Tax Free E-Commerce May be a Myth By Vernon K. Jacobs, CPA

Whenever and wherever there is any perceived opportunity, there will be hucksters, con artists and fast talking promoters who are only concerned about getting you to write a check and have no concern over whether you get any value or benefit from their products or services.

We believe the most widespread kinds of scams and schemes involving global e-commerce have to do with promises of being able to save taxes by doing business offshore. Many businesses are looking forward to a marketing environment where they can avoid the hassle and cost of collecting and remitting sales taxes to hundreds or even thousands of different tax agencies. Merely being an out-of-state or even an out-of-the country vendor is not a guarantee that you will be able to avoid any or all obligations to collect sales taxes. Some jurisdictions will claim that simply having your web files copied onto the computers of their residents will be sufficient to require you to collect sales taxes for them. Some countries or U.S. states will argue that if you have an affiliate who is physically located in their country or state, you are thereby subject to collecting sales taxes on sales to their residents. Other jurisdictions will insist that you collect sales taxes if you merely have a web server in their state. 

As for income taxes on offshore business profits, this will be a far more contentious and complicated issue than sales taxes. A lot of promoters will tell you that you can set up a web based business in their tax haven jurisdiction and you can accumulate profits tax free as long as you wish. However, doing that is likely to get you into an argument with the tax collector in your country -- particularly in the US. Without advance consultation with a knowledgeable tax professional, you are likely to discover that your tax collector has a wide variety of little known laws and regulations that can trip you up and cause your offshore profits to be taxable. 

For example, U.S. taxpayers who transfer intangible assets to a foreign corporation in exchange for stock in the corporation are likely to be subject to income taxes on the royalty value of the intangible asset. Or, if a U.S. taxpayer forms a foreign corporation and uses it to sell products that are purchased at a favorable price from a U.S. company owned (directly or indirectly) by the taxpayer, the profits from those products may be currently taxable to the U.S. owners of the foreign corporation. A similar problem occurs when a foreign corporation is used to purchase products from various sources but the products are then sold to an affiliated U.S. company at an inflated price.

Business entrepreneurs who have a serious interest in setting up an offshore business need to have a physical presence in the foreign country, a license to do business there, employees, equipment and records of company transactions. Operating through an IBC will not suffice because an IBC is not permitted to conduct business in the country where it is organized.

The IRS has indicated unofficially that they will challenge arrangements whereby a U.S. person sets up an IBC in a foreign country, rents space on a web server in that country (or another foreign country) and then sits at a computer in the U.S. feeding information to the foreign based web site.

If you are able to establish a self sustaining business in a foreign country that is not just a paper shell and is not dependent on support operations from the U.S., then it may be possible to legally defer the payment of taxes on any profits until they are repatriated to the U.S. in the form of dividends or gain from the sale of stock in the foreign company. For most entrepreneurs, this will require that they move to the foreign country and live there for a few years.

And if you have a bone fide foreign based business, then you may be able to also accumulate a modest amount of income from investments without current taxation. But doing this requires careful "navigation" through a minefield of complicated tax traps for the unwary and uninformed.

Much greater "due diligence" is required to evaluate the quality of a foreign based web service than of one in your own country. And don't forget that if you have a dispute with the foreign web service, you are likely to have to seek recourse in a foreign court, with different rules. 

Vernon Jacobs
Copyright, 2003
July 21, 2003
 

About the authors: Vernon Jacobs is a CPA who provides tax accounting and consulting services for clients with international interests. He edits and publishes theonline International Wealth Protection Reports ..  J. Richard Duke , JD, LLM is an attorney who specializes in international tax law and is an Adjunct J. Richard Duke is a Professor of international tax law. and a practicing attorney in the international speciality.  He is a Consulting Editor for  theonline International Wealth Protection Reports Sponsored by Offshore Press, Inc.., Copyright, 2004, all rights reserved. Offshore Press, Inc., Box 8194, Prairie Village, KS 66208. Phone (913) 362-9667. Email to Offshore Press  Vernon K. Jacobs, Webauthor .