A 2009 study of American chief financial officers in the high-tech industry predicted there will be a decline in offshoring in 2009. The new hot location: the United States.
The study, entitled “The BDO Seidman 2009 Technology Outlook,” found 22 percent of U.S. executives planned to outsource work to companies that would perform the work in the United States. Sixteen percent said they were going to send their work to China while 13 percent selected India. “This is the first time in many years the United States led India and China as an outsourcing destination,” says Don Jones, international tax partner at BDO Seidman, LLP.
For example, Jones says one of his firm’s clients is moving its manufacturing from China. It is currently deciding on a location either in Michigan or Tennessee.
Less than half the CFOs (42 percent) indicate they have operations outside the United States, compared to nearly double that (79 percent) last year.
The global economic slowdown is the chief reason for the switch, posits Jones. “Today’s CFOs are very cash conscious. Everybody is hoarding cash. They feel liquidity is crucial.” He says they don’t want to invest in future outsourcing projects — especially in manufacturing or research and development — because of the costs required to ramp up offshore. “In the short term, keeping work at home requires less cash outlay,” he explains.
For example, supply chain and shipping costs are much higher to China than the Midwest.
The cost of doing business offshore is “getting higher and higher”
Other concerns support this decision. He says some CFOs reported they were concerned about sending work to India because of the Satyam fraud and the Mumbai attacks. Jones says some view India “as an increased risk.” Nearly one-third (29 percent) said their primary concern about offshoring was an uncertain business and political climate.
The second concern about India is the cost differential. Rising wages and infrastructure costs combined with a strong rupee have eaten away at the labor arbitrage. “It isn’t as great as it used to be,” he says. Add that to the risk factor and suddenly the United States looks like a viable alternative. “Companies are rethinking India because it’s costing more to send work there and they now perceive it as a more dangerous place,” he continues.
Third, Jones says China and India are now making it more difficult for foreigners to do business there from a tax perspective. In 2008 India’s annual budget decreased tax incentives for high-tech companies and increased to 12.3 percent a tax on businesses that provide services.
In addition, Jones reports “the tax authorities are becoming far more aggressive in taxing U.S. parents of Indian subsidiaries.” He says this particular tax ranged from 10-12 percent until last year when the government jumped the tax bite to 20-25 percent. “That’s a dramatic increase,” he points out.
In addition, Jones says the taxing authorities “are becoming more sophisticated” in finding ways to capture incomes from foreign companies in their jurisdictions. He cites the Vodaphone case. In early spring 2008 Vodafone PLC, a Dutch company, acquired CGP Ltd, a Cayman Islands company. The Cayman company owned a subsidiary in India. The Central Board of Direct Taxes in India issued a show-cause notice to Vodaphone saying it had to pay capital gains taxes that the seller typically incurs. In essence, the taxing authority asserted the gain on the disposition of shares of a non-resident company to another non-resident company is taxable in India.
The tax rate is 22 percent, which gives Vodaphone a $2.44 billion tax bill. Add on a 100 percent penalty, and the potential liability is $4.88 billion. Then add interest. “This is contrary to logic when taxing capital gains,” says the tax partner. “What is this stance going to do for foreigners making investments in India?” he asks rhetorically.
The study found about a quarter (26 percent) of the respondents say tax regulations are giving them pause about sending work offshore. Jones says the CFOs surveyed were “collectively shaking their heads because the Indian government is making it difficult to do business there.”
As for China, shipping rates have increased significantly in the last 10 years, Jones points out.
The bottom line: “Overall, the cost of doing business in India and China is getting higher and higher. It used to be a no-brainer to outsource to India. Now it’s becoming too expensive and too complicated,” says Jones.
Sixty-two percent of CFOs say their companies currently outsource services or manufacturing. The most common non-U.S. locations are India (50 percent), Southeast Asia (31 percent, down from 50 percent in 2008), China (19 percent, down from 26 percent in 2008), and Western Europe (19 percent).
Lessons from the Outsourcing Journal:
- The current economic downturn is causing companies to conserve cash. One result: they are considering sending new outsourcing projects to low-cost U.S. destinations rather than offshoring.
- A BDO Seidman study found India has some challenges as an offshore location because of the rising rupee, more expensive infrastructure, and higher wages. All affect the labor arbitrage gain.
- Recent Indian taxing decisions on non-resident corporations are making it more expensive and difficult to business there.
How the study was done: BDO Seidman hired a third party to interview CFOs in the U.S. high-tech industry, encompassing telecommunications, hardware, Internet, IT services, and software firms. 2009 is the second year of the survey, which explores the topics of industry growth, challenges, M&A activity, executive compensation, security, accounting, international operations, and outsourcing issues in the U.S. technology industry.