Tax Implications of E-commerce Developments
Latest Actions of Leading Agencies and Tax
Authorities.
Khalil Jarrar J.D. LL.M. [email protected]
707-287-7286
Presented to Professor Ana Penn Mid-Term Paper
Introduction
The evolution of the internet has changed the way business is conducted locally and globally. International trade has never seen a true borderless economy until such evolution took place. This growth came with its own challenges to reforming traditional notions of contract formation defining jurisdiction, contract formation and taxation issues.
The scope of addressing new developments of e-commerce goes beyond a five page paper and as amorphous as the concept itself. Thinking electronic commerce is not limited to the new
“traditional” online purchases, as in clicking on an item, adding to the shopping cart and
checking out. The UNCITRAL1 model law includes to any kind of information in the form of a data message used in the context of commercial activities, which broadens the base of what falls under the umbrella of e-commerce. E-commerce has been defined differently by each major organization and regulatory body. Generally speaking, e-commerce is the use of electronic systems to engage in commercial activities. Businesses use e-commerce to buy and sell goods and services create greater corporate awareness and provide customer service. These challenges stem from the very basic character of e-commerce as global, borderless, virtual, and anonymous, whereas the international tax regime is a state-based regime focused on territorial borders and physical presence.2 The growth of technological advancements outpaces the regulatory frame-work which adds another wrinkle to narrowing down specific issues. At a point where different leading agencies were about to come to terms with major issues on e-commerce taxation , cloud3 computing emerges with its own challenges to taxation blurring jurisdictions with greater anonymities and as nebulous and amorphous in geography ,form and function as ever. Earlier initiatives intended to encourage the growth of electronic commerce. Internet Tax
Freedom Act, was signed into law by President Clinton with a moratorium on internet taxation at the federal level and restricting states from enacting its own.
Bearing in mind the complex and entangled nature of the issues at hand combined with the restrains of a five page paper , I will only mention the major players in regulating e-commerce taxation and expand on one emerging issue , cloud computing and tax implications.
1
UNCITRAL is the United Nations Commission on International Trade Law. Established by the United Nations in 1966 to harmonize the law of international trade, it is a core legal body of the United Nations system that works to create accessible, predictable and unified commercial laws.
2
RICHARD DOERNBERG ET AL., ELECTRONIC COMMERCE AND MULTIJURISDICTIONAL TAXATION (2001).
3
Who addresses e-commerce law at the international level?
Several organizations contribute to the development of global e-commerce law at the international level. Different organizations have tended to take the lead on different issues: • UNCITRAL has played a leading role in developing model laws for e-commerce
transactions;
• OECD4 has been at the forefront of Internet taxation, e-commerce consumer protection and privacy;
• WIPO5 has been the international leader on digital copyright and trademark issues involving domain names;
• ICANN6 has implemented the Uniform Domain Name Dispute Resolution Policy, which has addressed thousands of domain name disputes;
• The Hague Conference on Private International Law has been the worldwide leader on Internet jurisdiction issues;
• WTO7 has considered e-commerce trade barriers.
• USA, including the president’s role and the legislative bodies and the delegation under the commerce clause of the US constitution.
To address some of the global issues, we will begin with initiative of the US government as the main player in the world as 80% is split in the US. U.S. e-commerce sales in 2011 were estimated to be $197B. Up by ~17% from 2010. It is estimated the Apple App Store generated $3B in revenue in 2011.
The 1998 Internet Tax Freedom Act was a United States law authored by Representative
Christopher Cox and Senator Ron Wyden, and signed into law on October 21, 1998 by President Bill Clinton in an effort to promote and preserve the commercial, educational, and
informational potential of the Internet. This law bars federal, state and local governments from taxing Internet access and from imposing discriminatory Internet-only taxes such as bit taxes, bandwidth taxes, and email taxes. The law also bars multiple taxes on electronic commerce.
1. Two of the fundamental purposes of ITFA were to ensure the continued growth of the Internet and to prevent multiple or discriminatory taxes which could
potentially stifle the growth of E-Business. 2. The highlights of ITFA included:
No federal taxes on Internet access or E-Commerce;
Declared that the Internet should be a tariff free zone;
Established an advisory commission – the Advisory Commission on Electronic Commerce;
Three year moratorium on multiple or discriminatory taxes on E-Business; and
Three year moratorium on new taxes on Internet access fees.
4The Organization for Economic Co-operation and Development.
5 WIPO : World Intellectual Property Organization. 6 The Internet Corporation for Assigned Names and Numbers.
The aforementioned act has been renewed twice by both former president Bush and president Obama.
However with the economic downtrend for the past few years , states and local governments have been scrambling for revenues which forced the states to start compelling internet retailers to collect sales taxes . The recent events lead California to compel Amazon to collect sales tax on California, a long battle that was concluded by Amazon succession to the collection of taxes .
In an explanation of its "sales tax requirements," Amazon noted that products it or its
subsidiaries sell online are subject to collection of the sales tax in California as well as Kansas, Kentucky, New York, North Dakota, Pennsylvania, Texas and Washington.8
There are 7,600 taxing authorities in the U.S. comprised of states, cities, towns, counties, transportation districts, and other special local jurisdictions imposing tax for transactions occurring in their boundaries .In an effort to streamline future sales taxes for the purpose of uniformity among states, SSTP was initiated.
What is SSTP?
1. Streamlined Sales Tax Project – a group of representatives from 44 states met to develop a Model Act for a uniform sales and use tax act – went into effect 10/1/05.
2. See (http://www.streamlinedsalestax.org/)
3. Project started through suggestion of ACEC and National Governors Association. 4. Mission: develop measures to design, test, and implement a sales and use tax system
radically simplifying sales and use taxes (uniform tax bases, sourcing rules, rates). 5. Focus: improving sales and use tax administration systems for both Main Street and
remote sellers for all types of commerce. 6. Sales Tax Fairness and Simplification Act
7. The "Sales Tax Fairness and Simplification Act" was introduced in the House / Senate in 2007 and expired with the last Congress.
8. Supported by SSTP, the National Retail Federation (NRF), and the National Council of State Legislatures.
9. In the view of many states, enforcement of an existing tax is better than levying a new tax on constituents.
10.Belief is applying sales tax to all retailers’ brick and mortar, catalog, and online is fair.9
International Internet Taxation
Too many issues arise once internet taxation is to be discussed, one of the main issues is
Jurisdiction , the nature of the entities that are involved in any transaction whether it is subject to taxation of not . For example, business to business transactions might not be taxable if it is between resellers and will not be taxed at the consumer level . Also consumer to consumer transactions are not subject to taxation as well. The classification of the product itself, whether tangible or not plays a role , not to mention the distinction between a service versus a tangible product. Once a determination is made for the taxability of a product the other issues might arise such who can assert a jurisdiction on whom , whether the person or entity has a taxable presence through the principle of Permanent Establishment.
8 http://articles.latimes.com/2012/sep/15/business/la-fi-mo-amazon-collecting-ca-sales-tax-20120915
Permanent Establishment
1. Taxable presence in the international tax context refers to
permanent establishment (“PE”) or U.S. trade or business. 2. Tax treaties define PE as the carrying on of the
business of the enterprise through a fixed place of business.
3. PE generally exists if:
Place of management or branch office
Factory or mine
Activity not remote from the actual realization of profits.
4. In the absence of a treaty IRC defines taxable presence as “U.S. trade or business”
Income effectively connected with a U.S. trade or business subject to U.S. Tax
Level of activity must be considerable, continuous and regular. 5. There is little guidance on how to tax e-
business transactions
6. Companies must rely on existing statutes and case law developed when commerce was
dependent on ‘bricks and mortars’.
7. Major issues for companies engaging in eBusiness are:
When can a state tax the company? (Nexus)
Where is the electronic transaction sitused?
Emerging Issues
Cloud Computing
Ernst & Young's Global Technology Center in March conducted a survey of its Tax Advisory Panel (TAP) members to review the tax considerations related to providing cloud computing services in their respective countries. The countries reviewed included those in which cloud service providers most often conduct their operations. The survey requested information concerning taxable nexus,1 transfer pricing rules and requirements, withholding tax, value-added tax (VAT), tax rulings, and advanced pricing agreement (APA) laws and procedures. The TAP members then provided a rating for their country based upon its tax environment.10
11
By virtue of cloud computing, multiple jurisdictions can be asserted in one location depending who the ultimate user is for each block of hard drives which makes it hard to ascertain the applicable tax method if the location of such hard drive farm is the main determining factor. Tax issues do not involve the sales tax as it might involve income tax issues for individuals and entities marketing such services as well.
Do we apply destination based method or origin based method to resolve such issue?
Conflicts can also arise with the computation of sales tax on software, especially when there is no clear distinction whether the software is part of the sales transaction or transferred. Some
102012 Daily Tax Report, October 15, 2012 Bloomberg BNA
11Image created by Sam Johnston using OmniGroup’s OmniGraffle and Inkscape (includes
retailers bundle software with hardware where the software is treated as a hardware sale. Also, some vendors provide their customers with their own software for internal use only.12
Here are some proposed methods in relation to cloud computing: 1) Nexus
Before the complex issues of taxability and sourcing can be addressed, a vendor of cloud computing services must first consider the threshold issue of nexus. “Nexus” is the term used to describe the amount and degree of business activity that an entity must have in a state before the state can subject the entity to state tax.
2) Sourcing
While the characterization of cloud computing components as taxable or nontaxable is an essential part of understanding the state tax implications of cloud computing, it is the first level of a two-part inquiry. Both the characterization and the source of the taxable
commodity must be determined in order to understand the overall state tax implications of a transaction.
3) Taxability of Services , leases and APIs
A cloud computing transaction typically involves providing a consumer with a combination of an Internet-based hosting platform, support for programming languages, disk space, a back-end database, and bandwidth. The signature characteristic of cloud computing is that it allows a consumer to simultaneously engage servers, storage, and bandwidth on an “as needed” basis.13 In summary, E-commerce at large and cloud computing in particular raise numerous and unresolved state sales-tax issues. These issues are likely to be resolved piecemeal on a state-by-state basis. However, as they are being resolved, cloud computing will present vendors and consumers with potential sales-tax planning opportunities. In many cases, cloud computing will make it possible for consumers to obtain many of the benefits that were once associated with taxable purchases.
To conclude, as long the technology is still evolving and moving at a faster pace than regulations it will be near impossible to count on any development at one point without becoming as
obsolete as the technology itself. Practitioners, researchers and lawmakers will play the catch up game , a quandary of the globality and the borderless state presented by the internet is the same dividing factor policy-wise locally and across international borders.
Khalil Jarrar J.D. LL.M 11/4/2012
