A finance director has many roles to play; each of them, however, should aim to maximise the interests and satisfaction of existing and future shareholders.

Among these many roles, these are the most important:

• contributing to the elaboration and implementation of the overall strategy;

• structuring the financing sources of the company to reduce the cost of capital of the company and ensure its long term solvency and profitability;

• assessing the different investments and capital expenditures and selecting the ones with the best balanced risk/return profile; and

• ensuring that the accounting procedures and policies offer existing and potential shareholders/investors a transparent and fair view of the company’s market value.

How does the tax director fit into this and how can he or she help the finance director to meet these goals?

Asking the question is already saying that the company’s tax strategy is subordinated to the overall goals of the company and should have no life of its own. The consequence of this is that complex tax schemes with no grounding in the business should not be part of a company’s tax strategy. The reasons for excluding these tax schemes from a company’s tax strategy are not only of an ethical nature; they derive also from the company’s financial objectives. In fact, these tax schemes violate two of the previously mentioned goals of the finance director:

• they blur the image that the financial markets have of the company since they entail a tax risk which is probably not properly taken into account in the accounting books;

• they temporarily lead to a wrong assessment of the profitability of the firm, which is artificially boosted by a tax advantage which may not be sustainable; and

• they may also (depending on the kind of tax schemes used) help reduce, artificially and temporarily, the cost of debt used for computing the overall cost of capital. This in turn may result in an artificially low cost of capital which will lead to accepting capital investments and capital expenditures which would have otherwise been rightfully rejected.

The conclusion of all this is that sound business management should lead a CFO to require that the tax director refrains from complex tax schemes that have no business ground.

Let’s now turn our attention to what the CFO should positively expect from the tax director. The most important contributions a tax director can make are:

• helping the company optimise the way it will implement its international development;

• finding the optimal shareholdings structure;

• establishing a sound transfer pricing policy; and

• helping the CFO define the optimal capital structure.

Optimising international development

Obviously it is not the role of the tax director to determine the markets the company should enter. It is, however, his or her duty to investigate how tax friendly each country is in which the company plans to settle. This is of the utmost importance for the company if it wants to properly calibrate its commitment to that particular country (should it be, for example, a full-fledged subsidiary or a simple branch sales organisation?). The tax friendliness of each country envisaged for some sort of presence by the organisation should be considered and analyzed both from an internal point of view (tax regime of the country: for example, level of the tax rate; tax deductibility of different charges and expenses; possible use of accelerated depreciation schemes; existence of severe anti-earnings stripping rules, and miscellaneous taxes) and an external point of view (for example, tax treaties with other countries, withholding taxes on dividends and royalties). The importance of that type of investigation cannot be overstated, particularly when the company is on the verge of setting up some kind of hub for a region, a subcontinent, a continent or even the world, be that a research centre , a production facility or a financial headquarter.

The CFO should make sure, through the active involvement of the tax director, that these tax considerations will be taken into account along with other important factors such as the size and depth of the market, the availability of abundant and well qualified people, business-friendly labour legislation and the existence or absence of political restraints.

Optimisation of the shareholdings’ structure

It is frequently said that only the consolidated balance sheet and profit & loss matter. This is, of course, perfectly true from an economic point of view and from the point of view of the financial analysts who want to measure the true and real performance of the analysed company.

However, it is not the consolidated group which pays the dividends to the shareholders; only the mother company can act as the payment agent for that. This mother company must therefore be able to pay the dividends which its management has deemed an integral part of its financial strategy.

These are the main points which will have to be considered when establishing an optimal shareholdings’ structure:

• too flat a structure could lead to many impairments, which will directly have an impact on the books of the mother company, reducing its ability to pay dividends;

• too pyramidal/vertical a structure could significantly reduce the speed with which the profits of the intermediate subsidiaries will be made available to the mother company, though interim dividends may somewhat help alleviate this problem

• level of withholding taxes in each country under consideration; possibility of getting those taxes back in the different configurations envisaged for the shareholdings’ structure, as well as ease and speed with which this can be done.

Here the tax director can help the CFO find the right balance between these two conflicting goals by pinpointing when a pyramidal structure protecting the balance sheet of the mother company (and therefore both its net results and its ability to pay dividends) neither slows down the flow of dividends to the mother company nor entails high tax costs when it does.

Establishing a sound transfer pricing policy

Once the markets to be entered have been identified, the size and the nature of the involvement defined and the organisational structure of the shareholdings established, the CFO should require explicitly from the tax director that he or she sets up a sound transfer pricing policy.

It should not be the goal of the transfer pricing policy to maximise the profits left in the mother company or in another group company located in a tax friendly country. This should have been dealt with before (when the nature, the depth, the size and the shape of the international development was decided and when the structure of the shareholdings was determined).

The transfer pricing policy has to be determined according to internationally accepted principles and should aim to reduce to the minimum level the risks of being rejected by the tax authorities of one or several countries. This has to be the case not only for ethical reasons but also for practical business purposes: transfer pricing policies are always scrutinised by the tax authorities of every country. There is no room in this field for tinkering with the internationally accepted rules or for amateurism since reassessment by local tax authorities of the tax return of one or several subsidiaries will result in huge legal disputes .These legal disputes are always costly, not only from a financial point of view; they tarnish the image of the group and tie up for a long time people who could be better used somewhere else.

Though internal tax specialists and the tax director him- or herself know very well all the tax schemes on which a sound transfer pricing policy should be based, setting one up is by no means an easy task. The CFO should therefore recommend that the tax director be assisted for such a task by a specialist tax consultant.

In practice, it is of the utmost importance to understand, if tax risks are to be minimised, that a sound transfer pricing policy does not stop with the determination of the right mechanisms for computing what the transfer price for a given product exchanged between two subsidiaries belonging to the same group should be. A sound transfer pricing policy should in fact include these items:

• a description of the products, the industry and the markets;

• a definition of the competitive environment;

• a list of the activities and risks assumed by the seller and buyer firms;

• an explanation as to why the chosen mechanisms (for example, market minus, cost plus or profit split) are appropriate; and

• a detailed explanation of how the base (for the market minus and the cost plus) as well the plus and minus have been computed and fixed.

Two more words of caution: the CFO will have to ensure through regular and periodic audits that this procedure is correctly applied throughout the group and updated when necessary.

Determining an optimal cost of capital

We refer here to the cost of capital of the mother company as well as the subsidiaries.

To put it simply, though at the risk of oversimplifying, capital is made of two components: capital stock made available to the company by its shareholders and debt.

The cost of capital is nothing else other than the weighted average cost of each of its component. Since the cost of debt in normal circumstances is tax deductible, it is tempting to lower the overall cost of capital through financial leverage (increasing the share of the debt in the global financing sources).

How this could be done is mostly the responsibility of the CFO, who should take into account, among other things, the business risks associated with the markets in which the company operates and the level of operational risk due to the degree of operational leverage (the higher the share of the fixed costs in the total costs the higher the risks). It is enough to say that the riskier the global position (, for example, a highly volatile market or a high degree of operational leverage) of the company is, the greater the share of the capital stock should be if insolvency risks are to be reduced to a reasonable level.

Here, the CFO should require the tax director to inform him or her of the existence of any legislation against earnings stripping since this type of legislation will obviously limit his or her ability to fund the foreign subsidiaries in the way he or she may want. By denying tax deductibility to part or all of the interest expenses, this type of law always aims to prevent the siphoning of the local subsidiaries’ results through payments of interest on massive loans from the mother company or an affiliated company and are coupled with a low capital stock. Since this type of legislation may substantially differ from one country to another in the way it is designed , implemented and enforced, it is of the utmost importance that the tax director informs the CFO of the main features of those laws in each country in which they exist and where the group has a subsidiary or plans to have one.

Impact of tax on business

The goal of this article has been to show that:

• tax matters have an enormous impact on the result of every business decision. It would be, however, disastrous to look at every aspect of the business through fiscal lenses;

• tax matters, however technical and complex they are, are far too important to be left only to specialised technicians; and

• tax problems are much more easily solved when dealt with before taking the business decision which may trigger them

The CFO has to bring tax considerations into a business discussion early enough. It is also his role to make sure that tax considerations will not be in the driving seat. Striking the right balance between the two is not an easy job. It is perhaps the one, however, through which the CFO will contribute the most to the overall success of the company for which he or she works.

Jean-Louis Huchant (jlhuchant1@yahoo.fr) is a former board member and CFO of Bayer in France.

The views and opinions presented in this article are his alone. They do not reflect in any way the views and opinions of the companies he has worked for or been in contact with.