© 2000 arthur andersen all rights reserved. fta annual meeting tax issues presented by different...

© 2000 Arthur Andersen All rights reserved.

FTA Annual MeetingFTA Annual Meeting

Tax Issues Presented by Tax Issues Presented by Different Internet Business ModelsDifferent Internet Business Models

June 6, 2000June 6, 2000

Karl A. Frieden, PartnerKarl A. Frieden, Partner(617) 330-4727(617) [email protected]@us.arthurandersen.com

© 2000 Arthur Andersen LLP2

Trends in E-Commerce Explosive 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.


Trends in E-Commerce Five E-Commerce Trends

• Borderless Commerce

• Digital Commerce

• The Hollow Corporation

• Real-Time Commerce

• Changing Business Models


Trends in E-Commerce Borderless 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.


• 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.

Trends in E-Commerce Borderless Commerce


Trends in E-Commerce The 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.



• 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


• 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.



Trends in E-Commerce The 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.


• 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.

Trends in E-Commerce The Hollow or Virtual Corporation


• 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.

Trends in E-Commerce Real-Time Commerce


Trends in E-Commerce Transformation 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.


• On-line catalogs

• Virtual communities

• Portals

• Auctions

• Reverse auctions

• Subscription-based services

• Infomediaries

• Aggregators

• Vertical markets

Trends in E-Commerce Transformation of Business Models


‘The future ain’t what it used to be’

--famous Yankee philosopher Yogi Berra

Trends in E-Commerce


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.

Trends in E-Commerce Tax Complexities


• Comparison to U.S. sales tax

– No local taxes

– No jurisdictional constraints

– No multiple tax on inputs

– No narrow taxable categories

Trends in E-CommerceValue Added Taxes


• 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.

Nexus and Jurisdictional IssuesDe Minimis Physical Presence


• 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, localmarket orientation, affiliate programs.

• Drop shipments

• Affiliate nexus

Nexus and Jurisdictional IssuesAttributional/Agency Nexus


• 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.

Sales, Use and Transactional TaxesOverview


• Differential tax base• Broad differences in the taxation of consumer outputs.• Wide variations in the taxation of business inputs.

• Seller or Agent.

• Gift certificates.

Sales, Use and Transactional TaxesTangible Product Issues


• 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.

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.

Sales, Use and Transactional TaxesDigital Products


• 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.

Sales, Use and Transactional Taxes Sales and Use Tax Simplification


• 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.

State Income Tax IssuesTangible Property Sales


• 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.

State Income Tax IssuesDigital Goods and Services


• 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.

International Transactional TaxesValue Added Taxes


• 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.

International Transactional TaxesVAT/Customs Duty Issues in a Digital Age


Federal and International Income TaxesOverview

• 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.


• 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

Federal and International Income TaxesOverview


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 at1-800-248-3248or www.cch.com

© 2000 arthur andersen all rights reserved. fta annual meeting tax issues presented by different...

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