LINKS IN THIS SECTION

- Executive Summary
- European Union VAT and E-commerce
- Corporation Tax and E-commerce

RELATED SECTIONS

- Regulation of Offshore E-commerce
- Offshore E-commerce Facilities
- Offshore Professional and Financial Services
- Offshore E-commerce Applications

The US and Canada are the main sales tax jurisdictions. The operation of such consumption taxes depends heavily on the ability of the taxing authority to find traces or records of transactions, thus motivating taxpayers to comply with the law because of the near-certainty that they will be found out if they don't. It is obvious that once an individual consumer can buy and receive digital but taxable goods or services through the Internet, then it is going to be hard to collect tax if the seller is outside the tax jurisdiction.

The taxing authority won't know and can't know about the transaction unless the consumer chooses to tell them, which history says is not likely!

The supply of goods ordered and paid for from a distant seller and requiring physical delivery within the taxing jurisdiction is a simpler case, because a cross-border transit is necessary. The supply is taxable only when there is nexus, and even then enforcement can be patchy; but Internet sales of this type are no different from existing mail-order catalogue sales.

For traders within the US who obey local tax laws, the Internet has been an almost tax-free zone because of the moratorium on Internet access taxes and the ban on taxation of inter-state supplies of products and services where there the supplier has no taxable 'nexus' in the destination state, something which previously only benefited mail-order companies.

Although President Bush had expressed his support for a permanent extension of the moratorium on Internet access taxes, the chances of a compromise being reached in the Senate over the issue seemed unlikely at the end of 2003. The House of Representatives had passed legislation extending the moratorium on a permanent basis to all forms of internet access, and removing the grandfather clause contained within the temporary moratorium which allowed the 10 states which began to levy taxes on internet access prior to the enactment of the moratorium to continue to do so, but a similar bill stalled in the Senate over concerns about the potential cost to state authorities.

Senator Lamar Alexander (R-Tennessee), one of the main opponents of the Senate bill, which was sponsored by Senators Ron Wyden (D-Oregon) and George Allen (R-Virginia), had put forward proposals whereby the language of the lapsed temporary moratorium would be extended by two years, and would be changed to cover DSL internet connections. However, the grandfather clause allowing his and other states to collect internet access taxes would have remained.

The stand-off continued in 2004, and by mid-year is still seemed that an extension of the moratorium would be hard to achieve. The same applied to the attempt to repeal the ban on sales taxes on interstate supplies, which the states hoped would be accepted by Congress in response to the SSUTA initiative to create a harmonised sales tax regime. By July, 2004, 46 states had joined the initiative, and most were working to bring their laws into compliance with SSUTA's standardized regime. Once states representing 20% of the population are fully in compliance, the initiative will come into force, something that happened in 2005.

In November, however, in a 'lame duck' session of Congress, the Senate voted unanimously to extend the moratorium on the taxation of internet access for four years. Under the legislation, local and state governments are restricted from levying taxes on internet access services, including broadband and wireless services.

However, other services such as internet mobile phones remain outside of the legislation’s remit, as will the sale of goods and services made over the internet. Expanded provisions covering high speed broadband services had initially sparked fears from local officials that their ability to collect taxes at the local level would be severely curtailed, although a last minute provision allowing them to continue assessing existing telephone taxes assuaged these fears somewhat.

The House followed the Senate, and in December, 2004, George W. Bush signed the bill into law. The moratorium will be in place until November 1 2007, and is also retroactive to cover the year of 2003, during which the previous moratorium had lapsed. In fact, the states had by and large refrained from imposing new access taxes during that period.

The move was welcomed by internet service providers such as America Online and Time Warner, as well as by representatives of the telecommunications industry. “With forward-looking policies that encourage real competition, like the Internet tax moratorium, consumers and the nation’s economy will benefit from increased investment and innovation in the telecom sector,” enthused Walter B. McCormick, Jr., President and CEO of the United States Telecom Association, shortly after Mr Bush signed the bill.

However, not everyone was happy with the access tax ban on internet services, especially municipal and state governments, which were particularly upset over the expanded provisions covering broadband services.

The response of the states to losses of sales tax revenue on Internet commerce was to band together in the Streamlined Sales Tax Project (SSTP), which resulted in the Streamlined Sales and Use Tax Agreement (SSUTA).

Under the SSUTA, states are required to establish uniform definitions for taxable goods and services, and maintain a single statewide tax rate for each type of product. The project also seeks to simplify tax reporting requirements for online sellers.

21 US states had passed legislation to join the SSTP (Streamlined Sales Tax Program) by March 2005, with a further ten states well ahead in the legislative process, and virtually all states having announced their agreement in principle.

In July, 2005, the SSTP made further progress when tax officials, state lawmakers and industry representatives agreed to establish an 18-state network for collecting taxes on internet sales in a deal that they hoped would encourage online retailers and Congress to adopt the national online sales tax framework.

"The vote is a culmination of over five years of hard work by states, local governments and businesses interested in seeing the complexity in sales tax [reduced]," noted Stephen Kranz, tax counsel for industry trade association the Council on State Taxation.

As a result of the agreement, software vendors contracted by the Streamlined Sales Tax Project began on October 1 of that year to provide free tax collection and remittance software and services to online merchants who had voluntarily agreed to collect taxes on all online sales on behalf of the 18 participating states.

In June, 2006, meanwhile, the United States House Judiciary Committee approved legislation which aimed to simplify the application of business taxes across state lines.

The Business Activity Tax Simplification Act sought to resolve the issue of states seeking to collect business activity taxes from businesses headquartered in other states by setting out specific guidelines for when an out-of-state business may be charged a tax for doing business in a state.

US Taxation of Foreign E-commerce Transactions

As regards international transactions, the existing rules are clear about sales of physical products delivered in the United States: if the seller is in a country with which the United States has a double tax treaty (almost all high-tax countries) then there is no sales tax unless the company has a "permanent establishment" in the United States; for other countries (including almost all offshore jurisdictions) products are taxed on arrival if the sale is "effectively connected with the conduct of a US trade or business".

There is little certainty about the effect of current US legislation on the taxation of sales made from non-US web-sites. Some indications given here are not definitive answers, and any trader should seek professional advice relevant to their own particular situation.

The location of the server in or on or with which a contract was concluded has an uncertain impact on taxability. It is thought unlikely that a server based in the US constitutes a 'permanent establishment', but sellers are well-advised to avoid such if possible. Even if the server is not a problem, the server's host might be an 'agent', who can be deemed a 'permanent establishment'. A host who also provided transaction-processing, support and marketing functions would probably cross the line into being a permanent establishment, especially if the host does not have many clients.

It is also unlikely that the positioning of a server in an offshore jurisdiction by a "treaty country" business would change the origin of the sale, but no one knows for sure. By the same token, it is unlikely that an offshore (non-treaty) company could avoid taxability by using a server in a high-tax (treaty) country.

So for physical products, the conclusion seems to be that e-commerce doesn't really change much, unless a company moves from a treaty to a non-treaty country. Usually this would happen in order to gain corporation tax benefit and that benefit would have to be set against the taxability of US B2B sales.

For digital products other than software there is the additional difficulty that it is not clear what is being sold. The rules for software say that it is delivered where it is downloaded, and taxed accordingly, as if it was a physical product. Other types of download may be treated equivalently to software, but may instead be treated as generating royalty income, which would be taxable regardless of whether or not there is a permanent establishment in the US. There are as yet no rules. The normal rate of tax (to be withheld by the US buyer) would be 30% on royalties, which could be partly reclaimed by the seller if in a treaty jurisdiction. But it seems most improbable that a private buyer of, say, recorded music in the US is going to deduct and remit tax on purchases from a remote vendor, and only slightly less improbable that a business would do it unless they are buying on a large and noticeable scale.

The problem for a business selling downloadable products into the United States, and not needing to allow for tax as things stand, is evidently that retrospective legislation may make it liable for large amounts of tax on past transactions. Businesses will have to make their own decisions about what to do. For a small business with occasional US sales, the danger can probably be disregarded, but for a larger business with a substantial Internet trade in the European Union, there is a real chance that the IRS will come after them one day.

LINKS IN THIS SECTION

- Executive Summary - A quick overview of major developments in the taxation of E-commerce with special reference to offshore e-commerce.
- European Union VAT and E-commerce - EU taxation of onshore and offshore e-commerce transactions including recent legislative developments.
- Corporation Tax and E-commerce - The impact of corporate taxes (income or corporation tax) on the profits of e-commerce, the location of servers and business units onshore and offshore.