work on how professional accountants should approach tax work and to key changes to the IESBA International Code of Ethics for Professional Accountants to address tax planning activities.