Article

The Taxation of E-commerce

As e-commerce becomes more mainstream, serious issues arise concerning both income and consumption taxation. These issues have yet to be resolved; however, this article will outline some of the problems and questions that lie ahead.

The current technology associated with e-commerce is new, but there have been other technological advances over the years that have also impacted the way companies conduct business in our economy. The introduction of the telegraphy, telephone, computer, fax machine and voice mail have all had varying degrees of influence in the technology of data transmission. What is so remarkable about the Internet, however, is that it has shrunk physical distance to such an extent that it makes geography irrelevant. Transactions that used to take weeks or days to be consummated can now be completed in hours and minutes. E-commerce permits low-overhead capitalism to thrive, and as technology continues to improve, electronic transactions will only increase in volume and dollar value.

The mechanics of the Internet are straightforward. A person requires a computer, equipped with a mode of communication, usually a modem and a telephone or cable connection, and communication software, often referred to as an Internet browser. The user connect to the Internet (part of which is commonly referred to as the World Wide Web) by dialing a local access number provided by an Internet Service Provider, or server. Once a connection has been made, the user is said to be “online” and can connect to any Web site or home page on the Internet by keying in the appropriate Internet address.

Internet Service Providers also provide the user with their own individualized electronic mail account. This allows the user to communicate quickly and efficiently with others who have set up similar accounts anywhere in the world.

The home page “lives” on a server which acts as a conduit between the customer’s computer and the commercial seller on the Web. As along as the consumer can send digitized text, sound, images or video over the Internet, he is capable of ordering goods and services and performing financial transactions.

The Internet was originally designed by the United States military. Today, as private enterprises connect to it and use it for commercial and individual activities, its reach has extended beyond domestic borders and into the world of international commerce. This has had serious implications on the way its transactions can be taxed.

When it comes to traditional forms of business, it is easy to identify when a company has established a branch plant within a foreign jurisdiction. The bricks and mortar can be easily identified. The taxation of profits generated from the plant either form part of the income of the consolidated enterprise or is considered to be separate income generated from one of a series of local operations.

Bilateral tax treaties between countries iron out the specifics of the above issues and allocate taxing rights between treaty partners.

E-commerce transactions, on the other hand, are conducted without the benefit of bricks and mortar. Digital technology knows no physical boundaries when global markets are established over the Internet. A server can be located anywhere in the world without any difference to the user.

As of now, e-commerce transactions resemble mail order catalogue sales of days gone by. The taxation of such transactions falls within the jurisdiction of the country of residence of the company fulfilling the order on behalf of the customer.

A company may nominally operate out of Toronto. In reality, its server can be located in a tax haven in the middle of the Atlantic Ocean and it can arrange to have its wares shipped to customers directly from suppliers located in the United States. Who will have jurisdiction on taxation matters? Its mind and management are in Canada, its server on the Isle of Man and the heart of its operations flow from Alabama.

So far, this issue has yet to be resolved. Each of the three jurisdictions can logically lay claim to be the location of the company's operations. The company would probably prefer to have its operations taxed within the tax haven, and will argue their position accordingly. Today, they would probably be successful.

However, in the not too distant future, e-commerce will develop to such an extent that ideas that were satisfactory for a bricks and mortar economy will not suffice for the new technology. At that point, the entire question of taxing e-commerce transactions will have to be re-evaluated and re-negotiated into new treaties and protocols covering all the trading nations of the world.

Article ©2000 The Quarterly Dividend
Reprinted with permission