E-tax avoidance fears sparks EU action

With the rise of e-commerce, tax specialists and business analysts are turning their attention to the issue of e-taxation. For now, there are no e-commerce specific taxes so an e-business faces similar tax issues to those weighing on traditional enterprises.

While internet-based businesses may not be liable to pay new taxes, they are certainly making it harder for governments to collect their dues. Recent estimates indicate that, by 2003, business-to-business (B2B) e-commerce turnover will top ({@denom})1.3 trillion ( ({@denom})1.57 trillion) - a figure tax collectors can't ignore.

Currently, extension of value-added tax liability into e-commercial trades is causing the most controversy in Europe - an issue that will come to a head at a showdown meeting of EU finance ministers on November 27.

The most serious problem for tax collectors arises over non-physical products downloaded from the net such as music, software and online videos since it is almost impossible to track delivery of digital products.

If someone in the UK buys a compact disc from a local shop, he automatically pays 17.5% VAT; if it is bought from an American online retailer, he is not liable to pay tax. However, if it is a B2B transaction he should, but may well escape the tax he is supposed to pay, because the taxman cannot trace digital downloading. The hub of the problem is geographic. Traditional methods of taxation are defined by the physical location of a company.

The internet has created an environment where business can be undertaken with minimal physical presence - something that has worried the EU's tax offices and ultimately the European Commission. The Union's executive agency has proposed that foreign companies with annual online sales of more than ({@denom})100,000 in the EU should register for VAT in at least one EU country and then collect the tax on all services downloaded from the internet. But this would be almost impossible to enforce.

The EU's 15 member states have rejected this because they fear it may lead all these companies to register in Luxembourg, where VAT is set at the EU minimum of 15%, rather than Sweden, Denmark, Belgium where rates are over 20%.

Anne Fairpo, senior manager in e-tax solutions KPMG explains: The EU sees no reason why, if physical packages are liable, that it is not justifiable to make digital downloads taxable as well. The easiest way to find a solution would be to nominate one country for registration for non-EU members wanting to sell in Europe. This would stop the rush to Luxemburg. Another solution would be to create an EU registration that was not country specific. This probably would be an average VAT rate, although the Scandinavian countries will not be happy with this as they will lose out.

The US is hostile to these proposals as they object to acting as unpaid tax collectors for the EU. France has come up with the solution of making firms selling in the Union register in each member state where they sell with the proviso that sales exceed ({@denom})5,000. But this has sparked complaints from US Trade Representative Charlene Barshefsky since US companies' download sales represent 90% of the global total.

A different proposal from Belgium would allow for a single place of registration, with the tax receipts redistributed to the other member states in line with the volume of download trade. This would be equally if not more complicated. Fairpo adds a word of warning: Businesses exporting to the US should be wary of an American backlash. At the moment, if a company is trading in America, and does not have a physical presence there, it is not liable to collect sales tax. But the compliance angles may be reformed and start extending these taxes to non-nationals; especially more aggressive states such as California.

Having a physical presence in a country can also add to tax implications. Businesses or individuals operating over the net are moving to low-tax countries or to tax havens to ensure that they pay the lowest tax possible. The internet makes it harder to pinpoint the identity and location of individuals or businesses engaged in taxable activities.

The 29-member club of richer nations, the Organisation for Economic Cooperation and Development (OECD), has drawn up a model tax treaty. This deems a company's country of residence for taxation to be the country of effective management and control of the main business. In the UK, central control and management is interpreted as the highest level of control of the business of the company, not the place where the main transactions are carried out.

The current major issue of debate is whether a website or a server can be defined as a fixed place of business. Gabs Makhlouf, director of the UK inland revenue's international division has stated that: We take the view that a server is insufficient in itself to constitute a permanent establishment of a business that is conducting e-commerce though a website on the server.

Having said all this, the size of the potential drain on tax revenue is probably exaggerated since most products cannot be digitised and distributed over the net. Where a company decides to set up in business depends on many other factors besides tax; after all it is only profitable if the cost of setting up an overseas office is less than the tax savings. The problems lie more in the future of e-commerce, rather than the present.