How private equity firms can make the most of their tax data

The importance and benefits of managing tax data more effectively

Jul 23, 2020

Key takeaways

Optimizing tax data allows funds and portfolio companies to quickly respond to investor inquiries.

Tax departments are challenged to collect and synthesize data from multiple sources before preparing for analyses.

Your providers can be key resources for support, insight and systems to help resolve data issues.

Tax technology Business tax Private equity

Lauren Demas, an RSM US LLP principal, explains what private equity firms should be doing with their tax data and how to get started.

Middle Market Growth (MMG): To get started, can you first just tell us a little bit about your background and your role at RSM?

Lauren Demas: My role at RSM is to help with the technology initiative that our leaders have brought forth and help launch PartnerSight, which is our new tax compliance technology tool. We're really excited about it and getting great feedback in the market.

My passion for technology came from working in private industry. I was at a top-five asset management firm and I managed all the U.S. tax compliance filings there. So thousands and thousands of filings in U.S. tax operations. So I'm pretty well keyed into the use of data, the use of tax data, and getting that through the full life cycle from launching a deal all the way through closing a deal and in the operating life in between.

MMG: Staying on the topic of tax data, which you just mentioned: The business and investment communities have become more and more focused on big data in recent years and on data analytics generally. So I was hoping you could talk about why tax data in particular is something firms are looking at more closely and what's behind that interest.

Demas: You know, with tax data, it's really interesting when you look at the majority of structures that are within a private equity firm or a real estate firm or asset management, however you want to label it. Those structures are in place for tax reasons. So the reason that you see hundreds or thousands of entities is really for tax reasons and tax structuring. So that is a big driver within an organization to effectuate those structures and make sure that they're operated as they were intended. You can also appreciate that there's a pretty rapidly changing regulatory landscape that we've seen over the past year. And quite frankly, you know, that's been consistent for the past few years and we expect a lot of change to come on board. So being able to use your data as intended for the life cycle of your deals and your structures, and then being able to respond to the changing regulatory landscape is why tax data is so important within an organization.

MMG: Can you expand on those benefits and maybe point to some of the specific areas that tax data can help firms address at the fund level?

Demas: Being able to respond to different types of questions that come in, either from LPs or your C-suite or different regulatory agencies and using that tax data to get to a quick answer or using it for just analytics within the organization or analytics of a deal, you know, looking at things during the life cycle and seeing where you are and doing measurements that way. A lot of times, the data that is asked for isn't really that complicated, but what becomes complicated is putting them together and the way that things need to be collected.

So if you think about data from the three data pillars that we see of investment, legal entity and investor, sometimes the connection points between those three data pillars is pretty complex. And that often leads to the questions coming into the tax department and tax saying, let me have a little bit to get all of that data together so that I can start to do my analysis and, you know, causes them to go away from what they're working on for a few hours to put that together. And if you can imagine that being repeated time over time. So sometimes it's almost death by a thousand cuts because the data in and of itself isn't as complicated, but the volume and the connection points between the data can be pretty tricky. And often you have a lot of people who are very skilled in data wrangling and key person dependencies that come with that within a firm.

MMG: So it sounds like it's almost a resource question—you're pulling people away to connect the dots. And that is what ends up being quite time consuming.

Demas: That's right. That's right. And what we're working toward is getting data to be what we call tax ready and tax ready isn't necessarily the tax answer. What tax ready really means is it's ready for the tax department to do their tax work on top of it. So often when a tax department gets data, they are often then conforming that data to be in a way that they then can layer on the tax adjustments or the tax analysis on top of that. So what I think a lot of firms are looking to is they're trying to systematize all that conforming that happens within a tax department so that the data can come to a tax department from a system. And then they can just go ahead and layer on their tax adjustments or do their tax analysis or different tax modeling without that intermediary step of getting data ready for tax.

MMG: And based on your work with clients, is there an example or two you could speak to where an investment firm used its tax data in a way that helped them achieve some type of goal or meet one of their priorities?

Demas: Yeah, for sure. Some of the notable results that we're seeing is people were able to smooth out those high peak hours that are often experienced during what we call busy season for producing tax returns and that sort of thing. And they're able to do that by having more consistent data throughout the year, so that preparing a year's worth of results doesn't always need to happen in January or February. It can happen throughout the year. And you can really smooth out those high peak hours that are felt both by you and by your provider. And I also think with that smoothing out of hours, there's often times people are looking to reduce fees and a major way that people can do that is to reduce those high peak hours and spread them to times throughout the year that maybe those peaks don't exist and work can be more easily absorbed.

MMG: And we've been talking about the fund side of things. So I was hoping we could switch gears and look at the operating business level. What are some of the ways that tax data can benefit a portfolio company or be better used at that level?

Demas: Well, often at the portco you see a lot of similar issues that you would at the fund with some of the differences being, at the fund, you typically have more legal entities and more investors that you're reporting out to. At the portco you have a lot more operating-type activity, even though you could have a number of legal entities and LPs that you're reporting out to, but at the portco, having that data sorted out allows for quicker turnaround for things like quarterly estimates or different requests that come from your LPs, which traditionally are funds, right. And they're responding to requests from their LPs. So it allows for a quicker pivot and a quicker way that you can answer any of those questions that come in and get to a tax answer in a much more expedient manner than before.

MMG: So it sounds like there are really good reasons to focus on tax data and to find ways to collect it and manage it more effectively. I want to get into how to do that. What kinds of resources, either internal or external, does a private equity firm need, if it wants to make better use of this type of data?

Demas: Yeah, that's a great question. And the answer is really, it depends. One of the things you might want to look at is what systems are you using and are you using them to the fullest capability? So, you know, you might not need to make another investment in another technology, maybe just tweaks to how you're using your current technology. The next part I would look at is I would look to the tax department and quite frankly, I would look to all of the departments and say, what data do you need? What do you define that data as? So almost a data dictionary. And then, where are you getting that data from? And then start from there. And from there, you can kind of see where some inconsistencies might be, or some ways you can smooth out some of that data that each of the departments is using either directly from the system or maybe from offline systems.

The third thing I would do is I would lean on providers. So often your providers see a lot of different clients and they know a lot of different things that people are working toward and what did, and maybe what didn't, work. So I would lean on them and I would also lean on your resources and your connections throughout the industry, because tax data and optimizing it is a pretty pervasive topic in the industry. And so a lot of people are going through it. And I often found when I was in the position of talking to other people, understanding what they're doing, what worked and didn't work was really great to know as I was going through that journey myself.

MMG: That makes a lot of sense. I'm interested too, in, in what some of the barriers or challenges you've seen that prevent firms from getting the most out of their tax data. I mean, you kind of alluded to one just now and maybe not utilizing systems to their fullest extent. So I was hoping you could talk more about that and maybe some other challenges you've seen firms face.

Demas: The first thing I would say is: the tax department is a super user of other departments’ systematized data. And the reason I say that is most tax departments don't have a system within their tax department that they can produce data out of. Right? So they're sort of getting data from accounting, legal compliance, you know, investor relations, a lot of different departments and trying to harmonize that data themselves. So I think that's a pretty big challenge. Also everyone's favorite system of Excel has its limits. While Excel is great, there's only so much it can do, right? And so sometimes if you reached the limit of Excel and you reached, you know, some other limits, it's time to look elsewhere. And some of the other places I would look would be, you know, what do your providers have to offer you from a system capability? And how can you leverage what they're doing and their technology investments to further what you're trying to accomplish within your organization.

MMG: In addition to those systems, are there any other things you'd recommend firms do as they look to adopt a more sophisticated approach to using and managing their tax data?

Demas: To be quite honest with you, the first thing I would do, and I mentioned it before, is I would create a tax data dictionary. And if you're in a tax department, you might think, why do I need a tax data dictionary? I know what I need, and I know what I mean by investor, or legal entity or, you know, anything to that extent. But what you're really trying to do is to provide your organization with a list of data that you need and how you define it. One of the things that we find is sometimes even basic definitions of investor differ among different departments because people see them differently, right? So if you're in investor relations, you might think of investors as that big umbrella investor that you go to for fundraising. Whereas within the tax department, you see investor as someone who signed the sub docs for a specific legal entity. And so for your systems to be able to harmonize all those different definitions, it might be a little bit of a challenge. But the first step I would say is creating that tax data dictionary and saying, here's the data I need. And here's what I mean by it. And I would go in that data dictionary and I would list out the three data pillars of legal entity, investment and investor, and I would categorize the data needs and have them fall under each of those data pillars.

MMG: Interesting. So it's almost kind of knowing your audience. Just because you, as a tax professional, know the definitions of these terms, your colleagues in other departments might not be using them the same way.

Demas: That's right. And you know, some of what we found is when the tax department does create a tax data dictionary, it can resonate within the firm. And often they might ask other departments for their own data dictionary, indicating what they need and what they mean by it. So they can then harmonize all of those data elements and the definitions, and then look at their systems and say, how can we get our systems to produce this for everyone with the least manual intervention before it gets to the ultimate destination.

MMG: To what extent does a firm need to commit new investment to implement some of the things we've been talking about today? Is this the type of undertaking where they're going to need to think about investing in new systems and personnel to make the most out of their tax data? Or is it, like you said earlier, just kind of tweaking existing systems?

Demas: I think it depends on where the organization is on their data journey. And to what extent are they currently leveraging the systems that they're using? So it could very well be an investment, but most likely it's going to be looking at the systems they are currently using and exploring how can they optimize that. A lot of firms have made great investments in great systems. And so how can they get it to produce data for the enterprise and all the downstream users with the least manual intervention possible? So I think it depends.

I think from a personnel standpoint, what I've found to be useful is someone looking at data from a data governance perspective, because it's one thing to collect all of the data needs from tax and maybe from other departments, but then it's another thing to have the sort of governance around it. So your systems are continually harmonized and not just once, but it's going on throughout the life cycle of the organization.

So I think it depends. I would also lean heavily on the providers that you use and bring in people who have done this before. Here at RSM, we have a lot of people, myself included, who have been both a client and a provider. So we've seen both sides and we have that insight. When you are doing tax compliance, we know that's not the only thing going on in your organization or within your tax department. Deals don't stop; the life cycle of data in your organization doesn't stop just because we're doing tax compliance. So we're pretty tuned in to that sensitivity and have an idea for how to help you move that forward.

MMG: That's such a good point because I think it is easy to think about this in a vacuum. But I mean, you're right. This is going on while everything else is also going on.

Demas: Yeah, definitely. I mean, it's one of many things and it can be all consuming, but still, you know, your day job goes on while you're working on a special project. So we're very aware of that. We've built a system called PartnerSight that really helps improve the tax compliance process and shifts everyone's focus from that low value-add, but necessary data manipulation, to more high value-add analytical. And I think that's a theme that sort of cuts across everything. Both when you look at internally, what you could do to optimize your data, and then externally, you want your providers to help you shift that focus as well from low value-add but necessary to high value-add analytical. And we believe that PartnerSight not only does it, but we're excited for other offerings that will come along with PartnerSight in the future.

MMG: That sounds exciting. As we wrap up here, Lauren, are there other insights you'd offer for firms as they go down this path, based on your experience working with private equity?

Demas: I'll tell you from my perspective, it always helped me to know that, especially when I was going through it as a client, that I wasn't the only person going through this; a lot of other firms have similar issues. So for one, it's not an anomaly. If you have tax data issues, just getting to that starting point to do your analysis—I would work your resources, right? So I would talk to your providers. I would talk to your colleagues who may have gone to a different firm and, you know, just your whole circle of advisors out there, and see what's going on in the industry and how people are handling either this generally, or if it's for a specific issue that you might have, people who have gone through this before. So I would work your resources. And then internally I would look at, you know, what is everyone spending time on within the organization from a data perspective and can any of that be systematized? So that it's not a cyclical event that happens.

Podcast originally published by Middle Market Growth.

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