Philippines: Outsourcing in the Philippines

Outsourcing is either a dirty word or the holy grail, depending on which side of the debate you’re on.

It’s one of the hottest of the hot button economic issues this political season in the United States, with John Kerry declaring companies who outsource as "modern day Benedict Arnolds". There is legislation pending in several US States prohibiting outsourcing of state government contracts.

Economists on the other side say it is an inevitable result of globalization: business will go where wages are cheapest and quality is comparable. In the long run, the US will benefit, since more spending power by Indian and Philippine middle-class workers will unavoidably result in more business for American companies. Studies from the World Bank also indicate the potential upside by way of reduced costs is huge: an estimated US $ 138 million for the US banking sector alone. A recent report by the McKinsey Global Institute backs the outsourcing strategy. For every dollar of work moved offshore, the US economy gets back $1.12 to $1.14 in income, says the institute.

Outsourcing right now has no standard legal definition. It can be defined as the transfer of a commercial function to an outside service provider, subject to the customer's retained authority and responsibility to third parties and shareholders for continued success of the customer organization. This normally involves long-term contracts. Virtually any long-term service contract is outsourcing, to some degree. This is distinguished from projects, or "contracting out."

Outsourcing has been here for quite some time. In the 1960’s, the outsourcing model was successfully used by American car manufacturers to be more competitive with Japan. Instead of manufacturing all of a car’s parts, Ford or GM would source non-vital parts, say carburetors, from specialty sub-contractors. They were then free to concentrate on marketing and distribution. Back then, it was accepted as just another business tactic.

The IT boom in the late 1990’s spawned the latest version of outsourcing. Because of the Internet, distance was no longer that much of a factor. By then companies started to look offshore, specifically India and the Philippines, to leverage the local workforce’s low-cost wages with the high proficiency in English. Offshore outsourcing, or the outsourcing as we know it, was born.

Now, it seems there are no limits to what can be outsourced. In the mid 1990’s AOL started a tech support facility in a former US Military base in northern Philippines. Dell and AIG soon followed. Dell set up a call center hotline to help new PC buyers in the West Coast with their questions. AIG also invested in a call center for telemarketing.

Other activities which have been outsourced are customer service, computer programming, bill processing, legal research, income tax preparation, accounting, mortgage processing, medical transcription and X-ray interpretation.

The Philippines is one of the top ten outsourcing destinations in the world, according to a recent study by consulting firm AT Kearney. It has a large, college-level workforce with good English capabilities. In spoken English, Filipinos fare better than Indians, as they need no accent neutralization training to be able to talk with English –speakers from Western countries.

Acccording to the CEO of DAKSH eServices, a business process outsourcing (BPO) company with over 6,000 employees, the Philippines is second only to India when it comes to attractiveness. Sanjeev Agarwal says "The Philippines is one of the two most preferred outsourcing destinations due to its skilled, educated and highly trainable manpower. The country boasts of 35 million skilled workers, 3,80,000 graduates annually and a literacy rate as high as 94 per cent. It also has the largest population of US GAAP-certified professionals outside of the US, therefore offering tremendous potential for outsourcing of financial services."

The Philippine Government recognizes the huge economic benefits of foreign investment in the outsourcing industry. It has cooperated with the private sector in setting up an investor-friendly regulatory climate, offering fiscal, tax, and other incentives.

Outsourcing in the Philippines is classified as an Information and Communications Technology (ICT)- or Information Technology (IT)-enabled service sector. The local outsourcing industry is divided into five sub-sectors, namely: (1) contact centers; (2) business process outsourcing (i.e., shared financial and accounting services); (3) software developments services; (4) animation; and, (5) medical transcription.

Incentives available to outsourcing companies doing business in the Philippines largely depend on the specific regime under which such companies are registered. Thus, an outsourcing company may choose to avail of incentives under (1) the Omnibus Investment Code by registering with the Board of Investments (BOI) or (2) the Special Economic Zone Act and the "Guidelines on the Registration of Information Technology Enterprises and Operation of IT Parks and Buildings" by registering with the Philippine Economic Zone Authority (PEZA) as an Information Technology Enterprise.

The main difference between the two regimes is that a PEZA registration involves physically setting up operations inside a PEZA IT Park or Building. On the other hand, a BOI registration is not limited to a specific area or building. A company can locate anywhere in the country. Companies should carefully study these factors and how they impact on overall profitability.

Under the Omnibus Investments Code of 1987, an investor in the preferred areas of investment enumerated in the Investment Priorities Plan (IPP) is entitled to certain benefits and incentives.

Outsourcing is designated as a priority investment area. The 2003 IPP lists Information and Communications Technology (ICT) as a priority investment area that covers the following: (1) ICT services; (2) ICT-enabled services; and (3) ICT support activities.

The 2003 IPP Guidelines further describes ICT-enabled services as business process outsourcing (BPO). BPO "refers to business lines that can be transformed and delivered through the means of ICT infrastructure" and includes: "customer contact centers, engineering and design, animation and content creation, distance learning, market research, travel services, finance and accounting services, human resource services and other administrative services (e.g., purchasing)."

Foreign corporations can set up a 100% owned branch or subsidiary in the Philippines.

For foreign entities more than 40% foreign-owned, at least 70% of total services rendered must be exported.  The entity may be registered as an export IT enterprise and can have paid-up capital of at least US$2,000,000.

Under the latest guidelines issued by the BOI, all registered enterprises engaged in the eligible ICT-related projects shall be entitled to the following incentives:

• A bonus year may be granted in each of the following cases: (1) the ratio of total imported and domestic capital equipment to the number of workers for the project does not exceed US$10,000 to one (1) worker; or (2) the net foreign exchange savings or earnings amount to at least US$500,000 annually during the first three (3) years of operation.
• If registered projects are located in a less developed area as identified in the IPP, the firm shall be granted pioneer incentives, i.e., an Income Tax Holiday for six (6) years

If an outsourcing company decides to locate inside a PEZA IT Economic Zone, it can avail of a host of tax and other incentives.Any outsourcing enterprise engaged in certain IT related activities can locate inside a PEZA Zone. The activities include the following:

• Software development and application, including programming and adaptation of system softwares and middlewares, for business, media, e-commerce, education, entertainment, etc.;
• IT-enabled services, encompassing call centers, data encoding, transcribing and processing, directories, etc.;
• Content development for multi-media or internet purposes;
• Knowledge-based and computer-enabled support services, including engineering and architectural design services, consultancies, etc.;
• Business process out-sourcing using e-commerce;
• IT research and development; and
• Other IT related service activities, as may be identified and approved by the PEZA Board.

Under the latest guidelines issued by the PEZA, a registered IT or ICT enterprise shall avail of the following incentives:

• Income Tax Holiday (ITH) for four (4) years for Non-Pioneer IT Enterprises, or six (6) years for Pioneer IT Enterprises;
• After the ITH period, the perpetual option to pay a special 5% tax on gross income earned, in lieu of all national and local taxes, except real property taxes on land owned by developers;
• Exemption from payment of import duties and taxes on imported machinery and equipment and raw materials;
• Additional deduction equivalent to 50% of training expenses, chargeable against the 3% share of the national government in the special 5% tax on gross income;
• Permanent resident status for foreign investors with initial investments of US$ 150,000.00 or more;
• Employment of non-resident aliens required in the operation of IT Enterprises; and
• Other incentives, as may be determined by the PEZA Board.

Whether you are for it or against it, the reality of outsourcing is hard to disregard. The theory is very simple: it can be an opportunity for a business to cut its costs in an area by up to 50% while maintaining the quality of the work. Businesses should therefore take a long, hard look at this phenomenon to offer their customers and shareholders increased value while remaining competitive in the global environment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.