Accounting Firms: The Next-Gen Managed Service Providers for Tax Functions

Abstract/Business Case

1    Introduction

The paper explains the emerging trend of managed services for the tax and accounting function. The managed services engagement has been a prevalent trend in the information technology industry over the last two or three decades. The accounting industry is however the latest to adopt this ‘cosourcing’ trend.

2    Main

The paper will describe the meaning, applicability, and prevalence of the cosourcing trend in tax functions worldwide and in India. The recent PricewaterhouseCoopers (PwC) acquisition of the General Electric (GE) tax team and the Ernst & Young (EY) tax partnership with American International Group, Inc. (AIG), forms the basis of the paper. This paper could be of particular interest to accountants and tax and finance professionals looking to explore new opportunities in the global and Indian tax services industry.

3    Recommendation

The paper identifies probable candidates that could establish tax/accounting arrangements with managed service providers (MSPs) in the future and lists their advantages to both outsourcing corporation and absorbing/acquiring company. It also elucidates the evolution of the professional services firm model, highlighting the strengthening legal capabilities of accounting firms.

1. Introduction

The accounting industry is witnessing a new era in tax function management across the globe. Some of the largest professional services firms (e.g., the Big Four: Deloitte, PwC, EY, and KPMG) are converting to managed service providers (MSPs) for tax/accounting functions. The tax/accounting function is just the start of MSP arrangements for the Big Four. In the future, the Big Four could forge MSP arrangements with their clients for the following services as well:

• Marketing
• Advertising
• Consulting
• Legal services
• Internal audit, etc.

With global companies taking the lead in adopting MSP arrangements in tax functions, Indian businesses are expected to jump on the bandwagon in the years to come. The Indian arms of the Big Four would be the preferred choice of Indian multinationals for tax MSP arrangements due to the Big Four dominance in the country. For the nonaudit portion of the accounting industry (tax and financial consulting services), the Big Four command more than 50 percent market share in India. The Big Four experience and client base in India make them the obvious choice for tax MSP.

2. All about Tax/Accounting MSP Arrangements

2.1 What Is Meant by a Tax/Accounting MSP Arrangement?

Under a(n) tax/accounting MSP arrangement, a company cosources or partially outsources its tax technology and tax compliance operations to an accounting firm. A company usually outsources tax functions that are not central to a company (but are country/territory dependent) to a professional services firm (acting as the MSP). For example, European value-added tax (VAT) matters of an Indian corporation could be outsourced to a professional services firm under a tax MSP arrangement/engagement.

The tax MSP arrangement is not a fully outsourced tax function arrangement. The outsourcing company does retain and maintain an in-house tax team for strategic tax work and management of the cosourced MSP.

2.2 What Portions Are Outsourced by Corporations in a Tax/Accounting MSP arrangement?

Corporations outsource tax activities of a transactional nature to an MSP. A few activities that can be outsourced are

•  Tax accounting and reporting (by jurisdiction)
•  Direct tax return preparation (company income tax filing)
•  Indirect tax return preparation (corporate VAT, goods & services tax (GST), sales & use tax filing), etc.

Tax activities of strategic nature, namely, expatriate tax strategy formulation (global mobility strategy), mergers & acquisitions tax strategy, tax policy formulation and administration, transfer pricing strategy, etc., are retained in-house within the corporation, managed by in-house tax professionals.

2.3 How Are Companies Moving Towards Tax/Accounting MSP Arrangements?

a) All major companies across the globe and in India have incumbent tax teams. Tax teams could comprise 20 to 1000 employees, depending on a company’s magnitude and complexity of business (as well as the industry a company belongs to).

b) Companies planning tax/accounting MSP arrangements are moving a part of their tax teams to their existing tax supplier (usually a professional services/accounting firm). Typically, the outsourcing company floats a tender-inviting bid for a tax MSP arrangement. Bidders meeting the outsourcing company requirements are awarded the tax MSP contract.

c) A smaller tax team is however retained in-house for strategic tax initiatives.

d) A tax MSP arrangement takes the form of a renewable contract. To start with, the parties under the MSP arrangement (the outsourcing company and acquiring accounting/professional services firm) sign an agreement for four or five years. If the MSP arrangement yields the expected results, the contract is renewed further after the end of the contract term, or the arrangement is made permanent.

e) With an MSP arrangement, the employees transferred to the professional services firm serve as the staff of the acquiring company (and no longer remain on the payroll of the outsourcing company). Associated fixed employee costs are transferred from the outsourcing company to the acquiring company.

2.4 Why Are Companies Brainstorming on Tax/Accounting MSP Arrangements?

The key factors responsible for a corporation’s behavioral shift towards a tax MSP arrangement are

• Complexities associated with country-by-country reporting (CbCR) requirements laid down by the Organization for Economic Cooperation and Development’s Base Erosion and Profit Sharing plan for corporations
• Huge number of tax returns to be filed by businesses across multiple jurisdictions
• Increased corporate direct/indirect tax liabilities of multinational corporations (MNCs) with the recent enactment of The Tax Cuts and Jobs Act (TCJA) in the U.S.
• Expected changes in international taxation and other tax liabilities post Brexit
• Anticipated tax changes as a result of the North American Free Trade Agreement (NAFTA) and Trans-Pacific Partnerships (TPP) renegotiations
• Cross-border taxation issues arising as a result of import/export bans and regulations (imposed by China and the U.S.)
• GST implementation and filing requirements in India
• VAT enforcement by the Gulf Cooperation Council (GCC), etc.

2.5 Which Companies Have Taken the Tax/Accounting MSP Route?

GE’s tax department, known as the ‘Harvard of tax departments’ was the pioneer in forging a tax MSP arrangement with PwC in April 2017. The AIG global tax deal with EY followed (in April 2018). Another Big Four firm, Deloitte LLP, claims to have had a cosourcing tax arrangement with McDonald’s Corporation since 2009, where Deloitte has been managing foreign tax returns and U.S. state and municipal returns for McDonald’s ever since.

Below are a few related case examples:

Case Study 1: The GE–PwC Tax Cosourcing Deal

In April 2017, 600 accountants, lawyers, and tax advisers across 42 different jurisdictions in GE moved (were transferred) to PwC. A team of 20 corporate tax professionals remained with GE to manage the new arrangement and other strategic tax activities. PwC has one of the largest tax practices globally, and the largest among the Big Four firms, with 41,000 tax professionals spread across 157 countries worldwide.

• The PwC–GE Cosourcing Arrangement: The 600 GE employees who moved to PwC do tax work for both GE and other PwC clients, and GE receives a share of revenue that the transferred unit generates for PwC.
• Benefits to GE: GE files more than 5,500 tax returns annually across 300 jurisdictions worldwide. GE aims to cut associated costs and intends to focus more on its core operations. According to Jeff Bornstein, GE’s chief financial officer, “The PwC deal would save about $100 million a year for the 5-year term of the PwC agreement.”
  The company mentions that GE did not need a big tax team after its capital separation from the group; hence, the PwC deal was a ‘more creative’ solution to layoffs, which would have otherwise cost GE $50 million.
• Benefits to PwC: PwC obtained access to the proprietary accounting software developed by GE at no additional cost. Experienced tax professionals from GE are expected to strengthen the tax workforce of PwC, thereby enabling PwC to acquire new tax clients or effectively serve the existing tax clientele. It is estimated that PwC’s annual revenues will get a 10 percent boost for the years 2017 and 2018 with this cosourcing arrangement.

Case Study 2: The EY and AIG Strategic Tax Compliance and Technology Agreement

In April 2018, AIG signed a five-year managed tax services and technology agreement with EY.

• The EY–AIG Cosourcing Arrangement: Select members of AIG’s global tax compliance and tax technology teams will be moved to and accommodated within EY’s tax technology and direct and indirect tax compliance practices at U.S. federal, state, and local levels, as well as globally. Based on the performance of the five-year agreement, the deal could be extended or the MSP arrangement made permanent.
  An internal tax team of a few members is however retained to focus on strategic tax processes.
• Benefits to AIG: AIG intends to get specialist tax services from EY (owing to their inherent knowledge and experience in the tax field) along with access to the EY tax platform. AIG aims to improve its tax process efficiencies with the MSP arrangement.
• Benefits to EY: Following the footsteps of PwC (in the PwC–GE deal), EY plans to utilize the experience and knowledge of the incoming AIG tax professionals to win new clients.

2.6 Who Are the Probable Candidates That Could Establish Tax/Accounting MSP Arrangements in the Future?

The following could be identified as probable candidates for tax/accounting MSP arrangements:

• Foreign corporations with market capitalization of $50 billion and more. Indian corporations with market capitalization of at least ? 30,000 crores
• MNCs with 30+ years of operating experience in their respective industry
• Corporations having huge and mature tax teams (150+ tax professionals)
• Industrial corporations whose core operations are unrelated to their tax domain operations.

In the international market, pharmaceutical companies such as Pfizer Inc. and Merck & Co. Inc., as well as banks like Citigroup Inc. and J.P Morgan Chase & Co., are probable candidates. Other companies that could be considered are IBM, MetLife, Goldman Sachs, and Prudential.

In India, probable corporations that could experiment with outsourced tax function arrangements could be the Tata Group of Companies (especially Tata Consultancy Services), leading auto manufacturer Maruti Suzuki, Reliance Group, and Telecom Giant Bharti Airtel, to name a few.

2.7 What Are the Advantages of Tax/Accounting MSP Arrangements for Companies Outsourcing Their Tax Teams?

• Cost Reduction and Need for Cost Savings: With an MSP arrangement, the outsourcing company can move from fixed employee costs to a relatively lower variable cost model. The fee payable to professional services firm for tax services is lower than the cost of full-time in-house staff hired. Outsourcing companies can save 1–5 percent on their labor costs with MSP arrangements.
• Specialist Tax Support: MSP arrangements allow outsourcing companies to gain tax process efficiencies by leveraging accounting firm domain experience and using their proven tax technology tools.
• Outsourcing Company Focus on Strategic Tax Activities: With the outsourcing of tax compliance processes, the in-house tax team (if retained) can focus on strategic tax activities such as mergers & acquisitions tax advisory, green/carbon tax policy administration, investment incentives, and so on.
• Focus on Company’s Core Operations: The savings accrued as a result of a tax MSP arrangement can be reinvested in the outsourcing company’s core operations, thereby boosting its core business capabilities.

2.8 What Are the Advantages of Tax/Accounting MSP Arrangements for Accounting Firms Absorbing/Acquiring the Outsourcing Company’s Tax Teams?

Employees acquired/transferred from the client’s (outsourcing company’s) tax teams have intimate company/industry knowledge that will enable the accounting firms to win more work from existing clients or contracts with new/additional clients. The key advantages to the accounting firms are as follows:

• Opportunity to strengthen tax practice with relatively lower investments (very low capital investment).
• Savings on Employee Training Costs: The acquired staff are presumed to have prowess in taxation matters, with almost negligible training needs (as compared to training required for fresh hires).

Additionally, the accounting firm that is acquiring such tax teams might have a chance to pick similar MSP arrangements with its other clients.

3. Conclusion

3.1 Tax/Accounting MSP Arrangements and Evolution of the Professional Services Firm Model

Reexamining the GE tax team acquisition by PwC, one sees a resurrection of the legal capabilities of the Big Four firms following the deal.

1. In 2010, GE reported $14.2 billion in worldwide profits but no taxes according to the New York Times’ investigation, “GE’s Strategies Let It Avoid Taxes Altogether.” In the same year, GE’s tax department was acclaimed to be “the World’s Best Tax Law Firm.” This accolade was the result of GE’s efforts to build its tax department (during the 1980s and 1990s) to reduce its reliance and expenditure on outside counsel.
2. Since April 2017, however, when GE downsized its tax team (mostly consisting of lawyers), the work has been reassigned to an accounting firm (a Big Four firm), and not a law firm. David Wilkins, a Harvard law professor researching on the Big Four, said, “It is an example of how these firms have expanded beyond accounting, and gained a foothold in the legal market by selling their expertise across a broad range of areas well beyond tax, and into compliance, regulatory planning and other specialties.”

The above example illustrates the blurring difference between the work of an accountant and a legal professional in the evolving professional services firm model.

3.2 The Move from ‘Unbundling’ of Corporate Legal Services to ‘Rebundling’ (by the Big Four)

Corporations across the globe and in India are planning to save on outside counsel-related costs. Therefore, companies’ general counsel refrain from using a single law firm as a one-stop shop for all legal matters. Instead, each law suit or legal project is broken down further into sub-deliverables and assigned to the supplier quoting the lowest price. Most such projects (sub-deliverables) are taken up by the Big Four, who bid the lowest price for such assignments. The Big Four undertake huge volumes of such projects (since traditional law firms tend to quote relatively higher for sub-portions of legal work). Consequently, the Big Four have rebundled these legal sub-deliverables with their tax and compliance service offerings. Rebundling by the Big Four has hence removed the clear distinction that previously existed among professional services, i.e., the distinction between the accounting and legal services.

The above phenomenon marks out the Big Four as the ‘power houses’ in the accounting industry (globally and in India), which are slowly strengthening their foothold in the legal space.

Considering the benefits and feasibility of tax cosourcing, and the evolution of the professional services domain, the tax/accounting MSP arrangement could be the way forward for Indian corporates. As for the global conglomerates, legal MSP arrangements could be the future trend for their legal department in the coming decades.

References

[1] “600 GE tax professionals moving to PwC”, Journal of Accountancy, January 14, 2017

[2] “Global Tax 50 2017: The GE/PwC outsourcing deal”, International Tax Review, December 13, 2017

[3] “AIG and EY Announce Strategic Tax Compliance and Technology Agreement”, Cision PR Newswire, April 12, 2018

[4] “EY signs global tax deal with AIG”, Accountancy Daily, April 18, 2018

[5] “AIG Shifts Some Employees to EY in Managed Tax Services Collaboration Deal”, Carrier Management, April 13, 2018

[6] “BRIEF-AIG And EY Announce Strategic Tax Compliance And Technology Agreement”, Thomson Reuters, April 12, 2018

[7] “General Electric’s Novel Tax Deal Could Lead the Way”, The Wall Street Journal, January 30, 2017

[8] “PwC/GE tax deal - a game changer for the way businesses use consultants”, PwC, January 13, 2017

[9] “Ernst & Young teams with AIG on tax and tech”, Accounting Today, April 13, 2018

[10] “GE, Like McDonalds, is Outsourcing Some Corporate Functions. How Soon Before It Happens With Law Departments?” JD Supra, February 8, 2017

[11] “PwC hires half of ‘the world’s best’ tax team”, Australasian Lawyer, March 21, 2017

[12] “PwC’s Takeover of ‘The World’s Best Tax Law Firm”, Bloomberg Law, March 15, 2017

[13] “PwC hires half of GE’s tax team in groundbreaking deal”, Top Lawyer Firm, March 16, 2017