Staying on top of state and local tax law can be a tremendous strain on tax departments. How do tax teams get the data they need to comply with the rules?
A rapid change in state and local tax laws, regulations and procedures is happening while companies and tax executives are being asked to do more with fewer resources. FEI Daily spoke with Peter Michalowski, national practice leader of PwC’s State and Local Tax (SALT) practice, about the challenges these changes present and how companies are planning to leverage technology, outsourcing and other means to address their expanding reporting and regulatory compliance burden.
FEI Daily: Are companies generally proactive when it comes to preparing for regulatory developments?
Peter Michalowski: Some companies are better prepared than others, but most organizations with sophisticated tax departments are very involved in the legislative and regulatory process. The tax department works closely with the various business stakeholders and, in particular, with the government affairs group within the company.
Most large businesses have a government affairs group that employs lobbyists, both at the federal and state and local level, to represent their interests. That is the case whether it be developments related to business or tax legislation and regulation. Many of our clients are very engaged in this process.
Businesses also work with industry and trade groups. At the state and local tax level, there’s an organization called COST, the Council on State Taxation, and their membership is made up mostly tax professionals of Fortune 1000 companies. They closely monitor state tax, legislative and regulatory developments, and they provide thought leadership and suggest legislative policy positions on behalf of their membership. Businesses may also rely on external resources, including law and accounting firms to monitor legislative and regulatory developments. Our firm, for example, invests significant resources in monitoring state and local legislative and regulatory developments for clients.
It’s a combination of the tax department, government affairs within the company, lobbyists and industry and trade groups working together. That combination is really how companies can best stay engaged in the process of preparing for legislative and regulatory change at the state and local level.
What often happens within the company is the tax department works with the business teams to model various scenarios depending on what the legislative and regulatory changes look like. The company evaluates the impact the changes will have on the business to determine if there are changes they need to make as a result —both from a structure and compliance perspective.
FEI Daily: What’s the risk if a company doesn’t prepare adequately for these kinds of changes?
Michalowski: There are several different risks. One risk is the potential for a surprise impact to financial statements. If companies are not prepared for these changes and have not analyzed the impact, there could be unexpected financial statement implications at the time the legislation is adopted. Typically, companies communicate the potential impact through financial statement or other disclosures. If they know legislation is going to be enacted and there will be a material impact, they’ll disclose the estimated impact of that pending change.
From a financial reporting perspective, companies may have requirements under SEC and GAAP rules to disclose the impact of legislative changes at the time of enactment, so they need to stay ahead of it.
In addition, from a tax reporting compliance perspective, tax departments need to be able to get the data to be able to comply with reporting requirements.
Another risk many companies face in this changing tax environment is adequately preparing for the impact on a company’s current and future tax profile. For example, in an effort to close perceived loopholes, states may enact law changes that label certain activity as taking place in a ‘tax haven’ and impose new tax reporting requirements related to those activities. A company needs to evaluate the impact at the state, as well as the federal and international levels of these and similar proposals.
In sum, companies that are not adequately prepared for change may have financial reporting impacts, additional tax compliance and administrative burdens of these new rules.
A related issue is the cost to a company’s business. Some of these changes have the effect of increasing a business’ effective tax rate and cash taxes payable, as well as increased administrative costs to comply with the new provisions.
FEI Daily: What challenges do companies face in their preparation efforts?
Michalowski: The reporting requirements for tax departments are greater now than ever. Companies used to operate in more of a “bricks and mortar” fashion. Now, in our digital economy, companies are not limited by physical location and are operating across all states, as well as globally, and there are tax implications to this expanded presence.
Tax law has evolved at the international, federal, and state and local level to capture the changes in the way companies do business. Now companies are filing tax returns in many more jurisdictions, so it’s not uncommon to see most of our clients filing in 40 or 50 states. There are also the local filing requirements on top of the state filings, and the complexity of the rules in those states and localities continues to increase.
When you’re operating across 50 states, there are similarities in state tax filing requirements, but there also are different rules among the states. To stay on top of all of the rules is a tremendous strain on tax departments. It requires companies to invest more heavily in technology to help automate the function as much as possible. It requires companies to have access to better financial data, and that too can be challenging.
As companies go through acquisitions they may inherit legacy systems that don’t ‘talk’ to each other. In those circumstances, how does one get the data needed to comply with these new rules? For example, many of the new state income tax rules address how to source income based on where the customer is located. Within these rules, there’s a hierarchy of guidelines a taxpayer must use to determine how to make that sourcing determination. Extracting the data necessary to comply with these guidelines from the legacy systems presents a real challenge.
All this is happening at a time where there’s a lot of pressure on costs. Certain industries, like the financial services industry, have been through years of cost cutting to improve their bottom line. At the same time, they have tremendous regulatory reporting requirements being put on them. You’ve read about all the Dodd-Frank and other federal regulatory requirements that the financial industry is dealing with and it’s putting a major strain on tax departments to comply with these voluminous reporting requirements. At the same time, they’re also trying to be proactive and work with the business to make sure their tax strategy aligns with their business strategy.
Companies are looking for more real-time data capabilities so they can do real-time modeling and use data analytics to determine the tax impact of different business transactions that companies are looking at. The way they’re doing that is leveraging technology, looking for outsourced solutions and trying to put more process around how they deal with compliance and reporting.
FEI Daily: How will these changes impact a CFO or a finance team?
Michalowski: The CFO is looking at it from different levels: financial reporting, tax rate and cost, and business structure. First, the CFO wants to know the impact to the company’s financial statement. The CFO wants to make sure they have their financial accounting around taxes correct and they are complying with all the reporting requirements. The second piece is managing the tax rate and tax costs as best as possible, because they’re trying to deliver earnings for their shareholders.
The third thing a CFO is looking at is how the changes in the state and local tax landscape impact how he or she wants to run the business. If you’re thinking about where you want to invest in terms of opening new facilities or hiring employees, one consideration is where is the most tax-advantageous locale to make the investment? Certain states offer attractive credits and incentive packages to encourage companies to locate there and create jobs. There’s a race for jobs around the country, and around the world.•