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Journal of Law, Information and Science |
PROFESSOR BRIAN ANDREW[*] & MARK HUGHES[**]
The article examines the challenges to existing national tax regimes by the growth of internet commerce, looking at such problems as the difficulty of identifying the parties and locating the transaction for tax purposes, obtaining documentation and evidence, and the problems posed for tax and customs officials by the dematerialisation of trade, disintermediation, the cashless society and growing access to tax havens and off-shore banking. The changes facilitate large scale tax evasion and threaten transaction-based taxes such s the GST and will require the rewriting of many tax treaties.
The future rise in internet commerce presents a range of challenges for revenue authorities and national governments. Ecommerce has the potential to significantly increase the level of economic activity both nationally and internationally and governments face the challenge of encouraging an expansion of this activity whilst ensuring that an appropriate amount of tax is paid on these transactions. Now small enterprises and ordinary consumers have the opportunity to buy and sell goods internationally from the comfort of their home using personal computers.
In some cases goods and services can be downloaded electronically and the whole transaction can be protected by sophisticated encryption technologies. There is a real challenge for tax authorities to determine which transactions are taxable, the taxable quantum and which government has the right to levy tax. Consider the simple example of a consumer in Australia who downloads software made in India which is marketed via a web site in Vancouver and delivered by a server located in the Cayman Islands. The problem for revenue authorities is to identify the transaction and the appropriate jurisdiction, followed by the assessment of tax and then obtaining payment from the relevant taxpayer. All of these issues could be addressed in different ways and there is the possibility of double taxation or no taxation because of the security which cloaks the transaction(s).
Pinto has listed some of the major challenges as:
• Establishing identity
• Establishing location
• Documentation and evidence
• Dematerialisation of trade
• Impact on customs procedures
• Disintermediation
• Access to tax havens and off-shore banking
• Cashless society
• Tax treaties
• Loss of transactions-based taxes (Pinto 1999)
Each of these issues is discussed below.
There is a need to identify the occurrence of a transaction, where it has taken place and by whom. This may be difficult in a world of commerce where it is a relatively simple matter to arrange for the untraceable use of an internet site. The true owner of a web site may not be ascertainable easily and this site could be used for internet commerce by an unidentified third party. The internet address will tell you who is responsible for maintaining the web site but nothing about the computer that corresponds to the address or where the machine is located. The offshore location of web sites makes this a major problem for revenue authorities in the future.
Once a transaction has been identified and the identity of the parties determined there is still a problem of jurisdiction for tax authorities to overcome. Those engaged in ecommerce will be able to create a web site in almost any country irrespective of their country of residence or the source of the transaction. Traditional taxation concepts rely on actual presence or economic connection to a particular location, whereas electronic commerce has little dependence on physical location. This will make it more difficult for taxation authorities to determine where an activity has been conducted.
Revenue authorities have extensive authority to obtain documentation and other information from taxpayers who reside within their area of jurisdiction. Tax treaties provide for the sharing of information between authorities but where the records are maintained in a tax haven where banking secrecy laws prevail it is impossible for tax authorities to obtain the relevant information. Further, some transactions conducted in cyberspace do not leave an audit trail or documentation which would be suitable evidence for the levy of tax. Laws will have to be amended to place the onus on the taxpayer to produce appropriate documentation of ecommerce transactions, but whether these laws could be enforced where a web site source of a transaction is located in a tax haven remains problematic.
The expanding trade in services which has been a feature of the expansion of developed economies will flow over into the internet and this will compound the problems for taxation administrators. If goods are bought and sold through the internet there will be a physical movement of commodities across national borders which could attract tax and customs attention. Where a service, eg insurance, is sold over the internet then identification of the transaction becomes particularly difficult and tax authorities lose the capacity to make an assessment of liability based on the comparison of inputs and outputs. This rise in the service economy associated with electronic commerce is the major threat to the tax base of most countries. Serious erosion of the tax base could occur in this area.
Currently it is possible (or soon it will be) for products such as videos, CDs and software to be downloaded directly from the internet and it is possible to reprint books and other paper products. In this context it will be very difficult for revenue authorities to detect the actual transactions and the tax base will inevitably be eroded as a result unless tax authorities are able to come up with some alternative technology to attack this threat, eg. a tax chip inserted into every computer. Such a step may be possible but care must be taken not to stifle the economic benefits from electronic commerce and there are privacy issues in such a step.
Where goods and services are bought ‘on-line’ through the internet and delivered ‘off-line’ through normal mail order then normal Customs procedures should be able to identify the transaction and facilitate the normal levy of transaction taxes such as Customs duty or VAT payable. The transaction could also be ‘logged’ for other tax purposes. The major problem with this type of transaction is their likely expansion in the future and the need to ensure that Customs resources are increased to cope with the greater volume.
The supply of ‘on-line’ goods (eg. book reprints) and services (eg. digitised information) presents serious problems for any tax system which includes transaction taxes, such as a VAT or Sales Tax. In such a case the place of supply may not be identifiable because the supplier has no identifiable physical presence and the result could be no tax or double taxation depending upon the arrangements made. The U.S.A. believes that the internet should be a ‘duty-free’ zone which is limited to goods and services delivered electronically (USA Treasury 1996). This is a superficially attractive proposition which could help to expand internet commerce, but it would clearly benefit the rich developed countries with more goods and services to offer ‘on-line’. Smaller countries could be seriously disadvantaged by this U.S. approach.
As noted above an ‘information economy’ will result in a substantial reduction in the intermediate processing of transactions. This will remove a number of convenient taxing points in the production and distribution cycle and it has the potential to disturb the existing audit trail which is used by revenue authorities to identify and tax certain transactions.
An example of disintermediation is provided by Dell Computers. This company has enjoyed significant time and cost savings through its decision to sell its product on line. It has no network of distributors. This decision dovetails with its use of Just-In-Time inventory systems to minimise obsolescence of inventories. More and more firms are adopting this sort of practice as the effectiveness of Just-In-Time inventory systems can be greatly improved by eliminating, or taking charge of the distribution network by dealing directly with customers via the internet.
Banks will also suffer from this phenomenon due to the availability of a large number of banking facilities on the internet operating in an offshore environment with some in tax havens. Traditionally banks have been a reliable source of information on money movements, and this information has been used by revenue and other authorities, eg, central bank, police, customs, to provide evidence about a range of transactions. Internet Banking, E-cash and smart card technology can all be used in money laundering operations. It is well known that these technologies could be used to smuggle currency in and out of countries in violation of the laws of those countries. These technologies can also be used to transact normal business without the knowledge of the authorities. This could obviously assist the ‘underground economy’ (Mondex).
Revenue authorities should be aware of the capacity of internet banking and electronic purse services to facilitate the development of the ‘black economy’. Such services should be tightly monitored by taxation authorities with the awareness that the financial intermediation services traditionally provided by banks can be by- passed through the use of these technologies.
Tax havens and offshore banking facilities have always been available to the rich and to large corporations but the internet will make such things accessible to a large range of taxpayers. Already some tax havens provide banking secrecy through numbered and coded bank accounts and this can be combined with on line international money transfers including a range of payment options. Internet banking has the potential to offer ease of access, immediate transfer of money, anonymity in some cases and low transaction costs. All that is required is for residents to gain confidence in the security and financial credentials of the offshore banking facility for a large range of individuals and corporations to begin to use this facility. This is a particular problem for an open economy, like that of Hong Kong, which relies on its reputation for quality financial services and which has been shown itself to be remarkably innovative in the past.
Internet commercial transactions could pass through a large number of jurisdictions including a number of tax havens, often for good economic reasons, before the money is finally deposited in the home bank account backed by a perfectly lawful activity. This will require the complicity of local authorities in tax havens and that of international banks, but such facilities already exist.
“For tax evasion to be successful, the complicity of countries prepared to set themselves up as tax havens is fundamental. This complicity must extend to providing a low or zero tax regime for all internet commerce. This must extend to internet businesses and internet banks which deal with internet commercial transactions. The banking system has an important role in facilitating the laundering of any profits made back into the country where the real owner of the commercial website resides. While tax havens have always been with us, what is different now is that the internet makes them accessible to the masses. With bank secrecy ensured in the tax haven, everyone has the potential to participate in large scale tax evasion” (Warren, 1997).
The cashless society based on electronic money technologies such as e-cash and smart cards promises many benefits in the form of speed, convenience and security of transactions. But real time e-cash transfers over the internet may leave no audit trail and no physical record, such as bank statements, cheques, receipts or deposit slips. This will remove or reduce the capacity of tax authorities to monitor many transactions. While we still have a society with a few large banks, cash and paper transactions it is important for taxation authorities to work closely with the existing financial institutions so as to jointly develop systems for dealing with e-cash transactions so that the flow of funds is properly accounted for, including systems which apply in the physical transaction world where necessary.
Tax treaties will have to address new non-physical concepts of a permanent establishment, the attribution of profits to it and the allocation of tax jurisdiction between the treaty partners. Digitised information could be the source of income and this income could be characterised as royalty income or income from services. A multilateral tax treaty between a group of countries could be necessary to formulate ground rules and procedures for dealing with digitised information.
As observed above, electronic commerce makes it possible for goods and services, previously available only in a tangible form to be supplied and delivered in electronic form. This change will threaten the capacity of a sales tax, excise or VAT/GST to operate. It is certain that the tax base of all transaction-based taxes will be undermined by internet trading to some extent.
It cannot be emphasised strongly enough that the combination of tax havens, bank secrecy, transfer pricing arrangements and a cashless society present a great threat to the tax base. Revenue authorities need to be pro-active now before the proliferation of tax evasion through this combination of facilities gets completely out of hand.
Department of Treasury (USA), Selected Tax Policy Implications of Global Electronic Commerce 1996
Mondex Report, 1994, Mondex in Comparative Perspective, Commissioned by Visa International.
Pinto D., Taxation Issues in a World of Electronic Commerce 11th Annual Australasian Tax Teachers Conference, Canberra, February 1999
Warren N., 1997 Tax and the Internet: An International Perspective, ATO Conference Sydney, November 1997.
[*] Deputy Director Division of Management and Technology, University of Canberra.
[**] Lecturer in Accounting, University of Canberra.
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URL: http://www.austlii.edu.au/au/journals/JlLawInfoSci/2000/4.html