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Outsourcing: opportunities and challenges for the corporate tax executive.

At Tax Executives Institute's 1992 Annual Conference, the Institute's Corporate Tax Management Committee held a session on outsourcing, featuring a panel of TEI members and representatives of three Big 6 accounting firms. Outsourcing is a hot topic, and it evokes strong feelings from corporate employees. Indeed, some in the audience felt that by sponsoring the session TEI was allowing the Trojan Horse into Troy. Others agreed that, by understanding outsourcing and its causes, the tax executive can influence and direct his or her firm's outsourcing of taxes.

This article--by two of the panelists--summarizes the principal points that were made during the conference session. It provides a brief description of outsourcing and its roots, discusses how poor communications may increase the likelihood for outsourcing, and describes how the tax executive may better approach the issue of outsourcing to do a more effective job of managing the tax function of the company.

I. The Views of a Senior Tax Executive

Professional journals note that more and more companies are turning to outsourcing for assistance in managing some or all of their internal operations. This practice of outsourcing means handing over a corporate function to a firm that specializes in that function. Anita Micossi's article "Farming It Out" in Enterprise Magazine states that outsourcing has always been a logical option for non-strategic areas such as payroll processing, public relations, building maintenance, and human resources. Recently, outsourcing has become a more visible concept as companies turn to it in operational areas, such as engineering, logistics, design--and tax. Some companies are signing multiyear, multimillion dollar deals divesting themselves of operational functions deemed not strategically vital. Hechinger's has outsourced the entire corporate tax function; Montgomery Ward has outsourced most of its tax positions; and British Petroleum has outsourced a significant portion of its tax compliance work. Other companies are actively exploring plans to outsource part or all of their tax function.

A. Overview

The "trend" toward outsourcing is being driven in part by the revolution in information technology, which has turned many corporate activities into routine functions. Traditionally, outsourcing was standardized and defined by boilerplate contracts of limited duration. In the past, managing information flows and completion of tasks was more difficult when an outside firm did the work. Today, however, successful outsourcing engagements feature customized agreements between organizations that permit company personnel to spend more time using the technology to advance business objectives, and less time on day-to-day tasks.

Outsourcing is not a Trojan Horse. It is an outgrowth of the current business environment of total quality, reengineering, peer review, and benchmarking. Outsourcing is just one of the options available to companies. The question is whether it is the right option for any particular company and what process should be followed in making that determination. The key to the answer is good communications.

There are many ways of asking, "Are you sure that you are providing the best service to your clients?" Without an ability to communicate and communicate well, the tax executive is limited in his or her ability to answer the question and, therefore, effectively to serve his or her clients (including those to whom the tax executive directly reports and the company's operating groups). The good communicator is not threatened by outsourcing because outsourcing is merely one vehicle for the tax executive to consider in providing management with good advice. In other words, the tax executive is an integral player in the outsourcing decision. Indeed, any outsourcing should be furnished only upon the recommendation and initiation of the tax executive. Poor communicators, on the other hand, may feel endangered; they may be denied the opportunity to pose, let alone answer, the question. The solution is for them to become better communicators; they need to evaluate and enhance their roles within their corporate cultures to ensure that they are an integral part of management's team.

Do you feel appreciated? Do you have adequate resources? Are you well compensated for your efforts? Many tax executives answer these questions "No." It is no surprise then that these tax professionals view the current phenomenon of outsourcing as a threat to their continued employment. In today's world of downsizing and reorganizing, every successful employee must make positive contributions to the corporation. Good communications skills are essential to success in any organization. Employees who do not add value--or who are viewed as not adding value--to the shareholder may be perceived as, at best, a necessary evil or a "black box." As a consequence, they stand a good chance of being outsourced.

B. Communications Is the Key

How can this situation be effectively addressed, if not remedied? Many tax professionals do not talk in terms their CFO and CEO understand. They talk about Code sections, regulations, and court cases. They provide options with no recommendations, or recommendations out of sync with management's strategic goals. They offer no suggestions on how to achieve management goals with the best results and minimal risk. Upper management understands and is interested in earnings per share, cash flow, financial statement presentation, and level of risk. With these things in mind, plain language should be used to advise management on the best choice, including what trade-offs may be involved in taking a specific tax position (i.e., possible erosion of earnings or cash outlays in the short run that will be more than made up in the long run).

It is no surprise that corporate tax executives with poor communication skills feel put upon by upper management. Frequently, they have insufficient resources and work long hours. When they talk, management's eyes may gloss over. They receive no positive reinforcement for the tax function from their supervisors. They become negative in their responses to management, which aggravates the relationship between the tax department and senior management. As a result, management is even less likely to consult with them in planning and decision-making, and that further isolates the tax function from the core business.

The focus on outsourcing in today's business climate can be viewed as either a threat or a wake-up call. The latter makes more sense. The outsourcing phenomenon gives the tax executive an opportunity for greater and more open communications with upper management. If the tax executive brings the subject up--or seizes the initiative-he or she can frame the debate. The tax executive can point out the many benefits provided by the corporate tax department. The tax executive's most important role is as part of management's team. Tax executives who are good communicators are more likely to succeed in this role. Successful communicators focus on both the question asked by management and the answer to be provided. They carefully listen to the question asked by management to understand what is said, what is not said, what is requested, and the climate in which the answer is to be provided.

To be most useful in management's decision-making, the tax executive must provide an answer that is clear, succinct, reasonable, and presented in terms management understands. The tax executive may wish to conduct a customer satisfaction survey to determine which of the tax department's clients are happy (and why) and which are not; the tax executive can then develop a business plan to address those issues raised by his or her clients. Another source of ideas and insights is the tax executive's colleagues in other companies. Fellow tax executives are a tremendous source of knowledge and vast resource of prior experiences.

When effectively integrated into the business, the senior tax executive and other tax personnel are critical employees because of the positive contributions they can make to the corporation's success. For example, the tax group can save their companies millions of dollars structuring mergers, acquisitions and international transactions. They may be able to achieve a lower overall effective tax rate even though the corporation pays taxes both overseas and in the United States on the same transaction. With their knowledge of state and local tax laws, tax executives can assist upper management in making business decisions that minimize taxes, thereby increasing profits and making the company more competitive. Technical knowledge alone, however, is not what makes the in-house tax professional invaluable. It is such knowledge in combination with an understanding of the corporation's goals (and the particularized goals of the operating groups), ongoing experience with the myriad personalities involved, knowledge of the company's practices (including past and present accounting), and appreciation for the corporate culture that enables the tax executive to bring more to the table than the outside consultants.

There are numerous ways in which the tax department and the tax executive can make a difference, but not all of them do. Why? Communications ! The tax executive should become partners with management in creating an environment in which everyone participates in minimizing taxes. The tax department's role is to be user friendly, to listen to what the operating groups want to accomplish, and to respond positively with suggestions that both minimize tax (and risk) while maximizing earnings and cash flow. The operating group and CEO should understand the risks, but the tax executive should always strive to provide results-oriented, bottomline answers. The tax executive should have a recommendation, explain the risk and state whether he would provide for a contingency under FASB 5 (contingent liabilities).

C. Pretax vs. After-Tax Analysis

Another factor that may contribute to poor communications exists in corporations that measure results on a pretax basis. This arrangement discourages operating managers from being as interested in tax considerations, which in turn makes them less open to involving the tax department, especially if they are charged for using the tax groups services. The tax executive should make every opportunity to reduce the operating group's sales tax, gross receipts tax, property tax, and unemployment tax, all of which affect earnings before income taxes.

In addition, the tax executive should point out to the CFOs and CEOs the advantages of evaluating operating units on an after-tax basis, even though some income tax allocation issues between operating groups will arise. The opportunity to create a win/win situation for everyone (the shareholder, the CEO, the operating group and the tax department) is greater when results are measured on an after-tax basis.

D. Outsourcing as an Opportunity

There are some areas, such as expatriate tax calculations, where outsourcing may make sense. The tax executive should objectively advise management on the benefits of limited outsourcing in such situations. He or she should also point out, however, that outsourcing--especially when undertaken to cut short-term costs--can be counterproductive. Indeed, trimming the bottom line in the short run should not be a primary motive in successful outsourcing, but to be effective in delivering this message to management, the tax executive must have good and open communications with company leaders. Management's willingness to listen to the tax executive's advice concerning the possible long-term damage that could flow from efforts to achieve short-term results by outsourcing the entire tax function will depend on the tax executive's overall credibility. Although limited outsourcing may be appropriate in specific circumstances, the outsourcing of the entire corporate tax function is unlikely to occur in any organization where the tax executive has good communications with management.

Thus, management's consideration of outsourcing should be seen as an avenue to opening up and enhancing communication between the corporate tax department and management. It should serve as an opportunity for the tax executive to refine his or her relationships with upper management and to integrate tax planning (and the tax function generally) into the corporation's goals and strategies.

In the absence of an outsourcing initiative, a customer survey may be a good beginning. Only by getting in on the ground floor in strategic corporate planning and maintaining open communications can the corporate tax department prove its value. Suggestions and alternatives on how to structure transactions and implement management's overall goals with the lowest possible tax cost should be offered. The more the tax executive becomes involved in corporate planning, the more invaluable he or she becomes to the corporation. The outsourcing phenomenon should be viewed, not as a threat, but as an opportunity to acquire additional resources, to increase compensation levels in the long run, and to get more appreciation for tax departmental efforts in the short run. This opportunity exists for the tax executive who understands upper management's goals and works within the organization to provide information, suggestions, and recommendations that try to overcome obstacles and successfully implement management's goals.

II. The Views of a Major Accounting Firm

The extension of the outsourcing trend to corporate tax departments creates a multidimensional challenge for the corporate tax executive. As part of the drive to make American companies more competitive globally by improving efficiency and minimizing costs, the prospect of out| sourcing is in fact an opportunity for the corporate tax executive to add value and optimize the company's investment in the tax function. It is also an opportunity to elevate the tax department's role in the strategic financial management of the corporation.

A. Overview

Outsourcing is not a new concept to major corporations generally, and it certainly is not new to corporate tax departments. It is simply a new term for resource allocation decisions that tax directors have been making for years. Most companies have traditionally outsourced a variety of tax functions, including expatriate tax administration, executive tax preparation services, and relocation tax administration. 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 and multilocation companies. This concept has yet to be fully tested and proven over time. Although it is fairly simple to quantify the benefits of outsourcing discrete tasks, it is not as easy to evaluate the advantages, or costs, of outsourcing the corporate tax function in its entirety.

One of the principal determinants of a decision to outsource is likely to be the perceived value received for the cost. As in any analytical comparison of cost differences, great care must be exercised to compare exactly similar work products. (Curtis C. Verschoor, "Evaluating Outsourcing of Internal Auditing," Management Accounting, February, 1992.)

With the corporate tax function, is it possible to compare costs for "exactly similar work products"? Some accounting firms do not believe it is. The knowledge that internal tax professionals have of the corporation derived from their day-to-day interactions and networking with all levels of management is critical to designing the ultimate tax strategy for the corporation, and difficult for an outside 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 it is difficult to express in dollars. Some accounting firms strongly believe that the most effective approach to the corporate tax function for major, multi-location companies is one that combines inhouse tax professionals with outside tax specialists. Experience shows that coupling the corporate tax executive's knowledge of the business with the specialized skills of selective outside tax consultants yields the greatest benefit to the corporation.

Nevertheless, tax outsourcing is on the rise as companies focus on core business areas to improve competitiveness and shareholder value. Given these external forces, what is the best course of action for the tax department? The most productive course is to initiate consideration of change rather than wait to react to it. The most positive change that a corporate tax executive can make is to transform the tax department from simply a service department into a strategic resource for management.

Corporate tax departments have the highest perceived value for the cost in cases where tax professionals are an integral part of the strategic financial management and planning process of the corporation. In the most successful cases, the tax function is a part of the planning process for ongoing operations, major strategic business decisions (e.g., to merge, acquire, spin-off, liquidate, or dispose of subsidiaries/business units), and the evaluation of financing alternatives, including tax-favored strategies.

New financial accounting and reporting requirements for income taxes and ever increasing complexity in tax law have significantly increased the time and cost of compliance, and have challenged the continuing level of quality for many corporate tax departments. In some cases, the compliance function consumes a disproportionate share of the corporate tax department's resources. Outsourcing, when applied appropriately, can play a significant role in keeping the corporate tax department focused on the company's core business strategies. If relieved of burdensome, labor-intensive functions, in-house tax professionals can devote more time and attention to generating tax planning ideas, reducing effective tax rates, and improving after-tax profitability of specific business units and the organization overall.

B. Corporate Tax Performance Improvement

Corporate tax outsourcing is just one aspect of the drive to improve business processes in American companies. The advantages management seeks from outsourcing are reduced cost, a fresh viewpoint, and resources to cover peak work loads and special or temporary projects.

Corporate tax departments can achieve these advantages through the application of performance improvements methodologies. In fact, performance improvement studies concerning the tax department should be a prerequisite for making any major outsourcing decisions. When high-cost existing processes are outsourced, the cost-benefit analysis may easily favor outsourcing. A more valid comparison, however, is to compare external contract costs with the estimate of internal operating costs after implementation of process improvements. This will ensure that only activities that are cost effective to be outsourced are contracted out. More important, the function will be outsourced at the minimum price the market should bear.

Performance improvement studies can help management identify (i) the true benefits and costs of the tax department's current structures and processes, (ii) structures and process flows that can be streamlined or eliminated to reduce costs and improve timeliness, and (iii) tax functions that enhance the quality of input to the core business decision process and have a ripple effect on the company's core business areas.

C. Alternatives to Full or Partial Outsourcing

A rigorous self-appraisal and performance improvement analysis can help corporate tax executives identify alternatives to full or partial outsourcing while meeting management's objectives of improving quality and cycle time and reducing costs. Alternatives to full outsourcing include:

* Redesigning the tax function to increase efficiency through improved work flow and better use of automated systems and technology.

* Outsourcing segments of the compliance function, and retaining the tax planning, financial accounting and reporting, and the tax examination functions.

* Outsourcing selected tax functions that cannot be performed with the existing resources and skill base.

Regardless of the form chosen, decisions to reduce or partially outsource the tax function cannot be easily reversed in the near term. Tax department performance improvement studies can serve as useful benchmarks in evaluating these alternatives. (In addition, for the larger tax department, performance improvement studies may be especially appropriate for staff training, library and file maintenance, computer usage and other technology issues, and staff performance reviews.)

Redesign the Corporate Tax Function: A rigorous redesign of current tax department structure and operation can significantly enhance the advantages of in-house tax compliance and planning staff through:

* Identification, reduction, and elimination of activities that do not add value or are not essential to the company's overall tax strategy.

* Increasing the effective use of existing and new technology.

* Assessment and implementation of more efficient workpaper and document organization and storage for multipurpose use and retrieval ease.

* Identification and implementation of performance measures to encourage and monitor enhanced productivity.

Outsource Selected Tax Functions: A major advantage of a tax department performance improvement study is that it will help identify those tax functions that cannot be efficiently performed with existing in-house resources and are prime candidates for outsourcing. These include nonroutine tax functions requiring a high degree of specialized knowledge, such as tailored computer programs for foreign tax credit calculation and planning, tax basis LIFO computations, time-intensive seasonal tasks such as state and local tax compliance, and transaction-oriented tasks such as tax planning and compliance matters relating to acquisitions, dispositions, and restructuring of business units. Frequently, these tasks are best performed in a joint effort by outside consultants and in-house personnel.

Outsourcing Compliance: In some cases, outsourcing of selected elements of the tax compliance function will streamline the tax department and better leverage resources for more strategic tasks. At the same time, the company will retain a training ground for strategic issues, tax planning, etc., and allow these professionals an opportunity to develop key relationships with operating staff. Retaining the financial reporting and forecasting functions with inhouse tax personnel directly involved in operations and planning could eliminate certain redundancies, provide reliable information for the outside tax compliance provider, and greatly facilitate the internal and external tax return review process. In some few cases, it may be appropriate to outsource the entire compliance function-but. companies that choose such a course of action run the risk of losing the training, operating, and relationship benefits noted above.

D. Where Outsourcing Provides the Greatest Benefit

Corporate tax outsourcing should not be applied as a blanket policy. As previously stated, a thorough analysis of existing functions and processes is the best way to determine how outsourcing can be used to enhance efficiency. In today's economy and highly competitive markets, however, there are a number of situations where the perceived value of an internal tax function may not support the cost of maintaining a staff of highly specialized tax professionals. These include:

* Tax department activities that involve discrete recurring, process-driven tasks, as well as seasonal requirements, and tasks whose volume fluctuates from year to year lend themselves readily to a higher perceived value for the cost if outsourced. An outside organization may be able to perform these tasks more efficiently and cost effectively by virtue of economies of scale. Classic examples are expatriate tax programs, foreign tax returns of countries where there are no qualified corporate financial personnel, and relocation tax services.

* Tax departments in companies that have realized recurring large net operating losses and where the financial condition seriously threatens continued viability.

* Tax departments that have or need large tax staffs to cover a diversity of functional areas. The larger and more diverse the tax department, the more likely that the cost-effectiveness of one or more of its processes could benefit from a performance improvement analysis. Such analysis may identify the root cause of inefficiency that can be corrected by changes in the process. On the other hand, the review may conclude that it is more economical to expand the scope of the services provided by outside tax specialists in selected segments of tax compliance and planning. This use of incremental personnel can be more cost effective than adding full-time employees necessary to cover the maximum work load peaks during the year.

E. Some Practice Issues for the Accounting Firm Engaged in Outsourcing

Historically, accounting firms have been involved in outsourcing selected tax compliance functions, such as expatriate tax services and corporate state and local income tax returns. Outsourcing of the entire compliance function--or, indeed, of the entire tax function--raises a series of professional issues for which there is not much precedent.

For example, the outsourced tax return produces the self-assessed tax liability of the corporation and, accordingly, is still the legal responsibility of the corporation. Many of the positions taken on the return, however, may not be substantively decided by corporate employees as a consequence of the outsourcing arrangement.

Does this alter the traditional independent contractor relationship of the accounting firm service provider and the corporate client? Does it make any difference whether the accounting firm hires former employees of the client who are terminated as a result of the arrangement? If the accounting firm is also the outside auditor of the client, does the outsourcing arrangement impinge on its "independence"? How does one reconcile differing tax penalty standards for "preparers" and taxpayers? How do you deal with disclosed tax positions if the parties disagree? Who will bear penalty costs? Is indemnification appropriate? Is there any greater risk of loss of privilege by virtue of the arrangement?

Although a full explanation of the answers to these issues is beyond the scope of this paper, all these issues should be discussed and must and can be answered favorably before a company can make an informed decision concerning outsourcing part or all of the tax function.

III. The Corporate Tax Department of the '90s

In today's constantly shifting business environment, it is imperative that corporate tax executives stay ahead of the trends that affect their companies and their roles with in the organization. To deliver value today, tax professionals must go beyond knowing the tax law to becoming partners in business. The indispensable tax department is an integral and integrated part of the company's financial management team. To attain this position, in-house tax professionals must understand their company's business, its people, and its processes, and they must apply their tax skills to furtherance of the company's strategic goals. Effective communication across the organization is very important not only as a means of demonstrating the value the tax department delivers, but to establish relationships and integrate with the company's business units.

Communication between the corporate tax department and its outside auditor is also important. An open line of communication will afford both parties the opportunity to discuss issues of performance improvement on a periodic basis--rather than in a crisis mode in response to a question of outsourcing raised by upper level management. From the accounting firm's perspective, open dialogue on these issues with the head of the client's tax department would serve the common goal of both parties--to maintain the most effective and cost-efficient tax services in support of the financial needs of the corporate client. With such open dialogue, the issue of outsourcing is not a threat; rather it is a catalyst for the kind of collegial effort by internal tax management and its external tax advisers to jointly serve the client's needs.

(*) Mr. Levine expresses his appreciation to Laurence P. Russe II of ICF Kaiser International, Inc., and Mr. Lerner expresses his appreciation to M. Ray McGovern, Ernst & Young's National Director of Tax-Human Resources, and Bernard A. Finkelstein, Regional Director of Tax in the firm's Cleveland office, for their assistance on this article.

MARTIN A. LEVINE is Vice President and Director of Taxes for ICF Kaiser International, Inc. Previously, he was Director of Taxes and Special Studies at Communications Satellite Corporation. Mr. Levine received a B.S. degree from American University and is a certified public accountant. He has served as President of Tax Executives Institute's Baltimore-Washington Chapter and as chair of the Institute's Corporate Tax Management Committee. He currently serves on TEI's Board of Directors and is chair of its Membership Committee. He is also a member of the American Institute of Certified Public Accountants.

HERBERT J. LERNER is National Director of Tax Services for Ernst & Young. He previously served as Vice Chairman-Tax Services for Ernst & Whinney, having started with the predecessor firm in 1963. A graduate of Rutgets University and Georgetown University Law Center, Mr. Lerner is a certified public accountant and a member of the District of Columbia Bar. He served as Chairman of the AICPA Tax Division for a two year term (1986-1988).

CPE/CLE Accreditation

Tax Executives Institute has historically provided its members with excellent educational programs. In light of the minimum requirements for continuing professional education that state CPA and bar associations now impose, the design and conduct of TEI's conferences, seminars, and courses become even more important.

To assist TEI members in satisfying their CPE requirements, TEI has contacted accrediting agencies in all 50 states and the District of Columbia to request information about approval for sponsorship of continuing professional education programs. In addition, TEI has become a qualified sponsor of CPE programs in respect of IRS enrolled agents.

Boards of Accountancy. TEI is currently registered with the following Boards of Accountancy: Illinois (#158-000651), Indiana (#CE92000119, Exp. 12/93), New Jersey (#160, EXP. 6/30/95), New York (E90-253 (9/1/93-8/31/96)), Ohio (P0087), Pennsylvania (PX61 3L), and Texas (#3522). TEI is also registered with the National Association of State Boards of Accountancy (Sponsor No. 91-00116-92).

Continuing Legal Education. The Institute is registered in the following states as a sponsor of continuing legal education programs: California (Exp. 8/94), Iowa, Kentucky (1992 47th Annual Conference - 25.5 credit hours, 0 Ethics credit; 1993 43rd Midyear Conference - 25 credit hours), Minnesota (1993 48th Annual Conference - 17.25 credit hours; 1993 43rd Midyear Conference - 17.25 credit hours), Missouri, Ohio (1993 43rd Midyear Conference - 18.75 credit hours, 1.0 Ethics credit; 1993 48th Annual Conference - 23.75 credit hours; International Tax Course - 25.25 credit hours), Oklahoma (1993 48th Annual Conference - 26.5 credit hours; 1993 43rd Midyear Conference - 22.5 credit hours), and Wisconsin (1993 48th Annual Conference 28.0 credit hours; 1993 43rd Midyear Conference - 25.0 credit hours).

Note. Several states, such as Wisconsin and Georgia, require the individual to submit conference materials directly to the CLE Board. TEI provides a continuing professional education form for each registrant at its conferences, courses, and seminars, which should be completed at the conclusion of the program and returned to the TAI Registration Desk for verification and signature. A copy of the form is retained and filed at TAI Headquarters.
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Author:Lerner, Herbert J.
Publication:Tax Executive
Date:Sep 1, 1993
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