E-commerce: Tax net needs repair

Burgeoning e-commerce is creating some taxing issues for authorities around the world.

While there is broad support internationally for the idea that e-commerce should not be subject to tariffs, that is not the same thing as saying that it should be tax-free.

The organisation for Economic Co-operation and Development (OECD), which is taking a lead in developing ground rules in this area, espouses the principle that the impact of tax should be neutral between conventional and electronic commerce.

That principle is challenged in at least two areas - digitised products and imported services.

Buy a compact disk at your local CD store and a ninth of what you pay is GST; download the same music over the net and the taxman misses out (so do the owners of the intellectual property, in all likelihood, but that is another story).

In the case of software, tax authorities have long recognised that the same stuff could be imported either on disks or via the telecommunications system.

Following World Trade Organisation rules, where it is possible to distinguish the value of the software from the value of the physical medium carrying it, only the latter attracts GST.

But the same principle does not apply to imports of music or videos.

Come the day when music, movies and books can (legally) be downloaded at reasonable speed and cost, a significant hole will open up in the tax net.

"Business-to-consumer e-commerce presents very difficult enforcement issues, if you are trying to impose GST on people who would not otherwise be registered for GST," says Marie Pallot of the Inland Revenue's tax policy division.

It is difficult to tax a transaction if you don't know it has occurred and the other party is in another country.

But if it is too hard to tax cyber transactions, then the OECD's neutrality principle would appear to make it untenable to continue to tax the equivalent transactions just because the vendors happen to have physical premises in New Zealand and sell the product in a shrink-wrapped form.

Imported services are another potential source of anomalies.

When GST was introduced in the mid-1980s, the volume of imported services was so low that the cost of trying to collect tax on them was thought to outweigh the likely benefit.

Now, the internet makes it easier to import services which, if they were sourced locally, would be subject to GST.

How much of a problem this is depends on how easily foreign-sourced services can be substituted for local ones.

"A lot of OECD countries already impose GST on the import of services by businesses," says Ms Pallot.

Most affected are those who make exempt supplies, especially financial institutions, because they cannot make use of input tax credits.

The most favoured option among OECD countries in terms of collecting the tax is a "reverse charge" mechanism, Ms Pallot says, where firms which import services self-assess GST and account for it in the normal way as part of their GST returns.

Officials are due to report to the Government on these issues by the end of the year, with a view to releasing something publicly in the first half of next year, she says.

E-commerce also raises issues of residency for income tax purposes.

Does the use of a web server in another country make a company liable for income tax in that country? Does it constitute a 'permanent establishment' and therefore a taxable presence in that country?

The OECD issued guidelines on this last March.

Craig Elliffe, a tax partner with accounting firm KPMG, says: "Where an enterprise effectively rents the foreign server equipment, the conclusion is that it will not constitute a permanent establishment. Since the firm has no tangible assets in the country it is thought there is no physical presence."

Mr Elliffe says the OECD's conclusion was that internet service providers would not themselves normally constitute permanent establishments of the taxpayers, as they would not have authority to conclude contracts in the taxpayers' names, and furthermore were acting as independent agents in the ordinary course of their business, as evidenced by the fact that they host many enterprises' web sites.

The IRD's general manager, policies, Robin Oliver, says tax authorities just had to accept that as a result of e-commerce some kinds of economic activity would no longer take place in New Zealand.

Where, for example, imported books had traditionally been stored in warehouses and sold through a chain of book stores, adding taxable value in the process, the consumer might now order them through the net.

"So there's a loss to the tax bases, but the economic activity is no longer happening in New Zealand and we have to recognise that," says Mr Oliver.

Herald Online feature: e-commerce summit

Official e-commerce summit website