The Tax Man vs. Hedonists

Liquid Engines Inc. can't do much about death, but corporate taxes are another matter.
John P. Mello Jr.August 26, 2003

At a time when technology start-ups are rare and technological innovation even rarer, this Sunnyvale, Calif.-based company plans to launch an entire suite of products designed to help companies manage financial performance. The first product, out later this month, is tax-planning software that can, Liquid Engines claims, fully analyze in 5 to 10 minutes the kinds of mind-numbing tax situations that typically keep teams of consultants busy for weeks — situations involving perhaps scores of business units operating across dozens of states, each with hundreds of unique tax regulations.

Relying on a powerful econometric modeling technique called hedonics, the software can cope with any number of financial constraints and variables and zero in on the optimal solution to virtually any corporate tax-planning problem, claims CEO Joe Fantuzzi.

Hedonics, which originated in the 1950s, is a technique that is now closely associated with Stanford Graduate School of Business. Derived from hedon, the Greek word for pleasure, hedonics has proven itself to be a powerful tool for analyzing prices and consumer choice in such markets as housing and personal computers, where many qualitative factors contribute, each with a different weight, to the perceived value of products. The price of a house, for instance, may reflect its distance from a train station, the quality of nearby schools, its age, and neighborhood demographics.

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So Liquid Engines’s software assigns weights to the many financial conditions and outside business factors, some of them not easily quantified, that affect taxes and cash flows. The technical challenge has been to encode the matrix-intensive hedonics algorithm in software that rapidly finds optimum solutions. The company has been helped by two Nobel laureates from Stanford: Liquid Engines board member A. Michael Spence and technical adviser Myron Scholes, known best for his work on the Black-Scholes options-pricing model.

If the software works as advertised, it could appeal strongly to finance executives who have struggled to grasp the full tax implications of, for example, a merger between two companies made up of, say, 100 or more legal entities each. It could also help with the tax questions raised when restructuring a single enterprise’s far-flung operations, such as, “Where is the best place to locate this new factory, and which of our 147 business units should own it?” Complexity aside, many tax rates are up, according to tax software and research firm Vertex Inc., which may motivate companies to fight back with technology.

“Many times the answers to these problems are counterintuitive,” says Thomas McCarthy, a partner at Grant McCarthy Gagnon LLC, a tax consultancy and early Liquid Engines customer. Because it’s generally too costly to hire the experts needed to evaluate the tax considerations of more than two or three possible scenarios, executives have relied on rough, back-of-the-envelope calculations and intuition. Says McCarthy: “The corporate tax guys have been the tail that is wagging the dog.”

Those What-If Scenarios

Fantuzzi says Liquid Engines changes all this by giving planners a highly interactive exploratory tool. Using any standard Web browser, he explains, they can analyze and compare different “what-if” scenarios almost as fast as they think them up. The program, he says, can work toward virtually any objective, not solely the minimization of overall tax payments. To avoid extra scrutiny in a certain state, for instance, a company may have the program limit the reduction in tax payments there to no more than 20 percent year-to-year.

While several big accounting firms have built sophisticated tax-related software — Deloitte & Touche offers a package called CorpTax, for example — their focus has been largely on compliance or pulling together data to prepare tax returns. Other venture-backed start-ups, such as Sabrix Inc. and Axentis LLC, address compliance, too, with special emphasis on the Sarbanes-Oxley Act of 2002. With a dedicated repository of historical tax and financial data extracted from customers’ main enterprise apps, Liquid Engines’s software can also, the company says, help with compliance and visibility.

But the big payback, Fantuzzi says, will be in managing and optimizing financial performance. In the coming months, the software will be extended with facilities for analyzing and optimizing cash flows as well as debt and equity structures across global jurisdictions. The software will take into account varying tax laws as well as currency and interest fluctuations, international customs and treaties, and differing accounting principles.