The mounting regulatory and cost pressures on tax departments can undermine an investment management firm's success. An additional sea of regulatory, operational, and compliance changes is visible on the horizon. Tax departments unprepared for these significant changes may struggle to upskill existing talent and upgrade their current technology infrastructure. This new wave of complexity may also stall firms with inefficient operating models potentially causing delays, penalties, or even impacting firms' reputations.
Traditional tax operating models typically are developed incrementally, rather than in response to a defined strategy, which can lead to suboptimal results. Unlike conventional outsourcing solutions, new strategic operating model changes can help the tax function take a quantum leap forward. In addition to potential cost savings, these new approaches can allow firms to refocus their specialized tax resources on activities that drive strategic value for the firm. New tax operating models may allow for customized processes built on a scaled common technology architecture. The following sections will dive more deeply into the possible challenges and benefits of these new tax operating models, and explore important factors to consider when making a decision.
The market trends indicate a growing emergence of a fully outsourced model where a third-party provider is engaged to provide tax compliance and advisory services. A focused in-house tax team makes management decisions, gives strategic guidance, and provides review signoffs, which translates into less investment in technology and processing requirements. The model helps retain institutional knowledge that might otherwise be lost and may also involve transferring in-house talent to the third-party provider.
Talent shortages and regulatory complexity contribute strongly to the mounting pressures on tax departments. The complexity has grown across four dimensions: maintaining optimal talent levels, managing global interdependency, increasing regulations, and digitization of tax reporting. Complex operational activities are consuming an increasing amount of technology and talent resources afforded to tax departments, often leading to stop-gap solutions that can create inefficiencies while failing to deliver a sustainable solution for the future.
A supply gap for talent in the field of taxation is on the horizon. According to Bloomberg Tax 2021 Corporate Tax Department survey, 70% of US survey respondents across industries somewhat or strongly agreed that corporate tax departments were under-resourced, indicating high demand for tax talent.1 However, the number of CPA candidates and the number of accounting, taxation, and related degrees awarded has declined over the last several years.2 Furthermore, the percentage of accounting professionals in the age group of 55 years or above—professionals expected to retire in the next five to 10 years—is higher than the percentage of professionals in the age group of 45 to 54 years—the group expected to take on the responsibilities of retiring professionals—indicating an aging workforce.3 These factors point to a supply-demand gap for accounting and tax professionals, making hiring and retaining talent increasingly difficult.
Tax compliance now depends on navigating an international web of interconnected rules. The total number of international tax treaties in force has grown to more than 18,000.4 According to the Thomson Reuters 2021 State of the Corporate Tax Department survey, 80% of tax departments across industries, including financial services, had tax responsibility in 17 countries on average.5 Comprehension of these treaties may be even more essential for investment managers of funds with very complex global operations. For example, a firm may be headquartered in country A, offering funds to customers located in country B, and those funds may be investing in assets located in countries C, D, and E. Such complex international operations require firms to understand the local tax laws and cross-border tax agreements of all jurisdictions where they operate. Companies may find it increasingly challenging to handle this international web of tax complexity.
Due to COVID-19, many countries introduced tax reforms to increase economic growth, promote environmental and social issues, support investment, and increase tax compliance amid the pandemic disruptions.6 Tax laws have become more detailed and specific, increasing significantly in complexity over the last two decades, especially in the United States. Title 26 of the US Code, which consists of federal statuary tax laws, has swelled from approximately 3,200 pages in 2000 to approximately 4,000 pages in 2021 (see figure 1).7 One example of regulatory changes driving increased reporting requirements is Schedules K-2 and K-3 filings (20+ pages of new standardized reporting) in addition to Schedule K-1 filings by partnerships in the US for international tax-relevant items.8 The additional Schedules K-2 and K-3 reporting require new processes, a time and resource-intensive exercise, to systematically gather, analyze, and report accurate data. Regulatory pressure continues to increase stress on tax department operations.
Many tax departments function on manual processes coupled with limited digital support for data collection and processing activities. As tax regulations become more interconnected, tax departments may be required to digitize in order to keep up with the flexibility and speed of reporting requirements. According to a Deloitte survey, 70% of survey respondents across industries, including financial services, predict that government revenue authorities will have more direct access to their systems within three years.9 Furthermore, some revenue authorities are shifting to real-time digital tax compliance models requiring a quick turnaround.10 To keep up, taxation systems may need to connect a company’s internal data sources with the compliance systems of revenue authorities. Compliance with emerging real-time data requirements may push tax departments to digitally transform, adding additional operational burdens to an already strained tax department.
Implementation of strategic operating model changes may help tax departments focus resources and increase opportunities to contribute more meaningfully through activities such as strategic planning, tactical business advisory support, and management insights.
Filing frequent, digitized, and granular reports and managing the impact of higher global complexities and an evolving regulatory landscape require considerable investment in talent and technology. Tax operating model changes can help firms fill the technology and skills gap and simultaneously realize cost savings.
Technology can help firms more efficiently tackle the highly resource-intensive tax compliance process. It also needs to be agile and scalable to handle the frequent changes in the complex tax ecosystem. Although tax may be a critical function for operations, finance leadership may prefer to allocate resources to functions that contribute more directly to customer success. According to a cross-industry survey, lack of resources and budget top the list of reasons for respondents’ underutilization of technology in tax operations.11 Strategic changes to the tax department's operations can help firms mitigate the costly and burdensome exercise of continuously upgrading technology systems by leveraging the services of an external service provider.
Some companies now expect tax functions to contribute more strategically as they accelerate digital transformation. According to a Deloitte survey, 67% of respondents from the financial services industry expect increased demand for tax advisory support for digital business models.12 To keep up with evolving responsibilities, firms may also need to upskill talent as tax professionals of the future could require a very diverse skill set. The diverse skills required are expected to include global project management, data management, technology application, process optimization, and strategic business advisory.13 Strategic outsourcing can relieve the firm's tax department from talent hiring, retaining, and upskilling responsibilities and allow the retained employees to focus on oversight and higher value-add items.
However, one of the most important factors that make a case for implementing strategic operating model changes is the cost savings potential. The Deloitte Center for Financial Services developed a proprietary model that forecasts how much expenditure an investment management firm's tax department can save through these strategic changes. The model predicts savings from as much as 23% to 31% of the tax department's total cost, depending on the firm's current level of outsourcing. Factors that could contribute to savings include better employee utilization, process efficiencies, hiring and replacement cost savings, and other synergies accrued from consolidation of operations to leveraging one service provider. Improved technology and process efficiencies are the major expected contributors to cost savings, not reductions in force. For an industry facing margin pressures, such savings can translate into an operating profit margin rise of 14 to 19bps.14 The model predicts that the realized savings reach their full potential gradually in three to four stages as the transition proceeds, as effective communication, talent transition, and process and technology realignment take time for fruition. Each stage may typically last 3—12 months depending on the organization's size. Furthermore, the model assumes that the level of work remains the same; however, since the tax regulatory environment continues to grow in complexity, the realized savings may exceed the estimates. The model also forecasts that the US investment management industry could potentially save about US$3.5 billion over the next five years through strategic operating model changes in their tax departments, assuming that the sector starts realizing the full potential of savings.15
In a nutshell, these strategic solutions can help firms establish a tax operating model that creates opportunities to save costs and repurpose resources from managing critical operational tasks to performing tasks that more directly drive value for customers and the firm.
Here’s a scenario of how a theoretical investment management firm with characteristics based on multiple sources for business metrics and Deloitte Center for Financial Services analysis saved 26% of their tax department expenditure by implementing strategic tax operating model changes.16 The theoretical firm reached the full potential of savings in four stages; let us analyze the cost saved across all stages.
All stages are cumulative and include savings accrued in the previous stages.
Stage 1: The theoretical firm realized hiring and replacement savings at this stage as employees were transferred to the new service provider. The shift provided employees with exposure to more efficient software and streamlined processes, which led to lower levels of task-switching. Lower levels of task switching ultimately translated to slightly higher utilization of transferred employees. Other miscellaneous cost savings accrued in this stage due to the consolidation of shared resources such as real estate, payroll systems, human resources, and software.
Stage 2: Added savings accrued due to operating on a common technology infrastructure. Savings were realized due to efficiency improvements from the unification of reporting systems. An example of this unified reporting includes the use of a dashboard for reporting updates from different data streams instead of disjointed mechanisms used by various internal business functions and external vendors.
Stage 3: At this stage, the theoretical firm’s new service provider performed technology and process integration with the current infrastructure platforms running on similar operating environments. By the end of this stage, most of the technology integration was complete, and the firm started to benefit from the reduced wait time for information.
Stage 4: This stage involved integrating the most challenging pieces of technology and process infrastructure at legacy vendors and the internal tax department onto the new cloud-based platform. The exercise involved developing and optimizing customized solutions to integrate systems successfully. A large portion of process efficiency linked to collaboration was realized in stage 4.
Savings due to the reduction of unnecessary communication and ineffective coordination were realized across all the stages based on the level of technology integration and realization of other consolidation synergies at each stage.
Compliance with firms' third-party risk management (TPRM) practices is a requisite while participating in any outsourcing arrangements. Leading practices that help address TPRM requirements for implementing the new strategic tax operating model changes typically include governance and talent planning. These elements can be essential for a successful implementation since the change may require leveraging an external party to provide certain tax compliance and advisory services. Specific actions that may significantly increase the chances of success include establishing horizontal and vertical communication channels, and retaining the right talent.
Effective communication represents one of the most important aspects of establishing an adequate governance mechanism. A governance review board with a hierarchical committee structure, the right communication cadence, and escalation protocols can help effectively communicate operational updates and data across different levels of the organization. Each committee may consist of members from the service provider and the investment management firm. Committees should meet at a fixed cadence, with higher-level (more strategic) committees gathering less frequently. Firms should set protocols that define conditions to escalate an issue to a committee higher in the hierarchy. Furthermore, firms with strong communication structures such as governance review boards may be more likely to provide effective risk mitigation through consistent adoption of tax policies, better escalation of issues, and quicker resolution of tax controversies and notices. Figure 3 shows a governance review board with three hierarchical levels. The number of hierarchical levels can change based on firm size as smaller firms may only need one or two levels. Apart from creating a vertical communication channel, firms should also set a horizontal communication model defining how individuals should communicate within a given committee.
A finely tuned combination of horizontal and vertical communication channels can help establish effective oversight over strategic changes in operating model.
—Dave Earley, partner, Deloitte Tax LLP
Complementing communication channels with the retention of the right talent can make the control and oversight mechanisms more effective. Since the strategic change may require firms to work with smaller retained in-house tax teams for governance activities, formulating a robust talent retention strategy can be crucial. In addition to the core technical tax competencies, the retained employees may be required to exercise business and behavioral competencies such as finance management, relationship management, contract management, and service delivery management. Furthermore, care should be taken to ensure that retained employees have adequate scope to reap benefits, such as learning and teaming activities, brought about by the new strategic arrangement. Retained employees with diverse skillsets and access to upskilling opportunities are likely to generate greater business value and help build solid relationships.
These strategic changes impact both retained employees and employees transferred to third-party service providers. With the proper level of care and attention, both groups can flourish. Talent considerations are important components of every step in the decision and transition process.
Firms that prioritize and plan governance and talent ahead of any tax operating model change will likely be more successful in their tax transformation journey.
It may be easy to think that running and operating tax departments are necessary but not differentiating elements of most investment management firms. However, when a siloed tax process leads to delays, penalties, and increased work, it can negatively impact a firm’s image. Take Schedule K-1 filings for example: delayed investor reporting, needs for amendments, or confusing footnotes, can lead to investor resentment. Firms that have timely and streamlined tax reporting processes can positively differentiate themselves from the competition. With adequate governance, strategic tax operating model change can allow tax work to be done more efficiently while eliminating the responsibility of running and maintaining a full-fledged tax department and simultaneously realizing cost savings. In certain circumstances, the revised model may also offer transferred employees opportunities for a continued career path while retaining institutional knowledge that could otherwise be lost.
However, strategic tax operating model changes do not represent a universal solution as every firm has different requirements and faces unique challenges. Choosing an operating model that is best suited likely depends on current outsourcing status, technology infrastructure, governance, and risk management requirements and capabilities. Furthermore, optimal operating transformation should consider employee transition and career opportunities for employees, as well as a long-term roadmap for cost savings.
Methodology for margin savings calculation
Methodology for calculating the savings potential of the US investment management industry
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