Will Outsourcing Stay Close To Home?

Monday, November 02, 2009

Will Outsourcing Stay Close To Home?

Obama's stance is supported further by recent U.S. international tax reforms proposed by the administration. The reforms, if passed, would have the effect of eliminating or significantly reducing tax benefits of offshore planning structures currently enjoyed by many U.S.-based multinational corporations

By Don Jones, BDO Seidman

The calls for domesticating outsourced labor have increased in recent years. In fact, many predict that now is the time when we begin to see U.S. companies bring their IT and business process outsourcing functions closer to home. Proponents identify several recent shifts in the economic and political landscapes that support this viewpoint.

The first factor is the recent layoffs in the technology and financial services sectors in the U.S. resulting from the downturn in the economy. There are significantly more people on the market as a result of these layoffs. It is expected that increased capacity for skilled talent will enable U.S. companies to tap into the U.S. labor market much more easily than in the past. Downward pressure on wages as a result of this dynamic will contribute to the attractiveness of the U.S. as an outsourcing destination.

It is worth noting that critics of this view point to the fact that certain skill sets needed for jobs currently outsourced outside the U.S. are not aligned with the talent pool within the U.S. Retooling of the talent pool will be necessary, which would need to start with revamping university curriculums and trade school programs. The degree to which the surge in capacity in the U.S. labor market will translate into a decrease in the cost of labor disparity with outsourcing destinations outside the U.S., however, remains to be seen.

Second, few people doubt that President Obama’s stance on keeping jobs in the US will be among the highest priorities on his administration’s agenda. This may result in some rather lucrative government incentives available for U.S. companies. One incentive that Obama promises to companies operating in the U.S. is the extension of the research and development tax credit. This credit is available to companies for research and development activities that are performed in the U.S. and can amount to as much as a two to three percentage point reduction in the company’s federal income tax rate. States such as California allow a research and development credit as well.

Obama’s stance is supported further by recent U.S. international tax reforms proposed by the administration. The reforms, if passed, would have the effect of eliminating or significantly reducing tax benefits of offshore planning structures currently enjoyed by many U.S.-based multinational corporations. For instance, U.S. multinational companies currently enjoy the benefits of having the majority of their income taxed outside the U.S. by shifting functions such as IT outsourcing, research and development and call centers outside the U.S. Obama plans to significantly erode these structures by taxing more of this income that has been moved offshore.

Finally, the rising costs of implementing and maintaining outsourcing relationships in geographically distant jurisdictions will cause business leaders to rethink their outsourcing strategies. Leaders of high technology companies have held that certain countries, such as India and China, historically were regarded as favorable countries to outsource skilled services such as manufacturing, IT, programming, R&D, distribution and call centers. The declining strength of the dollar, rising wages, labor turnover and bottlenecks in urban infrastructure no doubt will aggravate existing outsourcing arrangements.

Maturing tax laws and the increased aggressiveness of foreign tax authorities’ audit practices are additional factors contributing to the higher cost of outsourcing business functions overseas. For instance, recent legislation passed in India had a deep impact on U.S. technology companies operating in India. The provisions most likely to impact U.S. high technology companies are:
India will now tax gains on share transfers of offshore companies. The tax will be retroactive to transactions entered into from June, 2002, subjecting many prior year cross border transactions to Indian tax. This comes in the wake of the Indian Department of Revenue’s realization that it could collect millions of rupees in tax revenue from these transactions.

The new laws have not extended the tax holiday for units registered under the Software Technology Parks and Export Oriented Units regulations. As a result, high technology companies saw their tax holidays in India expire on March 31, 2009.

The short-term capital gains rate has been increased from 10% to 15%.

Packaged software will now be subject to the same 12% excise tax that has historically been assessed on customized software. It was previously taxed at 8%.

The new laws added a wider array of services subject to the 12.36% Service Tax.

The two main additional services impacting the high technology industry are services relating to information technology software for use in the course or furtherance of business or commerce, and Internet telecommunications services. This includes services provided in relation to Internet backbone services, carrier services, Internet traffic services, telecommunications services and access services.

The tax return filing deadline has been shortened. The due date was moved from October 31 to September 30.

As problems mount with the costs of maintaining foreign outsourcing arrangements, more U.S. multinational companies are testing ways to house these activities in the U.S. for the lowest possible cost. Factors such as flexible work environments, home office arrangements and the ongoing elimination of language and cultural barriers are promising attributes for retaining functions in the U.S. that were previously performed offshore. U.S. multinationals are increasingly seeing the benefits of low labor costs offshore outweighed by poor customer service, which may make retaining functions like IT and call centers in the U.S. more attractive in the long run.

Despite the fact that many believe we will see an increase of outsourcing IT and BPO functions to the U.S., there are still many attractive reasons to consider outsourcing these functions offshore. It is generally easier to find the appropriate talent in the major offshore jurisdictions. For example, China and India alone produce more than 10 times the engineering graduates per year than the U.S. does. Proponents of outsourcing offshore point out that the labor disparity is still wide enough to compensate for the shortfalls discussed above.

In the long run, the shifting global economy will probably dictate where these functions are performed. As business becomes more global and as emerging markets mature, the disparity of outsourcing destinations might eventually shrink enough not to matter.

Don Jones is a Partner in the Technology Practice of BDO Seidman, LLP, a national accounting firm providing assurance, tax, financial advisory and consulting services.

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