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13. Taxation and E-commerce

Direct Tax

It is unlikely that e-commerce will have any significant impact on direct taxation (e.g. income tax, corporation tax and taxes on profit) in practice.

The fundamental beauty of the Internet, from the perspective of those who wish to minimise their tax administration, is the ability to perform transactions at a distance. Selling electronically is an obvious opportunity for a business to either reduce or avoid a tax footprint outside the country where it is resident. A business will still be liable to tax where it is resident, but it does not necessarily have to have a taxable presence elsewhere to meet its commercial objectives.

Web sites and servers through which sales are made cannot constitute a taxable presence in another country.  A web site alone is not a fixed place of business and so does not create a taxable presence in another jurisdiction. Only if the business to which the web site belongs also owns or rents the server, and if the activity carried out via the web site is not within the normal exclusion for preparatory or auxiliary activities, will a taxable presence exist. In this instance, using an ISP to host a site allows a company to avoid having a taxable presence in any other country.

Indirect Tax

There are however important considerations for indirect taxation (e.g. Value Added Tax or sales tax) such as when different rates of tax apply to goods and to services. A book (a product) may attract one rate of tax, but in digital form be considered a service by the tax authorities and thus attract a different rate of tax. It should be noted that the EU recognises digitally delivered products such as software, digital music, digital books, etc as services.

VAT

The Internet enables companies to reach customers without regard for national boundaries. That said, cross-border sales must nevertheless comply with specific indirect taxation rules like Value Added Tax (VAT) and withholding taxes. Payment of VAT is determined based on what, where and to whom goods and services are sold. The rules within the European Internal Market differ for goods and services.

Goods

VAT and Goods

The VAT liability on supply of goods is determined by the physical movement of goods when a sale takes place and by the status of the customer. The way goods are taxed in respect of VAT is not affected by the growth of the Internet. The existing VAT system applies to goods purchased electronically and then delivered by traditional means.

Where a business established in the EU sells goods to a private citizen (i.e. not engaged in business) within the EU, the VAT rules for mail order apply. These are based on thresholds. Each EU country has a threshold of either 35,000 or 100,000 Euro per year. If a company’s sales of goods to consumers in another Member State exceed that threshold, the company must hire a tax representative in that Member State, register for VAT in that Member State, charge customers VAT at that Member State’s rate and have their VAT representative file VAT returns in that Member State. If sales are below the Member State’s threshold, VAT is charged at the rate applicable in the company’s country and is filed locally. There is currently a lack of harmonisation in VAT rates, with standard rates ranging from 15-25% in the EU.

Some individuals and organisations are considered “non taxable persons”. They include private individuals, public bodies, charities and some businesses with low turnover or wholly exempt activities.

Services

VAT and Services

The Internet is not only an efficient order management medium, but also a means of delivering a product itself. Customers can conveniently download any form of software such as digitised music or games, or other intellectual property such as training material or consultants’ advice. Such products are, from the perspective of EU VAT legislation, classified as supplies of services and so taxed as services. Moreover the EU mail order rules regarding turnover thresholds do not apply.

The current VAT rules for services do not adequately address the supply of services delivered on-line by digital means, notably in the case of services traded between EU and non-EU countries. At the time of writing, electronically delivered services originating within the EU are always subject to VAT irrespective of the place of consumption, whilst those from outside the EU are not subject to VAT even when delivered within the EU. This situation has the potential to constitute a major distortion of competition and to place EU service providers at a disadvantage in relation to non-EU service providers. However, this could soon change.

The European Commission has presented a proposal for a directive to modify the rules for applying VAT to certain services supplied by electronic means as well as subscription-based and pay-per-view radio and television broadcasting. The objective of the proposal is to create a fair market for the taxation of digital e-commerce in accordance with the principles agreed at the 1998 OECD Ministerial Conference. A basic principle of the EU VAT system is that no new or additional taxes are needed for e-commerce. Existing taxes should be adapted so that they can apply to e-commerce.

The proposal mainly concerns the supply, over electronic networks (i.e. digital delivery via the Internet), of software and computer services generally, as well

The proposal will ensure that when these services are supplied for consumption within the European Union, they are subject to EU VAT, and that when these services are supplied for consumption outside the EU, they are exempt from VAT. The proposal also contains a number of facilitation and simplification measures aimed at easing the compliance burden on business.

Non-EU operators would only have to register for VAT purposes where they undertake business-to-consumer transactions (a different regime applies to business-to-business). Where their annual sales to consumers in the EU exceed a minimum turnover threshold of 100,000 Euro, non-EU operators would be required to register for VAT purposes, but only in a single Member State (they could choose any Member State where they supplied services). They would then charge VAT at the rate applicable in the Member State they have chosen and only have to deal with a single tax administration within the EU.

The proposal is expected to be adopted by the end of 2001.

To help business to comply with the requirements laid down for invoicing in respect of VAT the European Commission proposed on November 20, 2000 a Directive on the harmonisation of the of rules on invoicing for VAT purposes.

The aim of the this proposal is to simplify, harmonise and modernise the rules on invoicing concerning VAT to be paid in the Community as well as to recognise the legal validity of electronic invoices.

The proposal contains a number of mandatory items to be included on all invoices (such as Invoice number, date VAT rate, total price etc.). It gives the supplier the possibility to send an invoice electronically (provided appropriate digital signatures are used) and to outsource in some cases invoicing operations. Guaranteed are principles such as free choice of the place and method of storing invoices providing immediate access, legibility and data integrity. A controversially discussed issue is the question whether advanced electronic signatures must be used when sending an invoice electronically. This provision was heavily opposed by industry because the infrastructure for using this kind of signature is not yet in place and the use would be extremely expensive.

When this problem is solved the proposal might be adopted by the end of 2001.

Withholding Tax

Many countries have withholding taxes on certain types of income originating within their borders. These are withheld at source by the payer and are usually based on gross revenues. For a business they are at best a cash flow cost but at worst a real cost if full credit for withheld taxes cannot be obtained against the business’s home country tax liabilities. The types of income to which withholding taxes are most typically applied are dividends, interest, and, more significantly for a company doing business electronically, royalties. Some countries, most notably those in the developing world, also have withholding taxes on service or technical fees paid abroad. However, no country has yet introduced a withholding tax specifically on income generated by electronic means, so a company will not, in principle, increase its exposure to withholding taxes by doing business on the Internet.