Basu To Tax or not to tax? That is the question? Overview of Options in Consumption Taxation of E-Commerce
Journal of Information, Law and Technology
To Tax or Not to Tax? That is the question? Overview of Options in Consumption Taxation of E-Commerce
Subhajit Basu
Lecturer Information and Technology Law
School of Law, Queen’s University Belfast
This is a refereed article published on: 30 April 2004
Citation: Basu, 'To tax or not to tax? That is the question? Overview of Options in Consumption Taxation of E-Commerce ', 2004 (1) The Journal of Information, Law and Technology (JILT). <http://elj.warwick.ac.uk/jilt/04-1/basu.html>.
Abstract: Consumption taxation of e-commerce should be consistent with the basic principles of international taxation. In order to aid the policy-based discussion in relation to consumption taxation, this paper provides an outline of the fundamental policy concerns that arise in any thoughtful consideration of changes in a system of taxation. The paper explains in broad terms the objectives and principles that should guide the consumption taxation of e-commerce and it critically evaluates the different options forwarded primarily by the OECD for collection of consumption taxes.
Keywords: E-commerce, Taxation of e-commerce, Consumption taxation, Destination and Origin Principle
1. Introduction: The Nature of the Debate
‘The greatest challenge to a tax regime is its ability to adjust and adapt to a changing world. The coming of the age of e-commerce, the increased mobility it brings to business, and the greater flexibility it offers to the way that transactions and communications are made is the latest and perhaps the most demanding of these challenges’ (Deloitte & Touché, 1997) [1] .
The relationship between taxation and the emergence of the modern state, in short, was one of ‘mutual constitution’: taxes made the state, and the state made taxes’ [2]. Given this history, it is not surprising that taxation was, and continues to be, viewed as a central function and prerogative of the state. The study of taxation had been largely a parochial issue. It focused, mainly, on national concerns. Globalisation however initiated international co-operation and the development of ‘international taxation’. However, even when an international perspective has been necessary, such as when concerning the taxation of truly multinational enterprises, it has usually been approached as an aggregation of national perspectives rather than by adopting a truly international one. This history of taxation now raises intriguing questions for the present day. Territorial States are not particularly well suited to the task of taxing non-territorial e-commerce.
Any serious attempt to examine the legal and policy issues raised by taxation of e-commerce must begin with an understanding of the technological and business background out of which they arise [3] . This background has been described clearly and in detail elsewhere [4] . Even so, it is appropriate to begin this discussion with some observations about the attributes of e-commerce that have significant implications for taxation, and the fundamental issues that these attributes pose for tax administration and also place in context the more technical consumption taxation issues to which most ofthe paper is devoted. Jeffrey Owens, Head of Fiscal Affairs for the OECD, back in 1997 identified six characteristics of the Internet that would influence the operation of tax systems. [5]
First, the ability of the internet to establish public and private global communications systems that are secure and inexpensive to operate. The simplicity and low cost associated with establishing an Internet presence infers that relatively unsophisticated enterprises can operate a commercial web site.
Second, the process of 'disintermediation' whereby the Internet eliminated or substantially reduced the need for intermediaries in the sale and delivery of goods and services, and in the provision of information. E-commerce requires a small number of distribution, sales representative, broker, and other professional intermediaries.
Third, the development of encrypted information, which protects the confidentiality of the information, transmitted on the Internet. Whilst it is possible to detect a message sent by one person to another over the Internet, encryption generally precludes understanding the content of the message.
Fourth, an increased scope for the integration of business functions, e.g., design and production. Private Intranet networks are now widespread in Multinational Corporations (MNE’s). The OECD estimates that at least two-thirds of Internet transactions take this form. This development produces a closer integration of transactions within an MNE and makes it increasingly difficult to separate out the functions carried out by related enterprises. This integration may also produce a dramatic synergistic effect--- the sum of the parts being much less than the integrated whole.
Fifth, the Internet provides greater flexibility in the choice of the organisational form by which an enterprise carries out its international activities.
Sixth, the Internet has led to a fragmentation of economic activity. The physical location of an activity, whether in terms of the supplier, service provider, or buyer of goods or user of the service, becomes less important and it becomes more difficult to determine where an activity is carried out. [6]
Owens also points out that there are several technical features of Internet and intranet systems that are likely to have significant impacts on the operations of tax systems, namely, the lack of any central control; the lack of central registration; the difficulty if not impossibility of tracing transactions; and the weak correspondence between a computer domain name (i.e., an Internet address) and reality (i.e., the actual geographic location of the addressee or the computer equipment used to transmit or receive the information). Owens’ observations remain as true today as they were when he made them six years ago, even though 1997 may seem like the ‘Dark Ages’ by the standards of Internet time. One does not have to be a tax expert to discern the broad implications of the foregoing developments for territorially based taxing regimes [7] . First, there is the sheer magnitude of the increase in cross-border transactions. Second, to deter evasion, it is the responsibility of tax authorities to monitor economic activities. However, given the decentralized structure, the variety of transmission media, the binary format, and the various encryption and security measures, the tax authorities’ ability to monitor economic activity-involving e-commerce is impaired. Further, tax collection in the digital environment poses a number of problems including:
·The determination of the type of tax to be collected
·The ability of the vendor to collect the tax
·Determining the jurisdiction in which tax should apply
·Verifying the place of consumption
·Determining the correct tax treatment of bundled products, bad debts, and tax credits
·Retaining data
·Complying with audit requirements [8]
While the evolution of e-commerce raises these issues in regards to the application of traditional consumption tax rules in each of these above stated areas, all of these issues are compounded by the potential for different implementing legislation in individual countries. In some instances, the potential for multiple laws addressing identical issues in different ways might be as challenging as finding any single way to address the underlying issue. In addition to creating high compliance costs for governments and suppliers, the implementation of inconsistent laws and definitions possibly will result in double taxation or unintentional non-taxation of e-commerce transactions [9] . Hence, from the standpoint of tax administration, the principal challenge remains how to implement geographically limited taxing systems in a technological environment that renders geographical borders essentially irrelevant.
The debate on taxing e-commerce has initially been focused on tangible products sold to businesses and consumers, which is not surprising given these transactions account for the largest percentage of e-commerce sales. However, this trade does not raise any fundamental taxation issues, because the proper destination-based consumption tax can be levied once the consignment passes through customs. However, if both the payment method and product is digitized—for example, downloaded software paid for with electronic cash—vast tax enforcement issues arise because the origin and destination of these transactions is obscured. To be able to effectively tax a consumption transaction under traditional taxation principles, tax collectors need to know where the transaction takes place and whether the transaction involves a good or service. Sellers of intangibles often do not know—and typically do not have a need to know—the physical location of their customers. Indeed, the anonymity of the Internet makes it very easy for customers to hide their identity and physical location for tax evasion and privacy reasons. Moreover, it may be difficult for the tax authorities to determine the location of the vendor, who typically collects the consumption taxes. For example, the vendor may sell its products using a Website on a server located in another country or jurisdiction. Accordingly, the point of origin and destination of transactions is obscured, making it hard to enforce fiscal frontiers. The crux of the problem is that the Internet and new communication technologies have introduced the new channel through which sales occur. It is a matter of debate, however, as to whether these new channels create new products. Some believe that delivery through these channels alters the character of a product to such a degree that it should be considered as wholly new product, distinguishable from that delivered through traditional channels, and therefore treated as unique for tax purposes. Others believe that digitising a product does not alter the purpose of the product and therefore the digitised version should be treated the same for tax purposes as that delivered in physical form. Typically, countries apply differential tax rates to goods and services, which necessitates a clear classification of digital products as one or the other. A key question is then whether a downloaded movie is functionally the same product as a rented movie. In addition, tax administrators rely on following a 'paper trail' of transactions for auditing purposes, whereas digital transactions typically do not generate such records. Can and should these transactions be taxed? [10] The debate on the effective taxation of e-commerce has yielded a number of proposals on tax collection models, ranging from the traditional vendor collection model to models employing third parties, some of which are reviewed in this paper. This paper also attempts to provide an answer to the principle question: What kind of taxing regime would allow participants in e-commerce to pay and collect taxes in an administratively feasible fashion to those states with a legitimate claim on tax revenues?
2. Principles for a New Tax
The principle difficulty in developing an e-commerce taxing regime for consumption taxes is that the Internet is still a new medium whose full ramifications are not close to being understood. However, concerning tax policy it is believed that while it may be necessary to modifythe tax systems of both States and Local governments to accommodate e-commerce, the basic contours of taxation are not likely to change dramatically; neither the composition nor the nature of taxation is likely to change fundamentally.The OECD’s work on consumption taxes, which is firmly based on the Taxation Framework Conditions, expresses similar views. In this context, it is worth recalling the most relevant emerging conclusions of these conditions:
·First, the taxation principles that guide governments in relation to conventional commerce should also guide them in relation to e-commerce. In other words, no new taxes should be introduced exclusively for e-commerce.
·Second, existing taxation rules must be used to implement these principles.
·Third, the process of implementing these principles should involve an intensified dialogue with business and with non-member economies.
In addition to these conditions the OECD identifies a number of Taxation Principles. The most relevant for collecting Consumption Taxes are:
·First, efficiency Compliance costs for taxpayers and administrative costs for the tax authorities should be minimised as far as possible.
·Second, neutrality, certainty, and simplicity. The tax rules should be clear and simple to understand so that taxpayers can anticipate the tax consequences in advance of a transaction. This includes knowing when, where and how the tax is to be accounted. Simplicity often conflicts with other important objectives of tax policy; where this is true, it is necessary to make trade-offs between simplicity and other objectives.
However, in spite of these international agreements, the taxation of e-commerce is no less chaotic now than it was 3 to 4 years ago when the negotiations were first started. One contributing factor is the resistance of taxpayers towards the payment of taxes and their effort to structure their affairs in order to minimize taxes payable. A second factor is the desire of cash-starved nations to maximize tax revenues. Together, these factors pose challenges and opportunities for both taxpayers and the tax authorities in their approach to the taxation of e-commerce.
McLure (1997) argues that there should be few further principles to guide the deliberations in the area of tax policy. First, and most obviously, it will be important to avoid distorting choices of how to satisfy a given need, taxation rates should not differ, depending on the technology and commercial channels used to satisfy needs. It should treat all commerce equally. It should not discriminate in favour of or against e-commerce; nor should it distinguish between types of products (tangible, intangible, or services) or income from them. For example, taxation should not distort the choice of how to provide the following products: music (tapes or compact disks vs. downloaded from the Internet), movies (video cassettes vs. downloaded), and reading materials (printed books, magazines, and newspapers vs. downloaded). Second, it will be important not to distort the choice of technology used to provide particular intangible products and services: for example, the provision of television signals over the air using traditional broadcast technology, via cable using wires (provided by either cable companies or public utilities) and fibre optic cables, or via direct transmission to satellite dishes. Third, taxation should not affect the choices of whether and how to 'bundle' various goods and services for purposes of pricing. This means that there should be neutrality towards bundling. For example, whether to include software on compact disks sold with books and whether to use lump-sum prices or itemized charges for basic and enhanced telecommunications and for the services of ISPs and OSPs, including, especially, the bundling of content and Internet access. Fourth, taxation should not distort location decisions or trade between jurisdictions and should neither favour nor penalize local producers and distributors. This has several dimensions, including avoidance of tax-induced distortions of competition in the provision of tangible products, intangible products, and services. Location distortions may have either interstate or international dimensions [11] . Further, from a tax administration point of view (and compliance), any taxing scheme should be made relatively easy.