Taxing the Internet


Taxing the Internet

Online Commerce Tests International Tax Laws

By Ed McKenna

Contributing Writer

Tax-free online commerce will be a boon for the U.S. economy unless foreign governments try to snag some revenues by imposing Internet taxes, say U.S. government and industry officials.

"In the international arena, [tax disputes] are not really legal. But they're cultural and diplomatic, and we're going to find that not necessarily everybody else in the world regards an interest in the U.S. high-tech industry in the same way as we do," warned Edward Maguire, an international tax partner with Deloitte & Touche LLP, based in Washington.

Commercial activity conducted over the Internet is projected to grow from fewer than 100,000 transactions in 1995 to about 25 billion transactions in 2005, according to a study by Killen & Associates, a market research and consulting firm in Palo Alto, Calif. The value of the goods purchased will jump during the same period from about $10 billion to $1.6 trillion - about 14 percent of all worldwide retail and wholesale purchases, said the study.

An interagency team, headed by President Clinton senior adviser Ira Magaziner, has prepared a draft plan for international online commerce. The draft plan, which will be sent to the White House in March for approval, is called "A Framework for Global Electronic Commerce." The plan urges the federal government, the 50 states and foreign governments to avoid devising new taxes for online commerce.

"We identified commerce on [the] Internet as one of the most important areas that we could look at for accelerating U.S. exports and also accelerating growth of the U.S. economy," Magaziner told the Internet Tax Policy Conference Jan. 24 in Santa Clara, Calif.

"There are already 12 countries [in Asia and Europe] that we are aware of that are considering putting duties on Internet sales," said Magaziner. Also, a European Union group is studying the potential of a so-called "bit tax." Complicating this situation is the natural inclination of many countries to use duties to protect their own industries and to shield their local culture from foreign influence.

"We realized that if we can do this right, if we can get the right kind of environment in place ... we can accelerate the growth" of trade on the Internet, Magaziner said. Furthermore, in five to 10 years, "trade across the Internet will actually dwarf any other category of trade we have," he said.

"On the other hand, if we do it wrong, we will spend 30 or 40 years trying to undo bad policy. Once bad policy is put in, there are certain interests that get built up around it. It takes a long time to undo it," he warned.

Magaziner's effort is complemented by the Treasury Department, which is investigating how the U.S. tax code should be tweaked to ease online commerce and is taking the lead for the United States in current discussions among the countries participating in the Paris-based Organization for Economic Cooperation and Development. A member of the OECD's Committee for Information, Computer & Communications Policy, which is looking at issues related to the Internet, the U.S. agency is urging the group to look into tax issues, said an OECD spokesman in Washington. The committee is unlikely to complete its work and issue recommendations for at least six months, he added.

Ira Magaziner, a senior adviser to the president for policy development, said any new Internet taxes that are adopted should be uniform.

The Treasury last year also issued a Notice for Proposed Rulemaking on the sale or transfer of software, which is intended to clarify software-related tax regulations. A public meeting on the proposal is slated for March 19 in Washington.

In general, industry has welcomed Magaziner's task force and Treasury efforts. The task force paper is "a valuable and positive contribution," said Harris Miller, president of the Information Technology Association of America. The policy paper's stance on keeping the Internet free of new taxes or duties is compatible with the industry view.

"The Treasury paper gives a good description on electronic commerce and then goes over the substantive tax issues," raising "the various compliance and administrative issues but doesn't give much of a hint which way they're going to go," said Maguire. "In their approach I see three things. One is they're going to try to stick with the traditional tax code. They aren't going to rewrite the tax code," he said. "The second point is for income tax purposes they want to treat electronic and physical modes of delivery the same way," he noted. Finally, "they are relaxed" about the potential loss of tax base caused by companies moving off shore to escape U.S. taxes.

"The Department of Treasury regulations [on software transactions] are an excellent first step at what can be a very difficult process," said Ira Cook, director of tax for Borland International Inc., Scotts Valley, Calif.

"New software regulations are vital to get a handle on how digitized transmission and ... software can be characterized from an international point of view," Maguire said.

"The issue of whether it's a sale versus a royalty transaction has implications that filter through the whole U.S. [tax] code. These regulations ... are very important to the industry because it solves a lot of issues for us ... and brings some certainty not only in this country but in a lot of other countries as well," he said, noting that many countries look to the United States for guidance on these types of issues.

Cook added, however, that there must be additional clarification in certain areas. For example, Cook said the Treasury Department's definition of a computer program - "a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result" - "is a little broad" and needed "to be fleshed out." Sorting through the many examples given in the proposed rule making, he found several ambiguities in the agency's findings.

"So that we can get some uniformity ... I think the U.S. government needs to take this [document] to foreign countries ... through its diplomatic channels or however they can and get some parity from the other countries," Cook said. "If the IRS adopts these rules, it's one way. Being a net exporter, it's great for the guys importing software, but it may not be great for the guys exporting software. That's not the way the code should work. It should be fair for everybody."

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