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Tax problems in relation to the Internet (American Overview)

Written by Jaime R. Ángeles

Sunday, 12 October 2008 15:21

“Inconsistent and inadministrable taxes imposed on Internet activity by sub national and national governments threaten not only to subject consumers, businesses, and other users engaged in interstate and foreign commerce to multiple, confusing and burdensome taxation, but also to restrict the growth and continued technological maturation of the Internet”. California Assembly Joint Resolution No.41 (January 2000)

As we all know we live in an era of rapid technological and social change. Technologies and businesses that were unknown a few years ago are now widespread. Most recently, the explosive growth of telecommunications technology, including the Internet, has enabled people to communicate and exchange information on an unprecedented scale.

These technologies present tremendous opportunities to enrich all of our lives in so many ways, many of which we are likely not to have envisioned. These new technologies bring with them social changes and new ways of doing business. Services are an ever-growing sector of the economy. Internet infrastructure allows information, services, and money to be instantaneously transferred anywhere in the world, and the traditional corporation could itself become obsolete in certain cases as "virtual corporations" have brought a particular form to make “Ebusiness” with the Internet as platform.

These technological advances put particular pressure on the principles governing the taxation of transnational transactions. It is the very nature of these developments that they tend to blur national borders and the source and character of income. Consequently, significant issues often arise regarding how the income arising from transnational transactions utilizing these technologies should be treated under current rules. As a result, it is possible that countries will claim inconsistent taxing jurisdiction, with the attendant possibility that taxpayers will be subject to international double taxation. If these technologies are to achieve their maximum potential, this must be avoided. Our overall tax policy goal in this area should emulate policy in other areas -- maintain neutrality, fairness and simplicity -- a policy which serves to encourage all desirable economic activity new and old.

We have to consider that the information and communication technologies, which underlie this new way of doing business, open up opportunities to improve global quality of life and economic well being .

We pretend to present some cases in America about the Internet and the tax issue. In some countries there are legislative initiatives, in others they are attempting to use real brick-and-mortar rules to a digital world.

United States

Today figures of Electronic Commerce in the United States are considerable, and take us to the field of consideration of “what is going to happen with the Government (tax) regulations”. The United States Census Bureau estimates that in the second quarter of 2002 the e-commerce represents 1.2 percent of the total of the retail sales in the United States, going up to a number of US$9,378 millions. The figure of the fourth quarter of 1999 was a high of 0.6.

Government authorities have claimed their share of taxes in those figures because the book bought over the Internet, that magically appears in front of the customer, it will still be delivered on roads maintained by the States.

Currently, states are prohibited from collecting existing use taxes from remote, online sellers. States can only require sellers that have a physical presence or "nexus" in that particular state to collect these taxes. This patchwork of roughly 7,500 state and local tax jurisdictions jeopardizes Main Street bricks-and-mortar retailers and state revenues and is extremely cumbersome to businesses in today's new economy. A University of Tennessee study showed that the inability to collect sales and use taxes on remote sellers would cost states more than $20 billion per year beginning in 2003 . Other studies of uncollected sales and use tax estimate that the losses for all Internet sales for 2000 was between US$0.3 and US$3.8 billion and that the loss for 2003 would be only between US$1.0 and US$12.4 billion (5% of projected sales tax revenue). Even the lowest figures presented, express the importance of the Internet tax matter.

The United States has, as many other Countries different problems, or situations to control on the Internet Tax issue:

A. The treatment of remote purchases vs. locals (same / outside states)

B. Difference between tangible and intangible goods. Status of services.

C. Sale and Use tax

D. Constitutional control on interstate commerce

E. Technologies

This enumeration is why we have to think that the Internet and e-commerce serve as a “wake-up call”. Some analysts consider that is time to improve and update the existing tax systems as the United States pick up the pace in moving from the industrial era to the information age.

The problems of on line sale taxes do not started with the Internet sales. The tax wedge between local and remote purchases, actually began with catalog sales in earlier decades, means shoppers can buy locally and pay sales tax, or they can buy remotely and, more often than not, avoid paying sales or use tax on the purchase. The tax differential can amount to a discount of up to 10 percent, everything else equal.

The concerns of collecting sales and use tax on out-of-state purchases, particularly the adverse impact to main street retailers and subnational governments were addressed in the 1965 Willis Report in the US Congress.

What are the constitutional limitations on when interstate commerce may be taxes by state governments and / or related to tax collection? State taxing authority has been successfully challenged on constitutional bases in the context of levying state use taxes on out-of-state vendors reaching in-state purchasers by mail order or telephone order .

In Quill Corporation v. North Dakota , involved a seller of office equipment and supplies (Quill), a Delaware (USA) corporation, with offices and warehouses in Illinois, California and Georgia. Quill did not have any property or employees in North Dakota. Quill sold office supplies and equipment to customers in North Dakota. Quill mailed catalogs to these customers and advertised in national magazines. Under North Dakota law, Quill was required to collect use tax on its sales made to North Dakota customers because quill was engaged in regular solicitation of customers in the state. Quill challenged the North Dakota law as violating both the Due Process Clause and the Commerce Clause of the U.S. Constitution. North Dakota challenged a U.S. Supreme Court that had previously addressed the “minimum connection” requirement of the Due Process clause , because a company doesn’t need a salesperson in a state to obtain a sale. Instead a catalog and a mail-order system an be just as successful for a company .

North Dakota was partially successful in its argument because the Court stated that it would be more appropriate to not focus on physical presence, but to instead look at whether the company’s contacts with the state make it reasonable for the state to require the company to collect use tax. Despite the Court’s relaxation of the due process physical presence requirement, the Court stated that North Dakota’s enforcement of the tax against Quill was an unconstitutional burden on interstate commerce in violation of the Commerce Clause. However, the Court pointed out that because the Constitution gives Congress the right to regulate interstate commerce, Congress could provide a mechanism to allow states to collect sales and use tax from interstate mail-order business that was not physically present in the state, without violating the Commerce clause.

This decision generated the idea of “necessary nexus” with the state to be taxable and also how much physical presence is needed, or what type of presence is needed. The answers of these questions depend on the law of each state because some states have specifically excluded some types of presence from creating tax obligations.

The U.S. Congress is entitled to overturn the Quill decision, but doing so in these moments, could impede interstate commerce and the growth potential of e-commerce, because the great number of sales tax jurisdictions in the U.S., and it would create a need for a multistate business to comply with a multitude of rules, forms audits, etc., would no doubt impede interstate commerce. Some legislative attempts have been generated .

Another interesting aspect, in the USA, is about the taxes and services. The services are only taxable if specifically enumerated; for example, all states currently tax canned software. Some states amended their tax laws to enumerate that sales of software and information processing are taxable events. Other states relied on the existing tax structure and argued that diskettes are tangible property that is taxable unless otherwise exempted. Therefore, in 16 states the sale of canned software in tangible form is taxable but the sale of digitized canned software is not taxable, allowing firms to determine the taxability of this intermediate input by varying the means of delivery .
The Department of Taxation and Finance relied upon the New York State Tax Law, sections 1105(a) and 1110(a)(A) for the proposition that “sale of digitized music recordings over the Internet constitutes the sale of intangible property and is not subject to sales or compensating use tax.”
This opinion cited The Stock Market Photo Agency, Inc., Adv Op Comm T & F, November 12, 1999, TSB-A-99(48)S, which held that the taxpayer’s “receipts from the electronic transfer of digital photographic images over the Internet represents receipts from the sale of an intangible and are not subject to sales tax.” The Department also ruled that information and entertainment services are not considered taxable services when distributed via Internet.
In July 1997, the White House released a paper covering various legal and operational aspects of electronic commerce. The principles of the actual IFTA were present when they said that “no new taxes should be imposed on Internet commerce”. Also stated that taxation of e-commerce should follow current principles of international taxation, should avoid double taxation and be simple to administer and easy to understand.

Moratorium Law – Internet Tax Freedom Act (ITFA)

The United States enacted the Federal Internet Tax Freedom Act (ITFA, P.L. 105-277, 10/21/98) that imposed a 3 year moratorium (from 10/1/98 through 10/21/01) on state and local taxes on Internet access, unless such tax was generally imposed and actually enforce before October 1, 1998. States with this exception are Connecticut, Hawaii, Montana, New Hampshire, New Mexico, North Dakota, Ohio, South Dakota, Texas, Tennessee, Washington and Wisconsin. This moratorium was extender to November 1, 2003 (H.R. 1552, signed by President Bush on 11/28/01), with a change of name Internet Tax Non-discrimination Act (ITNA).

The Act has four main provisions:

1- Beginning in October 1, 1998, the Act imposed a three-year moratorium on

1-a) "Taxes on Internet access"
1-b) "Multiple or discriminatory taxes on electronic commerce."
1-c) “Bit Tax”

2- The Act established a 19-member Advisory Commission on Electronic Commerce (the Commission), composed of members from the federal government, local and state governments, and appointed representatives of the electronic commerce industry who are selected by the majority and minority leaders in the House and Senate.

The Commission's principal directive is to undertake a "thorough study of Federal, State and local, and international taxation and tariff treatment of transactions using the Internet and Internet access and other comparable intrastate, interstate or international sales activities." The Commission's had to submit a report outlining its findings-including legislative recommendations on Internet taxation-no later than 18 months after the enactment of the Act, or April 21, 2000. The Commission failed to reach a consensus and its report was issued to Congress in March 2000 with less than the required supermajority vote required by the Law. The Congress could not take further action on the ACEC report.

3- The Act states that it is the "sense" of Congress that no federal taxes on the Internet and Internet access should be enacted during the three-year moratorium. In other words, the federal government should not tax the Internet at the same time that it is prohibiting state and local jurisdictions from doing so.

4- Finally, the Act urges the President to seek to enter into trade agreements that "remove barriers to global electronic commerce."

The moratorium applies to multiple or discriminatory taxes on e-commerce. Exceptions: a) Persons or entities who knowingly communicate via the Web in interstate or foreign commerce for commercial purposes, materials that is harmful to minors (with some exceptions); b) Internet access provider who doesn’t offer screening software to limit access to material that is harmful to minors.

The IFTA preserves state and local taxing authority to the extent the particular tax is not covered under the moratorium.

Streamlined Sales Tax Project

The lack of consensus in the ACEC originated a “minority report” . This report explains the minority’s concerns with the majority report, lists several principles that should guide reform and lays out a proposal for state and local governments to address issues of applying sales and use taxes to e-commerce. Together with the suggestions of the National Governors Association (NGA) , created a Model Act and Agreement for a uniform sales and use tax act, with the idea to simplify the sales tax collection burdens on remote sellers in return for Congressional authorization (openly invited by the Supreme Court in the Quill decision) to impose tax collection responsibilities on remote sellers . The name of the project is Streamlined Sales Tax Project (SSTP). At this moment 38 States are involved in the SSTP and the work is being conducted through four work groups dedicated to:

a. Tax Base and Exemption Administration
b. Tax Rates, Registration, Returns, and Remittances
c. Technology, Audit, Privacy and Paying for the System
d. Sourcing and Other Simplifications

The differences that continued among the States originated that the National conference of State Legislatures (NCSL) created its own SSTP model legislation. As some States have modified for their legislatures this project. Actually, there is another attempt to unify all the bills. Some states have approved a model legislation and are trying to launch a pilot to seek experiences.

The simplification issue will continue on the table in the United States. Various simplification techniques have been proposed, such as:

a) Third-Party Collection .- Under the leadership of Utah Governor Mike Leavitt, the NGA has drafted a detailed and highly complex proposal that would establish one or more "Trusted Third Party" clearinghouses that would collect and redistribute taxes on every Internet purchase. Before a sales transaction is complete, the clearinghouse would receive information about the purchaser, product cost and description. Using software that includes information on all state and local taxes, the clearinghouse would send back to the vendor the amount of tax to be added, collect the tax and, after deducting a fee for itself, pay the taxes.

The Trusted Third Party concept has several promising elements: It takes the burden off the businesses, it avoids creating another federal bureaucracy and it allows technology to lead us out of the morass. Also a credit card company or other transaction-processing company might charge, withhold and remit sales tales for all states imposing sales taxes on behalf of remote sellers.

It is also fraught with some staggering challenges:

a) The number of taxing entities in the United States, each of which would need to be kept up-to-date;

b) In addition, definitions of taxable items vary: For example, 18 states charge a sales tax for clothing, but within those 18 states, definitions of what comprises clothing vary greatly.

c) National Sales Tax.- Because use taxes are so difficult to collect, and because of the logistical difficulties of a Trusted Third Party proposal, some people are proposing a national sales tax. Other than an additional burden on businesses, the system would be straightforward, uniform, and simple to collect. More significant snags appear with redistribution of a national tax. First, most states have already experienced the left hand of the feds taking away and the right hand giving back pennies on the dollar. Also, the per-capita redistribution will not seem equitable to states that do a higher volume of e-commerce, such as California. Even with those problems, it is the easiest proposal to implement. But getting Congress to enact a national sales tax would probably be about as easy as outlawing baseball.

d) Proxy Tax .- Another option is to forget the whole sales tax idea and add another tax on the telecommunications structure -- ISPs, local providers, land and cellular lines and equipment. While this would avoid the complexities of sales and use taxes, the telecommunications industry, which is already heavily taxed, would object vehemently, and with good reason, to becoming a whipping boy for the Internet sales tax dilemma. The international issue of tax collection problem has not been directly faced in the United States. Negotiations with major trading partner should commence.

Canada

Canada authorities are convinced that specialized Ecommerce tax should not be imposed, in order to help the develop of Ecommerce itself. The Advisory Committee on Electronic Commerce recommends that tax authorities continue to tax electronic commercial transactions in accordance with existing tax legislation. Enforcement processes should be bolstered, especially with respect to intentional non-reporting, to ensure widespread compliance. Furthermore, to ensure a harmonious global tax regime, international cooperation is strongly encouraged.

The Canadian doing business abroad are affected by the tax situation in the United States, as the largest Canada’s trading partner. In dealing with income, consumption, and import taxes levied in 50 states on a variety of bases, as well as a number of municipal tax systems, Canadian businesses run the risk of unintentionally not reporting income, facing double-taxation possibilities, and bearing a significant compliance cost. Canada currently negotiates tax treaties to resolve double-taxation possibilities between jurisdictions. Greater emphasis will be required on the important role of the Departments of Revenue and Finance in advancing the interests of the federal, provincial, and territorial governments, as well as Canadian business, in the international arena, especially in negotiating multilateral income tax agreements and a coordinated/cooperative consumption tax arena.

Collecting the taxes is always an important issue. Two concepts that were raised in the course of the Committee’s review of issues and its subsequent deliberations on recommendations were a “bit tax” and a formulary apportionment tax system.

In simple terms, a bit tax , as explained in the US IFTA Law, is a form of consumption tax (or tariff) levied on the transmission of digital information. The concept of a bit tax is contrary to one of the fundamental principles in Ecommerce — not imposing new taxes on electronic transactions. Furthermore, the concept of a “transaction tax” on the flow of electronic information, without regard to the value of that information, could create economic anomalies, taking into account the size of the messages: An important financial transaction may take less bytes than the transfer of a movie, and the tax might not be in accordance of the transaction made.

The Formulary Apportionment Tax System is another point to review. Interjurisdictional conflict is present in the Tax problem over the Internet. Canada has warned that Electronic commerce exacerbates the possibility of multijurisidictional tax on the same transaction or the same profit. The solution to this problem would be international cooperation and agreement on the appropriate sharing of tax revenues between competing jurisdictions.

In the course of its deliberations, the Advisory Committee on Electronic Commerce Committee discussed whether Canada should consider advocating a new approach to international allocations of income, profit, and tax base. One such approach would be a global formulary apportionment of the worldwide income of enterprises conducting business in several jurisdictions. Canada already uses a version of formulary apportionment to allocate income between provinces for domestic income tax purposes (part IV of the regulations to the Income Tax Act).

As it has been developed , a global formulary apportionment tax system would allocate the global profits of a multinational enterprise (MNE) group on a consolidated basis among the various corporations that comprise the MNE and among the various jurisdictions in which they conduct business, on the basis of a predetermined and mechanistic formula. The same formula could be applied to allocate profits of a single enterprise conducting business in several jurisdictions.

There are three essential ingredients to a global formulary apportionment system:

• Determining the entity to be taxed — which of the subsidiaries or branches of the enterprise should be included in the global taxable entity;

• Determining the global profits — especially when different jurisdictions have different rules for measuring income and loss; and

• Determining the formula for allocating those profits among the competing jurisdictions.

Global formulary apportionment requires — that is, the arm’s-length principle. More important, it could lead to an unfair allocation of taxes on profits among countries.

We consider that this task is almost impossible to accomplish, taking into account: a) The need of an strong international consensus; b) it would not eliminate the risk of double taxation, c) it is doubtful whether it would be easier to administer than the current status and c) the amount of enterprises doing business over the Internet. The United States example on SSTP should be reviewed to follow its experiences.

Goods and Services Tax (GST)

A Canadian purchaser who acquires a product from a foreign supplier does so through a wholesaler or distributor located in Canada. The Goods and Services Tax (GST) regime, like most commodity tax regimes, imposes the obligation on the vendor to collect GST from the customer and remit the tax to the government. Reporting requirements, handling of remittances, and enforcement/verification processes are all currently focused on the registrant suppliers. The company that has no resident in Canada definitively will not accomplish Canadian rules.

Under the GST regime, where a business acquires products or services outside Canada and tax is not collected by the vendor or Customs, the business is required to self-assess and remit the required GST, so long as the business would not be entitled to claim a full input tax credit. Where an individual consumer is involved, self-assessment, although technically required under the GST regime, rarely occurs.

In that particular issue the Advisory Committee on Electronic Commerce has recommended that even if faced with loss of GST revenues due to the failure of consumers to self-assess GST on their purchases over the Internet, the Government of Canada should avoid the temptation to react by imposing additional onerous collection and registration requirements on electronic commerce vendors. Also, Revenue Canada should consider the feasibility of developing a communication strategy to make small businesses and consumers aware of their obligations to self-assess GST in situations where it will not be collected by the vendor or Customs. The Administration in Canada should develop a communication strategy for non-resident vendors to encourage them to register to collect and remit GST. A description of the benefits of registration should be included, along with a commitment from Revenue Canada that registration, in itself, will not be considered to result in Canadian income tax obligations for the vendor.

The report also express concerns, that exists not only in the Canadian Government, but in authorities world wide, about:

a. The “Duty” to be paid by tangible goods that pass customs, and also the record keeping in Ecommerce transactions;

b. Electronically kept records should be accepted, and if the taxpayer converts the records from one format to another, it is his responsibility to ensure that the converted records are accurate and readable;

c. Certain concerns on encryption of the records have been also expressed.

In Canada, in the point of identifying the “non-filers”, it has been recommended that the Authorities start an active campaign to locate non-filers to include electronic commerce activities. It should consider programs to identify businesses conducting Internet commerce, such as:

a. Accessing the domain registry and identifying domain names for Canadian businesses;

b. Establishing a system that identifies Canadians doing business over the Internet;

c. Developing compliance programs based on the population and results of previous audits of businesses with a presence on the Web (risk management); and

d. Developing WebCrawler software to trace non-filers to complement existing programs.

Also it has been recommended that Revenue Canada should review current penalties for non-compliance, to use it as deterrent. The financial institutions might help in identifying the non compliers, because the method of payment would be always through a Bank (Ecash, credit cart, debit card, check, etc.). The simplification mentioned in the USA regime is the same position as this recommendation of the Canadian Committee.

Peru

In Peru exists the “sales tax”, called General Sales Tax (IGV), similar to the Value Added Tax (IVA) of other jurisdictions. This tax is due at the moment of the sale, on the date of emission of the receipt, or the moment of delivery of the goods, the event that occurs sooner. If it is a sale of trademarks, patents, copyright, or similar, the payment dates are fixed for the payment of the IGV. The Peruvian rule of sales receipts states that if the sale of (tangible) goods is made over the telephone, internet, fax or similar media, the receipt should be issued the date of the payment and handed over to the customer with the delivery of the goods. The rule mentioned does not accept electronic receipts, generating a difficult situation for the logistic of the electronic sales in Peru.

In the Peruvian case, the Law of the IGV imposes a Value Added Tax (IVA) to the tax payer that uses in the country services rendered by a non-domiciled (person). If the service is rendered by a non-domiciled person and used (or consumed) by a tax payer domiciled in Peru, such tax payer is in the obligation to pay the tax, regardless the place where the supplier of the service is located

Venezuela

The Official Decree in Venezuela considers that the Internet is priority policy for the development and adaptation of the administrative activity. That is why mandates the use of internet technology to the Governmental agencies in the development of their activities and goals. The new Tax Organic Code (Gaceta Oficial No. 37.305, o/d October 17, 2001) enables the interchange of digitalized information between the Tax Agency and the tax payers. Nevertheless, it seems there are some situation, at discretion of the authorities, where physical documents are mandatory. Specific rules should be enacted to control the notifications to and from the Tax Agency in order to protect the rights of the citizens declaring their tax obligations.

Dominican Republic

The Dominican Republic (D.R.) Tax Law (11-92 o/d May 16th, 1992, G.O.9835) states that Income Tax should be paid for gains made in the D.R. , by persons or companies regardless if they are legal addressed in the D.R. . Also the Sales Tax (Tax over the transfer of industrialized goods and services – ITBIS from its initials in Spanish) is imposed over all sale of industrialized goods and all serves and rent of services . The wording of Law 11-92 includes all type of transfer / negotiations of industrialized goods and services.

Going to the Internet sales, the companies making business in D.R. with or without the Net, selling goods, offering services (tangibles / intangibles) are subject to retain and pay to the Administration the ITBIS generated by the transfer operation. The obligation of the ITBIS starts when the good is “delivered” . Regarding services, the ITBIS is due when the “render” of the service has ended. . In both (goods and services) the ITBIS should be paid, also, when the invoice is “issued” . In business over the Internet this generates a big gap for the administration, because the invoice could be issued (any where in the world) and not delivered to the customer . The obligation is similar to the Peruvian situation, but the Dominican authorities has a lack of specific regulations to the Internet sales, as mentioned above in the explanation about Peruvian situation.

The problem in the D.R., as we have seen, is not what type of transaction is subject to the sales tax – ITBIS, it would be collection, and the difficulty to enforce the operations of a company, that only make business over the web with the major target in the Dominican market (located in or outside the D.R.). Technically the company that sold the goods or rendered the services subject to the ITBIS should make a monthly declaration and payment of the amounts retained. As in the Canadian situation, a registration is mandatory with the Dominican Authorities in order to render the ITBIS. We consider that the supervision of these operations are difficult for the Dominican Internal Revenue Office, due to the tradition high evasion, and the impossibility to obtain the registration for all the companies doing business electronically in the Dominican Republic and located outside the Island.

Another important topic with the Internet taxes in the D.R. is that all telephone services, not only are subject to the ITBIS, as explained above, but to a 2% contribution to the telecommunication fund administrated by the Dominican Institute of the Telecommunications – INDOTEL. All telephone / Internet / cable connection invoice reflects the 2% paid to the telecommunications company .

Talking about the D.R. we have to make a quick reference on the new digital signature law, just approved by the Dominican Congress. It has a flavor of the bill of the United Nations Committee on International Trade Law (UNCITRAL), with important definitions on Digital signatures , and Data Messages . It also contains the principle that the validity of the information will not be denied for the only reason that is reflected in a “data message”.

The data message is considered “entire” when it has been complete and unaltered. The reliability required will be decided – by the judge – taking into account for what reason the information was generated and all the relevant circumstances of the case. This law recognizes the validity of the transactions expressed through a data message.

As the model of UNCITRAL, the Dominican Law pays attention to the Certification Entities of the digital signatures and the governmental agency that is going to supervise these entities.

Conclusion

The United States is the country, in the Hemisphere, with more complex advances in the affair of Tax / Internet. Their Constitutional issue to collect multijurisdictional taxes has to be solved. That is why the states are mobilizing to continue the process of simplifying sales tax systems. The vehicle of collection the taxes should be reviewed with the international regimes.

Taxes over the Internet sales should be included as negotiation topic in the agendas of the free trade treaties being formed at this moment in the Americas. The Free Trade Agreement of the Americas (FTAA) should be updated in order to have a new treaty with new rules, not old rules for a new type of business as e-commerce.

In general, even though there is the consideration of “not taxing the internet”, we all know that if the new economy goes on that road, there is no way that the governments are going to continue only with the brick-and-mortar model of collecting taxes. New forms of business (e-business) are going to be targeted by new way of taxes. The incentives needed to expand Ecommerce are going to end soon. And international collaboration is needed to define the e-collection of taxes for two reasons, first to make it feasible (the collection) and also to impede the discrimination and abrogation of sovereign authority of less developed countries.