Against the Tide: The Hidden Costs of Offshoring
Jo Ann M. Pinto
2005 -Advances in technology have meant that many of
the services once performed as personal professional services,
including tax preparation, can now be electronically exported
via the Internet to lower-cost workers in emerging-market
countries. According to Forrester Research, 3.3 million professional
positions, mostly in information technology and financial
services, will move offshore by 2015.
An Offshoring Primer
To its proponents, offshoring offers tangible benefits:
Routine, labor-intensive tasks can be performed at a much
lower cost in developing countries. U.S. manufacturers began
relocating production facilities to low-wage countries decades
ago, but until recently, white-collar workers were relatively
insulated from the quest to reduce labor costs. The Internet
has paved the way for the export of professional services
to lower-cost environments. India is an especially appealing
location because of its relatively well educated and English-speaking
workforce, favorable cost structure, and a time difference
that allows workflows to continue around the clock. Advocates
of offshoring claim that the overall demand for U.S. goods
and services will increase with the rising incomes of consumers
in developing countries. Proponents also contend that highly
skilled tasks, such as analyzing reports and rendering consulting
services, will continue to be performed by domestic workers.
While the largest accounting firms have always maintained
overseas offices to service multinational clients, recent
reports in the financial press suggest that firms of all
sizes now offshore tax-preparation services to processing
centers in India. In many cases this fact is not shared
with the client; nor does it necessarily translate into
a lower fee for tax services rendered. Firms engaged in
this practice have a U.S. partner review the return and
provide the tax-planning advice.
According to the New York Times, an estimated
100,000 returns were prepared overseas during the 2004 filing
season. While this is a tiny slice of the overall market
for tax-preparation services, the number was virtually nonexistent
just three years ago.
Are Clients’ Best Interests Served?
As someone who has engaged in tax-preparation services,
I know that there is simply no substitute for face-to-face
contact with the client. Important, tax-saving information
can be transmitted between the client and tax preparer during
a live interview. I recall the following incident from a
tax season years ago: While completing the return of an
elderly widow, I asked her in passing what she did in her
spare time. She laughed and said she had little spare time
because, in addition to holding down a part-time job, she
kept house for her son, daughter-in-law, and three grandchildren
(who lived in her home). The new information she disclosed
changed her filing status from single to head-of-household.
Aside from meeting the other requirements, her unmarried
granddaughter was a “qualifying person” for
purposes of determining head-of-household status. Not only
was I able to use this information for the current year,
I filed amended returns for the prior three years, reaping
her several thousand dollars in tax refunds.
That anecdote, only one of dozens I could recount, highlights
how live tax interviews can provide real added value to
Is There a Substitute for Experience?
To exercise appropriate due diligence, tax preparers must
be able to extract from their clients relevant information
solicited in plain language. For example, it is imperative
for tax preparers to understand what constitutes ordinary
and necessary expenses for a wide range of businesses; someone
unfamiliar with American culture may be unable to make the
distinction. A well-seasoned tax professional combines extensive
knowledge of the tax code, well-honed interpersonal skills,
and good business sense.
One acquires such skills from years of professional experience.
An accountant cannot review a return or provide tax-planning
advice without the experience of having personally prepared
hundreds if not thousands of returns. In the academic literature,
practical experience translates into procedural
knowledge, which stands in contrast to declarative
or book knowledge. Numerous studies, supplemented by common
sense, indicate that even the brightest accounting students
leave college with little or no procedural knowledge.
Exporting the base of the professional pyramid deprives
future generations of the opportunity to acquire the knowledge
and skills that will allow them to advance. Furthermore,
information flows work best when preparers, reviewers, partners,
and clients all have live contact with one another.
Data Security Issues
Many clients may be disturbed to find out that their return
is outsourced to an overseas processing center. The prospect
of fomenting client ill will is why firms engaged in this
activity may be reluctant to disclose it. Although Internet
usage has grown exponentially, a March 2004 report by the
Conference Board suggests that many individuals do not feel
comfortable transmitting confidential personal and financial
information over the World Wide Web. Fully 57% of households
surveyed with online access choose not to file their tax
return electronically, citing concerns with data security.
Outsourcing intermediaries, including Datamatix, SurePrep,
and Outsource Partners International, contend that their
Indian-based operations adhere to strict security measures
in order to protect the integrity and privacy of client
data. For example, Sureprep’s Indian employees are
required to sign nondisclosure/confidentiality agreements.
Data are encrypted during transfers to ensure their integrity.
Additionally, access to data-processing centers is restricted
by biometric palm scanners that verify employee identification.
Other security measures include scanning source documents
in the United States before they are transmitted, and printing
the returns stateside in order to maintain a paperless environment
CPAs that outsource tax-preparation engagements to a third
party must be careful not to violate standards and regulations
promulgated by both the AICPA and the IRS. Under the AICPA
Code of Professional Conduct, Rule 301, Computer Processing
of Client Returns, accountants “must take all necessary
precautions to be sure the use of outside services does
not result in the release of confidential information.”
In the event that a breach of this duty occurs, the CPA,
not the outsourcer, is ultimately liable to the client.
At its January 22, 2004, meeting, the AICPA’s Professional
Ethics Committee established a task force to examine whether
the AICPA needs to update its rules on outsourcing to incorporate
contemporary developments in this area. The AICPA’s
decision to revisit the ethical considerations of outsourcing
was prompted in part because current regulations do not
specifically address the issue of employing offshore entities.
In addition, the IRS has rules regarding safeguarding the
integrity of client information. Specifically, IRC section
7216 “prohibits anyone who is involved in the preparation
of tax returns from knowingly or recklessly disclosing or
using the tax-related information provided other than in
connection with the preparation of such returns.”
IRC section 7216 allows the sharing of client data with
an outside vendor as long as the information is used for
the express purpose of preparing that individual’s
tax return. Preparers that violate these rules could face
fines or imprisonment.
From the perspective of both the AICPA and the IRS, the
U.S. CPA or tax preparer will be sanctioned if client data
leaks out to unauthorized parties. The outsourcing firms
mentioned above contend that they employ Indian Chartered
Accountants, who face licensing requirements similar to
those of U.S. CPAs. Mediating international disputes about
ethics violations may be difficult, however, because different
governing bodies license and regulate the practice of accounting.
Liability questions. In addition
to ethical issues, individuals and firms that use offshoring
must evaluate whether their professional liability insurance
will remain in force if they outsource tax preparation to
a foreign operation. Val McDonald, an underwriter with Target
Insurance Services in Avon, Connecticut, which provides
errors-and-omissions coverage for tax preparation, said
she would not feel comfortable with the practice and suspects
that some firms are not disclosing this practice to insurers.
In her words, she “would look at a firm very differently”
if they were engaged in this practice. McDonald, an experienced
underwriter whose product is endorsed by the National Society
of Tax Professionals, stresses that when she writes a policy
she is insuring a known entity—that is, a U.S.-based
Potential Political Backlash
Many outsourcing decisions are motivated by the desire
to decrease costs; however, these decisions may lead to
declining customer satisfaction due to a perceived drop
in quality, the fear of identity theft, lack of fee savings,
and concerns about the exportation of U.S. jobs.
Predictably, the debate over the efficacy of offshoring
has spilled over into the political arena. It is estimated
that 250,000 to 500,000 U.S. positions have been eliminated
during the past three years due to overseas outsourcing.
Although these dislocations may be temporarily painful,
supporters of free trade contend that offshoring is just
the next, natural step in the evolution of global commerce.
Opponents view the exportation of white-collar jobs as tantamount
to economic treason.
Daniel W. Drezner, writing in Foreign Affairs,
points out that the economic benefits of offshoring, which
in his opinion are very real, are relatively diffuse, while
the costs from job losses are relatively concentrated within
a few sectors of the economy. A taxpayer’s sensitivity
to this issue may be influenced by the extent that either
clients or their friends or family members have been victimized
by overseas outsourcing.
Are the Cost Savings Real?
According to a case study prepared by Outsource Partners
International, it costs a typical regional U.S. CPA firm
$255 to prepare an average individual tax return. Meanwhile,
outsourcing intermediaries such as Xpitax charge between
$75 and $110 to prepare a tax return in India. These numbers
translate into a savings of 57% to 71% per return processed.
The promised cost savings may not materialize, however,
due to several factors. First, the estimated labor savings
may be predicated on unrealistic assumptions about the time
required for U.S. employees to complete tax preparation
work, employee productivity, and labor rates. Second, setting
up and coordinating work that is done half a world away
entails new costs. Third, monitoring quality control at
a remote location may be difficult. Finally, while Indian
accountants currently command wages that are a fraction
of those paid to their U.S. counterparts, wages will eventually
rise if the demand for competent professionals outstrips
The offshoring of tax preparation was not even envisioned
a decade ago and remained a novelty just three years ago.
How widespread this practice will eventually become remains
to be seen. The accounting profession has always adapted
to change, and in the past 20 years it has benefited enormously
from advances in information technology. Will this latest
innovation enhance the value of accounting services and
perhaps increase their affordability? Or will offshoring
produce deep structural changes within the profession, reducing
employment opportunities for U.S. accountants? Only time
Jo Ann M. Pinto, PhD, CPA, is an associate
professor of accounting at Montclair State University, Upper