Trends Driving Tax-Related Financial Restatements

Financial restatements are on the rise, and many involve tax. Material weaknesses or inaccuracies related to income tax accounting and the Financial Accounting Standards Board’s Accounting Standards Codification (ASC) 740 are historically among the top reasons for restatements. According to a report from Audit Analytics, tax was a top five restatement issue in 2021, when restatements reached their highest levels since 2006. That increase was largely the result of the sharp rise in restatements involving special purpose acquisition companies (SPACs), but restatements for domestic filers still rose year over year even when excluding SPAC restatements, indicating a growing issue.

Misstatements can be corrected in several ways, including through reissuance or revision restatements and out-of-period adjustments. However, because they affect stock price, financial restatements can cause significant problems — including reputational damage and financial harm — so it’s critical for public companies to take steps to avoid them. With additional FASB accounting standard updates and reporting requirements on the horizon, the tax risk landscape will become even more complex, leaving tax leaders with more changes and risks to consider.  

To prepare for evolving complexity and expanding tax risk, tax professionals must understand the top issues facing tax departments and causing restatements. A proactive approach to those challenges can help tax leaders navigate potential issues.

Causes for the Rise in Tax Restatements

Tax-related financial restatements typically stem from complexity in one of several areas, and the three most common issues are increasing regulatory complexity, persistent workforce issues, and internal process concerns.

Increasing Regulatory Complexity

Tax departments face a raft of new U.S. and foreign regulatory developments that have added even more complexity to an already challenging tax environment. Those developments include:

• FASB’s recent approval of amendments to reporting requirements for U.S. multinational enterprises (MNEs) to enhance transparency through more detailed disclosures in financial statements about taxes paid at the state and local, federal, and foreign levels;
• The Inflation Reduction Act’s introduction of a 15% corporate alternative minimum tax on the adjusted financial statement income of large corporations;
• The OECD Pillar Two model’s top-up tax for large MNEs with annual revenues of at least €750 million to address base erosion and profit shifting;
• Shifting customs and trade policy, along with new tariffs to protect supply chains considered critical to the economy and national security, such as those involving materials for semiconductors, battery metals, and more; and
• Evolving regulatory framework for cryptocurrency and digital assets in the U.S. and other countries, as exemplified by the Responsible Financial Innovation Act introduced in Congress and tax reporting rules proposed by the IRS and Treasury Department.

Persistent Workforce Issues

Increasing regulatory complexity has also mixed with recruitment challenges, creating a dynamic wherein shrinking tax departments must handle a growing workload, which further exacerbates tax risk. According to the 2023 BDO Tax Strategist Survey, two of the top three recruitment challenges tax executives face are a lack of candidates with specialized knowledge and shortage of new accounting graduates. With fewer people entering the profession and experienced professionals retiring in large numbers, that trend is set to continue for the foreseeable future.

Further compounding these challenges, many international companies must also manage global workforces, especially amid the growth of remote and hybrid work.

Internal Process Concerns

An array of process issues can contribute to inconsistent reporting and increase the need for restatements. Poorly documented policies, insufficient internal reviews, and a lack of strong internal controls can all damage the reporting process. Those problems often stem from insufficient technical resources and/or disparate technology systems that don’t provide a single source of truth.

In some cases, a company’s growth might outpace the capabilities of its tax function. What worked for a company with $100 million in revenue likely will not work for a company with $500+ million in revenue. Mergers and acquisitions (M&A) and post-merger integration can be related catalysts for issues of scale. Failure to involve the tax department before closing a transaction can increase the risk of tax uncertainties not being identified during due diligence. It could also hamper systems integration, lead to inadequate staffing in the tax department, or result in siloed information. Here again, business leaders may be unable to point to a single source of truth for data.

How to Navigate Evolving Tax Risk

Despite those challenges, proactive businesses can help mitigate tax risk and enhance reporting by considering the three tactics discussed below.

Routinely Give Tax a Seat at the Table  

The 2023 BDO Tax Strategist Survey divided respondents into two categories: Tax Strategists (29%) and Tax Tacticians (71%). Of the two groups, Tax Strategists are more often involved in strategic business decisions, which correlates to driving positive business performance. But more than 7 in 10 tax leaders are characterized as Tacticians, meaning most are not routinely brought to the table before decisions are made.

It’s critical for tax executives to have a say in strategic planning so leaders can properly factor in tax considerations before making key decisions. When a business understands the tax impact of a given decision and plans accordingly, it gives the tax department time to adapt to any changes — whether they apply to M&A, geographic expansion, regulatory compliance, or another area.

Rethink Staffing Models

Given the workforce challenges above, organizations should plan and structure their staffing models to meet their needs. A holistic assessment of the tax department — including employee skill sets and tax-related business needs — can help leaders define their requirements and create the right model. Often, the right mix of co-sourcing and outsourcing can help provide the tax function with ample resources to manage risk. Agility and flexibility can help prevent the need to revisit the entire staffing strategy whenever a change occurs that has tax implications, such as a regulatory shift or geographic expansion.

Tax leaders who have a playbook for addressing those issues and have established relationships with trusted co-sourcing and outsourcing providers will be better prepared to adapt. According to our survey, Tax Strategists are well ahead of Tacticians in terms of understanding options for a flexible staffing model. Overall, Strategists outsource and co-source more tax functions than Tacticians, which can help reduce the risk of errors and restatements.

Outsourcing and co-sourcing can also free up internal resources so that tax professionals can focus on more strategic work and provide knowledgeable guidance for the business. Evaluating all available options for the staffing model will become more important amid evolving regulatory complexity and talent pipeline challenges.

Review Internal Control Frameworks

Strengthening internal controls can also assist in significantly reducing tax risk. Business leaders should implement uniform policies and establish consistent controls and processes across their organizations. Maintaining a strong internal control framework is a continuous task, and weak control environments often occur in areas of the business that are less mature or were recently integrated or restructured. As the business grows, it’s vital to review and strengthen related controls.

Fortunately, advances in technology can enhance internal controls. For example, it is easier than ever to unify various data reporting systems used by different departments, locations, or business lines. There may also be opportunities to add robotic process automation for data entry to improve speed, accuracy, and the capacity to handle a growing volume of data.

Strategize for Success

As tax complexity evolves and the risk of tax-related financial restatements increases, businesses that understand the common causes for restatements and take steps to address them will be better positioned for success. But businesses don’t have to go it alone. Tapping an experienced third party to provide tax risk services can also elevate tax risk management. Involving tax leaders in strategic decision-making, assessing options for staffing models, and bolstering internal control frameworks can all mitigate tax risk and facilitate success across the organization.

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