Off-shoring of tax preparation services by U.S. accounting firms: an empirical study.(Report)

OVERVIEW

For purposes of this study, off-shoring is defined as the procurement of services by CPA (certified public accounting) firms outside the United States through electronic media. The term outsourcing in this study refers to procurement of services outside the firm, but inside the U.S. A review of current literature indicates that off-shoring of accounting services has been increasing and will continue to increase in the future. A survey was conducted yielding a sample of thirty-five (achieving a twenty percent response rate from a population of 175) of the top accounting firms in seven major U.S. cities. The authors encountered resistance from several firms in obtaining information because of the sensitive nature of this topic. The most significant finding from the sample data was that an increasing trend in off-shoring was not evident. Thirty-seven percent of the responding firms off-shored only limited amounts of tax return preparation to India, a country that possesses an abundance of English-speaking, trained accountants. In making the off-shoring decision, both cost-savings and non-cost related factors played a role. Almost half of the firms reported a negative impact on the firm from the decision to offshore and most claimed to experience negligible cost-savings. More than half planned to decrease or discontinue off-shoring in the future. The increased disclosure requirements of the American Institute of Certified Public Accountants (AICPA) and various State Boards of Accountancy along with the fear of losing clients may have influenced firms' decisions not to pursue off-shoring more vigorously. In the next phase of research, intermediaries or third-party service providers identified in this study may be contacted to gain more insight into the actual and relative volume of tax work done off-shore and the future direction of off-shoring activity in accounting firms.

INTRODUCTION

Current literature regarding the patterns as well as costs and benefits of U.S. manufacturing firms in subcontracting or outsourcing production and assembly tasks to newly industrialized countries (NICs) and emerging markets such as India and China is rich and abundant as these processes have gained much attention during the past fifty years. Improvements in productivity, cost efficiency, quality, and performance have been among the primary reasons that have encouraged companies to subcontract non-core activities to locations around the globe offering a comparative advantage (Dankbaar, 2007; Slaughter and Soon, 1996). However, externalizing or subcontracting in the services sector to off-shore locations, specifically in the business services sector, has also been growing rapidly in the past two decades. Albeit the lack of reliable national data, various published studies indicate that over a million service-sector jobs in the United States have been sent to off-shore locations to date.

Farrell et al. (2006) report (based on an examination of eight industries) that an estimated eleven percent (11%) of service jobs could be completed remotely in off-shore locations as the specific tasks require "neither substantial local knowledge nor physical or complex interaction between an employee and customers or colleagues" (Farrell et al., 2006, p. 24). Continuous advancements in technology and digitized communications only assure the increase of off-shoring of "impersonal services" or services that can be delivered electronically over long distances with little or no degradation in quality (Blinder, 2006). Published work in academic and trade-related journals, although limited, have focused primarily on identifying the criteria for successful outsourcing (on or off-shore), factors for choosing the right location and vendor, and the taxonomy of operating and strategic processes suitable for externalization (Farrell, 2006; Aron and Singh, 2005; Shamis et al., 2005). However, comprehensive studies at the industry and firm level of the nature and extent of outsourcing and off-shoring of services are rare, with one example being in the hotel sector (Espino-Rodriguez and Robaina, 2005). The results of the hotel sector study indicated that current outsourcing decisions were being decided on cost factors alone. However, any future increases in externalization would have to be determined based on strategic factors, not just cost reduction. The researchers suggested that more research-based studies be completed in other sectors to verify their findings. Therefore, the need for additional inquiries regarding firm strategy and behavior with respect to outsourcing and off-shoring across sectors is warranted.

In the accounting services profession, outsourcing to smaller accounting firms within the same country has been a common phenomenon among national and larger regional firms for decades. However, during the past five years, sending certain routine functions off-shore, such as tax return preparation and compliance work has been reportedly (although with anecdotal evidence) growing (Danziger, 2000; Goldman, 2002; Lombardo, 2003; McCausland, 2004; Mirchandani and Liggett, 2002). This growth has been attributed to the availability of electronic data transfer capability coupled with an abundance of cheaper skilled accounting and English-speaking labor pockets concentrated in countries like India and the Philippines. Friedman (2005) writes about the abundance of college graduates educated in accounting (and in English) in India. According to Friedman: "with the help of high-speed communications, stringent training, and standardized forms, these young Indians can fairly rapidly be converted into basic Western accountants at a fraction of the cost" (Friedman, 2005, p. 14). Indian companies specializing in accounting such as MphasiS, have established working relationships with small and medium-sized CPA firms in the U.S. The process begins with the electronic deposit of scanned documents such as the last year's tax returns and the current year's supporting tax documents on to a computer server in the United States. At the other end, in India, trained accountants access these raw data and complete the tax return directly on the server, without the capability of downloading, printing, or copying any of the confidential client financial information in order to assure protection of privacy (Friedman, 2005).

According to accounting trade journal literature, U.S. CPAs are beginning to off-shore tax compliance work (that does not require personal interaction with clients) not only for cost reductions but also to allow domestic staff to focus on higher-order services requiring personal interaction, such as tax planning and consulting, and to increase the speed of tax return processing by taking advantage of time zone differences (Robertson et al., 2005; Reeves, 2004). It is reported that the number of tax returns electronically prepared off-shore by Indian accountants was expected to increase from 25,000 in 2002 to 200,000 by 2004. One of the leading third-party tax providers has experienced more than 25 percent increase in off-shored services during the 2007 tax season (Wyle, 2007; Breslin, 2007; Gautreau II, 2005; Brody et al., 2004). A study by the Aberdeen Group (2003) predicts a one hundred and fifty percent (150%) growth rate in business process outsourcing (BPO) specifically in tax processing going off-shore within the next five years. According to Blinder (2006), further technological advancements will determine how much accounting work stays onshore and how-much will be delivered electronically from countries offering skilled labor at much lower wages. It is also estimated that not only will there be a significant increase in the off-shoring of tax return preparation, but other accounting services will also follow. The labor shortage within U.S. accounting firms, rising labor costs, and refocusing on higher revenue-generating activities such as advisory services, Sarbanes-Oxley compliance work, and financial consultation are some of the reasons for this increase (ValueNotes, 2006).

Apart from the aforementioned anecdotal evidence and forecasts on the increase in off-shoring, no current research exists showing the extent of, and significant impact, if any, of off-shoring of tax return preparation services from the perspective of U.S. CPA firms. Brody et al. (2006) collected a convenience sample of tax clients to explore their opinions and feelings about their tax returns being prepared off-shore. The authors reported that the majority of the respondents who used a paid-preparer were not even aware that their tax returns may be outsourced to off-shore locations and were not aware that paid preparers were not required to disclose the use of off-shoring. Most respondents appeared to be concerned that their tax returns may be sent overseas. In addition, over eighty percent (80%) of the respondents felt that their privacy was being violated and there was a loss of trust of their paid-preparers if they were not informed about off-shoring. While their findings (because of the sampling methodology) may or may not apply to the larger population, Brody et al. (2006) pointed out another important issue plaguing the accounting profession, i.e., the issue of disclosure or transparency to clients. The unethical behaviors of large public accounting firms contributing to corporate bankruptcies such as Enron and Worldcom have caused loss of public trust in the profession. The authors extended a request to the trade regulatory body (the AICPA) to take stronger steps in requiring accounting firms to disclose the utilization of off-shore service providers for tax return preparation.

Set against this backdrop, the study described in this paper attempts to fill a gap in academic literature in the sector-specific, firm-level research on the use of off-shoring. This inquiry examines the extent of off-shoring of tax compliance and tax return preparation work, the benefits and costs of the process from a firm perspective, and the implications of disclosure requirements to clients.

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