Bachelor Dissertation D.J. Françoijs 325571
How Can The International Problem of Taxing E-commerce Best be Solved?
How Can The International Problem of Taxing Ecommerce Best be Solved?
Bachelor Dissertation D.J. Françoijs 325571
How Can The International Problem of Taxing E-commerce Best be Solved?
Index
1 Introduction
1.1
Objective
1.2
Approach
1.2.1 On the possibility and desirability of taxation
1.2.2 Progress on and feasibility of International framework
2 E-commerce and its Taxation
2.1
Basics of E-commerce
2.2
The issue of taxing E-commerce
3 The Taxability of E-commerce
3.1
Principles of Taxation relevant to E-Commerce
3.2
Issues When Taxing E-Commerce
3.2.1 Digitalized Goods
3.2.2 Physical Goods
3.3
Proposals for Taxation of E-Commerce
4 Is Taxing E-commerce a Good Idea?
4.1
The Revenue Loss Argument
4.1.1. The United States
4.1.2. The European Union
4.2
Other Arguments
5. Towards an International Framework
5.1
International progress on handling e-commerce taxation
5.2
Reactions by National Governments
6. Conclusion
7. Sources
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1. Introduction
1.1 Objective
As we shall see in the first chapter of this research, taxing international ecommerce is not a straightforward job. There are some key differences between
regular trade and cross-border trade through e-commerce that make taxing it a
difficult job. Therefor, in this research I would like to find out; how can the
international problem of taxing E-commerce best be solved? But how do we
define “best”? Besides referring to a solution that is economically efficient, we
are looking for an outcome that is also feasible and that can be agreed on by the
international community. So what we are looking for is a mix of economic
efficiency, feasibility and international consensus.
1.2 Approach
How will we find our way towards the solution to this problem? We shall start of
with a chapter covering the basics of international e-commerce and the main
issues that arise when discussing the taxation of it. This so we can get a clear idea
of what kind of market we are dealing with. As further elaborated on below, we
shall then first discuss the possibility and desirability of taxing international ecommerce and continue to examine how an international framework might be
formed or is already forming.
1.2.1 On the possibility and desirability of taxation
Before looking at how to develop an international framework for the taxation of
e-commerce we want to go back to the economic basics. These consist of two
parts; the desirability to tax e-commerce on the one hand and the possibility to
do so on the other. We will start by assessing how feasible it is to actually tax ecommerce in order to find out if it would we possible to tax if we desired to do
so. There are some key differences between the e-commerce market and the
regular “brick and mortar” markets that provide us with some issues regarding
the set up of a taxation system. To assess the possibility of taxing e-commerce we
will first discuss the underlying principles of taxation. We will then use those
principles to evaluate the possibilities to tax the e-commerce market. A
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distinction between the physical and digitalized goods market will be made here
as different issues arise in these different e-commerce markets. Two specifically
innovative proposed solutions will also be evaluated on both their feasibility and
economic efficiency. Then we will have created a clear picture of what
possibilities we have to tax e-commerce and the pros and cons to such options.
To determine the desirability of taxing e-commerce we will start by determining
the main economic arguments in favour. The main argument in favour being the
possible substantial loss of tax revenues for governments. We will separately
discuss the EU and the US case, as there are some key differences there. Then we
will determine why it might be economically desirable to provide tax
preferences to the e-commerce market. Here we will discuss the infant industry,
externalities and optimal taxation arguments and determine their individual
relevance to this discussion. Afterwards we will be able to determine if it is
economically efficient to tax in some form or if it might be better to not tax at all.
1.2.2 Progress on and feasibility of International framework
After we have formed an accurate view on the desirability and possibility to tax
e-commerce it is a logical step to afterwards research what has so far been done
by countries to solve this issue. We will first review what role the OECD has
played in this matter and how it has dealt with certain issues regarding the
alteration of the OECD model tax treaty or its Commentary. As the OECD is often
a guiding institution for overall tax guidelines it seems logical to review the
national responses to the taxation of e-commerce whilst comparing it to what
the OECD has put forward. We will then review the national efforts so far and
afterwards we will discuss the European Union efforts. Then we conclude on the
general trends present, if there are any, and evaluate the effectiveness of the
proposed/introduced measures. This is useful so we can afterwards form an
educated recommendation on how to move forward from here whilst keeping
the initial reactions by all countries in mind.
The successes and failures of the OECD efforts so far will then be assessed and
we will try to find suggestions for improvement of their role. We will also
consider what other possibilities might exist for international institutions to
guide or force certain tax legislations in order to convert the international
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taxation into a smooth operation. A comparison between formal and informal
organisations will be made and we will draw our conclusions as to what the ideal
international tax organisation would look like. The focus in this discussion will
lie on the OECD as the institution to do so as it has taken that role in the past. We
will not however overlook other possibilities and assess the OECD critically on
both their efforts so far and its suitability for the job at hand.
Hopefully we will in the end be able to answer our main question; how can the
international problem of taxing E-commerce best be solved? We will thus built
up to answering this main question by answering the various sub-questions just
described such as: Is taxing e-commerce a sensible idea? If this were the case,
what sort of taxation tools would we ideally use? Has the way the taxation of ecommerce has been handled so far by countries been effective? What could be
improved in their approach? If we want one, what kind of international tax
organisation would be ideal? Is the OECD a good starting point as an
international tax organisation?
2. E-commerce and its Taxation
2.1 Basics of E-commerce
In 1969 the United States Department of Defence Advanced Research Projects
Agency created a network system that would later become know as “the
Internet”. After the benefits of such a system were quickly recognized by the
academic
community
in
the
1980’s,
the
dramatic
improvements
in
telecommunication technology and the emergence of the “World Wide Web” led
to the first recognition of commercial usage of the new Internet technology in the
1990’s.
This rapid technological development has enabled the Internet to
basically handle any kind of digitalized information. This means the commercial
sector now has the ability to reach millions of people from all around the globe.
Along with this, the share of commerce being conducted electronically has
experienced an astounding growth over the last decade.
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Where in 1998 the global market for e-commerce sales was estimated at $26
billion by the OECD (1998)1, by 2010 this had become $572,5 billion and the
predictions indicate it to grow to $963 billion by 2013 at a compounded annual
rate of 19,4% from 2010 to 2013. The US, Europe and Asia are currently
responsible for most of the e-commerce conducted, about 85%. Especially in Asia
the e-commerce retail market is currently exploding. Where in 2010 it was
estimated at $155,7 billion, forecasts indicate it to have more than doubled by
2013 to $323.1 billion; this is an annual growth rate of 27,5% as found by
Goldman Sachs (2011)2.
Before looking further into this matter it might be useful to define what we mean
exactly when using the term “e-commerce”. The official OECD statistical
definition states the following: “Electronic commerce refers to commercial
transactions occurring over open networks, such as the Internet. Both businessto-business and business-to-consumer transactions are included.” 3 These
transactions named can include electronic data interchange (EDI), online retail
and electronic financial services. The World Trade organization (WTO) has not
given a formal definition of the term yet but says it is generally understood to
refer to any kind of transaction where electronic information gets sent over the
Internet/other means of telecommunications. As there are many different forms
of e-commerce, the main following distinction is often made when discussing a
certain transaction:
1. Business to business (B2B), a transaction between two companies.
2. Business to consumer (B2C), a transaction between a company and a
consumer.
3. Consumer to consumer (C2C), a transaction between two consumers.
Even though there are many more such categories (think of all possible relations
between companies, employees, citizens, governments etc.), these three are
currently covering the largest chunk of all e-commerce being conducted.
Scoffield, H., E-commerce Expected to Explode, OECD Says, Globe & Mail, Sept. 29, 1998
Techcrunch, 2011, JP Morgan: E-commerce revenue to grow by 19 percent in 2011 to $680B
[Online] Available at: <http://techcrunch.com/2011/01/03/j-p-morgan-global-e-commercerevenue-to-grow-by-19-percent-in-2011-to-680b/> (Accessed 19 June 2012).
3 OECD, 2002, Glossary of Statistical Terms: Electronic Commerce [Online] Available at: <
http://stats.oecd.org/glossary/detail.asp?ID=4721> (Accessed 19 June 2012).
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2.2 The issue of taxing E-commerce
Along with the rapid growth of this completely new market segment came
various challenges. One prominent issue that arose was the one of taxation. This
because business being conducted over the Internet is completely different from
any other form of business that previously existed. Businesses now have servers
(locations) all over the world and sell (digital) products all over the world. The
first discussion was on the desirability to tax e-commerce. It has been argued by
for instance Goolsby & Zittrain (1999)4 that since the Internet is still an emerging
industry, taxing it could have harmful effects on its development. There also
seems to be an argument for giving tax preferences to e-commerce because of its
alleged positive network externalities. This last effect is highly controversial
however and has been called neglectable by both Zodrow (2003)5 and Varian
(2001)6.
On the other hand governments argued that not taxing or granting tax
preferences to this industry could greatly harm the tax revenue received by the
state. This view is also more in line with the tax neutrality principle. But if we
want to tax e-commerce, how do we set up a tax system that actually works
efficiently? This might sound a bit strange as for centuries we have been able to
levy taxes on just about anything. The taxing of e-commerce is a thorny subject
though. As e-commerce usually involves transactions transcending national
borders it is interesting to question which tax jurisdiction to apply. Also, which
tax principle does one apply; is it more efficient to use the origin principle when
taxing e-commerce? Or might the destination principle be more economically
efficient? The choice that is made between these two principles has great effects
on how to best set up the administrative procedures required when taxing ecommerce.
Right when this issue became apparent, different solutions were proposed.
There was the “Bit Tax” proposing to apply a steady tax rate to all bits of digital
information being traded on the Internet. The European Union came up with the
Goolsbee, A., Zittrain, J., 1999, Evaluating the Costs and Benefits of Taxing Internet Commerce,
Harvard Law School, Research Publication No. 1999-03-05/1999
5 Zodrow, G.R., 2003, Network Externalities and Indirect Tax Preferences for Electronic
Commerce, International Tax and Public Finance, Springer, vol. 10(1), pages 79-97, January.
6 Varian, H.R., 2001, Economics of Information Technology, Working Paper University of
California at Berkeley. http://www.sims.berkeley.edu/~hal/people/hal/papers.html
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e-commerce VAT proposal, which says that banks should keep track of all online
sales, and withhold the tax from the sale and allocate it to the appropriate
government. The Clinton Administration came up with a variant on the European
proposal. This proposal requires consumers to buy e-cards to make online sales
and allows governments to immediately collect their tax revenue from the sellers
of these cards.
As it became clear that e-commerce was a truly international matter, the OECD’s
CFA (Committee on Fiscal Affairs) started to try and develop a framework of
conditions for the governments to sign. In 1998 the governments adopted the socalled “Ottowa Taxation Framework Conditions”. These conditions, in 2001, lead
to the CFA endorsing the “Guidelines on the Definition of the Place of
Consumption in the Context of E-Commerce” and later, in 2003, the
“Consumption Tax Guidance Series”. These were useful but later it became clear
that there might be a need to lay down some common rules agreed on by all
countries. The CFA is currently working on this to really make an effort to
eliminate all the difficulties that still arise within the area of cross-border ecommerce taxation. But is it desirable to have such an organization laying down
the rules for the entire international community? Might it be in some countries
their best interest not to participate in this framework and continue their own
effort regarding how to handle the taxation of e-commerce? How should the
OECD’s CFA proceed from here?
3. The Taxability of E-commerce
3.1
Principles of Taxation relevant to E-Commerce
Before we start looking in to the actual taxability of e-commerce it seems useful
to first discuss some tax principle that are relevant to e-commerce. This way we
will be able to understand certain issues better.
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“Tax Neutrality” is the first principle we shall discuss. It basically requires an
equitable tax system to tax the same economic income equally7. If applied to ecommerce, this would mean that income earned through activities concerning
electronic trade would have to be taxed in the same way as any other form of
income. Taxing e-commerce differently could give either e-commerce or on the
other side any other form of commerce a competitive advantage8. Thus to
maintain an equitable tax system, no “new” types of taxes should be levied on ecommerce9 as it is just new mode of distribution or marketing.
Most tax systems use the “Permanent Establishment” principle to determine
where a firm is located in order to be able to tax the company’s income10. It is
therefore relevant to know that permanent establishment actually refers to,
especially when researching the case of e-commerce where the term
“establishment” gets very debatable. The OECD Model Income Tax Convention
states that permanent establishment may be attained by a company within a
country through the existence of a broker or an agent there11.
The last principles we shall discuss are the so-called “Destination” and “Origin”
principles for commodity taxation as described by Frenkel et al. (1991)12. On the
bases of both of these principles countries tax companies. The destination
principle says that the destination of the good’s final consumption determines
the tax rate in order to level the rate for all consumption within a given tax
jurisdiction. Meaning that whilst exports remain untaxed, whilst products sold
and produced domestically and imports are taxed at the same rate. The opposite
holds for the origin principle. Goods are taxed based on where they are
produced; the location (or origin) of the producer thus determines the tax rate,
irrespective of the destination of the products. Thus here, exports and products
made and sold domestically are taxed at the same rate whilst imports remain
untaxed. In the case of a transaction where both parties belong to the same tax
Cigler, J.D., Stinnet, S.E., 1997, Treasury seeks Cybertax Answers With Electronic Commerce
Discussion Paper, 8 Journal of International Taxation 56, 58.
8 Owen, S., 1998, State Sales and Use Tax on Internet Transactions, 51 Fed. Comm. L.J. 245 (19981999)
9 Owen, S., 1998, State Sales and Use Tax on Internet Transactions, 51 Fed. Comm. L.J. 245 (19981999)
10 OECD, 1992, Model Income Tax Convention on Income and Capital, Article 5.
11 OECD, 1992, Model Income Tax Convention on Income and Capital, Article 5.
12 Frenkel, J.A., Razin, A., Sadka, E., 1991, International Taxation in an Integrated World,
Cambridge, MA: MIT Press.
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jurisdiction, the tax principle used will not matter. In the next paragraph we shall
see why these two principles are so important.
3.2
Issues When Taxing E-Commerce
When trying to tax any transaction taking place it is imperative that it is legally
verifiable that the transaction has actually taken place. This thus requires certain
administrative systems to ensure there is verification of each economic
transaction. This verification can direct or indirect. Direct verification means that
the tax authorities observe each transaction whilst indirect usually implies that
the parties involved in the transaction are being audited. Since individually
observing each transaction is highly costly, auditing or indirect verification is
mostly used in tax systems nowadays. This can either be done through auditing
households or auditing firms. Whilst auditing of households for income tax
purposes is effective, it is ineffective in determining how much of a certain good
is consumed. Research by Varian (2001)13 shows that compliance rates for use
taxes in households are indeed very low, especially in the US. Auditing of firms is
usually done already for other purposes than validating transactions for
commodity taxation. The marginal cost of acquiring the needed information in
order to levy commodity tax is thus very small. It thus seems efficient to raise the
commodity tax revenue through the auditing of firms.
For some products
however verification is sometimes necessary through registration of buyer
anyway. How these two different administrative procedures work out depends
for a great deal on whether it concerns digitalized or physical goods. We will
discuss the differences later in this paragraph.
As e-commerce is known for often transcending national borders and thus
having parties involved in the transaction that belong to different taxation
jurisdictions. It must then be determined which tax principle to apply, the origin
or the destination principle. This choice influences the administrative
procedures required to verify transactions. We shall now discuss these
verification (and thus taxation) issues separately for digitalized and physical
Varian, H.R., 2001, Economics of Information Technology, Working Paper University of
California at Berkeley, http://www.sims.berkeley.edu/~hal/people/hal/papers.html.
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goods. We shall use the work of Bo Sandemann Rasmussen (2004) as guidance to
discuss these issues as he has provided a clear analysis in his paper.14
3.2.1 Digitalized Goods
The problem with e-commerce generated by sales of digitalized goods15 lies in
two things. First, the Internet provides anonymity making it impossible to
identify the buyer. Second, digitilized goods are non-rival goods meaning that
they can be sold without reducing the possibility to sell it again to another
consumer. If the origin principle would apply (or both parties would be in the
same tax jurisdiction) the required verification could be acquired through the
auditing of the selling firms. But the usual accounting of the cost side of the firm
would not suffice as the tax authorities need to make sure which number of
transactions has taken place. They would thus have to go through all the
payments made by buyers into the company’s accounts to get the verification.
Although this is not impossible it could be regarded as an excessively costly
process. One might thus assume that e-commerce taxation revenues based on
the origin principle are low for digitalized goods. This because firms anticipate
on the tax authorities to not be willing to effectively audit the firms as it is simply
too costly for them.16
With the destination principle in force, tax authorities would have to verify
transactions through the monitoring of the buyers. This verification can basically
take place in two different manors; verify the transaction of the digitalized good
from one computer to another, or verify that the payment for the purchase of the
digitalized good has taken place. Highly skilled computer forensics are now able
to retrieve all history from a computer even if the user tried to erase all his
actions. But as this is very expensive the cost of this verification method can be
classified as prohibitively high and thus not viable. The other option is for the
tax authorities to get the information they need from the credit card firms. This
Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
15 Goods that can be transferred via the Internet fully electronically
16 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
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however will undoubtedly trigger the use of more anonymous payment methods
and thus make this option ineffective.17
We might thus say that when a transaction concerns a fully digitalized good it is
not likely to provide a state with much tax revenue, regardless of which tax
principle is in force.
3.2.2 Physical Goods
The difference between e-commerce and conventional retail, when it comes to
transactions involving physical goods, is that with e-commerce, the parties
involved are often from different tax jurisdictions. As opposed to retail trade, for
e-commerce, the choice of tax principle thus becomes important again. If origin
taxation is used for e-commerce in physical goods it is basically the same as
conventional trade. The permanent establishment principle does become
important, as it needs to be defined where the seller is based.18 This can be done
by identifying the location of the servers, storage or shipping facilities. The
verification then takes place through effective auditing of the cost side of the
firm, this is possible for physical goods as they are rival, contrary to digitalized
goods. The manor in which the good is delivered to the buyer does not matter for
the verification; the tax collection will be handled by the selling firm.19
The destination principle would require the tax authorities to verify transactions
by identifying the buyer of the physical good. The advantage physical goods have
over digitalized goods in this respect is that they have to be physically delivered
to the buyer, creating an obvious opportunity for verification by tax authorities.
If customs control is present in the tax jurisdiction of the buyer, verification
takes place when the good enters the jurisdiction. If this is not the case,
verification is still possible but has to be done by auditing the firm that provides
Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
18 Basu, S., 2007, Global Perspectives on E-Commerce Taxation Law, Hampshire, Ashgate
Publishing Limited.
19 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
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the couriers that physically deliver the good. It is thus possible to tax ecommerce using the destination principle.20
Some practical issues, regarding the administrative systems responsible for
levying the right amount of tax on a certain transaction, need to be considered as
different systems provide different economic incentives for both households and
firms. Obliging firms to take care of the tax collection poses a significant
administrative burden on them, thus presenting them with additional costs if
they join the e-commerce market. For households however, the choice of
administrative procedure influences the extent to which trading with foreign
unknown firms in uncertain, implying that if more uncertainty is created by the
procedure, households will most likely participate less in the e-commerce
market. There are basically three options to deal with this issue; the selling firm
handles the tax calculation and collection, selling firm calculates whilst courier
firm collects taxes or the courier firm handles all tax matters. All of these options
have their up- and downsides. If the sellers are obliged to handle the tax
administration it is likely that fewer firms will operate on the e-commerce
market as this a great administrative burden and thus cost. Fewer firms will lead
to less competition in the e-commerce market leading to higher prices for the
consumers. If the delivery firms handle the tax administration, it will lead to
more uncertainty amongst consumers on the final price of the good. This might
then lead to reduced consumer demand for goods on the e-commerce market.
We might thus conclude that it is formally perfectly possible to use both the
origin and the destination principle to tax physical goods in the e-commerce
markets. It could however be argued, based on the analysis presented above, that
setting up administrative procedures to do so will be more straightforward
under the origin principle than under the destination principle.21
The destination principle is however the principle preferred by the OECD22 as it
is considered to be more economically efficient according to both Frenkel et al.
Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
21 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
22 OECD, 1998, Ottowa Taxation Framework Conditions.
http://www.oecd.org/dataoecd/46/3/1923256.pdf
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(1991)23 and Diamond-Mirrlees (1971)24. In determining which principle to
finally use the efficiency benefits of the destination principle should thus be
weighed against the administrative benefit the origin principle seems to offer.
3.3
Proposals for Taxation of E-Commerce
No that we have an idea of what issues arise when trying to tax e-commerce it is
time to take a look at three proposed solutions to tackle these issues. Later on in
this paper we shall discuss what countries have actually done so far in this
respect.
One of the first concrete ideas that was presented to tackle the international ecommerce taxation issue was the “Bit Tax” as proposed by Arthur J. Cordell
(1997)25. He proposes a tax that applies to “bits” of electronic information being
transferred via telecommunication. A specified tax rate would be levied on
certain volumes of data and would be collected by the telecommunications
carrier companies. This however leads to issues such which flows of data to tax
and then to possibly over- or understating the taxes leading to violation of the
tax neutrality principle. The complete burden of taxation would also be on the
carrier companies who would have to compensate for the expenses made to do
so. There would also have to be an international agency overseeing that all tax
collection and distributing to the governments concerned goes according to the
rules.
Chances of governments accepting such grave regulation of their
telecommunication companies seems unlikely. It is therefor not considered to be
a viable option.26
Another interesting option for the international taxation problem was presented
by the Clinton administration back in 1996; it was called the “Clinton E-card
Proposal”.27 It is the cyber-alternative to the Value Added Tax as we know it.
Consumers can buy cash cards (E-cards) in physical retail stores to spend
Frenkel, J.A., Razin, A., Sadka, E., 1991, International Taxation in an Integrated World,
Cambridge, MA: MIT Press.
24Diamond, P.A., Mirrlees, J.A., 1971, Optimal Taxation and Public Production I: Production
Efficiency, The American Economic Review, Vol. 61, No. 1 (Mar., 1971), pp. 8-27
25 Cordell, A.J., 1995, New Taxes for a New Economy, Government Information in Canada, Vol. 2,
No. 4.2
26 Chan, C.W., 2000, Taxation of Global E-Commerce on the Internet: The Underlying Issues and
Proposed Plans, 9 Minn. J. Global Trade 233.
27 Department of the Treasury, 1996, Selected Tax Policy Implications of Global Electronic
Commerce, Paragraph 8.4. http://www.caltax.org/!treas-ec.html
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digitally via the Internet. The place of consumption can thus be identified and
VAT can be calculated based on in which tax jurisdiction the card is bought and
the tax revenue can afterwards be distributed to the correct government via an
escrow agent. This proposal had several advantages; it satisfied the tax
neutrality principle, preserved consumer’s privacy and kept developing
countries happy as it rewarded their governments if residents purchased online
goods from abroad. The main disadvantages were the concerns over the
functionality of the cards and if the inconvenience of having to buy an e-card
would harm the growth of the still developing e-commerce market. There were
also concerns over the possibility to hack the cards and other forms of possible
fraud. 28 This proposal was being taken very seriously back then but has
somehow never been able to fully develop and does not belong to the possible
solution currently being debated. We will discuss those in a later paragraph.
4. Is Taxing E-commerce a Good Idea?
4.1
The Revenue Loss Argument
Due to the issues previously described there has so far not been any serious
taxation of e-commerce. This whilst, as we have seen in the first chapter, online
sales keep growing at a very fast pace. An obvious concern for many
governments is if this migration from trade from regular channels to the online
community is harming their tax revenues. We have then also immediately
arrived at the main argument for taxing e-commerce. This tax revenue loss for
governments consists of; sales and use taxes on goods traded via the Internet
that can actually be taxed (fully digitalized goods are thus excluded) and it only
goes for goods traded via e-commerce that are substitutes for goods that were
taxable to begin with. To get a clearer view on how big of a problem this is we
will consider the risks of tax revenue losses for the two biggest players in the e-
Department of the Treasury, 1996, Selected Tax Policy Implications of Global Electronic
Commerce, Paragraph 8.4. http://www.caltax.org/!treas-ec.html
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commerce market, the US and the EU. They will be discussed separately as their
markets and tax systems differ substantially.
4.1.1. The United States
The taxation of goods in the US is quite complicated as the system is a mix of
both local and state taxes. It gets more complex as each individual state has its
own tax base and rate for commodity taxation and five states do not use
commodity taxation. The destination principle is used in the US meaning that
with within state transactions the seller whilst for interstate trade the tax is
collected at the buyer collects the tax. Companies must have nexus (physical
presence) in the state the buyer is located in to be able to collect the tax,
otherwise it is thus up to the buyer to report their purchase.29 Varian (2001)30
has found out that the compliance rate for these use taxes by buyers are
extremely small and can be neglected. As this use tax is no new kind of tax,
buyers are required, also under the Internet Tax Freedom Act (2003) 31, to pay
these taxes and by not doing so are essentially guilty of tax evasion. As not all of
the total revenue from use and sales taxes come from the B2C market in the US,
there is also an important share of sales tax revenue coming from the B2B
market. But as companies are usually carefully audited it seems unlikely for
them to have a low compliance rate and no losses in sales and use tax revenue
should be expected to arise there. 32 Bruce (2004) 33 found however that
compliance rates for B2B sales on the US e-commerce market were nowhere
near to perfect and he estimated them to be around 70%. This thus implies that
revenue losses are also present in that market.
The Supreme Court decided in 1992 in the so-called “Quill-act” that firms
operating in the e-commerce market need not to collect use and sales tax in
states they do not have nexus. Local governments and states have lobbied
Tax Foundation, 1992, Quill Case http://taxfoundation.org/blog/important-tax-cases-quillcorp-v-north-dakota-and-physical-presence-rule-sales-tax-collection
30 Varian, H.R., 2001, Economics of Information Technology, Working Paper University of
California at Berkeley, http://www.sims.berkeley.edu/~hal/people/hal/papers.html.
31 International Tax Freedom Act (ITFA), 1998, http://www.opencongress.org/bill/110h3678/show
32 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
33 Bruce, D., Fox, W.F., 2004, State and local sales tax revenue losses from e-commerce: Estimates
as of July 2004, State Tax Notes 33(7): 511-518.
29
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heavily to revise this act in order to have online retailers collect taxes in all the
states they have customers. In this discussion the amount of revenue being “lost”
due to this act is central. The estimated revenue loss presented by these parties
come from the much-cited Bruce et al. (2009)34 study and amount to $7.7 billion
in 2008 rising to $12,7 by 2012 (about 2.5% of total local and state sales tax
revenue). These estimates were judged to be to high by Eisenach and Litan
(2010) as they said the other study greatly overestimated the growth of the ecommerce market and underestimated the tax collection efforts of small
companies. They estimated the total uncollected (or lost) sales and use tax on ecommerce to be $3.9 billion in 2008 against a forecast of $4.8 billion by 2012.
They also claim that as a percentage of the total state and local sales tax revenue
the missed revenue due to e-commerce is actually declining rather than rising
rapidly as Bruce et al. claimed. The actual amount of revenues being lost thus
remains a widely debated topic.
4.1.2. The European Union
The EU in practice uses a Value Added Tax system with a mix of the destination
and origin principle for intra-EU trade of physical goods. The destination
principle is generally used and implies that the VAT rate of the country of the
buyer is used to determine the tax. EU companies thus need to register in all
other EU countries they do business with. If the total yearly sales to a country fall
below a certain level (between €35.000 and €100.000 depending on the size of
the other country35) the origin principle is applied. These rules sound clear but
the there is no clear system for enforcement. Companies that are established in
low VAT countries (VAT in the EU varies from 15% to 25%) might thus be
inclined to apply the local tax even after the level to which it should switch to the
destination principle has been reached. The seller’s country tax authority has no
incentive to monitor this and it is thus left to the buyer’s country tax authority to
do so. This is hard for them though as intra-EU trade encounters no custom
control. Firms could also easily create subsidiaries in order to spread their sales
Bruce, D., Fox, W.F., Luna, L., 2009, State and Local Government Sales Tax Revenue Losses from
Electronic Commerce, State Tax Notes 52(7): 537-558, May 18.
35 European Union, VAT Directive, 2006, Article 34. http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2006L0112:20110101:EN:PDF
34
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revenue and thus not exceed the threshold set by the EU. Given these
circumstances it is likely that a larger, than would officially be expected, share of
the intra-EU trade will be taxed according to the origin principle. The EU does in
this way not “miss” any sales tax revenue but might experience a revenue
redistribution from relatively high VAT countries to countries where the VAT is
lower. The trade in physical goods with companies from outside the EU is taxed
according to the destination principle and is handled through the customs
control and collected by the delivery company. This provides EU consumers with
more uncertainty regarding the final price of the goods they are buying from
abroad but lightens the administrative burden on foreign firms exporting to the
EU as they do not have to register in each EU country. No tax revenue loss should
thus be expected from this sort of e-commerce.
As of 2003, the EU introduced a new directive on the taxation of digitalized
goods36. This directive requires all firms located in countries outside the EU to
pay the VAT the country they export their digitalized goods to uses. EU firms
exporting to outside the EU will not pay any taxes whilst intra-EU trade of
digitalized goods is taxed according to VAT reining in the country the company is
located in. In order for this to indeed bring in additional tax revenue on sales
from countries that are not part of the EU it relies on foreign firms reporting
their sales to the tax authority of the country the buyer is located in. Given the
costs this would generate, given the present technology available, to verify these
sales, it is highly unlikely that foreign firm will actually do this. The new directive
makes this into tax evasion but it does not bring in additional sales tax revenues
from e-commerce in digitalized goods.37
We might thus conclude that the EU does not lose too much sales tax revenue
from the e-commerce transactions regarding physical goods. It might however
have to deal with the redistribution issue as countries with high VAT’s compared
to other EU countries will not like this. For digitalized goods the EU has taken on
the new directive but still it is likely that most of the goods belonging to this
group will not be taxed as evasion is simply too easy.
European Union, VAT on Electronic Services Regulation, 2003. http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2003:264:0001:0011:EN:PDF
37 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
36
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4.2
Other Arguments
Besides governments fearing that their sales tax base is being eroded, there are
more arguments to consider. We shall first consider an argument made that, just
as the tax revenue argument, supports taxation of e-commerce. Afterwards we
shall consider arguments that can be used against taxation of e-commerce or for
the cause of providing a tax preference to e-commerce.
Especially “brick and mortar” retailers are eager to equalize taxation of ecommerce with the traditional retailers. The main arguments here are the “tax
neutrality” principle and the functioning of the free market. Basu (2007)38
argued that tax equality is at the basis of the free market and not taxing ecommerce and traditional retail equally will result in unfair competitive
advantages for the e-commerce market. Many US retail firms have united
through the organisation “e-fairness” to fight the in their eyes unfair difference in
taxation between traditional retail and online retail. Rasmussen (2004) 39
counter argued this as most likely being firms that fear increased competition
with online firms. Others have also stated that it could lead to conventional
retailers migrating to the Internet and that if government would really fear
revenue losses they should consider adjusting tax rates downward for retailers
instead of thinking of new taxes for e-commerce.40
In the early days of e-commerce, in the 90’s, it was often argued that the industry
needed to be protected, as it was a so-called “infant industry” that needed to be
protected from taxation in order for it to develop properly.41 Goolsbee (2000)42
studied the effects of introducing sales and use taxation on e-commerce in the US
and found that it would dramatically decrease the e-commerce market and thus
Basu, S., 2007, Global Perspectives on E-Commerce Taxation Law, Hampshire, Ashgate
Publishing Limited.
39 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
40 Lukas, A., 1999, Tax Bytes: A Primer on the Taxation of Electronic Commerce, Trade Policy
Analysis, Issue 9.
41 Gilmore, J.S., 1999, No Internet Tax, A Proposal Submitted to the ‘Policies & Options’ Paper Of
the Advisory Commission on Electronic Commerce.
http://lobby.la.psu.edu/043_3%25_Excise_Tax/Organizational_Statements/Americans_for_Tax_
Reform/ATR_Gov_%20James_Gilmore's_No_Internet_Tax_Plan.htm
42 Goolsbee, A., 2000, In a World without Borders: The Impact of Taxes on Internet Taxes,
Quarterly Journal of Economics, 115 (May), 561, 576.
38
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might hurt its development. The growth of the e-commerce market has however
exploded since then and can now hardly be considered to be an infant industry
(approaching the one trillion mark in revenue) and in the beginning it has also
been argued that providing the e-commerce infant industry with special
treatments keeps it from maturing and thus would actually negatively influence
it.43
Subsidies and taxes are often used if certain externalities arise from a market. If
the consumption of a good provides negative externalities for other agents it will
most likely be the case that, in market equilibrium, the goods is too abundant
from a general welfare point of view. The other way around, for positive
externalities, off course works as well. Thus if enough positive externalities
would arise from e-commerce it could justify the non-taxation or tax preferences
for the market. Zodrow (2003)44 presented his research stating that positive
network externalities could arise as the more people join a network such as the
Internet the more valuable it becomes for everybody already involved.
Rasmussen (2004)45 has argued however that this argument does not hold. He
states that as the biggest users will most likely be connected to the Internet first,
as they have the largest private benefit regardless of the size of the network, the
marginal benefit of the positive externality of more people joining will most
likely decline from the point where the network has grown to a certain size. He
argues that there might be logic in providing a subsidy to users joining before
this “critical mass” is reached but that afterwards the costs will outweigh the
benefits and it is thus not an efficient measure.
5. Towards an International Framework
McLure, C.E., 1999, Electronic commerce and the state retail sales tax: a challenge to American
federalism, International Tax and Public Finance,Volume 6, Number 2 (1999), 193-224
43
44
Zodrow, G.R., 2003, Network Externalities and Indirect Tax Preferences for Electronic
Commerce, International Tax and Public Finance, Springer, vol. 10(1), pages 79-97, January.
45 Rasmussen, B.S., 2004, On the Possibility and Desirability of Taxing E-Commerce, University of
Aarhus, Working Paper No. 2004-08.
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As we have discovered in the previous chapters, taxing e-commerce is possible
and desirable. These findings themselves however, do not solve the international
problem of the taxation of e-commerce. We will try to find out in this chapter
how an international taxation system should ideally take shape. The progress
made by international institutions will first be assessed and afterwards we shall
take a look at how national governments have acted so far. Based on these
findings we shall evaluate the international efforts so far and try to formulate
what an international taxation system should look like in the future.
5.1 International progress on handling e-commerce taxation
Many global institutions such as the United Nations, the World Bank, the
International Monetary fund and the World Trade Organisation have all in some
way contributed to shaping international tax agreements. The most influential
organisation however is the OECD as its model tax treaty46 is used by both its
member countries as non-OCD nations for interpreting, negotiating and applying
tax treaties that are bilateral. The OECD employs a Committee on Fiscal Affairs
that is the main force behind tax reforms on an international level. Their main
document guiding the taxation of e-commerce is the Ottowa Taxation
Framework47 that was established in 1998. It is a set of principles guiding the
international taxation reform efforts by the OECD regarding e-commerce. The
main guiding principles coming from the Ottowa Taxation Framework were;
already existing tax principles for international trade should be unchanged
towards e-commerce, tax neutrality between traditional trade and trade through
e-commerce, the compliance costs/administrative burden for taxpayers/taxation
authorities, reducing tax evasion and it stated that due to fast technological
change the international tax rules needed to be flexible.
The OECD has also changed and is still changing the model tax treaty according
to the principles set in Ottowa to adapt to the rise of e-commerce. These changes
concern defining permanent establishment (including server locations),
OECD, 2010 (latest update), Model Tax Treaty. http://www.keepeek.com/Digital-AssetManagement/oecd/taxation/model-tax-convention-on-income-and-on-capital-condensedversion-2010_mtc_cond-2010-en
47 OECD, 1998, Ottowa Taxation Framework Conditions.
http://www.oecd.org/dataoecd/46/3/1923256.pdf
46
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characterization of income and across border service income. The model treaty
is recognized by most national courts as a source of authority when interpreting
certain treaties and is considered to be highly influential as was also confirmed
by Landau et al. (2002)48.
More importantly the OECD has also tried to develop a policy in an area that was
previously not covered by any kind of international agreement; Value Added
Taxes and other forms of consumption taxes. In the Ottowa Framework
countries agreed on considering reforms regarding VAT’s, this due to the
appearance of e-commerce. An important reform was on applying the correct tax
jurisdiction for VAT purposes to across border trade. The OECD has agreed on
the following; for B2C international trade taxation the country of consumption
should be the jurisdiction is which the consumer usually resides whilst for B2B
trade taxation the jurisdiction in which the receiving business has its business
presence is used. The destination principle is thus now used and the recent
European Union taxation reforms on cross-border trade we discussed can thus
be justified by these agreements. The OECD now also publishes “The
Consumption Tax Guidance Series” which contains guidelines for the taxation of
internationals purchases on which VAT must be levied. The goal of these reports
is to stimulate international consensus on this subject.
5.2 Reactions by National Governments
Whilst on an international level a lot seems to have been set in motion, the
national governments seem to take it easy. A survey done by Cockfield (2006)49
suggests that, since the challenges posed by international e-commerce became
apparent in the early 90’s, only two tax laws and seventeen administrative
documents have been passed by national governments regarding the
international taxation issues of e-commerce. The rest of their actions on this
subject consisted of agreeing to or disagreeing with positions taken by the OECD.
Even nations deeply involved in the Internet such as the US, which has taken
several measures at a the local and state level regarding sales and use taxes, has
Landau, T.M., Doornbosch, H., Del Castillo, N., 2002, How to minimize the global PE risk, 13 Int'l
Tax Rev. 50.
49 Cockfield, A.J., 2006, The Rise of the OECD as Informal “World Tax Organisation” Through
National Responses to E-Commerce Tax Challenges, 8 Yale J.L. & Tech. 136.
48
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taken no action yet at the federal level regarding international e-commerce
taxation. The European Union however has introduced new legislation in the
form of the EU directive introduced in 2003. We have described this directive in
paragraph 4.2.1. and can say that it is the most (only) progressive action, not
undertaken by the OECD, towards the international e-commerce taxation
problem we have seen in the world.
We might thus be able to conclude that national governments are reluctant
towards implementing new taxation. Why is this the case? There are two
reasons. First, as there are very few to none empirical estimates on how much
revenue governments actually stand to lose from this international e-commerce,
they are not very likely to take action on those grounds. Except for tax revenue
losses estimates at the local and state level in the US there are no empirical
studies supporting how much there is being lost, if this would be the case.
Governments are thus likely to focus on different policy area’s where the
earnings might be higher/more tangible. Second, many countries already have
tax regulation regarding intangible products such as software, which can be used
as a framework to solve certain taxation issues regarding e-commerce. It seems
logical to use these already existing rules for traditional trade in e-commerce as
well as it follows the tax neutrality principle stated in the Ottowa Framework.
5.3 Evaluating the Past and Looking at the Future
In the previous paragraphs we have determined that the OECD took the lead
when it came to developing solutions to the international taxation of ecommerce problem. The OECD however can be described as a so-called “soft
institution” as the reforms made in the treaties are not binding for the tax
authorities of member countries50. What the OECD does is making discussions
possible, doing research and introduce reforms that are not binding. It thus
enables many forms of informal contact between nations in order to come to a
consensus and advance towards solutions. This approach tries to act in the best
interest of the member countries of the OECD by enhancing international
relations with the setting of ground rules for taxation, whilst also letting
countries keep as much sovereignty. There is also criticism towards this
50
Slaughter, A.M., 2004, A new World Order, Oxford University Press.
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approach as it does not create certainty of tax policies chosen by countries and
thus still allows for discrepancies between international taxation policy of ecommerce.
The opposite of this approach would be the introduction of a formal “World Tax
Organisation” that could enforce legally binding tax rules on all the countries
participating. This would eliminate international tax competition and could
theoretically avoid a race to the bottom in tax rates, as all countries would have
to comply with fixed taxation rules.51 This would however rob the national
governments of much of their sovereignty and also they still consider tax policies
and laws an important tool in setting out national policy. It is thus reasonable to
assume that most nations would not agree to this, at lest not in the foreseeable
future52.
The OECD approach thus seems like a logical step in the right direction. The
OECD also packs some enforcement power since 2005. As of then the member
countries have agreed on retaliation being possible against countries still
pursuing taxation practices that harms other members.53
In order for the OECD to remain the main global tax organisation it should also
include non-members in the discussion on international taxation issues. As the
members of the OECD are mainly rich developed industrial countries it thus also
represents their wishes and the views of for instance developing countries to a
lesser degree. It is however this limited amount of members and the relative
uniformity of their views that makes the OECD effective in creating consensus.
Allowing more countries with different economical interest to also join the OECD
is not likely to happen any time soon as it will greatly damage the OECD’s
capability to reach consensus. The OECD is however planning on involving the
less developed countries more and more in the international tax discussion. It
Owens, J., 1997, Emerging Issues in Tax Reform: The Perspective of an International
Bureaucrat, 97 TNI, 245-23.
52 Hellerstein, W., 2003, Jurisdiction to Tax Income and Consumption in the New Economy: A
Theoretical and Comparative Perspective, 38 Georgia Law Review 1, 45.
53 Sullivan, M.A., 2004, Economic Analysis: Latest IRS Data Show Jump in Tax Haven Profits, Tax
Notes 151.
51
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has already set up the International Tax Dialogue in which those countries can
participate and set out their views and exchange information on best practises54.
6. Conclusion
We started off by trying to find out if e-commerce is taxable in the first place. To
do so, we identified the major tax principles relevant to e-commerce and
discussed what issues arise when trying to tax e-commerce. We have discovered
that taxing digitalized goods is still difficult with the current state of technology
and provides little tax revenue. We found that taxing transactions regarding
physical goods in the e-commerce market is fully possible though. Great
attention however must be given to whether, the OECD preferred, destination
principle is used or, the administratively more feasible, origin principle is used
when setting up an international functioning taxation system.
Afterwards we went to find out if, now that we knew taxing international ecommerce was possible, it was desirable. We found out that for the US the sales
tax revenue losses were highly debatable but never amounted to more than 12% of the total sales tax revenue. For the EU it was clear that it was not really a
case of revenue loss but more one of sales tax revenue distribution. For both the
EU and US it was at least clear that an accurate view on the possible revenue
losses/redistributions is missing at this point in time. This is due to the highly
unpredictable future of digitalized goods sales and the hard to predict
development of connectivity to the Internet around the world. We have also
found out that the arguments for providing tax preferences to the e-commerce
market were quite weak. Both the infant industry and the positive externality
argument seemed to be out-dated, and reflected views that might be valid in the
90’s but are not so much anymore with a highly developed e-commerce market
and Internet network in general. The most important argument might however
be the one based on the principle of “tax neutrality”. As it might falsify
competition, makes governments miss some tax revenues and has no clear
OECD Committee on Fiscal Affairs, 2010, OECD Model Tax Convention on Income and on
Capital. http://www.oecd.org/dataoecd/52/35/1914475.pdf
54
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counter argumentation, it seems logical to not provide any tax preferences to
goods traded via e-commerce when designing a tax system.
After reviewing the progress on the international taxation of e-commerce on
both the national and the international level we can conclude that most of the
work has been done so far on the international level. The OECD has taken the
lead in developing certain tax principles all member countries can agree on.
Although it might be argued that the current enforcement mechanisms of the
OECD are too soft, the alternative will not be feasible in the near future as
countries are not likely to give up that much of their sovereignty. To partly solve
the enforcement problem, countries have agreed on retaliation as a tool to keep
members in check. The current path of involving less developed countries more
and more in the treaty adaptation process is also constructive, as it will help to
keep the OECD a legitimate international tax organisation.
To conclude overall we can thus now formulate the answer to our initial
question; How can the international problem of taxing e-commerce best be
solved? Although there is no instant solution to the problem we have defined
some grips for further progress towards solving the problem. We have defined
that the taxation of international e-commerce is fully possible and most likely
also desirable. More research needs to be done however to get a clear picture of
the actual tax revenue losses/redistributions due to the rise of e-commerce. This
is important as many nations use this argument to justify certain tax rules
without knowing the exact figures. Also we found that the OECD at this point in
time seems to be the ideal candidate for further development as a global taxation
institution. This due to its non-intrusive nature, consensus building and
willingness to involve less developed countries where possible. As we found that
the principles the OECD uses for guidance are sane, the solution to the
international e-commerce taxation issue thus lies in further developing the OECD
as an international tax organisation and making sure enough countries
participate in order for it to keep its global legitimacy.
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