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Trends in E-Commerce Explosive Global Political Issue

FTA Annual Meeting Tax Issues Presented by Different Internet Business Models June 6, 2000 Karl A. Frieden, Partner (617) 330-4727 karl.a.frieden@us.arthurandersen.com. Trends in E-Commerce Explosive Global Political Issue.

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Trends in E-Commerce Explosive Global Political Issue

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  1. FTA Annual MeetingTax Issues Presented by Different Internet Business ModelsJune 6, 2000Karl A. Frieden, Partner(617) 330-4727karl.a.frieden@us.arthurandersen.com © 2000 Arthur Andersen All rights reserved.

  2. Trends in E-CommerceExplosive Global Political Issue • The taxation of the Internet is the most explosive issue in global taxation today. • Local taxation: U.S. Conference of Mayors; National League of Cities, National Association of Counties. • State taxation: The NTA project; National Governor’s Association, Federal Advisory Commission on Electronic Commerce. • Federal taxation: The Clinton Administration White Paper, Treasury Dept. software regulations. • International taxation: OECD, European Union, National Government Study Commissions.

  3. Trends in E-CommerceFive E-Commerce Trends • Borderless Commerce • Digital Commerce • The Hollow Corporation • Real-Time Commerce • Changing Business Models

  4. Trends in E-CommerceBorderless Commerce • Borderless Commerce means business can be done with anyone at any time and anywhere. Geography is irrelevant. • A sharp increase in cross-border transactions will lead to a significant increase in cross-border tax issues, particularly in relation to international income taxes, customs duties, VAT and sales and use taxes. • Both dotcom’s and clicks and mortar companies will need to cope with tax rules in numerous additional jurisdictions. • There has been a growth in small businesses (less than $10 million in sales) selling over the Internet from 200 in 1996 to 30,000 in 1999 to a projected 400,000 in 2003.

  5. Trends in E-CommerceBorderless Commerce • Borderless Commerce will also result in a significant increase in nexus and jurisdictional issues and litigation. • Dotcom’s are frequently located in just one jurisdiction. • Click and mortar entities can establish separate Internet subsidiaries.

  6. Trends in E-CommerceThe Digital Economy • Electronic commerce is generally defined as transactions that involve the exchange of goods and services by electronic means • Direct electronic commerce involves goods and services that are both purchased and delivered by electronic or digital means. • Indirect electronic commerce involves goods and services that are purchased by electronic means, but delivered in tangible form by common carriers or some other traditional form of delivery.

  7. Computer software Books, magazines, and newspapers Movies Music (MP3) Financial transactions Teleconferencing & Videoconferencing Educational & training materials eMail Information services Bulletin boards & Chat rooms Certain telecommunications services Electronic banking Electronic stockbroker Games Business & Medical databases Remote medical diagnosis Remote Repairs Trends in E-Commerce The Digital Economy

  8. Trends in E-CommerceThe Digital Economy • The Digital economy will accelerate the trend toward a service-oriented, information-based economy. • Income and transactional tax rules related to the sale of services and intangibles are highly complex. • Tax rules are more easily applied to transfer of tangible property than to sales of digitized products. • Issues: Characterization of income, bundling of services and product sourcing rules, transfer pricing, etc.

  9. Trends in E-CommerceThe Hollow or Virtual Corporation • The Internet is accelerating the trend toward “hollow” corporations -- with narrowly defined core competencies. • Extensive outsourcing/partnering for functions such as manufacturing, R&D, customer service, shipping, transaction processing, etc. • Example: eMachines has 20 employees and over $1 billion in sales.

  10. Trends in E-CommerceThe Hollow or Virtual Corporation • New economy businesses are accelerating the trend toward an increase in intangible assets as a proportion of all corporate assets. • Technology, customer relationships, brand names, supplier relationships, etc.

  11. Trends in E-CommerceReal-Time Commerce • Compare over the Internet is in Real-time: a 24x7 business world. • More transactions are paperless • Real-time transactions will accelerate the trend toward automated transactional tax solutions. • Automated tax solutions will need to encompass both domestic and foreign transactional taxes.

  12. Trends in E-CommerceTransformation of Business Models • The revolutionary changes in business models create new and complex tax issues. • In 2004, E-Commerce transactions over the Internet will reach an estimated $ 3 trillion in the United States. • In 2004, E-Commerce transactions over the Internet will exceed $ 7.5 trillion worldwide.

  13. Trends in E-CommerceTransformation of Business Models • On-line catalogs • Virtual communities • Portals • Auctions • Reverse auctions • Subscription-based services • Infomediaries • Aggregators • Vertical markets

  14. Trends in E-Commerce ‘The future ain’t what it used to be’ --famous Yankee philosopher Yogi Berra

  15. Trends in E-Commerce Tax Complexities The U.S.: Collision of the Internet and Federalism • Internet first commercialized in U.S. • About 1/2 of Internet users in U.S. • Sales and use tax is largest single state tax revenue category. • 7600 U.S. state and local taxing jurisdictions. • Wide differences in sales and use tax base and tax rates.

  16. Trends in E-CommerceValue Added Taxes • Comparison to U.S. sales tax • No local taxes • No jurisdictional constraints • No multiple tax on inputs • No narrow taxable categories

  17. Nexus and Jurisdictional IssuesDe Minimis Physical Presence • The Quill and Wrigley cases. • Employee Presence: The standard is not clear: 2 days or 2 months. • Property Issues: Inventory, websites, licensed software. • Safe harbor for certain activities.

  18. Nexus and Jurisdictional IssuesAttributional/Agency Nexus • The Scripto precedent: solicitation activities performed by an • agent. • Pre-sales activities: marketing vs. solicitation. • Post-sales activities: repairs, installation, customer service, returns. • Web-site issues: hyperlinks; advertising vs. solicitation, local • market orientation, affiliate programs. • Drop shipments • Affiliate nexus

  19. Sales, Use and Transactional TaxesOverview • Borderless economy • Large number of new multi-state & multi-national taxpayers. • Indirect Taxes • VAT • GST • Customs duties. • Example: A manufacturer that becomes a retailer. • Example: A dotcom utility.

  20. Sales, Use and Transactional TaxesTangible Product Issues • Differential tax base • Broad differences in the taxation of consumer outputs. • Wide variations in the taxation of business inputs. • Seller or Agent. • Gift certificates.

  21. Sales, Use and Transactional TaxesDigital Products • 46 jurisdictions tax sales of tangible personal property. • There is a large variation in the breadth of state sales tax bases related to services and digital products. • Some states tax 100 or more service categories; some states tax virtually no services. • Goods and services delivered electronically are taxed under a number of different categories including telecommunication services, information services, computer services, cable television services and tangible property transactions.

  22. Sales, Use and Transactional TaxesDigital Products • Classification Issues • Narrow taxable categories • Bundling of taxable and non-taxable services. • Sourcing Issues • Location of the customer. • Sales to business customers - that utilize the product in multiple locations.

  23. Sales, Use and Transactional TaxesSales and Use Tax Simplification • Rising pressure for reform • One sales tax rate per state. • Uniform sales tax base. • Uniform or simpler administrative procedures. • More radical approaches: Base state system, real time or trusted third party approach.

  24. State Income Tax Issues Tangible Property Sales • For businesses selling tangible goods over the Internet, the traditional characterization and sourcing rules under the state corporate income tax will generally treat the products the same as before. • However, one major change is that businesses selling tangible property over the Internet will typically have more flexibility to locate their factors or production such as property or payroll in different jurisdictions so as to minimize state income taxes.

  25. State Income Tax Issues Digital Goods and Services • The state income tax rules regarding income earned from the sale of services or digital products are seriously outdated. • In this context, difficulties arise in the characterization of income, sourcing of income, and differential tax treatment accorded to tangible goods compared to services or electronic products. • The “income-producing” activity test is difficult to apply in a digital age.

  26. International Transactional TaxesValue Added Taxes • Transactional tax imposed on each stage of production or service delivery. • Credits for business inputs. • Broad tax base includes most sales of goods and services. • 15-25% tax rate in Europe.

  27. International Transactional TaxesVAT/Customs Duty Issues in a Digital Age • Sourcing issues: different rules for goods and services; different rules based on the location of the supplier; different rules for business and non-business customers. • Compliance burdens in a global economy. • Use of electronic invoices and recordkeeping • Customs duty issues - related to digital delivery.

  28. Federal and International Income Taxes Overview • Very little new law on the taxation of e-commerce. • Residence-based tax system. • Source-based tax system. • Comparison to state income tax rules: Apportionment vs. transfer pricing.

  29. Federal and International Income Taxes Overview • Permanent establishment issues • Classification of income • sale of personal property • services • royalty income • rental income • international communications income • Sourcing of income: Different rules for each category • Transfer Pricing

  30. For more information, see: Cybertaxation: The Taxation of E-Commerce,by Karl Frieden, published by CCH, March 2000 To order a copy of this book, please call or e-mail CCH at 1-800-248-3248 or www.cch.com

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