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Withholding tax on BPO services

The business-process outsourcing (BPO) industry is regarded as one of the fastest-
growing industries in the Philippines. The demand for outsourcing services is reaching
new heights, with the call-center services, finance and accounting, human resource and
even legal outsourcing taking up the biggest portions of the pie.

There has also been an emerging shift from cost-effectiveness (call centers) to skills
quality and competence (finance and accounting, etc.), which strengthens the
Philippines position as a global leader in the BPO industry.

The recent growth in the BPO industry has been characterized not by traditional call
centers but by more skilled and technical outsourcing. Although call centers still form the
largest part of the BPO sector, the Philippines has begun boosting its technically skilled
talent pool, including lawyers and its professionals in accounting and finance. To
achieve and sustain this rapid growth, the Philippine government has taken concrete
steps in ensuring that the industry is protected by airtight tax rules.

On April 8, 2008, the Bureau of Internal Revenue (BIR) issued BIR Ruling DA-219-2008
to clarify the applicable withholding-tax rate on various services offered by BPOs.
Generally, for this ruling to apply, the BPO must be characterized by the following
corporate background:

a. It performs activities which are not directly related to the business of its clients;

b. Its assigned staff are selected, hired and terminated by the BPO and not by their
clients;

c. Salaries and other benefits are also drawn directly from the BPO and not from its
clients; and
d. The BPO carries on an independent business and undertakes the performance of its
contract according to its own manner and method, free from the control and supervision
of its clients.

The outsourcing activities covered by the ruling are: (a) bookkeeping; (b) internal audit;
(c) payroll processing; (d) HR benefit administration; (e) data processing; and (f) staff
outsourcing.

The BIR ruled that bookkeeping services are expressly subject to 10- percent or 15-
percent corporate withholding tax (CWT) on professionals.

On its internal audit services, BPOs provide advice or guidance to clients to ensure that
their processes comply with established procedures relating to accounting-related
transactions. For such services, a BPOs internal audit service may be considered as
management and technical consultancy services which are likewise subject to a 10-
percent or 15-percent CWT on professionals; 15 percent if the gross income for the
current year exceeds P720,000 and 10 percent if otherwise.

On the other hand, there is a different tax treatment for payroll processing, HR benefit
administration, data processing and staff outsourcing services. They qualify under the
category of contractual services. Thus, a BPO that provides these kinds of services may
be classified under the category of a service contractor. Income payments for such
services are subject to the 2-percent CWT.

With the accelerating growth of the global offshore outsourcing market, the foregoing
BIR ruling on BPOs is timely and instructive. Investors will no longer be in a quandary as
to how they should be classified for tax purposes. This would then bring better business
outlooks and prevent unnecessary tax assessments in the future.

With this, the government and the investors may just focus on toiling the rich potential of
the Philippine BPO industry.