The OECD Observer
January 1999, No. 215

 

Billadongs, Dugongs, Internet and Tax
By Michael Hardy and Frances Horner

 

An uncertain world ...

Dr. Christopher Owens, a visiting professor of Anthropology at a prestigious US university, sits in front of his laptop computer in central Australia watching the sun set over a billabong, the only surface water for 400 km. A few weeks previously he had purchased an exquisite ceremonial mask in Papua New Guinea on the understanding that his university would reimburse him and acquire it for its collection. He was quite annoyed that the university finance committee had not subsequently approved the funds and he was now offering the mask to a specialist art dealer in Amsterdam by e-mail over a mobile phone. His next step was to send by e-mail samples of digital photos of Australian and New Guinean wildlife, including some spectacular shots of dugongs, a rare aquatic mammal, to stock photography libraries in Singapore, the United States and the United Kingdom. In the following weeks he makes sales to each of the libraries.

One morning Dr. Chris receives a response from the art dealer in Amsterdam who wants to buy the ceremonial mask. After an exchange of e-mails between Amsterdam, Australia and Dr. Chris’ lawyer in New York, a contract is settled. However, the art dealer assumes that Dr. Chris is in New Guinea when the contract is finalised.

A few weeks later the art dealer offers the mask as one lot in an Internet auction. The successful bidder pays with electronic money such that the art dealer is not quite sure in which country the buyer lives, although the shipping address is Germany. The mask is delivered to the buyer, but there is no accompanying documentation because all of the details were completed online and the buyer has forgotten to keep a copy of her e-mails.

Towards the end of the financial year, Dr. Chris receives a cheque from a stock photography library in Singapore indicating that they have sold some of his photos to a book publisher and that the cheque represents the copyright royalties of the first press run of a new book. This reminds Dr. Chris that he probably has to pay some tax in Australia. He is quite concerned because he has never had to consider the international tax environment and so he logs onto the Internet to download electronic copies of the Australian tax forms and advisory information.

Dr. Chris may have to consider whether his income from the sale of the mask should be declared in Australia or the United States and whether the contract documentation, which indicates that he was in Papua New Guinea, will cause problems. He will also need to work out where his royalty income should be declared.

The art dealer, who has found that the Internet gives his small business global reach, will need to consider whether consumption tax, like Value-Added Tax (VAT), is payable on his international sales. If consumption tax is payable, the dealer will need to determine whether it is payable in the Netherlands or the country of the purchaser and, if payable in the latter, how to determine that country and the appropriate tax rate.

The art purchaser, an avid Internet user, begins to wonder where she is going to find suitable documentation to enable her business to claim deductions or depreciation for her various commercial purchases on the Internet. The Singaporean stock photography library has to work out how to account for one set of payments to Dr. Chris when he was in Australia and another when he was in the United States.

 

The Drive for Certainty

Electronic commerce has the potential to be one of the great economic developments of the 21st century but, as the example above shows, the lack of certainty in many areas, including taxation, could hamper its growth. Tax authorities recognise that taxpayers demand certainty about their tax position. Certainty can be delivered by a clear statement of the rules. Some options that have been suggested are for a tax-free Internet or for special taxes, like ‘bit’ taxes. While these options might provide certainty, they must also be assessed against tax policy criteria like neutrality and efficiency.

Tax-free electronic commerce is not neutral, it would create an uneven playing field with the rules unfairly stacked against traditional physical markets. It would not contribute to the effective financing of the government’s provision of health, education, welfare, defence and other services.

‘Bit’ taxes, whereby each data bit in an electronic data stream is subject to tax, are also inequitable. An electronic message that consists of 100 bits of data will be subject to 100 units of tax. If the message results in 1,000,000 francs or 5 francs profit, the tax on the message will be same: 100 units. Worse, if the message is a personal letter, the tax is still 100 units. ‘Bit’ taxes are inconsistent with sound tax policy principles and have been rejected by tax administrators, tax policy-makers and taxpayers.

The above options represent extremes and neither seems feasible. However, there is a correct approach and it is a simple one: neutrality. Electronic commerce should be subject to existing taxes to the same extent as conventional commerce. This approach brings over 50 years of carefully crafted tax policy decisions to bear on the treatment of electronic commerce.

Even at this stage of development in the technological and commercial environment it appears that under existing taxation rules these principles can be implemented. However, in recognition of the unique characteristics of electronic commerce, innovative measures should not be precluded, provided that they are intended to assist in the application of the existing taxation principles, and are not intended to impose a discriminatory tax treatment of electronic commerce transactions.

 

The Challenges

The challenges posed by electronic commerce for taxation have been well documented at the OECD. The basic ones include: how to identify taxpayers engaged in electronic commerce and determine their taxing jurisdiction; how to ensure that appropriate records are created of business conducted by electronic commerce; how to collect taxes in the electronic commerce environment; how to ensure that any consumption taxes are levied in the jurisdiction where the final consumption takes place; and how to apply international treaty issues, such as permanent establishments and classification of income in electronic commerce. Another question is how to apply the OECD Transfer Pricing Guidelines to electronic commerce. Still another test—and one which is often overlooked in the tax debate—is how to use new technologies to improve taxpayer service.

In simple terms, tax authorities need to identify taxpayers to ensure that they are only taxed once and that they are only asked to pay tax for which they are legally responsible. Part of the identification is to determine which country the taxpayer is in when conducting a transaction so that tax is not paid to the wrong country. Details about the transaction are important, as the type of income (for goods or for services, as a royalty or for a sale) can change the rate of income or consumption tax, or the country in which it is paid. Details are also important where there are dealings between related taxpayers (a parent and subsidiary company for example) so that the tax obligations can be correctly split between the related taxpayers. Finally, details are required to determine whether a type of electronic commerce activity is substantial enough to be considered as conducted through a permanent establishment, which can change the country in which a taxpayer owes tax.

 

The OECD Response

Information is important in taxation (see pp. 18–21). Traditionally, the taxpayer is the primary source of information about transactions and this should remain the case in the electronic commerce environment. However, tax authorities should work with intermediaries to ensure that tax issues are also addressed systemically. Some of the commercial initiatives to consider include protocols to generate receipts, invoices and other documentation and those to ensure the integrity of information such as by the use of digital signatures. These types of developments will help the art purchaser get the documentation she needs to make her taxation claims. In the case of related taxpayers this type of information will probably mean that the tax obligations can be properly met in both jurisdictions where the related party operates.

One of the traditional sources of independent, third party information about transactions has been the financial sector and this could continue to be the case for electronic commerce activity. While many electronic payment systems create very good commercial documentation, there is the prospect of ‘unaccounted’ systems which operate like cash. As the ‘cash economy’ is thought to be a major sector of the untaxed economy in conventional commerce, tax authorities are understandably concerned about the prospect of a significant untaxed ‘electronic cash economy’. Tax authorities will work with financial industry associations and banking supervisory bodies, such as central banks, to address the potential challenges of an electronic cash economy, while recognising that it is unreasonable to attempt to enforce third party accounting for the myriad of minor private transactions.

On the issue of identification, businesses are developing authentication techniques to ensure that the buyer can identify the seller and vice-versa. Tax authorities could adopt or adapt these commercial techniques to make sure taxpayers are properly identified. They would be guided by the existing identification requirements, such as those to complete tax returns or for businesses to register as employers. Identification requirements for businesses engaged in electronic commerce would then be similar to those for conventional business.

Tax authorities have concluded that rules for the consumption taxation of cross-border trade should result in taxation in the jurisdiction where consumption takes place. Immediately this helps to resolve some of the questions that the art dealer is facing. VAT would be levied in Germany rather than the Netherlands, for example. While some questions remain, the art dealer has a good signal as to the direction that tax authorities are moving in and an assurance that they are working on reducing uncertainty. The stock photography library in Singapore would be interested to know that tax authorities have come to a view that where businesses in another country purchase the rights to use their stock photographs, those businesses may be able to use reverse charge or self-assessment mechanisms to determine the consumption tax. This would relieve the Singapore business of some of the burden of trying to keep track of all the consumption tax rates around the world. However, existing reverse charge mechanisms would need substantial revision to be suitable for business-to-consumer transactions.

While Dr. Chris probably does not have to consider whether his laptop, mobile phone and physical presence in Australia represent a permanent establishment, other taxpayers will have to consider such questions. The OECD will be providing more information, in the Commentary on the OECD Model Tax Convention, as to how the current definition of permanent establishment applies where electronic commerce transactions are concluded through a web site on a server located in a given country.

In order to collect tax in an efficient manner in an increasingly global economy, the OECD will consider developing an Article for inclusion in the OECD Model Tax Convention to allow assistance by one State in the collection of tax for another State. The OECD’s Committee on Fiscal Affairs is also examining ways to improve the use of existing bilateral and multilateral agreements, like the Council of Europe/OECD Convention on Mutual Administrative Assistance in Tax Matters.

Finally, some tax authorities have already developed Internet web sites offering up-to-date information and providing taxpayer guidance to help taxpayers engaged in electronic commerce get the information they need about their tax affairs. These sites might also be used to accept tax returns or other forms or data. In the example above, Dr. Chris has already started to benefit from this type of facility. Tax authorities could also use electronic payment systems to place taxpayer refunds directly into taxpayer accounts or to accept electronic payments, saving time, postage costs and mailroom processing, among other things.

 

Global Co-operation

Dialogue, often at the behest of the OECD, has enabled tax administrators and policy-makers to understand the commercial reality of electronic commerce and business groups to gain a greater appreciation of the concerns of tax authorities. There is a growing environment of trust and co-operation between tax authorities and the business community, which will prove useful in the drive to reach satisfactory tax solutions in electronic commerce. Obviously governments around the world, both inside and outside the OECD, will have to co-operate with each other too. Some of that co-operation is already in evidence. Several non-OECD countries were involved in the Turku tax roundtable on electronic commerce in 1997 and participated in the dialogue on tax and electronic commerce in the run-up to the OECD Ministerial conference in Ottawa in October 1998 (see p. 45). Other representative bodies, such as the Commonwealth Association of Tax Administrators (CATA) and the Inter-American Center of Tax Administrations (CIAT), were also involved.

These are all welcome signs of progress. But more international co-operation between all concerned parties will be needed if a neutral way of taxing electronic commerce is to be worked out. Only then will Dr. Chris begin to feel truly at ease about his tax obligations no matter where in the world he does his business.

 

OECD Bibliography

Electronic Commerce: A discussion paper on taxation issues, 1998 (used for discussions at the tax dialogue preceding the OECD Ministerial Conference on Electronic Commerce). (http://www.oecd.org/daf/fa/e_com/ottawa.htm)

For a list of web sites of tax authorities see: http://www.oecd.org/daf/fa/links/links.htm