Taxation in E-environment

How to change tax laws to reflect globalization through the Internet is a problem that many governments have grappled with. The fear is that the Internet may cause significant reduc­tions in tax revenues to national or local governments if existing laws do not cover changes in purchasing patterns. Basu (2007) notes that around a third of government taxation rev­enue is from domestic consumption tax with revenue from import taxation around 17%. Governments are clearly keen that this revenue is protected when purchases are made over­seas outside their jurisdiction.

Government revenue is normally protected since, taking the UK as an example, when goods are imported from a non-EU territory, an excise duty is charged at the same rate as VAT. While this can be levied for physical goods imported by air and sea it is less easy to administer for services. Here agreements have to be reached with individual suppliers.

In Europe, the use of online betting in lower-tax areas such as Gibraltar has resulted in lower revenues to governments in the countries where consumers would have formerly paid gaming tax to the government via a betting shop. Large UK bookmakers such as William Hill and Victor Chandler are offering Internet-based betting from ‘offshore’ locations such as Gibraltar. Retailers such as Amazon, Play.com and Tesco.com have set up retail operations on Jersey to sell items such as DVDs and CDs which cost less than an £18 Low Value Con­signment Relief threshold, so no VAT or excise duty needs to be paid.

This trend has been dubbed LOCI or ‘location-optimized commerce on the Internet’ by Mougayer (1998).

Since the Internet supports the global marketplace it could be argued that it makes little sense to introduce tariffs on goods and services delivered over the Internet. Such instru­ments would, in any case, be impossible to apply to products delivered electronically. This position is currently that of the USA. In the document ‘A Framework for Global Electronic Commerce’, President Clinton stated that:

The United States will advocate in the World Trade Organization (WTO) and other appro­priate international fora that the Internet be declared a tariff-free zone.

1. Tax jurisdiction

Tax jurisdiction determines which country gets tax income from a transaction. Under the pre-electronic commerce system of international tax treaties, the right to tax was divided between the country where the enterprise that receives the income is resident (‘residence country’) and that from which the enterprise derives that income (‘source country’). In 2002, the EU enacted two laws (Council Directive 2002/38/EC and Council Regulation (EC) 792/2002) on how Value Added Tax (VAT) was to be charged and collected for electronic services. These were in accordance with the principles agreed within the framework of the Organization for Economic Co-operation and Development (OECD) at a 1998 conference in Ottawa. These principles establish that the rules for consumption taxes (such as VAT) should result in taxation in the jurisdiction where consumption takes place (the country of origin principle referred to above). These laws helped to make European countries more competitive in e-commerce. An announcement from the EU explained:

Under the new rules, EU suppliers will no longer be obliged to levy VAT when selling prod­ucts on markets outside the EU, thereby removing a significant competitive handicap. Previous EU rules, drawn up before e-commerce existed, oblige EU suppliers to levy VAT when supplying digital products even in countries outside the EU.

The proposals are designed to eliminate an existing competitive distortion by subjecting non-EU suppliers to the same VAT rules as EU suppliers when they are providing electronic services to EU customers, something which EU businesses have been actively seeking.

The VAT rules for non-EU suppliers selling to business customers in the Union (at least 90% of the market), will remain unchanged, with the VAT paid by the importing company under self-assessment arrangements.

The OECD also agreed that a simplified online registration scheme, as now adopted by the European Council, is the only viable option today for applying taxes to e-commerce sales by non-resident traders. The tax principles are as follows in the UK interpretation of this law implemented in 2003 for these electronic services:

• supply of web sites or web-hosting services
• downloaded software (including updates of software)
• downloaded images, text or information, including making databases available
• digitized books or other electronic publications
• downloaded music, films or games
• electronic auctions or
• Internet service packages.

The UK VAT rules are as follows:

• if the supplier (residence) and the customer (source) are both in the UK, VAT will be chargeable;
• exports to private customers in the EU will attract either UK VAT or local VAT;
• exports outside the EU will be zero-rated (but tax may be levied on imports);
• imports into the UK from the EU or beyond will attract local VAT, or UK import tax when received through customs (for which overseas suppliers need to register);
• services attract VAT according to where the supplier is located. This is different from prod­ucts and causes anomalies if online services are created. For example, a betting service located in Gibraltar enabled UK customers to gamble at a lower tax rate than with the same company in the UK. This law has since been reviewed.

The situation is more complex where a company has transnational offices, these examples from HMRC (2003) also illustrate the logic behind the new legislation:

• Example 1: A UK business purchases digitised software from an Irish supplier for use only in its branch in the Channel Islands. Although the supply is received in the UK where the business belongs, it is used outside the EU and is outside the scope of UK (and EU) VAT.
• Example 2: A USA business purchases web-hosting services for its international busi­ness, including its UK branch. Although the supply is received in the USA, to the extent that it is used in the UK, it is subject to UK VAT.
• Example 3: A UK business purchases downloaded information from another UK business for use both in its UK headquarters and its Canadian branch. Although the supply is received in the UK, to the extent it is used in Canada, it is outside the scope of UK VAT. UK VAT is due only to the extent of use by the UK headquarters.

2. Freedom-restrictive legislation

Although governments enact legislation in order to protect consumer privacy on the Inter­net, as described in the previous section, it is also worth noting that some individuals and organizations believe that legislation may also be too restrictive. In the UK, a new Telecom­munications Act and Regulation of Investigatory Powers Act (RIP) took several years to enact since companies were concerned to ensure security and to give security forces the abil­ity to monitor all communications passing through ISPs. This was fiercely contested due to cost burdens placed on infrastructure providers and in particular the Internet service providers (ISPs), and of course many citizens and employees may not be happy about being monitored either! The Freedom House (www.freedomhouse.org) is a human rights organ­ization created to reduce censorship since it believes government censorship laws may be too restrictive. It notes in a report (Freedom House, 2000) that governments in many countries, both developed and developing, are increasingly censoring online content. Only 69 of the countries studied have completely free media, while 51 have partly free media and 66 countries suffer heavy government censorship. Censorship methods include implementing licensing and regulation laws, applying existing print and broadcast restrictions to the Inter­net, filtering content and direct censoring after dissemination. In Asia and the Middle East, governments frequently cite protection of morality and local values as reasons for censor­ship. Countries where Internet access is mostly or totally controlled by the authorities include Azerbaijan, Belarus, Burma, China, Cuba, Iran, Iraq, Kazakhstan, Kyrgyzstan, Libya,

North Korea, Saudi Arabia, Sierra Leone, Sudan, Syria, Tajikistan, Tunisia, Turkmenistan, Uzbekistan and Vietnam. Even the US government tried to control access to certain Internet sites with the Communications Decency Act in 1996, but this was unsuccessful. Refer to Activity 4.4 to discuss these issues.

Source: Dave Chaffey (2010), E-Business and E-Commerce Management: Strategy, Implementation and Practice, Prentice Hall (4th Edition).