Cost Reduction by In-House Services

[Submitted by CS. Mrs. Uma Kothari,
B.A.(H), AICWA, ACS,
Kolkata]

April 16, 2007

Higher rate of service tax:
Over a period of time tax rate on taxable services including education cess has gone up from 5% to 12.24% and will go up to 12.36% after the Finance Bill 2007 is approved. Furthermore, in view of the speech of the Finance Minister while presenting the budget 2006, the rate was increased from 10% to 12% as a step towards 'national level of goods and service tax'. One should not be surprised if in the next budget (2008) the rate is again increased to reach near or the level of 16% for uniform GST.

The rate of 12.24% ( to go up to 12.36% within a month or two) is quite high rate. The impact becomes more pressing when credit is not available for service tax paid if the user of taxable service is unable to avail credit for the tax element due to any reason like the user is not rendering taxable service or is not manufacturing excisable goods against which he can avail credit for service tax paid on various services or services availed are not qualified for credit.

High cost factors in our economy:
Our economy is already a high cost economy , and contribution of public sector and higher and varied taxes are major reasons for high cost. Public sector seems profitable only because of monopolistic conditions. Wherever public sector is competing with private sector (for examples telecommunication, petroleum products and fertilizers), the private sector is also high priced due to higher prices charged by public sector due to inefficiencies and revenue leakages in operations.

Service vs. sales:
The 12.24% rate is really very high, and it is a cause of concern. Now where sales tax rates are lower one may think to attempt to shift certain services from service to sales category to reduce tax rates.

More and more services are subjected to tax:
Every year more and more services are being brought into taxable category. The rate is same for all services, in spite of the fact that many services are very essential, and few services may only be called as luxury if at all. About 20 years ago telephones were considered somewhat luxury and a dream even by well to do officers. However, now even clerical people consider it as necessity and people engaged as peons in stable service are having telephones at their homes, mobile phones in their pockets and/or are also using telephones through PCO.

Why outsourcing of services:
Getting work done from outsider agency instead of through employees is called outsourcing of services. Outsourcing of service was and still preferred in many cases due to economy in operation and less administrative hassles. In case of employment of persons, a fixed cost element is added and that goes on increasing the breakeven level of any organization whereas in case of outsourcing of service, fixed costs are controlled and payments are based on productivity and efficiency and also as and when required. In case of outsourcing, element of fixed costs can be reduced or controlled.

Furthermore outsourcing is based on requirement, whereas in case of in-house there will be fixed expenditure irrespective of requirement.

Labour related problems:
Acute Trade Union related problems were also a cause of concern and it was preferred to avail services by out sourcing through contractors. Now-a-days, trade union related problems have also declined considerably and the workers have also understood that salary and wages are for work done and not for employment enjoyed.

Another problem was relating to provident funds and other funds. However, now these contributions are also taken in to account as package of salary and perquisites, and total package is fixed. Now-a-days even in case of out sourcing of services the element of such costs is considered when service charges are fixed on cost plus basis or even otherwise. Therefore, an organization, which is already having system of these contributions, need not be worried about associated work, and problems. And one cannot also expect savings on these scores by out sourcing because service provider may also have these elements of costs.

The rules of hire and fire are also getting softened.

Therefore, now it is easy to think of in-house activity in lieu of outsourcing in comparison to the situation, which prevailed about 20 years ago due to trade union related problems.

In-House service:
With reduced union problems, many employers will prefer to have employees instead of outsiders. Even in employment relationship, part time work, 3-4 days week, reduced working hours, flexible working hours, work from home are being considered and tested successfully. Thus, in changed scenario, in-house activity that is work through employees can be preferred in place of out sourcing.

Analysis of major services:
In any organization an analysis of major services which are being outsourced is required to be made. The same may be arranged in ABC category. First of all for A category of services, Comparative charts of in-house and out sourced services can be made. If it is possible to have in-house service, and it is cost advantageous, a policy decision can be taken in favour of in-house service.

Compulsory Outsourcing and savings:
Some services are required to be performed by outsiders - independent professional. For example statutory audit, tax audit, cost audit, etc. In such cases one has no option but to avail service from outsiders and have to pay service tax. However, by having better systems of internal check, internal control, internal audit, and full preparation through in hose people the work of outsiders can be made easy and less time consuming and therefore, the fees payable to them can be reduced by strengthening organizational capacity. This will also reduce cost on account of outsourcing attracting service tax.

Advantages of In-House service
It may be better to have in-house service departments for major services. Besides better control one can also have better teamwork oriented towards overall better performance of the organization. In case of in-house set-up, advantages of using the departmental people for other work can also be availed. In-House service shall also obviate need of establishing credentials of outsiders for the purpose of credit of service tax, allowability of expenditure etc.

Mergers of service receiver and service providers:
Service tax is basically based on concept of service provided by one person to other person. Just like concept that one cannot trade with him, it is true that one cannot render service to himself in commercial sense. Secondly for service, service charges should be levied by one person who renders service and payable by other person, who receives service. Therefore, any service captively availed will not be subject to service tax. For example, where the services are carried through own employees for own use that is captive use there will be saving of service tax.

In some cases it may be found convenient and economically suitable to merge the service provider entity with the service receiver entity so that outsourced service becomes in-house service and service tax is saved.

Besides mergers will enhance enterprise valuation.

Saving of service tax - a major cost reduction:
The policy of outsourcing definitely require a reconsideration in view of 12.24% tax and ever increasing services in tax fold. Services, which are not, eligible for credit against excise duty and / or service tax payable, there can be definite saving by in-house service. Therefore, wherever possible, the business may choose to employ people as salaried person instead of outsourcing similar services. For example few service are discussed below:

1. The function of internal audit, physical verification of inventory and fixed assets, management audit may be performed by employees appointed for that purpose instead of through practicing accountants or management consultants.
    
2. Commercial Civil construction for new construction as well as for repairs and maintenance matters may be undertaken through Engineers and workmen appointed as employees for that purpose instead of through contractors and consultants.
    
3. Major work of designing of buildings, interiors decoration etc. may be completed through employees and only for availing expertise senior Architects, decorator's services may be availed.
    
4. For purchase and sales of goods , fixed assets, air tickets, etc. commission agents may be substituted with employees.
    
5. Transportation of goods by road may be undertaken by purchasing / hiring vehicles and employing drivers, and helpers wherever possible and economically viable on the basis of quantity to be transported.

In-House service as a means of expansion and diversification:
Another advantage of adoption of in-house service can be a means of expansion - resulting in to deployment of idle funds, cost reduction, and profit improvement. In case of service intensive business using services as input for a substantial cost of product or services, it would be just like to have own resources of raw material. By in-house service one can achieve a diversification related with the existing business.

A chart for analysis:
A chart can be prepared in following manner taking net cost on account of service tax (after available credit) in descending manner, in respect to services which can be arranged in-house:

Cost saving assumed @ 10% on in house arrangement. Service tax saving considered only for non-cenvatable items.

After analysis of possible savings one can consider other aspects for making in house arrangements including capital budgeting, changes in fixed costs, impact on break-even point, improvement in margins etc. for taking final decision as to having in house services.

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