By Vernon K. Jacobs,
CPA
& J. Richard Duke,
J.D., LLM
| Internet
Taxation
By Vernon K. Jacobs,
CPA |
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Anyone involved with using the Internet or the World Wide Web is surely aware of the highly charged controversy surrounding the taxation of e-commerce. The controversy relates mainly to sales or VAT taxes, but there is also a lot of controversy about which jurisdiction gets to impose income taxes on any profits from sales made over the Internet.
In the U.S., there are reputed to be over 7,000 different taxing jurisdictions that would like to impose sales taxes on Internet transactions. The sales tax is paid by the buyer and is collected by the seller by adding the sales tax on to the price of the goods or services. The key issue is where the order takes place. At a retail store, both the buyer and seller are in the same state, city or county and the location (nexus) of the transaction is obvious. Where the buyer and seller are in different states, there are some disputes over which location has the right to impose the sales tax.
In the U.S., there is a long history of disputes regarding the taxation of mail order or telephone order transactions. Generally, such sales are subject to tax in the jurisdiction in which both the buyer and seller are located. Thus, if the seller has a business nexus in that jurisdiction, it is required to pay sales taxes on any sales in that jurisdiction. If a large retailer has a retail outlet somewhere in California and their New York based mail order (or Internet) division makes a sale anywhere in California, they are required to collect sales taxes and to remit the taxes to the state.
Outside the U.S., many countries impose a value added tax (VAT) that is similar to a sales tax, but it is collected in stages from each business as the product or service moves from the producer to the consumer. At each stage of production , the sale of the goods or services are subject to a VAT, but the business can claim a credit for the amount of VAT paid by previous businesses in the supply chain. Thus, each business pays a VAT on the incremental sales value that they add to the price of the product or service. Because a VAT is paid by the producer or seller -- without regard to the location of the buyer -- products or services that move from a country with a VAT to a country with a VAT may be subject to double taxation.
Nexus is generally used to mean a permanent location or establishment such as a store, a shipping facility, an office, or even a resident sales agent. Some states or localities (and countries) argue that the customer who downloads information from a web server creates a nexus in that state -- but such arguments don't seem likely to survive if disputed. When a web server is located in a country (or state) other than the headquarters location of the business, some countries claim that creates a nexus or permanent establishment in that country. Clearly, if a web server is located in country A and the customer is located in country B, the business is subject to overlapping taxes if both countries impose different definitions of what constitutes a nexus.
Similar complications apply to the imposition of income taxes on any profits arising from business transactions. Generally, the location of the business determines which jurisdiction imposes an income tax. If a U.S. based business makes sales outside the U.S. but has no physical nexus or permanent establishment outside the U.S., all of it's profits will be subject to income taxes in the U.S. -- even if all of its sales are to other countries. Where a multi-state business in the U.S. has offices or facilities in different states, the states have adopted a multi-state allocation forumula with which to allocate the profits of the company between the states based on a combination of (1) sales into each state, (2) the value of any property located in each state and (3) the amount of the payroll in each state.
With respect to disputes between countries where two or more countries impose an income tax on the same income of an international company or an individual, most countries provide for a tax credit that can be used to eliminate (or at least to reduce) the potential for double taxation. If a U.S. company pays an income tax to Canada on a part of it's business, that Canadian income tax can be deducted from the income tax owed to the U.S. on all of the company profits. However, the actual mechanics of computing these tax credits can get very complicated.
Subject to many complicated exceptions, if a U.S. person or business establishes and operates a business entirely outside of the U.S. -- and if the business can sidestep a variety of technical obstacles -- any profits from the foreign business are not subject to U.S. taxes until the profits come back to the U.S. as dividends, as a salary to an owner/employee or as a gain on the sale of the stock of the company. Similar rules apply in most countries that impose an income tax, but the details differ from country to country.
With respect to businesses that sell over the Internet into other countries, there is a huge potential for new disputes as to where the business is located. For example, if a business in the U.S. puts information on a web server in Bermuda, does that constitute a nexus or permenent establishment in Bermuda? If it does, then any business generated from the Bermuda web server could be regarded as being based in Bermuda -- which does not impose an income tax.
CONGRESS APPROVES INTERNET TAX FREEDOM ACT
The much debated Internet Tax Freedom Act is part of the 1997 budget bill. Heralded as the short-term solution intended to preclude unfair state and local Internet taxation while catapulting Internet Commerce, the Act is seen as a major win for E-commerce advocates. The ITF Act has been sponsored by Rep. Christopher Cox (R-CA) and Senator Ron Wyden (D-OR).
Since
Sen. Wyden and I introduced the Internet Tax Freedom Act in
March 1997, the need for it has become critical. Some taxes were
enacted
while the bill was under consideration. In the U.S. alone, the Internet
is susceptible to more than 30,000 potential state and local taxing
jurisdictions. This makes every Internet transmission vulnerable to
multiple taxation that could stop this rapidly growing medium in its
tracks.
The Internet Tax Freedom Act does the following:
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