How tax outsourcing can help portfolio companies reduce risk

For portfolio companies looking to reduce cost and risk associated with their tax function, outsourcing or co-sourcing should be considered.

Tax and finance transformation is now a must. Growing issues around supply chain, rapid tax legislation and shifting workforce dynamics — all exacerbated by the COVID-19 pandemic — are putting businesses under pressure and necessitate fundamental change. The 2022 EY Tax and Finance Operations Survey (TFO survey), which queried 1,650 executives in more than 40 jurisdictions and a dozen industries, including 364 privately owned companies, has found that organizations are struggling to find a balance between driving value, managing risk and reducing cost. In response, most surveyed companies are or are planning to undertake some sort of transformation.

Portco B: carve-out from existing entity

Portco B was a subsidiary of a multinational consumer goods company that was carved out and sold to the PE arm of a leading global investment firm. When part of the multinational, Portco B didn’t have its own tax department — instead, those functions were housed centrally in the parent company. The transition services agreement with the parent company only covered tax compliance for a short period of time, so Portco B needed to stand up a tax department immediately.

Building an internal tax department from scratch would be a years’ long undertaking, requiring not just finding and hiring experienced staff (as noted above, a challenge in the current environment) but also a large investment in technology for the finance and tax systems to enable the department. Given the target exit of seven to eight years, the PE firm determined that building a multifunctional in-house tax function would not be fast enough or cost effective as it would significantly cut into the eventual sales price. There would also be a risk that the practitioners brought in would not be skilled enough to confirm compliance in multiple jurisdictions.

Instead, the PE firm hired a third party and outsourced the majority of its tax department, keeping a small number of individuals to provide the controls structure and serve as liaisons to the business. This shifted the typical dynamic for an in-house tax department from compliance to a true business partner, while ensuring compliance from day one through the deep bench of skilled and sophisticated practitioners available through the third party. Bringing in the third party also gave Portco B access to its tried and tested tax and finance technology and systems, eliminating the need to purchase and implement its own. As an added bonus, the technology consolidated all data into a central view with robust analytics, giving leadership of Portco B and the PE company control and visibility around the globe.

While the PE firm has not yet sold Portco B, the benefits of this arrangement have been swift and comprehensive for both companies, including €57 million in refunds and indirect tax deferrals on day one, dedicated top tax talent in a complex and changing tax landscape; global consistency in approach, planning and risk management across all jurisdictions; compliance filings from day 1; and a tax model design that’s aligned with the firm’s operating model.

Portco C: consolidating entities

Another common scenario is when a PE firm purchases two or more companies in the same sector with similar products or services and integrates them to benefit from synergies and create one larger company that is much more competitive and valuable than the original companies were separately.

Integrating two or more companies is not easy. The PE company has to determine how to create one sophisticated tax department ready to manage the issues of a big company from several smaller tax departments, each with its own technology, processes and systems that cannot talk to the others.

Tax departments that previously consisted of few individuals may be overwhelmed with competing priorities, including accounting for the transaction, work related to the transaction structure and risk mitigation items, along with regular day-to-day tasks.

Without a clear execution plan and prioritization of tax items, there can be significant risk and lost opportunities. For instance, financial statement reporting may be extremely challenging compared with past practices. Vital tax items, such as modeling the impact of breaking tax years and key elections, will

need to be appropriately considered and responsibilities divided. And capitalizing on transaction-related opportunities (e.g., transaction cost analysis, employment tax savings) is critical. However, the individuals in the original small tax departments often do not have the sophistication, skills or knowledge to handle these crucial tasks.

Co-sourcing or outsourcing the tax department can be the quickest and most cost-effective way to manage the integration itself and the related transaction accounting and continue to do business. The tax professionals who remain with the new company can then focus on high-end planning opportunities and proactively identifying and mitigating any tax issues — which have been known to lead to millions of dollars of lost value at exit.

Whichever direction a company chooses to go, it’s imperative to proactively manage any and all tax issues, as they only build upon each other, getting worse and worse over time.

Contributors

• Anna M. Skvortsova, Partner, EY Private, Business Tax Services, Ernst & Young LLP
• Matthew Bender, Managing Director, Private Tax
• Jimi Karou, Senior Manager, Private Tax
• Amy Lesh, Senior Manager, Tax – Global Compliance and Reporting