Combined taxes on revenue stream when outsourcing work to a contractor

Question

Does outsourcing work to other contracting companies mean tax is paid twice?

Assume: Customer company A, outsourcing company B, and employee C.

• Customer company A needs work performed, and is going to hire company B, and company B going to pay employee C.
• Customer company A pays $1000 to get the work performed, and company B intends to pay as much as it can to the employee after considering taxes.

Is it true that company B will have to pay taxes on the full $1000 earned (let's assume 20%)? And that will only leave $800 to pay its employee, who will also pay tax of 20% leaving only $640 after-tax on a $1000 contract?

This would mean it's always better to work directly with a customer. Is that correct?

Answer 1

You need to consider that the payment of employee wages is generally a deduction to the employer, the same as paying other business expenses. Income tax is tax paid on net income, not gross profit.

ie: Assume I run a business and have $1,000 in revenue from my customer, $300 in wages, and $250 in other expenses, and a 20% tax rate.

My net income is $1000 - $300 - $250 = $450. My taxes paid are 20% * 450 = $90. My employee will pay personal taxes on $300 in income; my suppliers for other expenses will have their own $250 in income [of which some portion will be reduced for tax purposes by their own expenses, etc.].

In your example, Contracting Company B would have $0 net income [$1000 in revenue - $1000 in salary costs to employees = $0 profit], and therefore would not typically be expected to pay income tax*.

*These are the general principals; specific results will depend on the country involved. Impact of payroll taxes / input taxes ignored as that starts to get very jurisdiction specific.