VAT sword hangs over outsourcing

The cost of outsourcing contracts is likely to go up after Chancellor Gordon Brown hinted that a tax loophole allowing outsourcing firms to avoid charging VAT on contracts would be closed.

The National Outsourcing Association (NOA) has warned that a 17.5 per cent VAT hike will lead many companies with outsourcing contracts to feel the pinch.

Financial services companies that are unable to pass on VAT will be most affected by the proposed legislation.

Many outsourcing contracts currently stand at 30 to 40 per cent of a company's overall cost base, according to NOA figures.

Closing the tax loop would render many outsourcing deals financially unviable, forcing companies to bring outsourced processes back in-house.

Nigel Roxburgh, founding director of the NOA, also warned that companies may be driven to cancel current contracts with their existing supplier, and put their contract out for a much more competitive tender or consider offshoring as a means to slash costs.

"If you start charging VAT a lot of contracts would be uneconomical, either for the end user or the service provider," he said.

"If it were retrospective, it would have a seismic impact on the industry. Even if it only applies to contracts going forward, it would make the business case far less attractive."

Roxburgh also warned that it was unfeasible for many companies to bring outsourced operations in-house as they no longer had the required skills.

"For most companies it's unrealistic. The fact that this was mentioned in the pre-budget speech indicates that Gordon Brown would like it to go through," he explained.

"We'd like him to recognise the unintended consequences. The financial services sector is important to the outsourcing industry.

"The question is how the situation can be managed to the satisfaction of all parties. We'd like to have a dialogue on behalf of the industry."