Experts: Tax Changes Won't Curb Offshoring

Lower salaries are driving IT vendors to open offices overseas.

Analysts and tax experts contend that federal tax-code changes proposed by President Barack Obama last week likely won't meet his goal of persuading IT vendors to curb plans for opening and expanding offshore facilities.

The proposed tax changes, which must be approved by Congress, would affect IT vendors that run various operations overseas by disallowing deductions for various offshore expenses, including payroll, said Alan Appel, a tax attorney at Bryan Cave LLP in New York.

"By denying the [payroll] deduction, the hope is that it will be more expensive to operate offshore and it will give incentives to create jobs in the U.S.," Appel said.

However, Peter Bendor-Samuel, CEO of Everest Group, an outsourcing consultancy in Dallas, noted that the major motivation for IT vendors to move work overseas is the wide gap between salaries in the U.S. and those in many other countries. A job that pays $100,000 in the U.S. may cost only one-sixth that amount in India, Bendor-Samuel said.

Siddharth Pai, a partner at outsourcing consultancy Technology Partners International in Houston, said that IT vendors also establish software and services operations in countries like India because it's easier to find talented technical workers in sufficient numbers there. He added that India has a young population, where as the U.S.'s is older -- demographics that work in India's favor when companies are debating whether to expand overseas operations.

"If there is a tax consequence, it's de minimis to the overall impact" of outsourcing, Bendor-Samuel said. In any case, "this idea that people are doing outsourcing to avoid taxes is simply wrong."

Obama didn't address the wage gap in announcing the tax proposal, but he argued that the tax code has played a role in the growth of offshoring, including the outsourcing of jobs for highly skilled professionals.

In his remarks, he said that major Indian IT outsourcing center Bangalore has been a strong beneficiary of current U.S. tax laws. The U.S. has developed "a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, N.Y.," Obama said. Current tax laws give companies that create jobs overseas the ability to take deductions on expenses "when they do not pay any American taxes on their profits," he added.

Several top U.S. IT vendors, including Cisco, Dell, IBM, Hewlett-Packard and Microsoft, run software development and services subsidiaries in India.

The proposed tax-code change is about as close as the White House has come to addressing the controversial issue of IT offshoring. In fact, the administration has yet to address the H-1B visa program, which is heavily used by Indian outsourcers to bring foreign workers to the U.S. Experts say it's unknown how or whether Obama will tackle that issue.

Sang Kim, a partner in the international tax practice in the East Palo Alto, Calif., office of law firm DLA Piper, said that if anything, the tax code changes could have unintended consequences that could accelerate the flow of jobs overseas. A foreign country could, for instance, encourage U.S. companies to create jobs by offering subsidies that would mitigate the impact of changes to the U.S. tax code, he said.

"The argument is that it should stem the flow of jobs leaving the U.S., but the reality is I don't think the jobs are moving outside the U.S. because of tax policy," Kim said.

Meanwhile, India's National Association of Software and Service Companies responded responded to Obama's proposal by contending that U.S. businesses with global operations would have a harder time competing with their European and Japanese counterparts as a result of the tax changes.

John Ribeiro of the IDG News Service contributed to this story.

Copyright © 2009 IDG Communications, Inc.

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