Outsourcing the tax function: a survey.

Introduction

An ill wind blows over the corporate tax departments in private industry, both home and abroad. The phenomenon called "outsourcing" has tax directors, managers, seniors, and analysts pondering their futures.

These are difficult times, indeed, for private industry tax types. In an era of downsizing, rightsizing, etc., overhead departments such as tax have had to share the burden and bear the brunt of cutbacks and freezes, both salary and hiring. In the same period, tax professionals have had to deal with a seemingly annual major tax bill at the federal level. Aggressive, revenue thirsty state and city taxing authorities have become regular visitors at our places of employment with time-consuming audits, lengthy nexus questionnaires, and continuing attempts to squeeze every tax dollar possible cut of Corporate America. In the midst of the daily grind, tax departments must deal with an idea that, apparently, has caught the attention of management: hiring outside service providers to perform some or all of the tax functions now provided by the in-house group.

The concept of outsourcing has actually been around for years. Nowadays, however, "make-or-buy" alternatives are being debated in tax departments across the country on an ongoing basis. For example, do you as a tax executive use outside "vendors" for your software applications? Do you struggle with graphics and large copy requirements or do you send them to an outside source? If you have a difficult issue with the Internal Revenue Service, do you handle it internally or do you seek out legal counsel or assistance from an outside accounting firm? Who handles your company's payroll taxes? Who assists you with respect to your targeted jobs and investment tax credits and provides much needed expertise? What about reverse sales tax audits, property tax billings, etc.?

Are these jobs performed in-house or is a determination made that someone in the corporate marketplace can do them better for less? Sometimes, they are done outside. If that is the case, what is the big deal now about outsourcing tax functions? The big deal is that those who decided to outsource bits and pieces of their tax fiefdoms are now finding themselves outsourced by upper management.

What is the cause of this trend in Corporate America? Is outsourcing inevitable? Who is vulnerable and who is not? Having asked myself most of these questions (and others), I recently set out to try to put together some information about outsourcing of the tax function. I discussed the concept with a few of my peers in the Cincinnati Chapter of Tax Executives Institute, Inc. (TEI). TEI is an international organization with nearly 5,000 members employed by corporations and other businesses. These individuals are responsible for the administration of the tax affairs of their employers in an executive, administrative, or managerial capacity. I sought assistance as well from TEI's national office in Washington. Perhaps most important, I asked representatives of the Big Six" to respond to a lengthy questionnaire on many facets of outsourcing.

Peer Group Discussion

The participants in the peer group discussions were Kenneth Case, Assistant Treasurer and Manager of Taxes, The Kroger Co.; David Prewitt, Corporate Tax Director, Cincinnati Milacron, Inc.; and Joseph Hitter, Director of Taxation, The Mead Corporation. Mr. Case is the current President of the Cincinnati Chapter of TEI. Mr. Prewitt is a former Chapter President and currently serves as a Regional Vice President in TEI's national hierarchy. Mr. Hitter is also a past president of the Cincinnati Chapter of TEI.

The participants were asked why Corporate America is looking at outsourcing as an economic alternative. In the case of Cincinnati Milacron, Mr. Prewitt stated that his firm utilizes outside firms in various "special projects." He felt that the accounting firms already had the expertise and could satisfy Cincinnati Milacron's needs more quickly and less expensively than the corporation itself could if it tried to develop the required expertise.

At The Kroger Co., according to Mr. Case, the philosophy, either for internal or external work, has been "quality work at a fair price." Since 1984, Kroger has decentralized many of its corporate and tax functions with proven results. Mr. Case reported that the company's sales and use tax function was outsourced to the field, allowing him to reduce a job requiring six or seven people to a job requiring only one person with oversight responsibilities. At The Mead Corporation, according to Mr. Hitter, management undertook a complete review of all operations as part of an overall "rightsizing." At his own initiative, Mr. Hitter costed out each function performed by the tax department and asked the company's Big Six firm to bid on each of these functions. For the most part, the accounting firm was not able to match the in-house costs for those services provided.

Mr. Hitter stated that, historically, Mead has used outside service providers for a variety of tasks. He cited the use of law firms for special projects, litigation, international tax issues, and occasionally contacts and expertise in various localities. Big Six accounting firms are being utilized in the international tax-planning area and for expatriate work. Appraisal firms are used in acquisition and divestiture work, and in property tax cases. Mead also utilizes service providers for some property tax functions and occasionally in other tax areas when demand exceeds the budgeted resources.

As a result of the review of tax department functions at Mead, a determination was made to outsource the payroll tax function in its entirety to a service provider. Mead had previously allocated two people to this function. Although cost was certainly a consideration in the firm's make-or-buy decision, equally as important to Mr. Hitter and Mead was the quality of the service provided. Mead demanded and received--for fewer dollars--a "level of service" equal to or better than what was being provided on an in-house basis.

When the participants in the peer group discussion were asked about the increase in tax outsourcing, they responded :.n similar ways. At Kroger, according to Mr. Case, management is striving to be more competitive in the marketplace. Costs are being reviewed at all levels and performance is constantly being evaluated. At Milacron, according to Mr. Prewitt, management expects all departments to exhibit value and "prove their worth." "You must be able to showcase your usefulness to management on a regular basis," Mr. Prewitt reported.

Messrs. Case and Prewitt both touched on the importance of the perception that management has of the tax department, Both felt that tax departments need to do a better job of educating management on just what a tax shop can do if it is given the proper tools and opportunities. They agreed that if management perceived the tax department as merely "a bunch of paper filers," that perception could lead to outsourcing. Mr. Case added that it was important for the operations people to be educated in tax matters. "Name and face recognition are also important," he said. "The tax function cannot be relegated to one section of one floor in the corporate headquarters and be successful."

All three gentlemen also touched on the current environment in the Big Six. They agreed that the Big Six are under the same competitive and cost-cutting restraints as their client corporations. They also acknowledged each of their management's downward pressure on Big Six fees for audit and tax work. This has led the accounting firms to look into other growth areas for revenue.

In terms of the success of tax outsourcing to date, Messrs. Case and Prewitt questioned the service provider's ability to learn and know the business as well as an in-house tax shop. Mr. Hitter questioned whether these outsourcing engagements can be profitable in the early years of the contract. Other issues of concern are, as follows:

* When the audit and tax function are provided by

two different accounting firms, what type of communication

is possible between the two?

* What type of partner/staff rotation takes place?

* Are there short cuts to meet the budget for the

contract?

* Does quality suffer for economy?

* Are there "low ball" bids with corresponding fee

increases in the out years?

Accounting Firm Questionnaire

Since my discussion with these three tax professionals ended with a series of questions, it is only fitting that we turn our attention to the questionnaire submitted to Arthur Andersen & Co. (AA), Coopers & Lybrand (C&L), Ernst & Young (E&Y), Price Waterhouse (PW), Deloitte & Touche (D&T), and KPMG Peat Marwick (PM).

The responses from AA, C&L and E&Y are listed in their entirety. D&T, PW, and PM declined to respond to the questionnaire. Generally, the firms that responded perceived a definite bias in the questions. One firm labeled some of the questions "abusive." The respondents felt the questions were very "hard," "tough," "pointed," etc. Most of the questions in the questionnaire were provided by TEI members for use in an outsourcing presentation at the Institute's 1992 Annual Conference, which was held in San Diego, California. Considering the origin of the questions, bias may have been unavoidable.

I would also like to thank the firms that put forth the time and effort to respond to these questions. I realize the difficult position they are in and appreciate their willingness to provide information and answers to questions relating to an important and emotional topic facing the tax community today. I also believe, however, that the firms' participation in the survey--and the communication of their views through this article--was beneficial to them, because the article provides them a vehicle for the responding firms to address important questions about outsourcing in their own words.

The outsourcing questionnaire consisted of 25 questions covering many areas of concern common to the private industry tax community. The unedited responses from the accounting firms are listed after each question. Answers to these questions were provided by the following firm representatives:

AA Dett Hunter, Tax Partner in Charge--Cincinnati

Office

Daniel Koppenhafer, Tax Partner--Cincinnati

Office

C&L James Moore, Tax Partner in Charge and Regional

Director of Tax Services--Chicago Office

E&Y Moses Awe, Senior Tax Manager--Cleveland Office

Bernard Finkelstein, Tax Partner and Regional

Director of Tax Services--Cleveland Office

Questions and Answers

1. How does an accounting firm become involved in outsourcing a corporate tax department? Are such discussions always initiated by the corporation or does your accounting firm on occasion initiate the discussion? If your firm initiates the discussion, what criteria do you use to determine whether to initiate the discussion with a particular corporation?

AA: It is important to recognize that the discussions over outsourcing are only a small part of a much more important discussion by corporate senior management of the role of the tax function in a business. The value of this discussion is that it has in many companies, for the first time, explicitly focused attention on how the tax department meets its goal of exceeding senior management's expectations. It is unfortunate, although readily understandable, that the portion of the discussion that has focused on outsourcing has alarmed internal tax department personnel. But the reality is that this type of examination more likely leads to a stronger more focused tax department with a clearer mandate as to its duties and responsibilities.

Our goal in public accounting at Arthur Andersen, and we believe the goal of every corporate tax director, is providing cost-effective compliance and proactive management of the tax function that is integrated into the strategic planning of the company. The real issue is not outsourcing, but the proper combination of internal tax personnel and outside professional advisers for a particular company.

Outsourcing the entire tax department is probably not the right solution for 95 percent of the companies that currently have tax departments. However, outsourcing more parts of it may be the solution for some of the others. At the same time, for other companies adding to their tax department staff may be appropriate--even if politically unpopular in the midst of corporate downsizing.

Today's debate over outsourcing overlooks the reality that even large companies have outsourced part of their tax function, i.e., expatriate taxation, preparation of tax returns for overseas operations, personal property tax return preparation, real estate tax protests, etc. Thus, the issue is really not the advantages of outsourcing, but the appropriate scope of the use of outside professionals.

Today, publicity is centered on the occasional virtual elimination of a corporate tax department. What is overlooked is that just as many, if not more, new tax departments are being established. More important, what is often overlooked is that the discussion by executive management of the goal of the tax function has led to a greater appreciation of the tax department and the optimum mix of internal and external advisers. Such an examination often leads to an internal reallocation of resources within the tax department (i.e., perhaps more of an emphasis on state or international taxes as opposed to federal taxes). It can also lead to greater resources being provided to the tax department as long as executive management believes it is obtaining value for the costs invested.

Both accounting firms and internal tax departments have had to change to strive to exceed management expectations in providing value. Interestingly, accounting firms have sought to do so in part by emulating part of the "Best Practices" of internal tax departments. Accounting firms are hiring individuals with tax experience gained in industry, specializing people in areas in which corporations seek assistance (i.e., state and local tax, international tax, compensation and benefits, etc.), specializing people earlier in their careers, hiring paraprofessionals, changing the up-or-out system, investing in technology to reduce compliance costs, etc.

The controversy over outsourcing results because accounting firms have improved the services they offer corporations and in a few situations involving existing internal tax departments, executive management, for a variety of reasons, have decided that an accounting firm offers the most value for cost. What should not be overlooked is that in the vast majority of cases the "Best Practices" involve an alliance of tax department personnel and outside advisers to exceed executive management's expectations.

Historically, the discussion of outsourcing the corporate tax department is initiated by the company. This is particularly true where the outsourcing has to do with the level of quality and cost. Other situations where outsourcing is considered involved businesses undergoing change such as headquarter relocation, LBOs, divestitures, or financial troubles. Still other situations involve companies where there has been turnover in tax department personnel.

For a variety of reasons, companies as they grew decided to bring compliance and, in many cases, planning in house. Companies are now rethinking the function of their tax department, as well as virtually every other corporate function, and a few have decided to radically change their tax departments through outsourcing for a variety of reasons.

When Arthur Andersen raises the issue of outsourcing, the normal situation first involves a discussion with the head of the tax department.

E&Y: Outsourcing is not a new concept to corporate tax departments; it is simply a new term for resource allocation decisions tax directors have been making for years. Most companies have traditionally outsourced a variety of tax functions, including executive tax return preparation services, expatriate tax administration, relocation tax administration, and the tax-compliance function of foreign locations. Such discrete activities lend themselves readily to outsourcing and do not compromise the tax department's strategic role in the organization.

What is new is the concept of outsourcing the entire corporate tax function of major multi-entity, multi-location companies. This concept has yet to be fully tested and proven over time. While it is fairly straightforward to quantify the benefits of outsourcing discrete tasks, it is not as easy to evaluate the advantages or costs of outsourcing the entire corporate tax function. The knowledge that internal tax professionals have of the company derived from their day-to-day interactions and networking with all levels of management is critical to designing the ultimate tax strategy for the company, and difficult for an outside service provider to match. This understanding of the culture, strategic direction, and driving values of the organization is critical to arrive at the most creative, cost-effective, and practical tax-planning ideas, yet difficult to express in dollars.

Ernst & Young strongly believes that the most effective approach to the corporate tax function for major companies is one that combines in-house tax professionals and outside tax specialists. Experience shows that combining the corporate tax executive's knowledge of the business with the specialized skills of outside tax consultants yields the greatest benefit to the company.

In today's economy and highly competitive markets, some companies have realized recurring substantial NOLs, and their financial condition threatens their continued viability. In those situations, the perceived value of an internal tax function may not support the cost of maintaining a staff of highly-qualified internal tax professionals. Affected corporations may consider outsourcing their corporate tax function as no more than contract services for an ongoing compliance function.

While the benefits of combined teamwork by in-house and outside tax professionals are clear, tax outsourcing is on the rise as companies focus on core business areas to improve competitiveness and shareholder value. Given these external forces, the most productive course of action for the tax department is to initiate change, rather than wait to react, to it. Businesses have engaged Ernst & Young to better understand the costs, advantages, and the strategic implications of outsourcing.

Corporate tax outsourcing is just one aspect of the drive to improve business processes. The advantages management seeks from outsourcing are:

* reduced cost.

* a fresh viewpoint.

* resources to cover peak workloads.

* resources to cover special or temporary projects. Corporate tax departments can achieve many of these advantages through the implementation of performance improvement initiatives. In fact, a performance improvement study of the tax department should be a prerequisite for making any major outsourcing decision. Performance improvement studies can help management identify the:

* true benefits and costs of the tax department's

current structure and processes.

* structures or process flows that can be stream-lined

or eliminated to reduce costs and improve

timeliness.

* tax functions that enhance the quality of input to

the core business decision process and have a

ripple effect on core business areas.

C&L: In terms of who initiates the discussion, our experience is that it is generally initiated by the client organization, generally at relatively high levels (CFO, CEO, or Board). We have generally not initiated discussions focused on Tax Outsourcing. Where we have initiated discussions, this has generally been in the context of an overall review of the client's organization and not limited to tax.

You should be advised, however, that we have aggressively marketed tax-compliance and tax-consulting services throughout the history of the firm. Tax compliance and consulting are a Core Business to us and will continue to be for the foreseeable future. We have not singled out tax departments, or tax directors, for a special targeted marketing effort on outsourcing. These groups have been key relationship points for our firm, and to my knowledge we have not embarked on a campaign to displace them. We are, in fact, working closely with many tax departments around the country to improve their efficiency, their use of technology, and the business process used to gather and process tax-related information.

We define tax outsourcing as replacing a function currently being performed by employees of the client organization. This may include situations where we have C&L staff on site at the client and situations where we do not maintain a permanent "on site" presence. To my knowledge, we have no engagements where we have taken over all functions performed by an "in-house" tax department. Our role has been to generally provide those services that the client believes can be better performed by an outside service provider, rather than an "in house" unit staffed with corporate employees and managed by the client.

All businesses are currently evaluating or re-evaluating their critical mission and are looking at ways to improve operating efficiency and focus. We have been engaged by a number of concerns to assist them in that evaluation. This process crosses multiple service lines both within and without the enterprise and sometimes includes the tax support service group within the business enterprise, as well as other corporate functions. There is a growing tendency among business organizations to concentrate on their core business and what they do best with a related effort to identify non-core functions that divert management time and attention away from the core business.

2. From a purely mechanical standpoint, just how does outsourcing work? For instance, who pays the rent / utilities on office space previously occupied by the "tax department"? Is there wholesale displacement of tax professionals or do these tax professionals merely change employers? How are health care a and other employee benefits addressed? How do you determine "how far up" to outsource in a proposal? How much input does management have in these types of decisions? Are there guarantees included in engagements relating to costs, headcount, employee retention, etc.?

E&Y: The "mechanics" of outsourcing are as numerous in variation as the possible combination of outsourcing alternatives. The common levels of outsourcing are:

* Select tax functions such as the preparation of

state and local tax returns.

* Outsourcing the total tax-compliance function, but

retaining the planning, tax examination, and financial

accounting functions.

* Outsourcing the entire operational side of the corporate

tax function, but retaining the tax administration

function.

In each of these instances, the nature and level of resources that will continue to be provided by the company will vary greatly. Costs related to on-site facilities including office space, furniture, and supplies, micro-computer hardware, software, and peripheral equipment, and access to mainframe systems should be detailed on a contract-by-contract basis.

The decision by an accounting firm to hire company tax personnel will depend on the magnitude and scope of services required, the terms and conditions of the company's explicit requirements, the competitive situation, and the economics of the engagement. Internal tax personnel provide continuity and ease of transition, and are valuable because of their knowledge and experience regarding user needs, resources, and intracompany relationships.

C&L: In all cases that I am familiar with, employees displaced by outsourcing situations in tax are generally offered employment with our firm to the extent they meet our criteria for 'tax professionals." They are accorded the same benefits as other professionals in the tax line of business. Our tax practice is currently divided between Tax Consulting and Tax Compliance, and the professionals who are retained would be assigned to one of those units depending on their skills and job responsibilities. They have career paths identical with other C&L tax employees. In the case of larger engagements, guarantees relative to retention, headcount, etc., are the subject of contractual negotiation and will vary from engagement to engagement. We are constantly seeking highly skilled tax-consulting and tax-compliance professionals, and employees coming on from an outsource situation who are redundant will be offered other positions in the firm's tax practice assuming they meet our criteria. There are no more guarantees generally than we extend to other tax professionals in that career advancement and retention are based on performance.

AA: Each corporate outsourcing situation is unique. In most cases, some internal tax personnel are retained, although they may become Arthur Andersen employees. Normally, Arthur Andersen personnel will work at the client location so that there continues to be an everyday exchange of information with client management. Rent, utilities, computers, and other costs normally continue to be paid by the company.

3. Because accounting firms generally have substantial turnover, there is bound to be a learning curve for new persons assigned to the account each year, leading to inefficiencies and potentially missed tax savings opportunities. Can you quantify these tax costs?

E&Y: This perceived "issue" to outsourcing can, in fact, be a "plus" when managed properly. During Ernst & Young performance improvement engagements, we have observed in some situations that work stays with the person rather than the position. In corporate tax departments where professionals do not sufficiently turnover, the cost of performing tasks increases as the employee gains experience and receives increased compensation. Some corporate tax departments are limited in the amount of work that can be "pushed down" to lower level staff as the employee gains experience and can move on to more challenging tasks.

Under the Ernst & Young "teamed" approach, partners and senior managers would have a constant and close involvement on all engagements providing technical expertise and experience. The managed rotation of lower level staff will enable tasks to be performed at the appropriate experience and cost levels, allowing for an effective cost control for both the company and Ernst & Young. More important, in-house tax professionals who have been freed up by the outsourcing of routine and cumbersome tasks can focus on value-added activities such as identifying and resolving tax issues and planning opportunities.

AA: Your conclusion on the turnover rate at Arthur Andersen versus corporate tax departments is mistaken, particularly as it relates to learning curves. Arthur Andersen is changing the old up-and-out policy of constant turnover within our business units. Unrelated to tax department outsourcing, we are hiring and retaining some individuals on a career basis that do not include the expectations of partnership. Many companies, particularly at the compliance levels, have high turnover. The key is to retain the tax executives that manage and do the high-level consulting. Arthur Andersen is attempting to do this by retaining career specialists in state and local, federal, international, and other tax specialties. The firm attempts to minimize the risk of inefficiency and potentially missed tax savings by placing these federal, state, and international specialists, on a part-time basis, on these engagements. In so doing, companies are able to obtain, on an as-needed basis, persons with skills it would not be able to afford or need on a full-time basis.

C&L: Outsource engagements of the type you envision are generally fixed-fee type arrangements where the obligation to attain efficiency passes to the vendor of the outsourced service. In that context, we attempt to minimize turnover on an engagement of this type to attain efficiency goals. We do not have an up or out policy relative to tax-compliance professionals and do not manage that business under the concept that all professionals have to be "on track" to become partners to survive in the organization. You correctly point out that control of unwanted turnover at the staff level is critical to performing assigned tasks in an efficient manner and we understand this as well.

4. In considering the future tax audits of returns being prepared by an outside firm, do you advise the corporation of the probability that persons directly involved in preparing the return may be unavailable in subsequent years when the audits of such returns are conducted by the IRS or state audit authorities?

C&L: We cannot guarantee continuity any more than an existing employer can. We strive to retain key people on an engagement to minimize disruptions and insure efficiency, but we also provide a methodology where support for positions taken in tax filings do not just reside in the head of the preparer. Workpapers are maintained, generally electronically, to support positions taken on tax returns and the documentation will be available, even though the person who did the work may not be available. I will have to say that situations where we have come in to implement standards for workpaper preparation and retention have noted significant improvement over internal departments that sometimes rely on the same person doing the same job in the same way year after year.

E&Y: Many believe that the person who prepared the tax return is not necessarily the best one to defend it upon examination by the IRS and other tax authorities. A person not directly associated with the preparation of the tax return can provide objectivity--both real and perceived by examining agents.

Significant emphasis should be placed on adequate documentation of workpapers used in the preparation of tax returns. A system of standardized workpapers and required document retention policies should be in place to allow the company or their accounting firm to efficiently use these tax return preparation files in the examination process.

AA: Our strategy on contract tax management engagements is aimed at continuity of key personnel. The partner and key Specialists are generally career employees. Documentation of return positions is also emphasized to provide "footprints" if there is turnover. In general, we do not believe that turnover is substantially worse than normal tax departments--particularly for the lower level compliance personnel.

5. In discussing outsourcing of the entire tax function, is a corporate client advised of the lack of continuity and the implications this may have on tax liability if an entire corporate tax department is replaced?

C&L: It is by no means clear that continuity of staff performing the same function by rote year after year minimizes the corporate tax burden. Generally, new ideas relative to tax-planning result from a fresh look at issues and business processes. Clients are concerned with continuity by nature, and I feel these issues are appropriately addressed during the scoping of the engagement and the negotiations relative to service levels.

AA: Yes, lack of continuity when the whole tax department is replaced is a significant reason why the entire tax function is not outsourced. Normally, a key federal manager or tax-planning manager is retained by the company or hired by Arthur Andersen. It is not the strategic intent of Arthur Andersen to take over entire tax functions for many of the reasons these questions raise. However, there are situations where it is the best approach.

E&Y: Again, under the Ernst & Young "teamed" approach, the outsourcing of the entire tax function of major multi-location companies would be recommended only in limited circumstances.

6. Do you see any distinction between outsourcing a function that inherently has strategic planning as one of its integral components when compared to a function that solely relates to collecting, manipulating, and reporting data? If so, explain.

AA: Senior management understands the value of a good tax division and complete outsourcing occurs only when it does not think it has a world-class tax division. In large companies, compliance outsourcing can occur where costs are excessive because there are too many high price people doing compliance, the companies are staffed for peak periods, or they are not effectively using technology.

In some cases, the outsourcing is raised by executive management either because management does not understand what the tax department should do for the company or because the tax department is simply not doing a good job of communicating its value to the company. Arthur Andersen has completed significant engagements assessing tax department performance based on its "Best Practices" database. One of the results of such a study is normally a better understanding by the executive management and tax department of what are realistic expectations, and how a tax department should communicate with executive management on how it meets and exceeds them.

Interestingly, companies with one-person tax departments often display the largest divergence between managerial expectations and reality. More often than not, this occurs because of management's unrealistic expectations about what such a department can physically accomplish. These departments are often established to "reduce outside fees." However, what often happens is that the tax department becomes isolated from outside professional advisers and planning ideas are either not conceived or not implemented because of time constraints caused by the compliance burden. The actual tax cost of this can be dramatic. Executive management increasingly recognizes that personnel cost and professional fees are small relative to the cost of bad or incomplete tax advice.

One-person tax departments can be very cost effective, but this requires management to adopt the mind-set that the tax department's outside professional fees are not the result of its laziness or ineptitude, but rather the tax department's businesslike appraisal of what matters can be best or more timely handled by outside professionals.

E&Y: We recognize that there is a distinction between outsourcing of a function that is inherently strategic to the business versus other functions. Thus, outsourcing would not make sense for tax functions and activities that:

* relate to highly proprietary and strategic matters.

* require significant integration with business operations.

* need significant control from a risk management

perspective. However, many aspects of tax functions and activities lend themselves to outsourcing. These situations include:

* activities that are routine, recurring, process-driven

tasks.

* work that fluctuates from year-to-year or is seasonal

in nature.

* activities where economics of scale apply such as

in this use of technology and resource centers.

* work that requires a steep learning curve.

C&L: Tax planning on a strategic long-term basis is generally a key element of the overall business strategy of the enterprise, and we would not recommend that activity be left solely in the purview of an outside service provider without critical input from senior management of the business enterprise. Most companies now evaluating strategic plans do so in conjunction with firms that specialize in strategic planning.

7. Is outsourcing more likely to occur in non-U.S. companies (e.g., U.K. entities) than in U.S. companies, and if so, why?

C&L: Our experience has generally been that outsourcing has generally been more prevalent among companies with foreign parents and among U.S. companies coming out of LBO or acquisition-type transactions. I feel that this is more associated with the opportunity for a fresh look at the business rather than foreign versus domestic ownership. Many foreign companies, however, have a longer tradition of relying on outside vendors for tax-compliance services and less of a built-in bias against that usage.

E&Y: The competitive pressures in today's global market effect both U.S. and non-U.S. companies. Thus, the outsourcing considerations are not expected to be significantly different. We have observed that inquiries from non-U.S. companies have been proportionately greater. One reason for this may be that the concept of outsourcing has a longer tradition in Europe. Another reason may be the desire to avoid a significant headquarters operations in the United States.

AA: There is no real difference between non-U.S. companies and U.S. companies. Overseas headquartered firms do tend to use outside advisers more, though, perhaps because of specialized problems. Interestingly, U.S. companies probably also have relatively smaller tax staffs at their overseas locations.

8. If a corporation chooses to outsource its income tax-compliance function with your firm and your firm has its own proprietary tax preparation software, will such software be used in preparing that company's returns even though systems have been established and prior returns filed using another software system? What criteria is applied to determine whether this change in software utilization occurs?

E&Y: In almost all outsourcing engagements, the effective use of technology will be an integral and significant component of the company-outsourcer long-term relationship. Most companies have implemented a variety of technology to meet their current needs. The ability to easily access and manipulate data will continue to be an important factor for both the company the outsourcer. As part of the Ernst & Young "teamed" approach, our focus will be to implement technology that best meets the company's needs and to use proven available technology rather than invest resources in developing similar systems or otherwise change systems.

AA: Arthur Andersen has developed "Tax Director" and the new Windows-based AACTS products. We use these products internally. To date, we have generally used Tax Director in our engagements because it provides us efficiency because of our staff's familiarity with it, and it is obviously less costly to us. However, we have used other software where the client has previously used it and it makes overall business sense to continue.

C&L: Our experience has been generally to rely on existing software where it is appropriate and to replace it when clearly better products are available, whether they be inside or outside the firm. Our experience has also been to generally upgrade the use of technology in the process of gathering and managing tax essential data.

9. Have there been instances in your firm-client relations where you have suggested to corporate management that certain functions currently being performed by their public accounting firm could be handled in a more cost-effective manner by the client, thus resulting in reduced cost to the client and reduced fees for the firm?

E&Y: The Ernst & Young tax services mission statement states in part that "we will apply our tax expertise and understanding of our clients' businesses, together with other firm service capabilities, to develop solutions to our clients' worldwide business needs." Our internal continuous improvement initiatives and Corporate Tax Department Performance Improvement Services are two proactive and creative efforts in which we assist our clients to become more competitive. Recommendations resulting in process improvements, cost reductions, and performance enhancements is a primary goal in all of our engagements.

AA: We strive for a team approach to achieving the most efficient, high-quality tax compliance. Certainly, there are situations where certain functions should be handled by additional corporate tax department personnel. We have advised clients to set up tax departments in certain circumstances Arthur Andersen's goal is to help develop a world-class, efficient tax department in our clients, and our goal is work with them as a team to exceed senior management expectations.

C&L: As business advisers to our clients, we are constantly working with them to seek the most cost-effective solutions to all business problems, whether they be tax related or not. A professional service provider that places its own revenues ahead of the health of its clients will not survive long in this environment.

10. If the corporation outsources its entire tax function with an accounting firm that also serves as its independent auditor, can such independence be maintained for financial statement purposes assuming taxes are material? Please explain.

E&Y: Any time we perform tax-compliance and tax-planning functions for an audit client, Ernst & Young is careful that the work performed does not impair our independence and seeks to avoid appearances of conflicts of interest. Our experience indicates that, with proper planning and appropriate structure, independence issues can be resolved.

As part of our "teamed" approach, Ernst & Young tax personnel do not assume the role of management or employees. Management should be in a position to take responsibility for, and make decisions with respect to, such matters as tax return positions, elections, and disclosures for financial statements. Management should also maintain responsibility for maintaining the books and records from which information relevant to tax matters are derived. Finally, management should review and approve any tax-related work products.

AA: There is a technical independence issue, but as a practical matter, it can be dealt with. This becomes apparent when it is recognized that historically many public companies, particularly smaller ones, have had their public accountants do their tax returns and this has not, as a practical matter, resulted in independence issues being raised. This again points out that outsourcing is not new--virtually all companies at one time had their outside accountants do their tax work.

C&L: We do not believe providing tax-compliance or tax-consulting services to our audit clients impairs our independence from the client or our ability to issue our opinion on the financial statements of the client.

11. Does the outsourcing of corporate tax departments by public accounting firms create competition with the in-house corporate tax department for providing the corporation its tax services? If so, should corporate tax departments deal with public accounting firms as competitors?

AA: The fear of outsourcing need not create competition between corporate tax departments and public accounting firms so long as everybody is open about their capabilities. Every tax director knows he has increasingly limited access to internal resources and the best resources provide the best results.

Arthur Andersen's goal is to encourage teamwork. The bulk of our business is doing special projects for corporate tax departments. This has been true for many years and will continue to be so. Special projects are not a step to allow us to achieve outsourcing of the tax function. Rather, special projects are another way for Arthur Andersen to learn the client's business and to be proactive in proposing ideas in the future. We have had many conversations where tax directors feel that some outsourcing would be advantageous. Obviously, it goes without saying that the fear of displacement is huge, and it takes a working relationship and level of trust and confidence in each person's own position to work together successfully.

C&L: Competition is inherent in the business community of any free market society, and will exist. To the extent an enterprise has a make-or-buy decision with respect to tax services, some issues will exist. We feel we are more effective in operating in a collaborative environment where teaming is stressed, but there will always be those individuals who are threatened and consider their own interests ahead of those of the enterprise.

E&Y: Ernst & Young's "teamed" approach was designed with the recognition of the value of in-house tax professionals. Thus, for most major corporations, a corporate tax function strategy of combining in-house tax professionals and outside tax specialists would yield the greatest benefit to the company.

12. Might an accounting firm's handling of a "special project" for the corporate tax department be a step in assisting such accounting firm to achieve outsourcing of some or all of that company's tax function?

C&L: This is the "nose under the tent" scenario. This question begins with the premise that outsourcing of the corporate tax department is our, or any service provider's, ultimate objective. That is just not correct.

E&Y: The concept of outsourcing is not new for most corporate tax directors. The handling of a special project by an accounting firm is a resource-allocation decision tax directors have been making for years, This use of outside tax specialists should not be viewed as a step toward outsourcing all of the company's tax function, but merely the most effective use of resources.

AA: See Comments on Question 11.

13. In discussing possible outsourcing of an entire tax function for the corporation, how do you address the question of "risks" in preparing tax returns, taking audit positions, and choosing to go forward with either an administrative or judicial appeal? Please also relate how the results of such discussion may have implications on the company's audited financial statements, assuming the firm also is the company's outside auditor.

AA: Our approach to taking positions on tax returns that are prepared by us in outsourcing arrangements is not different from our approach on any other tax return we prepare. Likewise, we take the same position on appeals. We alert executive management, normally the CFO or Controller, to the issues involved and help the company make an informed decision. Naturally, the amount of discussion is consistent with the size and sensitivity of the issue. We do not feel this is any different from how corporate tax executives keep their supervisors informed.

C&L: The issue of risk management is critical to any decision. Our view is that as outside service providers we are held to the same professional standards as internal employees performing the same task. These relate to professional standards that apply to all engaged in the practice, and I would not distinguish between the two sources of service.

E&Y: See Comments on Questions 4 and 10.

14. In analyzing the tax-compliance function of a large multinational company, what thought is given to the following:

a. Where does the in-house accounting function finish

its analysis and where does the tax function

begin its analysis with respect to providing entries

to the balance sheet and P&L tax accounts?

b. Answering questions from business units on subjects

that are not "tax-planning questions"?

c. Supporting the tax-planning group throughout the

year with required "number crunching"?

AA: These questions about incidental work often performed by corporate tax departments highlight the necessity to detail what is included in the contract tax management engagement so that there are no major misunderstandings about scope. A certain amount of incidental tax advice is normally included in the price. However, good faith on both parties is required to determine when something is simple planning or is a major project. On an overall basis, the key to a successful relationship is not the size of the fees, but providing value for fees.

C&L: Coopers & Lybrand supports a view of a collaborative approach to the provision of tax services. In that context, it is vital that the business enterprise and the vendor of services have excellent communications dealing with the issues described [in the question]. Our experience has been that this can be done with no appreciable drop in the level of service to the business and in many cases enhanced levels of service are attained.

E&Y: See Comments on Questions 2, 6, and 10.

15. If an in-house tax-planning staff is separated from the tax-compliance function, will this adversely affect the effectiveness of the planning group because it is not aware of opportunities or consequences due to its restricted visibility?

AA: Your question rightly assumes that the tax function will not be successful if a wall is created between planning and compliance groups. We recognize this and much time is spent before the contract is signed in developing an approach to avoid this. Normally, our managers are involved in up-front planning of compliance engagements, and this allows them to identify issues that the planning personnel can then decide how to handle. Moreover, often internal tax department planning personnel will be involved in the development of book/tax differences, credits, etc.

C&L: To attain appropriate levels of efficiency, we feel that the compliance function should be performed by personnel who are highly skilled in project management, technology, and have business process skills. These are generally not the same skills found in outstanding tax planners. These groups need to be closely tied, however, with an ongoing dialogue on what is happening on both fronts.

E&Y: The ability to easily access and manipulate data will continue to be an important factor for both the company and the outsourcer. Technology should be strategically used to allow a continuous flow of information to both in-house tax professionals and the outside tax specialists. Also, see comments on Questions 8 and 17.

16. In the context of outsourcing, how do you see the relationship between the tax-compliance and tax-planning functions?

AA: The goal should be that, in compliance outsourcing arrangements, the relationship between tax-compliance and tax-planning functions are the same as between internal groups. We recognize that compliance personnel are often the originators of tax-planning opportunities, and we utilize up-front planning to provide the link between compliance, planning, and implementation.

C&L: See Comments on Question 15.

E&Y: See Comments on Question 15.

17. In discussing outsourcing of a tax-compliance function with potential corporate clients, do you attempt to quantify the tax-planning ideas that originated from the compliance group, and if so, how do you go about such quantification?

AA: We do not know how many tax-planning ideas the corporate tax department compliance group generates. Presumably, the corporate tax department is informing executive management it is doing these things. Indeed, often executive management does not realize all the things a tax department does. Often this is because of natural reluctance of corporate tax department personnel to "tout" themselves, but successful tax departments convey to executive management their successes so that executive management gives them the resources they need to do the job.

At the same time, if the premise behind your question is that in a contract tax management engagement involving just the compliance function--that accounting firms are unable to develop planning ideas through compliance activity--we disagree. We believe our methodology, people, and coordination with internal tax department personnel allow us to to this.

E&Y: We have observed that effective tax planning does not generally "originate" from the tax-compliance process. Tax planning should occur well before the tax-compliance process begins to be of greatest value. The tax-compliance process should merely be the reporting of implemented planning ideas. Often, items identified during the compliance process are generally adverse tax issues leaving limited options.

C&L: See our responses to previous questions on the need for close communication between compliance and consulting groups.

18. In discussing the possible outsourcing of an entire tax function currently headed by an attorney, do you bring to the attention of the corporate client the possible loss of attorney-client and work product privileges in discussing the potential engagement? (This would appear to be especially true in terms of transactions planning, corporate restructuring, and handling tax audits and appeals.)

E&Y: Under the Ernst & Young "teamed" approach, those functions that are highly strategic to the company would not be outsourced in its entirety. By the use of a balanced in-house professional and outside tax specialist team, the unique transactional opportunities and the specialized representation issues of a company can be addressed most effectively without elevating the concerns of the possible loss of client-attorney and work product privileges. Such concerns, if any, should be addressed early on.

C&L: There is no privilege relative to items and support for items going into a tax return. Privilege relative to exposure analysis, litigation risks, etc., is unimpaired.

AA: A corporate attorney, in-house or outside, could still be involved in sensitive areas and attorney-client privilege used where applicable.

19. Please describe how you determine the price to be quoted a client for outsourcing, considering both the compliance and planning functions. Are "loss-leader" prices utilized?

E&Y. The contract price for outsourcing will vary significantly on a case-by-case basis. Numerous factors will need to be considered. Although the scope and nature of the work and length of the contract period will be major factors, a number of other items will need to be addressed. Use of on-site facilities, continuing company support services such as access to mainframe systems, hiring of in-house tax personnel, and client relationship history are examples of sensitive issues unique to outsourcing that could significantly affect the determination of the contract price. It is our view that no one is served by a loss-leader type of approach.

AA: Contract tax management engagements are not priced as a "loss leader." Since price is only part of the equation, the issue is value for fees. They are priced based on obtaining full utilization of Arthur Andersent personnel, particularly where the engagement only involves compliance. If we can control when the work is done, we can do it cost effectively. In contract tax management engagements, we try to provide the best resources at the right time with prices quoted on a total cost basis rather than a per diem basis.

C&L: Fees are determined as in any other client engagement through analysis of value-added and cost-benefit considerations and open-market considerations. Usually multiple proposals are requested, and the market will determine appropriateness of pricing in an outsourced environment. There is no market discipline applied to in-house support functions. Engagements are not priced on a loss-leader concept, at least not for very long.

20. Do you price the outsourcing function differently depending upon whether the corporation is or is not already an audit client?

AA: There is no difference in price depending on whether the engagement is an audit client. On large audit clients, there is little information gained from the audit itself that relates to tax return preparation. However, because our audit partners and managers are "tax wise," there is some useful tax-planning information gained during the course of the year from them.

C&L: No differential is attached to audit versus non-audit pricing. Tax is a separate line of business at C&L, and is responsible for its own engagement economics.

E&Y: See Comments on Question 19.

21. What representations are made by your firm on tax savings ideas that are discovered when a corporate tax function is initially outsourced? What assurance can you provide to a corporate client that such tax savings ideas will not be shared with any other taxpayer, including other clients of your firm?

AA: Arthur Andersen makes no representations as far as tax savings. We also do not agree that such tax savings ideas will not be shared with other taxpayers, although proprietary factual information is never shared. Typically, tax savings ideas come from the fact pattern, not the tax law. Many people know the ideas, the issue is whether they can apply the legal theory to their particular facts.

C&L: Confidential client information is held on a confidential basis. Concepts developed with respect to client A that have applicability at client B may be shared unless there is a separate arrangement with client A or the issue includes information proprietary to client A.

E&Y: While some may argue that tax-planning ideas are proprietary, this concept is at best nebulous. In any event, privity of the client relationship would certainly be a factor to be taken into account.

22. In the event that an entire tax function is outsourced, who decides whether to maintain the company's tax return position during audits and administrative/judicial appeals? Does the CFO or some other non-tax corporate officer become the decision maker?

C&L: On all engagements we have undertaken, the client has retained some in-house tax expertise to focus on these issues. They are generally decided in concert with other service providers and financial management.

AA: On a complete outsourcing basis, the group would report to a CFO or comparable corporate officer who is involved in the decision-making process.

E&Y: See Comments on Questions 4, 5, and 10.

23. Where a corporation chooses to outsource the entire tax function with an outside accounting firm, how is such firm held accountable for quality? Who reviews the tax return?

AA: The firm is held accountable by the CFO, Controller, or Treasurer--normally, the same person who holds the in-house tax department accountable. The issue is not different in any way. Obviously, Arthur Andersen stands behind the quality of the work it provides. Success or lack of success is defined by the CFO by what the company is trying to accomplish and how the tax department fits into that vision. It is clear that contract tax management projects will be successful only if there is a clear understanding of the role of the tax function within the company. This is also true for in-house tax departments. Both the in-house tax department and outside professionals need to focus on what the CEO, CFO, and other senior management expect from its tax function and how to exceed their expectations.

C&L: In all situations I am familiar with, the client reviews the product as well as various taxing jurisdictions, federal, state, local, etc. All C&L tax functions are subject to our own review processes as well as peer review mandated by the AICPA and the SEC.

E&Y: See Comments on Questions 5 and 10.

24. Assuming a corporation outsources its entire tax function, who manages outside tax litigation counsel on both the state and federal levels? What criteria would the company use in selecting outside tax litigation counsel, and what steps would the company take to control outside litigation costs?

AA: Outside litigation is coordinated through in-house legal counsel or outside legal counsel, typically driven by existing relationships or who is the best litigation counsel for the particular issue.

C&L: We have no engagements of which I am aware that we manage inside or outside counsel retained by the client to contest issues.

E&Y: See Comments on Questions 4, 6, and 10.

25. Are you able to give us examples of (a) successful and (b) unsuccessful past outsourcings of tax departments, and the distinction between the two? Are you aware of any corporation which chose to transfer the work then performed in-house to an outside firm where such corporation has gone back to handling the tax work in-house?

AA: A discussion about successful and unsuccessful outsourcing projects is premature, since the current outsourcing cycle has only recently begun. As noted earlier, forms of outsourcing have been going on for years--although the term outsourcing is relatively new. Executive management is merely concentrating more now on outsourcing the tax department as they review outsourcing many more functions.

E&Y: The concept of outsourcing the entire corporate tax function of major multi-entity, multi-location companies has yet to be fully tested and proven over time. We are not aware of any company with a large tax group that has "insourced" the corporation tax function after outsourcing such work.

C&L: This area is too new to provide concrete examples of situations gone sour. As long as the service provider is competent and committed to the business, issues can be dealt with as they arise diffusing potentially troublesome situations as they occur.

Conclusion

After having listened to my TEI brethren and digested the accounting firms' responses to the 25-question survey, I have come up with some answers to my own questions:

* Is outsourcing here to stay? Absolutely! The marketplace

demands the presence of service providers

and the accounting firms are filling a need.

* Are the accounting firms becoming more aggressive

in pursuing outsourcing? Absolutely! They

are under the same cost restraints, revenue constraints,

and competitive pressures as private industry.

Outsourcing, at least for now, is seen as a

new revenue generator, and will be aggressively

pursued until proven otherwise.

* Is the outsourcing of some or all of Corporate America's

tax functions inevitable? Absolutely not! This

is a scenario where "we have met the enemy, and

he is us." $TThese are indeed the nineties. Tax professionals in private industry must be willing to change, adapt, streamline, and automate. Value-added, performance review, proactive, process management, team approach, communicate, and lead are the concepts and philosophies of the day. "Follow or get out of the way" tax departments will be visited by the outsourcing grim reapers, and rightfully so.

Change is constant and inevitable, but not always bad, and never to be feared. Management will give us an opportunity to have 1990s tax departments. From a dollars and cents standpoint, it is more cost effective to do it ourselves than have someone do it for us or to us. Management will applaud our own process review and emphasis on higher quality and more output for fewer dollars expended. They will support our own resource reallocations to turn our 1970s and 1980s tax shops into lean mean tax machines of the 1990s. They will encourage us to work with our accounting firms in a team environment whenever possible to accomplish these goals. These days of dwindling profits and fierce competition should give rise to new ideas and creative thinking. The compliance world's famous "SALY" rule (same as last year) will no longer cut it, and that is O.K. We, as private industry tax professionals, must be willing to re-engineer our departments. The answer to more work can no longer be more people. These "do more with less" times require innovative approaches to compliance, planning, and tax department resource allocations.

Employee headcounts should be tracked not only from an historical basis, but also in relationship to the up/down change in the mass of the company.

* Did new acquisitions automatically mean more

staff? If a corporation was downsized with significant

asset disposals, was there a corresponding

reduction in headcount? Have administrative costs 

kept pace with other costs in the company? Do we

have highly paid professionals performing tasks

that can be completed by lower-paid, less experienced

individuals? Are we cross-training our staffs

to maximize experience levels and broaden their

depths of knowledge? Has capital spending been

sufficient to provide state-of-the-art systems? How

much "crunching" is still being done by hand? Are

upper level openings filled from the ranks within

or do you go outside your department for top dollar

experienced replacements? Is there encouragement

to pursue advanced education through college/

seminars/professional organization memberships,

etc.? Do you really know what management's

perception is of the tax department?

These are just a few of the questions to ponder while you gather up departmental data for upper management. Yes, it seems that corporate managers are looking at outsourcing various corporate departments, and tax just happens to be one of them.

Corporate tax professionals must recognize that one of the principal factors contributing to outsourcing is complacency in the tax department. Another factor, according to Mr. Hitter, is arrogance. Professionals recognizing these tendencies in their tax department should file them in a records retention box or, even better, recycle these tendencies into a state-of-the-art full service tax shop that can survive any internal or external review. The rewards for the tax professional will be the appreciation of senior management and continued employment. (*) This article originally appeared, in a slightly different form, in Ohio Tax Review, which is published by Office of Graduate Studies of The Capital University in Columbus, Ohio, and is reprinted with permission. The purpose of the Ohio Tax Review "is to present Ohio state and local tax issues that go beyond mere reporting of the statutes, rules, or various rulings. It is [the publication's] goal to present articles that will stimulate discussion and provoke thought." For information on subscribing to Ohio Tax Review, see page 183. (**) The author acknowledges the contributions of Tax Executives Institute, Inc. (TEI), Washington, D.C., and Timothy McCormally, the Institute's General Counsel and Director of Tax Affairs.

STEPHEN A. MOORE is Director, Income Tax Compliance for Borden, Inc. in Columbus, Ohio. He is a member of the Cincinnati Chapter of Tax Executives Institute and served as the chapter's 1992-93 President. Mr. Moore received a B.A. degree from Ohio State University, and serves on the Board of Editors of the Ohio Tax Review.