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Policy statement
Tax issues and ramifications
of electronic commerce
Commission on Taxation jointly with the Business
and Industry Advisory Committee to the OECD (BIAC) 15
December 1999
French
version
Introduction
The Business and
Industry Advisory Committee ("BIAC") and the International Chamber of Commerce
("ICC") have worked together to explore issues arising out of electronic commerce,
which is radically changing business practices and processes. In this joint
paper, we identify potential tax issues that are expected to emerge as more
business is conducted electronically, rather than through traditional methods.
Electronic commerce raises
compliance and administrative issues. A technical understanding of the Internet
is required to fully appreciate the tax issues that electronic commerce presents,
as was highlighted in the OECD discussion paper for its 1997 Turku Conference
"Electronic Commerce: the Challenges to Tax Authorities and Tax Payers".
In addition, an international
perspective is required when addressing this subject, since electronic commerce
potentially cuts across national boundaries to a greater degree than traditional
forms of business. Accordingly, no nation should create a new regime or alter
its existing regime with respect to electronic business without serious consideration
as to the impact on its trading partners. In order to avert the potential for
double taxation, an internationally accepted consensus to the taxation of electronic
commerce must be developed. We believe that the OECD is the appropriate forum
to sponsor the required international dialogue, and its coordination of such
an effort will help to achieve the dual goals of avoiding international double
taxation and creating a climate of greater certainty. We also believe that input
from the business community is essential for governments attempting to cope
with the issues presented by this new medium: The OECD's ongoing study of these
issues is making an invaluable contribution in this field. This statement therefore
makes reference primarily to the work of OECD (of which BIAC is the natural
dialogue partner) but the points discussed are of equal relevance to non-OECD
countries, in which many ICC members are based.
The development of electronic
business is an extension of existing business models to take advantage of advances
in technology, and results in changes in the way in which international business
is conducted. Traditional tax policy and tax concepts have, over the years,
accommodated changing facts and circumstances. BIAC and ICC ("BIAC/ICC") see
no reaso
n why this evolution cannot continue. Therefore, we believe that a new
tax regime to deal with electronic commerce is premature.
As a starting principle,
we believe that techniques for applying existing taxation principles in the
electronic commerce must be built upon tools that businesses already use
to meet their market needs - it is only in this way that tax compliance
can be encouraged and sustained with the least burden, and the fewest economic
distortions.
As a secondary principle,
we believe that simplicity and clarity must be promoted in national tax regimes,
in order to allow for the global trading potential of the new communications
media. Tax rules everywhere should be understandable and user-friendly to allow
for the potential increase in foreign sales by small companies. Rules that are
difficult to understand and administer will neither encourage compliance nor
facilitate the growth of electronic business.
Significant issues and
questions
The following
is a list of the most significant issues:
- General comments:
- Permanent
establishment - establishing a taxable nexus for foreign taxpayers in
a treaty country
- Characterization
of income - tax treatment for transactions that use the electronic medium
to transfer digitized information
- Services
income - the appropriate source rule for services income
- Residency
- appropriate tests of corporation residence
- Transfer
pricing - appropriate allocation of income rules for electronically consummated
transactions, such as global trading activities
- Administrative
and compliance matters - steps necessary to preserve the auditablity
of tax returns without imposing burdensome information return requirements
on taxpayers
- Indirect
taxation - the application of the principle that electronically consummated
transactions will be taxed (e.g. by "VAT") in the country of consumption
- Summary
Currently, these issues
are under study by five technical advisory groups ("TAGs"), which report to
OECD working groups and are composed of representatives from the business community
together with delegates from tax authorities of OECD countries (and
non-OECD
countries). The aim of these groups is to thoroughly examine specific subjects
and, where possible, to develop solutions to issues that the authorities will
face.
General comments
Reliance
on existing principles
BIAC/ICC strongly endorse the principle of neutrality (i.e., that the tax system
should treat economically similar income similarly, whether earned electronically
or through non-electronic means). We believe that the best way to achieve neutrality
is through the adaptation, to the extent possible, of existing tax principles
and rules rather than the introduction of a new tax regime. We understand, however,
that some minor changes to existing tax law may be necessary to achieve the
goal of neutrality. BIAC/ICC are concerned over the possible adoption of new,
Internet-specific taxes. We strongly urge that such efforts be discouraged.
Bases
for taxation
OECD member countries, and a significant number of non-OECD countries, have
bifurcated income tax systems. Generally, residents are subject to taxation
on a global basis, while nonresidents are taxed on a source basis. Although
the details of the source rules may vary somewhat from country to country, the
thrust is generally consistent among such OECD and non-OECD member countries.
This is a long-standing international tax regime that is recognized by international
taxpayers.
BIAC/ICC do not agree with
the opinions of some commentators that tax policy in the electronic commerce
environment should be shifted away from any reliance on source-based income
taxation, thereby increasing the importance of residence-based taxation. While
we concede that certain aspects of the use of the electronic medium to conduct
commerce may lead gradually in the direction of residence based taxation, we
counsel against adopting this approach prematurely.
The international tax regime
practised by OECD member countries for taxing foreign persons, although not
perfect, has continually accommodated changing fact patterns. This is an ongoing
process that we believe has been accomplished with a minimum of difficulties
in most countries. The advent and growth of electronic commerce is, in our view,
merely another factual change.
Businesses use new technologies
to extend and improve upon current business models to reach new markets and
customers. The use of the Internet will permit nonresidents to conduct certain
types of transactions from a foreign location (e.g., sales of products and services)
without the physical presence in the host country that was previously required.
As a result, the host country may lose the income tax revenue formerly associated
with these types of transactions, ceding sole taxing jurisdiction to the residence
country. This trend makes it seem that residence-based taxation is becoming
more predominant, but this is a natural evolution that does not require changes
in tax policy.
Accelerating a move toward
residence-base income taxation through statutory amendments is likely to meet
with disapproval in many countries, particularly industrializing countries.
These nations tend to favor rules that better protect their revenue base which
translates into a heavy reliance on source based taxation. Such a situation
highlights the need for the development of an international consensus on this
issue.
We believe that existing
tax rules in OECD member countrie
s and a large number of non-OECD member countries
have achieved a reasonable balance between residence-based and source-based
taxation and we advocate their retention. Further, we would like to underscore
the importance of reaching an internationally endorsed and accepted solution
that eliminates the incidence of double taxation.
Role
of tax treaties
Generally, tax treaties impact source basis taxpayers by narrowing the scope
of taxability in the source country. Tax treaties should continue to serve the
purpose of reducing double taxation by minimizing the income tax burdens of
nonresident taxpayers in the host country. This is a crucial consideration in
the removal of tax obstacles from cross-border commerce (both in its traditional
and electronic form). Although, we believe that the existing tax treaty network
can accommodate the changes in the way that international commerce is conducted,
minor modification to the definitions in those treaties may be required to clarify
their application to electronic commerce.
Permanent
establishment
Permanent establishment
for income tax purposes is a treaty principle that establishes a threshold for
taxable nexus in a jurisdiction. Under this standard, merely engaging in business
activities in a host country will not necessarily establish a taxable presence.
Rather, the business activities in question must be carried out by, or through,
a permanent establishment that the foreign taxpayer maintains in the host country.
A permanent establishment is best described as a substantial presence of some
degree of permanence, physically situated in the host country, which actively
carries on business there (e.g., an office, a branch, a manufacturing facility,
etc.). In addition, certain types of agency arrangements can create a permanent
establishment of a foreign principal.
Electronic commerce enables
foreign enterprises to engage in business transactions with host country customers
from any jurisdiction (without creating a traditional permanent establishment
in the host country). That fact provides the stimulus to the reexamination of
the permanent establishment concept. For example, a transaction for the sale
of goods by a foreign supplier can be completed on the Internet (including offer,
acceptance, arrangement of the terms and conditions of the sale, and payment).
These transactions can occur without the use of a host country employee or agent.
The server (i.e., a computer storing the data that the customer would require
to enter into the transaction) used by a foreign supplier to transact this type
of business can be located anywhere. Such transactions formerly required the
foreign enterprise to set up an office in the host country to exploit the market
to any substantial degree. That requirement is no longer necessary, reducing
the incidence of permanent establishment.
We recognize that the enhanced
capacity to carry on international business activities from the country of residence
is not a new phenomenon, but the continuation of an ongoing trend. Sophisticated
technological innovations have made it far easier to conduct a business remotely.
The advent of electronic commerce has merely accelerated this trend. Moreover,
whether or not a business can exploit the market in another country to the maximum
extent possible via the Internet without establishing a local business presence
depends upon the facts and circumstances. It is our view, that many businesses
that will continue to utilize a physical presence in the host country in order
to maximize market penetration and to p
rovide local service and support to customers,
which may not otherwise be accomplished by relying solely on the electronic
medium.
BIAC/ICC see no compelling
need for a wholesale adoption of new permanent establishment rules for purposes
of electronic commerce. Some foreign taxpayers may be able to operate remotely,
thereby avoiding the host country tax under the current rules. They will be
taxed, however,on that income in their country of residence at income tax rates
comparable to the that of the host country.
Characterization
of income
Many types of information
can be digitized and transferred electronically including computer programs,
books, music and other types of images (e.g., motion pictures, videotapes, etc.).
A purchaser of such information could be restricted to using the purchased information,
could be granted the right to make a limited number of reproductions (for internal
distribution to its affiliates), or could be granted the right to reproduce
the information for resale to a mass market. These types of transactions have
occurred for many years in more traditional formats and will continue to be
consummated in electronic and non-electronic form. If changes to income tax
rules are ultimately necessary, any changes to be effected in the income tax
rules involving these data transfers must be applied to non-electronic transactions
as well as to their electronic counterparts in order to ensure neutrality of
treatment.
Facts and circumstances
have always played a major role in determining the tax consequences of business
activities. Although technology makes it easier to reproduce and disseminate
digitized information, we do not believe new rules to govern the classification
of income are necessary. The ability to handle data transfers electronically
is just a change in facts and circumstances which can be accommodated under
existing income tax rules.
An illustration of a "facts
and circumstances" approach is provided in the following example. A customer
desires to purchase ten copies of a particular book by receiving one copy electronically
with the right to reproduce nine additional copies. The statement speculates
that the transaction might generate royalty income because the right of the
purchaser to reproduce the additional nine copies is usually a right reserved
to a copyright holder or a licensee. Nonetheless, the substance of the transaction
clearly indicates that it constitutes a sale of ten books, and it should be
so treated for income tax purposes. We do not see a need for formulating new
income classification rules to avoid abuses in this area.
Software can be readily
transmitted electronically, and may warrant special attention because of complications
that currently exist that can result in double taxation. Countries may feel
the need to develop internal rules on the characterization of software transactions
for income tax purposes. BIAC/ICC believe that these rules should be created
utilizing a facts and circumstances approach to determine the economic substance
of the transaction and to distinguish software transactions that constitute
licensing transactions from those that constitute transfers of property. It
is crucial that countries strive to adopt uniform principles in the software
area to promote internationally conforming income characterization. International
tax policy makers should encourage such consistency since differences in characterization
will result in double taxation. It would be of great significance for OECD,
having start
ed this discussion, to set an example in this respect.
Consistency in characterizing
cross-border software transactions is also extremely important in the proper
application of bilateral income tax treaties. When a transaction constitutes
a sale, the taxability in the source country will depend upon the existence
of a permanent establishment there. Without a permanent establishment there
is no source country taxation. Conversely, the existence of a permanent establishment
will attract source country taxation. Under traditional international tax rules,
relief from double taxation should be available in the home country. Both fact
patterns generally provide double taxation relief.
If the source country applies
a royalty characterization, a withholding tax at the rate specified in the relevant
treaty will be assessed on the gross proceeds. Double taxation relief is also
generally available in this fact pattern. These are fairly straightforward situations.
Complications arise where the source country characterizes the income as a royalty
and subjects it to the nonresident tax while the home country asserts a sales
characterization for the same transaction, and vice versa. BIAC/ICC suggests
that the software issue be given full and adequate attention during the process
of reviewing the application of the existing tax rules to electronic commerce.
In addition to the potential
confusion between sales income and royalty income, digitized information could
present difficulties in defining services income and distinguishing it from
sales income and/or royalties. Again, we recommend that any issues arising in
this context be resolved through the application of a facts and circumstances
approach. A careful analysis of the facts and circumstances of transactions
involving digitized information flow in a service environment should provide
the appropriate income tax treatment without the need to prescribe a new set
of rules.
Source
of services income
Generally, in OECD member
countries, the source of services income is the geographic location in which
the services are physically performed. Under existing international tax rules,
service income is only subject to host country income tax if the services are
physically performed in the host country through a permanent establishment (e.g.
by employees who work in the country), or a fixed base (e.g. other representatives
of the foreign service provider in the country). When the services can be performed
from the country of residence, the foreign service provider generally will not
be taxed, either on the basis of net income attributable to a permanent establishment
or on a withholding/gross income basis in the host country.
As the use of technology
has increased, the connection between the location of the service provider and
the location of the consumer has become less significant. Even before the advent
of the Internet, services were provided from outside the country of the consumer.
Although the trend of providing more and more services from remote locations
will continue, it will still be necessary to render certain types of services
in the host country.
The use of the Internet
only represents a change in the facts and circumstances under which service
businesses are conducted. Residence-based income taxation will become more prominent
in accordance with this fact pattern, but this will occur as a result of the
changing environment. It should not be forced by way of statutory amendments.
The critical issue is not
whether the predominant source rule of the OECD countries is the appropriate
standard, but whether international harmony (i.e., consistency) can be achieved
so as to avoid the potential for double taxation. As noted, most OECD countries
use the place of performance test as a basis for sourcing services income. Developing
countries, however, sometimes use a place of use test, which conflicts with
the place of performance test. Under the place of use test, a foreign service
provider rendering services from its resident country to a consumer in a developing
country will frequently be taxed on a withholding/gross income basis in the
host country. For resident country tax purposes, the income will presumably
constitute domestic source income. The conflicting tax treatment results in
double taxation without double tax relief, an outcome which represents an extra
cost for companies doing business in developing countries.
BIAC/ICC do not recommend
changing the relevant source rules to the place of use test. However, we would
like to focus the attention of policy makers on this area. Inconsistency of
tax treatment between countries is already creating the potential for double
taxation. This situation will be exacerbated as the Internet makes the rendition
of cross-border services from the resident country more effective and efficient.
We urge that this issue be put on the agenda of international tax policy fora
for further study. OECD's Project Outreach would be an appropriate additional
forum for taking the discussion further.
Residency
Technological advances may
affect the continued viability of the "mind and management" test (as contrasted
to the place of incorporation test) to establish corporate residence. Tiebreaker
tests in various tax treaties also contain place of management standards to
settle on the country of residency for a dual resident taxpayer. Board meetings
by video conferencing could destroy the efficacy of the "mind and management"
concept by mitigating the weight generally placed on the location of board of
directors meetings in determining the place of management.
Most countries that use
the "mind and management" test for corporate residency understandably put more
weight on where the key management functions of the corporation are performed
than on where the board of directors meets. This trend would suggest that the
teleconferencing of board meetings is an insignificant criterion. An important
reason for the lack of importance placed on the location of the board meetings
is the flexibility, as a result of high technology communication, to conduct
board meetings in any location. This is an example of how tax rules have adjusted
to the changing facts and circumstances in the business environment without
the need for wholesale legislative amendments. BIAC/ICC believe that the tax
rules in most countries can easily adjust to the changes attributable to these
technological advances, with only minor modification.
Transfer
pricing: global trading
Global trading has increased
over the last decade from an almost insignificant level to the significant role
it now plays in the global economy. This is a result of the trend away from
regional and national economies to a global economy, coupled with enhanced communication
capabilities. Global trading could not exist without this sophisticated technology.
Transfer pricing is the
primary tax issue that arises in this subject area. This issue, however, should
not be considered in a discussion of the tax consequences of electronic commerce.
Global trading has been the topic of a statement issued as a chapter of the
OECD transfer pricing guidelines. Ascertaining the appropriate allocation and
apportionment of income and expenses arising from the cross-border trading of
financial products is a matter of properly applying existing transfer pricing
rules. It is not related to the reliance of this industry on enhanced technology.
Accordingly, we do not think the subject should be included in the consideration
of the taxation of electronic commerce.
Administrative
and compliance matters
BIAC/ICC do not believe that
the Internet will be used to escape taxation. Although the Internet has created
different means for the dishonest and criminally oriented, this opportunity
alone will not turn honest taxpayers into criminals. The overwhelming majority
of business taxpayers, including those in the multinational corporate community
are honest taxpayers interested in enhancing their profitability worldwide through
the use of legitimate means.
BIAC/ICC believe that it
is a worthy objective for governments to use their various powers to reduce
criminal activity. However, we do not favor attempts to over-regulate and burden
the business community with far-reaching information gathering and reporting
requirements beyond those already in force. The recent trend in many countries
is to require more information reporting from businesses with international
operations. These increased reporting demands already impose a significant burden
on the resources of corporate taxpayers. For this reason we urge that governments
and the OECD seriously consider the impact of any recommendations that
would impose additional levels of information reporting on the business community.
It is important to reiterate
that all techniques for applying existing income taxation principles to electronic
commerce must be constructed around the tools that businesses already use to
meet their market needs. For example, tax authorities should develop policies
and procedures for the acceptance of electronic records that companies are developing
for business reasons (e.g. improved speed and accuracy). By addressing application
issues in this way, high tax compliance can be sustained with the least burden,
and the fewest economic distortions.
Consumption
taxes
BIAC/ICC are of the opinion
that consumption tax rules (including collection procedures) should not be applied
so as to impede electronic commerce. The global nature of electronic commerce
makes the development of a framework for taxation on consumption a particularly
significant issue, which should be considered a top priority for international
tax policy makers (noting that progress in income tax issues cannot lag behind).
Accordingly, we take this opportunity to provide our views on this important
matter.
Fiscal authorities are
understandably concerned that electronic commerce provides business with the
opportunity to avoid the application of consumption taxes by locating in a jurisdiction
that does not impose a consumption tax, thereby causing consumers to favor foreign
over domestic suppliers for like products (and giving an incentive for other
domestic electronic sales companies to move to the low or no tax
jurisdictions).
We agree that consumption tax rules should be trade neutral and should not discriminate
between foreign and domestic suppliers.
The minimization of double
taxation is also important in considering a consumption tax framework for electronic
commerce. To reduce the occurrence of double taxation, attention should be given
to the consistent application of consumption taxes, like VAT, particularly in
the place of supply rules. Consideration should also be given to the development
of a mechanism to address relief of double taxation on consumption.
It is important to design
rules that are readily understood and administered by foreign and domestic business.
The incidence of non-compliance, particularly for foreign businesses, increases
significantly, as rules become unreasonably complex and burdensome to administer.
In keeping with the spirit of electronic commerce, governments should utilize
technological advances to reduce the compliance costs associated with consmption
tax. Business input could be of considerable assistance in this area.
BIAC/ICC believe that consumption
tax rules, such as VAT tax rules, should not be applied so as to impede electronic
commerce. Electronic commerce transactions should not be treated less favorably
than non-electronic forms of commerce, and complex compliance regimes requiring
service providers to act as collection agents should be avoided. To provide
consistency with non-electronic commerce, the responsibility for compliance
should remain with the vendor/supplier or a trusted third party until a satisfactory
internationally agreed arrangement is established.
It is important for fiscal
authorities to work with business before developing consumption tax rules applicable
to electronic commerce. We believe that OECD is uniquely positioned to foster
discussion of this important issue. As more business is conducted using these
new technologies, the importance of an international consensus regarding consumption
tax compliance and enforceability becomes more crucial.
Summary
BIAC/ICC strongly endorse
the continued application of the current tax systems of the OECD member countries
to address the issues that arise from electronic commerce. This is the surest
way to avoid trade distortion and to achieve neutrality. We reject the need
for new income and/or consumption tax regimes to deal with electronically consummated
transactions which, we believe, merely reflect a change in the way that business
is conducted. We are not opposed to changes where necessary to modernize tax
rules to clarify their application to this new way of conducting business. We
believe, however, that those changes should be carefully thought out through
consultation with the business community before they are implemented.
BIAC/ICC urge governments
from both OECD and non-OECD countries to build a broad international consensus
in an effort to minimize the incidence of international double taxation on income
or consumption, and to reduce compliance obstacles. As a result, businesses
will benefit, particularly small businesses, which stand to gain the most from
their ability to use the Internet and operate internationally.
Document n° 180/421
15 December 1999
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