The tax function in the asset management space has become less of a regulatory or compliance role and more of a risk management position — and even a planning opportunity. “To the extent that an asset manager was just looking for the tax returns to be done, the rules of the game have changed so much that it’s not enough to simply outsource the K-1 function,” said Layne Albert, Tax partner, Financial Services ̶ Asset Management, Grant Thornton LLP. Today’s complicated tax rules require a broad knowledge of regulations, an increase in efficiencies and a reduced risk of human error. A tax “rightsourcing” approach may be the best way to attain the maximum benefit of a strategic tax function.
To illustrate, Albert offered an example of this method.
Case in point: Strengthening hedge fund management
A global investment management firm, which was in charge of more than 40 funds, offered hedge fund solutions to investors. In delivering its products to investors, the firm seeded a host of other managers offering various investment strategies. The firm believed all it needed was a nuts-and-bolts approach to tax to get the K-1 form out the door to those investors.
The firm’s tax services provider was made up of employees of the hedge fund administrator, a setup that proved to be expensive in terms both of actual cost and of training to stay current about tax and the updates on ever-changing technology — all charged back to the management firm. In addition, the fund administrator was focused on completing a compliance task and was not at all focused on risk management or planning.
The management firm began to realize it needed more tax services than what it had been getting — that is, what it once considered good enough was no longer good enough. Specifically, it wanted the tax work to be more comprehensive, faster and cheaper, and to make its tax function more integrated into other financial aspects of the firm. The firm needed more than just a compliance function.
A co-source arrangement with Grant Thornton changed the equation for the firm’s tax function. Said Albert: “We took the key employees from the administrator and made them Grant Thornton employees, and at the same time we transitioned the tax work from the administrator into Grant Thornton. We were able to put their work papers and processes into our automated platforms, deleting 25% of the manual hours from the process. Automation increased the value of the deliverables by removing the risk of human error. We also accelerated the deliverable dates of the K-1s by one to two months, making investors happy and also taking costs out of the engagement.”
In addition to streamlining the tax process, Grant Thornton set to work automating manual tasks that involved the gathering and sorting of data, developing a standardized set of work papers and creating a written process around the engagement, which would result in any partner or tax professional being able to step in to perform engagement work, understanding exactly where the process was and what needed to be done next.
The benefits going forward
At the same time, the Grant Thornton tax team has been able to look at more strategic and thoughtful risk management tax issues, and identify other fund matters that could use attention, such as how the firm treats fund managers from a tax perspective, looking at state tax planning ideas and suggesting ways to increase the value of compensation to fund managers and firm owners.
Said Albert: “We’re helping the management team free up time to think about and discuss other risks, identify them, and make sure that they’re addressing them appropriately and seizing on opportunities that may have been missed because the focus was on manipulating data and getting K-1’s out the door.”
“Traditional hedge fund managers look at tax providers as merely compliance people,” said Albert. “And what they’re really missing is that there’s a quality component, there’s a strategic component, and there are management components that should be taken into account and are valuable to that hedge fund investor.”
The private equity (PE) side of asset management, whether it’s a launch or a mature PE group, requires a “holistic” view of the tax function and the many elements that touch on tax and finance, said Albert. “PE investing is much different from hedge funds and requires a different tax approach that should never be solely about compliance. Once a portfolio company investment has been identified, as you debate whether to raise funds outside the United States or make an investment outside the U.S., you have a game-changing event.” At that stage, said Albert, issues from a tax perspective become more apparent and require more thoughtful and proactive consideration.
He offered an example of this occurrence.
A case in point: Private equity
A PE company started out small, but as it expanded the number of funds it raised, and began to make acquisitions and eventually dispositions, it had to consider how to extend its tax function to take on more than a traditional compliance role. At some point the company realized it needed to coordinate all its tax work and marry the tax issues of acquisition and disposition processes with the fund and portfolio company structures, to gain synergies as deals moved forward. “Tax issues were creeping up on the CFO’s page, and the partners were thinking of more tax issues with regard to their investment and their investors,” said Albert. The company called on Grant Thornton.
A holistic approach helped manage investment in the portfolio companies from an M&A perspective and assisted in the structuring of acquisitions and dispositions to be sure all tax areas were covered in terms of risk and synergies considering the fund structures and tax characteristics of the funds’ investors.
“We made sure that whatever synergies were identified at the M&A process were actually implemented at the portfolio-company level,” Albert said. “For example, if we were going to save 10% on taxes because of a certain item being treated one way, we wanted to make sure that we were actually doing that at the portfolio-company level and getting the benefits that were promised to the investors.”
The Grant Thornton arrangement included work with the PE portfolio managers to be sure their expectation of their incentive income was appropriately set and managed throughout the ownership of the investments. “That way, when there would be realization,” Albert said, “there would be no surprises and no questions about the amount or character of income being recognized.”
The benefits going forward
What makes such a relationship work has a lot do to with managing the engagement, including making sure all the M&A partners working for a PE group know what everyone else is doing, which deals are a priority, and what fund issues exist that not everyone may fully know about. That was the case in this example. Said Albert: “The M&A process can bring a lot of value to a fund and its investors, but that value can evaporate if all the tax issues of the funds and investors are not taken into account during tax planning.”
Being involved in the early stage of a PE group allows Grant Thornton to help mold the tax function to have a solid understanding of the role the tax department takes. “And we’re very aware of when that private equity group will have achieved a critical mass in terms of tax issues, such that bringing some piece of that tax function in-house begins to make sense,” Albert noted. That happened in the PE case. “We helped them identify people. We helped identify what work made sense to be done in-house and what made sense for us to do at Grant Thornton — and how best to share the total burden and set priorities.”
Other benefits of ‘rightsourcing’ with a savvy tax provider
3 questions for asset management CFOs considering tax ‘rightsourcing’
• Are you talking about tax today more than you used to?
• Are your investors asking more questions related to tax strategies around their investments?
• Do you feel comfortable and knowledgeable when you discuss your tax positions among
The Tax Cuts and Jobs Act of 2017 and the significant shifts that occurred as a result have made having the right tax arrangement critical. For instance, real estate investment trusts became very favorably treated as investments, and publicly traded partnerships that were asset managers did better by converting to C-corporations. “These were proactive responses to tax reform,” said Albert. “And for those kinds of actions, which are important, you need to have the right tax partners up-front with you, discussing the opportunities — and discussing them still, as new opportunities arise.” Not everyone can implement the structures described here, but the best advisers present and discuss ideas, and allow companies to be more agile.
“In a world where you’re concerned only about compliance,” Albert said, “those opportunities are going to pass you by, or you’ll be the late adopter.”
A proactive approach is the best bet, he said. “You have to constantly think about how to drive value by minimizing data manipulation, and emphasizing and implementing innovative strategies, using technology to deliver a better and more timely product, and more accurately. These process improvements will yield time to focus on risk management and planning.”
For more on tax reform’s impact on PE, see Terrain shifts for PE M&A deals
Tax Partner, Financial Services – Asset Management
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