From the March 2007 issue of Treasury & Risk magazine

Odd Couple That Works

When Tiffany & Co. decided to take its China strategy to the next level by establishing a wholly foreign-owned entity to support its retail operations, much of the heavy lifting for the financial and operational design fell to organizations under the direction of treasurer Michael Connolly. The team's deep knowledge of the company's strategic priorities made the choice easy, but it wasn't the only criteria for involving the executive and his treasury. Besides his skill set in corporate finance and cash and risk management, Connolly also brought a substantial background in integrating tax principles that allowed him to shape a capitalization structure for the new Tiffany-China Co. with just the right mix of equity investment, inter-company loans and bank debt up front, including all tax rate considerations.

The $2.4 billion fine jewelry retailer--with more than 150 retail stores in 21 countries--had operated two boutique locations in Beijing and Shanghai. Under the new structure, Tiffany opened two new stores in China last year. It also has more control, a formalized supply chain process for imports, borrowing and cash management relationships with Chinese offices of two international banks that supply debt and cash services, and a financial platform for the future. "By bring-
ing the two disciplines [of tax and treasury] together, you get to ask all the right questions up front," says Connolly. "Our goal is that all subsequent surprises are operationally driven rather than due to a lack of design."

Connolly began his career at Tiffany as a tax specialist in 1989 when the company's annual revenues were $384 million. In 1997, he was named treasurer, after being involved with the company's push into new markets and operational and vertical expansion changes. Connolly has both tax and treasury answering to him, and he expects each to have an understanding of the other's point of view. "Our conversations are regularly around the potential local country and U.S. tax and cash management impacts of everything that we do," says Connolly, who also has responsibility over risk management at Tiffany. "It allows us to optimize our cash management decisions; for example, even though we may see an attractive investment opportunity in a particular market, we have to anticipate that there might be a tax haircut in computing the expected return.

That kind of day-to-day close coordination between tax and treasury is still pretty rare at many companies, where the two tend to live in separate camps except when a sudden, large transaction forces cooperation. But not having tight coordination on a regular basis can be a costly oversight in these days of surging deal making, expanded opportunities in overseas markets, heightened regulatory scrutiny and corporate fixation on cash flow.

For those companies in the relative minority where tax and treasury functions report through the treasurer or vice president of finance, the operational and efficiency benefits can be substantial. "Tax and treasury are natural allies," says Jeff Wallace, managing partner at Greenwich Treasury Advisors LLC. "On the international side, everything is an international tax arbitrage and almost everything treasury does, including in-house banking and cross border transactions, is international. When one person controls tax and treasury, they really get along."

That's the upside of cooperation; the downside of failing to cooperate may be serious compliance problems. In the first year of Sarbanes-Oxley Section 404 audits, tax accounting was a contributing factor in nearly one out of three material weakness filings, and for a slightly higher percentage in year two, according to, a research group specializing in due diligence and market intelligence services. The number of financial restatements that cite tax accounting as an issue has risen sharply in recent years, as has the number of tax-related late filings of financial statements. "Getting tax accounting right is causing a fair amount of discomfort," says Mark Cheffers, CEO of AuditAnalytics. The next compliance challenge for finance: Fin 48 (see sidebar story) on accounting for uncertainty in income taxes, which went into effect this quarter after a failed attempt to delay its implementation.

Even if a company acknowledges the added urgency of tax and treasury cooperation, managing the two under shared leadership poses another set of challenges, not the least of which is finding the right person with crossover skills. "Poor communication between tax and treasury is an age-old issue," says Stephen Baird, a principal at consultancy Treasury Strategies Inc. "Tax is a difficult issue for treasury people to get their minds around. It's often an art at some companies, requiring judgments by the tax people that can be difficult for the treasury staff to understand."

For a start, the two have fundamentally different objectives, even though both end up reporting to the CFO. "Tax people are motivated by reducing taxes, which does not automatically mean higher profits or usable cash flows," says Greenwich Treasury's Wallace. And when they aren't working to cut the corporate tax burden, their focus is on compliance and not the bottom line. At the end of the day, instead of working together, tax and treasury are going head to head. "There's often a competitive and tough relationship between tax and treasury," says financial office practice recruiter Elizabeth Ewing, a principal at Heidrick & Struggles and a former corporate treasurer. That can be exacerbated when a tax department is not included in corporate strategic issues early and a company is compliance focused, Ewing adds. "Companies should put their best team, including tax, at the front-end of transactions rather than cleaning up at the back end."

In fact, the common view of tax departments at some companies is one of a largely inward-looking set of individuals less concerned with big picture impacts than with an ever-expanding universe of rules. In contrast, treasury is one of the most forward-looking departments. These diverging perspectives become apparent in the area of risk management, where the focus is on the "what-ifs" and how to quantify them. "Treasury has very strong risk management capabilities," says Robert Warren, treasurer of Diebold Inc., a $2.9 billion producer of automated teller machines. "It's not part of a tax department's scope to have experience with risk management, to apply it to situations, measure it and manage it," despite the fact that tax accounting and tax compliance clearly pose enormous risks for companies.

Warren is one of the pioneers in merging the concerns of tax and treasury, overseeing both departments at the Canton, Ohio-based company for 20 years before the reporting divisions were realigned last year. His spadework paid off, however, and Warren reports that tax and treasury still have close working relationships. "Despite their differences, there needs to be significant coordination between tax and treasury to make both work effectively," says Warren.

But even the most reluctant tax department and treasury can find common ground when it comes to a major merger or restructuring, particularly if a deal involves a significant international component, and sometimes that is exactly the kind of event that can provide the justification for combining the activities under one executive. Take the case of $12.6 billion TRW Automotive Inc. In 2003, TRW hired Peter R. Rapin to oversee worldwide tax and treasury functions soon after it was spun off to the Blackstone Group and restructured through a leveraged buyout. Rapin already had experience overseeing both groups from his previous work, as treasurer of Engelhard Corp., now a division of BASF. At TRW Automotive, the need for having shared responsibility for treasury and tax was driven largely by complications with servicing the company's then $3.9 billion in debt. "Because this is an LBO structure, it puts a tremendous amount of emphasis on cash flow and being able to get cash flow to service debt," says Rapin.

A lot had to change at TRW Automotive to make that happen efficiently, including an overhaul of cash flow forecasting. Prior to the spinoff, the previous company's revenues were predominantly U.S.-based. Not so for the newly created TRW Automotive, which had some 60% of its sales of air bags, antilock brakes and other auto parts coming from sales outside North America. Traditional business segment forecasting methods were of little use for international tax purposes--and ultimately for efficient cash mobility. What the company really needed were forecasts by country and even by individual legal entity, a view more in line with tax office views on cash flow.

Serving the mandates of both tax and treasury when it came to cash flow would be difficult, but it was also imperative. "It [was] extremely important to be able to take a long-term view of how we are going to bring cash back from all over the world in order to reduce the debt load in the U.S.," says Rapin. Better coordination between the two departments has made it easier for TRW to not only get cash out of overseas operations, but also to get cash into countries like China that are mired in regimented tax and currency rules. "That's another example where having closer integration of treasury and tax works to everybody's benefit," he notes.

The combined authority has had other benefits. In more recent years, TRW Automotive has had an IPO and a series of acquisitions--transactions that have the potential of triggering significant issues involving debt covenants and credit agreements. "Having common control for both [tax and treasury] alleviates that concern that your tax team may be doing something which is perfectly acceptable in the tax world but may create a major issue under bank covenants or under the bond indentures," Rapin says.

But even without a merger at hand, there may be other drivers prompting tax and treasury to cooperate, such as changing tax rates overseas relative to the U.S. For example, German officials recently moved to sharply lower corporate tax rates from an average rate of more than 38% to 29% in 2008, and a rate reduction has also been discussed in Japan. Meanwhile, given the pressure on the U.S. federal budget and current Congressional sentiment, some worry that U.S. taxes may edge higher. From here may follow a situation that Treasury Strategies' Baird sees as a critical issue for treasury over the next several years. "A growing differential in foreign tax rates relative to the U.S. will mean less foreign tax credits and more trapped cash overseas that treasury will need to deal with," he adds.

Chuck Greene, vice president of tax and treasury at $3.5 billion Harris Corp., agrees that the more companies are involved with overseas transactions, mergers and acquisitions, and the intricacies of moving money from one country to another, the clearer it becomes that treasury and tax are very interrelated. Greene had been the company's tax director for a decade before he was made treasurer last year in charge of the Melbourne, Fla.-based company's four-person treasury department. Given his background, he retained oversight of the 13-person tax office. "Especially from the strategic side, when we are pitching ideas and, say, considering new convertible debt with tax arbitrage opportunities, if you don't understand both sides, you don't understand either," says Greene. "You need to understand how it affects the capital structure and how it affects the tax return."

The streamlined approach can also work to the benefit of a CFO, who can look to one person with a solid understanding of finance to explain tax implications of a particular deal rather than two. "I'm the only one they need to bring into the loop for tax and treasury," says Greene. "With fewer people involved in the process, things don't get left out and you don't have to rely on two people communicating to make sure that each considers the other's issues."

For Tiffany's Connolly, who sits on the board of the Association for Financial Professionals (AFP) and is a participant in treasury-themed conferences, the sometimes dysfunctional relationship that often exists between tax and treasury departments was driven home at a recent global treasurers' forum. Connolly asked the group of some 40 treasurers which issue kept them awake at night. "A recurring theme for just about everyone in the room," says Connolly, "was making sure they get to the table with their tax people."


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