Written by Patrick Brown
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?
Some BPO providers do not pay taxes because the local government where they operate offers exemptions and incentives to support the growth of the BPO industry. Top outsourcing destinations such as the Philippines and India draft tax exemptions beneficial to service providers and outsourcing clients.
For example, with India’s Goods and Services Tax (GST) Council agreeing not to regard BPO firms as “intermediaries,” service providers working with foreign clients no longer need to pay an 18% tax on services. According to Economic Times, this decision helps BPO companies save millions of dollars in taxes.
Outsourcing providers in India were long regarded as intermediaries by tax authorities, so they were required to pay 18% GST. But firms started disputing the tag, claiming they were not brokers but key service providers to foreign clients. So BPO vendors serving foreign clients are now treated as service exporters and no longer need to pay service taxes.
Meanwhile, the Philippine government enacted several laws to support the country’s growing outsourcing industry. BPO would not be the fastest-growing industry in the Philippines without strong support from the national government. It created the Philippine Economic Zone Authority (PEZA) to promote the establishment of economic zones for foreign investments.
Among the laws governing the framework for outsourcing vendors operating under PEZA are:
- Export Development Act (Republic Act No. 7844)
- Special Economic Zones Act (Republic Act No. 7916)
- CREATE Act (and Republic Act No. 11534)
BPO companies operating under PEZA receive tax exemptions and obtain fiscal and non-fiscal incentives. According to the Philippine Department of Finance (DOA), BPO companies have received an average of $467 million in total tax incentives from 2016 to 2019. The following summarizes some of the incentives they receive:
- An Income Tax Holiday (ITH) is when BPO companies are either exempted from paying taxes or have fewer tax obligations. The ITH period was recently updated to last for four years (for firms located in the National Capital Region and metropolitan areas) and six years (for firms in all other areas).
- Tier 1 industries, such as BPO companies, can avail of Special Corporate Income Tax (SCIT) for ten years. They must pay a tax rate equivalent to 5% based on gross income earned in place of all national and local taxes.
- BPO companies also benefit from Enhanced Deductions on taxes for labor expenses, research and production (R&D) expenses, training expenses, domestic input expenses, power expenses, and depreciation allowance of the assets acquired for producing goods and services.
- Importation Incentives or duty exemptions on the import of raw materials, capital equipment, spare parts, and accessories also apply, provided they are used for 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 an underground BPO company:
- 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!
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About The Author
Patrick Brown is the CEO and founder of Unity Communications. He’s a father, U.S. Navy veteran, endurance athlete, and music enthusiast. With an endless supply of childlike curiosity, he’s passionate about helping businesses thrive and succeed in the modern age. His company belongs to the 2021 Forbes Next 1000 and has been placed on the Inc. 5000 list twice in a row.
When not running a business or trying to keep up with his very active daughters, Patrick mixes music in his home studio, spends time cooking with his wife, or travels. His childlike curiosity about the world and his love of dance music keep him young.