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Delegating business operations to third-party vendors or offshore companies is called business process outsourcing (BPO). Its benefits can be long-term or short-term.
However, it is common for businesses planning to outsource to an offshore firm to have concerns regarding the reliability of their chosen BPO companies. They might also wonder why some BPO companies do not pay taxes and whether this is legal.
This article discusses why some BPO companies do not pay taxes and the implications of this. We also explore the potential risks of working with underground BPO firms.
Why Do Some BPO Companies Not Pay Taxes?
Certain BPO providers find themselves exempt from taxes due to the tax incentives and exemptions offered by the local governments in which they operate. These regional authorities often extend their support to foster the growth of the BPO industry, particularly in prominent outsourcing destinations like the Philippines and India.
For instance, India’s Goods and Services Tax (GST) Council decided not to classify BPO firms as “intermediaries.” This ruling relieves service providers engaged with foreign clients from the obligation to pay an 18% tax on their services. As the Economic Times reported, this move translates into substantial tax savings amounting to millions of dollars for BPO companies.
Historically, Indian outsourcing providers were categorized as intermediaries by tax authorities, subjecting them to 18% GST. However, these firms contested this classification, asserting they were not intermediaries but pivotal service providers to foreign clients. Consequently, BPO vendors serving foreign clients are recognized as service exporters and no longer burdened with service tax payments.
Meanwhile, the Philippine government has implemented a series of legislative measures to bolster the burgeoning outsourcing sector within the country. The Philippine Economic Zone Authority (PEZA) was established to promote the creation of economic zones conducive to foreign investments, underpinning the industry’s rapid growth.
Several key laws govern the regulatory framework for outsourcing vendors operating under PEZA, including the Export Development Act (Republic Act No. 7844), the Special Economic Zones Act (Republic Act No. 7916), and the CREATE Act (Republic Act No. 11534).
BPO companies operating under PEZA jurisdiction enjoy a range of tax exemptions and incentives. According to the Philippine Department of Finance (DOF), these firms received an average of $467 million in total tax incentives between 2016 and 2019. Some of the notable incentives encompass:
- Income Tax Holidays (ITH) grant BPO companies exemption from or reduced tax obligations. The ITH duration has been recently extended to four years (for firms in the National Capital Region and metropolitan areas) and six years (for companies in other regions).
- Special Corporate Income Tax (SCIT) is available to Tier 1 industries, including BPO companies, for a period of ten years. This involves a fixed tax rate of 5% calculated based on gross income, substituting all national and local taxes.
- Enhanced deductions on taxes related to labor expenses, research and development (R&D), training expenses, domestic input costs, power expenses, and depreciation allowances for assets procured for goods and services production.
- Importation incentives and duty exemptions for raw materials, capital equipment, spare parts, and accessories, provided they are employed in registered projects or activities.
Risks of Partnering With Non-compliant BPO Companies
Another reason some BPO companies might not pay taxes is that they are not registered or do not have a license to operate. These companies are called underground BPO companies. They allow work-from-home (WFH) arrangements while paying staff relatively higher compensations, but there is no security of tenure on the part of the workers.
Underground BPO companies are limited to services such as small, specialized roles and virtual receptionists. They cannot handle large-scale call centers, lead generation, or synchronized back-office operations.
Clients do not have guaranteed BPO security when working with non-compliant service providers. Privacy and security are also at risk because they do not follow the right data handling procedures. They also fail to comply with the standards and certifications needed for confidential information, such as:
- Payment Card Industry Data Security Standard (PCI-DSS)
- International Organization for Standardization (ISO) 27001
- General Data Protection Regulation
- Health Insurance Portability and Accountability Act of 1996 (HIPAA)
Below are other risks of working with underground BPO organizations:
- They are not dependable, so service quality suffers.
- Hidden costs in training and software or hardware upgrades, plus additional invoice costs, eat up your budget.
- Information transfer is not comprehensive, which leads to errors.
A company’s private data is exposed without robust data protection policies. One perk of working with a reputable service provider is the availability of information-related services, including data security. Businesses improve the accuracy of their data confidentiality procedures when partnering with a skilled managed service provider.
Regulated BPO firms pay their taxes properly and protect their best interests and yours. Ask what the BPO provider’s certifications and references are. Engaging with a trusted vendor means investing your money in a legal basket.
What Are the Tax Implications of Outsourcing?
Each BPO agreement has different tax implications based on the type of outsourced service you require, the structure of the arrangement, and the nature of the client and supplier. If you operate in the U.S., you can outsource any service that involves the creation of non-physical assets (intangible assets) or the development of software projects.
Companies in the U.S., whether they generate revenue from a foreign firm or in the United States, are obligated to pay a 35% tax. Companies whose gains from other nations do not return to the U.S. are not required to pay U.S. taxes on the matter.
Another implication of outsourcing is cost savings. Since registered BPO companies receive tax incentives and exemptions, they can offer more affordable solutions. You get the job done at a more affordable rate and with high quality.
The Bottom Line
Check references when you plan to enter into an agreement or a relationship with third-party firms. Remember that reputable BPO providers comply with legal duties and properly pay taxes.
If quality solutions are what you are after, refrain from working with underground BPO companies that are no match for licensed outsourcing firms. A reputable BPO vendor always acts in your business’s best interest.
Want to partner with a reliable BPO provider in the Philippines? Give us a call, and let’s connect!
