Outsourcing Income Tax Returns to India: Legal, Ethical, and Professional Issues

By Richard G. Brody, Mary J. Miller, and Michael J. Rolleri

E-mail Story Print Story

Outsourcing has been seen in various areas of the accounting profession, especially tax preparation. While much of this work is outsourced within the United States, the trend is to outsource to companies that themselves subcontract work—increasingly, to companies abroad, especially India. It is estimated that 25,000 tax returns were completed by accountants in India in 2002 and that almost four times that amount were processed in 2003. Current-year estimates are as high as 200,000 returns.

Outsourcing companies claim to employ individuals who are either Chartered Accountants or Indian Chartered Accountant candidates trained in U.S.-based tax law and tax return preparation. One such company, SurePrep, claims to represent more than 150 U.S. accounting firms, ranging from small local firms to large national firms.

The process of outsourcing personal income tax returns is fairly simple. A CPA firm obtains taxpayer information in the form of a tax organizer or source documents. The firm then scans the information and transmits it via a secure Internet connection to a hosting site. This site is often located in the U.S. in a subcontractor’s secure hosting facility. Client data are accessed by the overseas preparer company, using a secure connection. The overseas accountant then prepares the tax return using the tax preparation software requested by the CPA firm. Review notes and questions are e-mailed to the CPA firm for clarification. Once all questions are answered, the overseas accountant completes the return and has it reviewed internally. The CPA firm then downloads the completed return, reviews it, signs it, and sends it to the client.

Outsourcing Benefits

The major benefit to outsourcing is lower costs. Because the standard of living and the wage base in India are much lower than in the United States, the labor cost for accounting professionals is also much lower. This allows the outsourcing vendor to charge much less for each tax return than a CPA firm would incur itself. One provider, Prosystem FX, structures its price list based on return complexity, which is determined according to the number of source documents provided. The cost ($50–$150 per return) is substantially less than the cost of hiring, paying, and maintaining qualified staff within the CPA firm. This translates into the elimination of seasonal staff and overtime, more productivity from the core staff, movement toward a paperless digital environment, and faster return-preparation turnaround times. Other benefits include improved processes and workflow, and the ability to focus on the tax planning and review process.

Outsourcing Costs

Attractive benefits notwithstanding, the issues that arise from outsourcing deserve careful consideration. First and foremost is the confidentiality of client information. The process of uploading client data to the secure server relies on secure connections and proprietary software. The assumption is that the security for this would be in the hands of the outsourcing vendor, the company with whom the CPA firm has contracted to perform this service, and the hosting facility. The data are then accessed by the firm located in India, input into the tax preparation software, and retained at the secure hosting facility where the return will be uploaded to the CPA firm’s server. Again, all of this is done via the Internet and secure connections.

Many published articles have pointed out that the level of security used in this process far exceeds the level of security in most accounting firms’ back offices. The involvement of multiple companies within this process, however, means that the responsibility for security is both inside and outside of the United States. Were a breach to occur, who would be held responsible? The CPA firm is ultimately responsible to the client. Moreover, outsourcing critics question the promises that outsourcing companies make, believing that companies overstate the security they are able to provide.

Because any breach of security and release of confidential information may result in a lawsuit, CPAs should seek the advice of malpractice insurance providers. CNA, a leading provider of professional liability insurance for accountants, recommends incorporating a disclosure of electronic communication devices into the tax engagement letter:

In the interest of facilitating our services to you, we may communicate by facsimile transmission or by sending electronic mail over the Internet. Such communications may include information that is confidential to you. Our firm employs measures in the use of facsimile machines and computer technology designed to maintain data security. While we will use our best efforts to keep such communications secure in accordance with our obligations under applicable laws and professional standards, we have no control over the unauthorized interception of these communications once they have been sent.

Unfortunately, many CPA firms do not use tax engagement letters for nonattest clients, and do not provide this disclosure. The AICPA Ethics Ruling on Responsibility to Clients (ET section 391) questions-and-answers section addresses outsourcing tax preparation:

A member may use outside services to process tax returns. He must take all necessary precautions to be sure that the use of outside services does not result in the release of confidential information. Further, all preparer responsibilities remain with the CPA who is signing the return regardless of the fact that it may have been prepared by someone external to the firm.

CNA also recommends adding full disclosure of use of subcontractors to the tax engagement letter:

We may use a subcontractor (located outside the U.S.) to assist us in the preparation of your tax returns. The subcontractor has established procedures and controls designed to maintain data security and protect client confidentiality. As the paid preparer of your tax returns, our firm remains responsible for exercising reasonable care in preparing your tax return, and your tax return will by subjected to our firm’s normal quality control procedures.

When documents are scanned and transmitted, and when tax returns are completed, these data are stored electronically off-site from the CPA firm. For many CPA firms, this puts confidential client information (and digital copies of source documents) somewhere other than their own offices. Some firms look upon this as cheap storage, enabling them to return source documents to the clients and reduce the cost of storing paperwork. But what steps are taken to secure this type of data storage? Who is responsible for security, the outsourcing company or the hosting company?

The Gramm-Leach-Bliley Act and related Federal Trade Commission regulations contain restrictions on the disclosure of personal financial information and mandate the disclosure of privacy notices. Because tax preparation was considered “financial products and services,” those who prepare taxes are bound by this legislation, which took the accounting profession by surprise. In 2001, the AICPA published a sample privacy notice for use by its membership to comply with these laws. The section relating to disclosure of information states: “[W]e do not disclose any nonpublic personal information obtained in the course of our practice except as required or permitted by law. Permitted disclosures include, for instance, providing information to our employees and, in limited situations, to unrelated third parties who need to know that information to assist us in providing services to you.” Although this seems to cover outsourcing, CNA recommends disclosure of the use of a subcontractor in the body of the privacy policy given to clients. This may become a legal issue rather than, or in addition to, a moral or professional responsibility issue.

The service provider Xpitax recognizes the relevance of the Gramm-Leach-Bliley Act and recommends that outsourcing be referenced directly or indirectly in a CPA firm’s privacy statement to ensure compliance. Xpitax provides some additional explanation which suggests that such a statement should be sent to all clients indicating that “some returns” are outsourced. These notices may be enough for Xpitax to defend itself against certain criticism with respect to privacy and disclosure issues, but one can still question whether taxpayers will be indifferent to the outsourcing of their tax returns.

One thing that is abundantly clear is that the malpractice insurance industry wants CPA firms to use full disclosure, not just in the engagement letter but also in the privacy notice. Yet in all the promotional literature, the fact that the outsourcing company’s involvement is “transparent” really means that the client won’t know about it. Could this “transparency” be caused by a fear of client opinion if it were found out? Every CPA firm has to answer that question for itself, but an informal sampling of clients at two small CPA firms found responses to be overwhelmingly against anyone allowing access to financial information outside of the firm, let alone outside of the country.

Another concern is whether client information will remain confidential overseas. Outsourcing firms’ literature indicates that all of their preparers are highly educated, trained professionals of the highest integrity. When hiring staff, firms go through great pains to check references and transcripts and perform background checks to minimize the risk of hiring someone who lacks integrity. But CPAs never meet the people in India that do the work. How can one be assured that clients’ names, addresses, Social Security numbers, and financial information are not being sold or used indiscriminately?

Furthermore, one must question the skill level of the individuals preparing the tax returns. How does a U.S. firm know the accountants are truly qualified? Clearly, firms rely on the training process to improve the skills of their junior accountants, but what is not clear is what happens once the return is transmitted overseas. It is interesting to note that SurePrep issues a quasi-disclaimer: “While SurePrep’s accountants will prepare the tax returns, our role is transparent to the process from your clients’ perspective. Your firm is responsible for reviewing and approving the return prior to delivery.”

While limited data are available regarding the success or failure of the outsourcing of tax returns to India, at least one firm has reported problems. Gary Shamis, managing director at the Cleveland, Ohio, CPA firm of SS&G Financial Services, reported that his firm had planned on testing an outsourcing program with 100 tax returns, but stopped after 16 because there were too many problems. “They didn’t get the right answers,” Shamis said. While some may argue that this experience is abnormal, it should certainly bring the issue of quality out in the open. Is the training in India consistent with the training a U.S. tax preparer receives? Do the junior accountants receive enough supervision to develop their expertise?

Although, as stated previously, outsourcing is not limited to tax returns or to the accounting profession, it is interesting to note that, in January 2004, the U.S. Senate passed a law that bars American companies that have received government contract from giving out subcontracts to a source outside of the U.S. The accounting profession may want to consider the spirit of this law when considering the outsourcing issue.

Evaluating the Trade-offs

Not all outsourcing providers are created equal. While some may do an excellent job dealing with issues such as data security and competent accounting personnel, others are less careful. Anyone considering outsourcing should be aware of the services provided, the guarantees offered, and the feedback from previous and current customers.

Clearly, firms that outsource the preparation of income tax returns are likely to achieve significant cost savings. But at what cost? The profession does not need more scandals, and one must wonder why many CPA firms appear to have an unspoken rule that the client does not need to know about outsourcing. Deep down, we know taxpayers entrusting their return with a CPA are likely to respond negatively if their tax returns are prepared in India without their knowledge or consent. This may be another issue where the profession needs to step up to the plate and take a firm position—one that will enhance its reputation, not detract from it.

See Sidebar.