The current financial crisis, quickly turning into a more global economic downturn, may have long term side effects on corporations. Among them, increase in regulation and additional scrutiny of authorities is likely to lead to a rise in reporting pressure to a level never reached before. Growing public deficits will lead all major countries to increase the efficiency of their tax regulations and collection processes thus leading to additional tax pressure on corporations. This will consequently increase general tax risk on most multinational companies having potentially a negative impact on Shareholder Value. Despite the current gloomy perspectives, the situation also offers opportunities. Now is a good time for management to question and screen any mean for securing -and increasing- the firms’ healthiness and ultimately its Shareholder Value.
In this document, we suggest to consider the combined effects of Taxes on cross border activities and its risk mitigation in the shareholder value perspective.

Taxes on Cross Border Economic Activities
Enterprises operating in more than one fiscal jurisdiction (usually countries) have to calculate, justify and report on the part of revenue belonging to each jurisdiction. The business integration and cross-country spanning activities of such companies require defining the price used in internal sales between subsidiaries of a same group. This price is called transfer price.
The choice of the transfer price will affect the allocation of the total profit among the parts of the companies. This is a major concern for fiscal authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue for multi-national companies.
Business response to transfer pricing issues are various and most advanced multinational companies developed more complex business structures trying to avoid transfer price risk exposure. Partnership agreements and business control centers are examples of alternate strategies. Even if the need for proving the transfer price of goods, services, loans and IP rights is lowered using those strategies, the need for demonstrating Tax Rule Compliance in allocating profits among the parts of the companies remains and leads to even more complex reporting needs at group level.
The transfer pricing and other subjects impacting taxable profits are not country specific topics but universal ones and any company operating in more than one country faces them.
Cross border tax issues are major risks for multinational companies and can affect dramatically their results, reputation, share price and shareholder value. Risks can be classified along the following categories:

• Reputation risk - The risk of becoming headline news;
• Cash flow risk - Also described as tax audit risk – unexpected cash payable relating to previous years;
• Accounting risk – Unexpected Income or Losses issued by accounting positions that can no longer be maintained, i.e. depreciation of tax assets, losses carry forwards, etc.;
• Regime risk – Influence on future cash flows due to a change in attitude with respect to tax planning or regulatory changes.

Increase in control and enforcement measures, combined with extended international collaboration between Tax Authorities mandate for appropriate and extended Tax Reporting Capabilities on the side of multinational companies.

Impact of Effective Tax Rate (ETR) on Shareholder Value
Development in Corporate Finance over the last 20 years has shown rising attention on Shareholder Value. As traditional accounting methods have turned out to be unreliable in valuation, new and value based oriented metrics have emerged such as Economic Value Added (EVA), Cash Flow Return on Investment (CFROI), Market Value Added (MVA) among the major. Those methods have become standard tools and are now widely used by professionals in corporate finance, financial analysis, stock market analysis and more generally in most investor relations.
Without arguing the pros and cons of each approach, let’s consider the effect of Taxes on the common computation of a firm's EVA.

Given EVA is calculated as:

where
NOPAT =            Firm operating profits after Taxes, but before financing costs & non-cash entries except depreciation
k =                     Firms’ weighted average cost of capital
Capital =             Total cash invested in the firm over life, net of depreciation

EVA is frequently expressed as:

where
r =                      Return on Capital as

And finally Return on Invested Capital (Source: Value Based Managament by John D. Martin and J. William Petty, Harvard Business School Press, 2000):

where
NOPBT =            Net operating Profit before Taxes

Similarly to the accounting return on net assets (RONA), the return on invested capital is function of (1) the firms’ before taxes operating profit margin, (2) the capital turnover rate, and (3) the cash tax rate. Therefore, we can conclude that the return on invested capital is driven by how the firm manages its income statement, its balance sheet and its taxes. By measuring this (EVA), we can observe if the firm is creating or destroying value.
The point we would like to stress is that Management of a firm can increase firm value only by one of the following actions:

1. Increase the rate of return earned on existing base capital (generating more operating profits without investing additional capital)
2. Invest additional capital with a higher return than the cost of new capital
3. Liquidate capital from investments where inappropriate returns are being earned.

From (1), we see that Effective Tax Rates (ETR) have the most effective impact on return on invested Capital and therefore on Shareholder Value. This is substantiated by many studies of famous international consulting firms like PriceWaterhousCoopers that asses: "…a 1% fall in a company’s cash tax rate can have the same impact on shareholder value as an increase in its sales of 12-15% over ten years..." (Source: "Winning Opportunities in a Challenging World", PricewaterhouseCoopers - January 2005 Issue no. 52)

Many additional management actions can (should) be undertaken for increasing the return rate of invested capital, ensuring a sustainable long-term growth and competitive advantage. Increasing gross margin, working on any cost section of the income statement, optimizing of working capital and so on, are not to be ignored. But working on ETR optimization with appropriate reshaping of the firm's value chains and transfer price optimization is, without any doubt, the most rewarding as it provides short to long term additional returns on invested capital.
According to Jörg Walker, Partner and Head of Tax, KPMG Switzerland, tax policies and the way firms are dealing with them is no longer a backroom issue; it is a fundamental part of good corporate governance, which needs to be communicated openly and effectively.
Thus, in addition to regulatory pressure, Shareholder Value perspective should increase management concerns about appropriate ETR optimization.

Combined Tax Compliance Risks Mitigation & Shareholder Value Preservation
As tax compliance risks are universal and ultimately not dependent on specific tax optimizing strategies, it becomes obvious to work on both sides, the defense itself while keeping in mind the optimizing potential. This because lowering the Firm's ETR increases the return rate of its invested capital.
Mitigation of tax risks, with or without precise optimizing strategy in mind, relies on interdisciplinary approaches involving Corporate Management and Corporate Tax Departments now appraised on post-tax results. Ultimate success in defense of efficient business models, value chain re-designs and corporate tax optimization planning against Tax Authorities involves complete and comprehensive documentation of Rules, Principles (Arm's Length, APA's, Value Drivers…), Calculations, Reporting and Accounting Standards, proving consistency of compliance at every level of the company.
Sharpening the Firm's transfer pricing policy might be risky as coming closer to the edge, unless the Firm is able to manage and demonstrate its ability to control the four systemic tax risks: reputation, cash flow, accounting and regime risks.
For both aspects, Information Technology provides valuable means that can no longer be ignored. Indeed, proving the consistent use of rules or sustainable calculation rules to tax authorities in cases of transfer pricing implies the ability to trace the complete process. This ranges from formal documentation, business reasons and rules, transaction descriptions, identification of related parties, calculation rules down to each line of calculated results for all cost, revenue, asset and liability items involved. The amount of elementary transactions that needs to be reported on in addition to the numbers of calculation that needs to be computed is growing rapidly and it is not unusual to face loads ranging in millions or even more for large and complex businesses. The spreadsheet and word processing approach can hardly fulfill these needs, especially not since the burden of proof was pushed back to companies. Risks are therefore rising again and only largely automated, consistent, integrated and secured systems will be able to address this level of complexity and stay competitive in future.
Using financial reporting solutions as a starting point for building a transfer pricing solution is reasonable since they cover nearly 80% of tax purpose data. Those solutions are used anyway for Legal and Management reporting purposes, but lack the remaining 20%.
For many years now, our mandate has been to support corporate management in daily operations by promoting, integrating and developing appropriate architectures, tools and systems. On this path, we have progressively gained insight and experience that lead us to bridge the gaps of missing parts in addition to existing systems. Our solution now extends Oracle Hyperion Financial Management with additional functionality, leveraging it to a Full Collaborative Tax Planning and Defence Environment. This approach offers many advantages over other existing solutions that address the challenge starting from a tax documentation perspective.
It delivers significant savings, additional returns and increased process automation to large corporations while sustaining their international Tax Optimization strategy. Additionally, this approach fulfils rising requirements of tax authorities to use the same data for tax and financial reporting.